PAYMENT AND DISCREPANCIES
Letters of credit issued by most banks around the world are subject
to the UCP 600. “UCP” stands for Uniform Customs and Practice for
Documentary Credits, which is a body of rules (not laws) on letters of
credit. The conventions under the UCP were first adopted by the
International Chamber of Commerce in 1933 and have subsequently
been revised many times since then. Federal laws and some state
laws, also govern letters of credit.
In addition to understanding the rules of letters of credit, as outlined
in the UCP 600, exporters should have a basic understanding of the
International Commercial Terms (INCO Terms) of trade such as FOB,
CIF, CFR, DDP, etc. (Please refer to our webpage discussing INCO
Terms, which provides a basic overview.)
Strict versus substantial compliance
Under the UCP 600 issuing banks are obligated to make payment
under letters of credit when conforming documents (bill of lading,
packing list, invoice, certificates, etc.) are presented. The documents
are to be in strict compliance with the terms stated on the letter of
credit. Generally, rulings in legal cases, revolving around the issue of
payment when discrepant documents are presented, have come
down on the side of strict compliance rather than substantial
compliance. However, strict compliance does not demand oppressive
perfectionism such as the misspelling of a word. A typical
discrepancy, which would fall under the strict compliance rule, is that
the invoice does not describe the goods exactly as specified in the
terms of the letter of credit.
Letters of Credit deal in documents
Another important principle underlying letters of credit is that all
parties concerned deal with documents alone, and not with goods,
services and/or other performances to which the documents may
relate (refer to UCP 600 - Article 4). In practical terms this means
that issuing banks make payments under letters of credit based on
the examination of documents, not on the examination of the goods.
The letter of credit does not protect the applicant from paying for the
shipment of defective merchandise. The applicant cannot wait until
the goods arrive, examine the goods, and then approve payment
under the letter of credit.
Available by payment or negotiation
Payments under sight letters of credit are “available by payment” or
“available by negotiation”. Banks in the United States typically issue
letters of credit which are “available by payment” with payment made
at their counters in the US. This means that the exporter’s bank in
the foreign country must send the documents to the issuing bank for
examination and payment. Banks in foreign countries commonly
issue letters of credit which are “available by negotiation with any
bank” (see SWIFT field 41D), naming a US reimbursing bank
(SWIFT field 42D) where the negotiating bank is to obtain the US
dollars for the conforming presentation of documents.
In the event a US exporter receives an L/C which is “available with
negotiation at any bank”, the exporter may present the documents
with the original L/C to the advising bank or its own bank. Many
banks are reluctant to negotiate an original L/C if it was not advised
through them because the letter of credit may have been amended
and the negotiating bank would not be aware of all the amendments.
If, after examination, the documents are found to be conforming, then
the negotiating bank will courier the draft to the US reimbursing bank
or send a telex or SWIFT transmission claim and courier the
documents to the foreign issuing bank. The negotiating bank then
must wait for the reimbursement bank to wire the funds representing
the L/C drawing to the negotiating bank. Once the funds arrive by
wire transfer from the reimbursing bank, the negotiating bank does
the appropriate paperwork to indicate the successful drawing by
reducing the L/C liability and credits the seller's account.
If the L/C is a negotiable one and the documents have
discrepancies, the US negotiating bank can:
1. Return the documents to the exporter for correction, if possible
and time permitting.
2. Send the documents to the issuing bank on an approval basis.
3. Cable the issuing bank for authority to pay.
The US negotiating bank is accepting a higher level of risk on
negotiable credits because payment will not be made until the
documents arrive at the issuing bank, and if discrepancies are found
and the issuing bank may demand return of the funds. (This rarely
happens, but is theoretically possible.)
Prompt decision to honor or dishonor presentation of
documents/negotiable credits
The responsibility of the negotiating bank under a letter of credit is to
examine documents and make a prompt decision to honor or
dishonor documents based upon their examination. Since the letter
of credit is the legal obligation of the issuing bank, the decision to
honor payment upon document presentation rests with the issuing
bank or its designated negotiating bank.
If the presented documents are not in compliance with the terms and
conditions of the letter of credit, the documents may be sent to the
issuing bank on an approval basis. The issuing bank must give
notice to the exporter’s negotiating bank by telex or SWIFT without
delay, but no later than the close of the seventh banking day
following the day of receipt of the documents (UCP 600 - Article 14,
Section D). Under the UCP, issuing banks have a reasonable time to
give notice of discrepancies or dishonor to the exporter’s negotiating
bank. The limit of this reasonable time is seven banking days under
the UCP rules.
The time within which the issuing bank must give notice of
discrepancies is the lesser of a reasonable time or seven banking
days. Where the terms and conditions of the letter of credit are
straightforward and uncomplicated, the reasonable time period would
be much less than the seven days. The issuing bank may contact
the applicant to determine if the applicant wants to waive the
discrepancies and make payment under the letter of credit. If the
applicant decides not to waive the discrepancies, the consequences
can be complicated. The issuing bank must give notice to the
exporter’s negotiating bank, detailing all discrepancies and stating
whether the issuing bank is holding the documents at the disposal of
instructions from the exporter or is returning the documents to the
presenter. Since the exporter retains title to the goods, the exporter
may have to arrange for disposal of the goods, clear customs, and
pay demurrage charges. Once the applicant makes the decision not
to waive discrepancies, the underlying import/export transaction
becomes much more costly and resultant business relationship
between buyer and seller will obviously be strained.
If discrepancies are found in the documents and the exporter wants
to be paid quickly, the exporter should fax its buyer in the foreign
country and request that the buyer contacts its bank’s letter of credit
department to waive those discrepancies. The buyer will always have
more leverage over its bank than a seller in sending a SWIFT or
telex follow-up to the foreign bank. In addition, a fax to the buyer will
be much cheaper than having the bank follow-up with a SWIFT or
telex, since the bank will charge for this service as well.
Preventing discrepancies
In order to prevent discrepancies from occurring when documents
are presented under the letter of credit, the exporter should take the
following steps as soon as the sale is concluded, but before the letter
of credit is opened.
1. Fax the buyer the terms of the letter of credit, which should
conform to the underlying contract of sale between the exporter and
importer.
2. After the buyer completes the letter of credit application, which it
will take to its bank, the exporter should also ask that the buyer fax a
copy of the letter of credit application to the exporter for its review. It
is much cheaper to change the terms of the proposed letter of credit
BEFORE it is issued; after it is issued the buyer has to pay additional
fees for amendments to change the terms of the letter of credit.
3. The exporter should make sure that the description of the
merchandise as it appears in the letter of credit is stated exactly the
same as on the invoice. The exporter must insure that the
accounting department (invoice), shipping department (packing list),
and the freight forwarder (bill of lading) are all aware of the
importance of describing the goods in conformance with the L/C.
4. The exporter should request at least a 14-day period in which to
present documents after the shipping date. If the L/C is silent on the
presentation period, the period of time that is allowed by Article 43.a
of the UCP is 21 days. Since late presentation is one of the most
common discrepancies, this simple request should alleviate the
possibility of a late presentation. Not only does a 14-day (or more)
period allow the exporter some extra time in putting together the
documents, it also allows for time to make the needed corrections to
discrepancies after the negotiating bank discovers discrepancies. A
21-day period is essential for transferable letters of credit since the
process of presenting documents by both the first and second
beneficiaries can be time consuming. (If the presentation period is 21
days, the exporter, of course, can present documents as soon as
practical in order to speed up the receipt of the L/C drawing.)
5. The exporter should discuss the INCO terms in the L/C with its
freight forwarder to insure that the proper shipping documents can
be provided with the shipment along with the required signatures if
necessary.
Common discrepancies
In order to assist the exporter in reviewing the documents when
compared to the terms of the letter of credit, we have put together
the following list of areas where typical discrepancies occur. The
exporter should have a detail oriented person within the company do
this examination and not rely exclusively on the bank or freight
forwarder to catch discrepancies. The exporter should make sure
that its staff dealing with L/C’s and its freight forwarder are familiar
with UCP 600.
Draft (Bill of Exchange)
Although drafts are similar to checks, they do not possess any
special characteristics such as micro encoding. The easiest method
of preparing drafts is to use your PC word processing program or
have your bank prepare it for you.
The draft is correctly drawn if:
1. The draft refers to the letter of credit; specifying issuing bank and
its L/C reference number, and is phrased according to the L/C terms.
2. Amount in words is identical with amount in figures.
3. The draft bears the appropriate endorsement if the payee is the
exporter.
4. The exporter signs the draft.
5. The tenor of the draft (at sight or some days after sight or bill of
lading date) conforms to the terms of the L/C.
6. Names and/or addresses of drawee and buyer agree with L/C
terms.
7. All names are correctly spelled.
8. The amount of the draft correlates to the invoice.
Invoice
1. The invoice indicates that it has been prepared by the exporter
and addressed to the buyer (account party under L/C). The names
of the buyer and seller on the invoice should correspond exactly to
the names and addresses of the account party and beneficiary in the
L/C.
2. The merchandise is described exactly as in the letter of credit; the
merchandise description must be consistent with the packing list and
bill of lading. All documents must be consistent with each other.
3. Purchase order numbers agree with the L/C if they are listed.
4. The invoice must list the prices and unit prices and various
charges/expenses if required by the L/C.
5. A sufficient number of invoices must be presented as required by
the L/C. (Read carefully, as sometimes the importer may request
multiple invoices marked as "ORIGINAL" and additional invoices
marked as "COPY".)
6. The invoice must indicate shipping terms, if required by the L/C.
7. If required by the L/C, all listed items (merchandise, freight,
insurance, and handling) must be allowed under the shipping terms.
For example, if the shipment were on a C&F basis, but the exporter
bills for insurance, then a discrepancy would occur.
8. The amount of ocean freight and/or insurance premium, if listed,
agrees with amounts shown on bill of lading and/or insurance
document and/or other documents.
9. If the L/C allows partial shipments, the portion of merchandise
shipped should not be invoiced out of proportion to the total amount
of the L/C.
10. The invoice must show all the clauses, certifications, and/or visa
requirements following the exact the terms of the L/C.
11. Shipping container descriptions (quantity, weight, and
measurement) on the invoice must correlate with the bill of lading,
packing list, and other appropriate documents if required.
Insurance Documents
1. If L/C requires an insurance certificate, a certificate should be
presented; if an insurance policy is required, then a policy should
accompany the presented documents. Under UCP Article 34.a the
insurance documents must appear on their face to be issued and
signed by insurance companies or underwriters or their agents.
Under UCP Article 34.b if the insurance document indicates that it
has been issued in more than one original, all the originals must be
presented unless otherwise authorized in the L/C.
2. It is not endorsed, to be in transferable form, provided the L/C
does not require the buyer, its bank, or other representative to be
the beneficiary of the insurance.
3. It is in the currency of the L/C unless the L/C states otherwise.
4. Under UCP Article 34.f. the insurance must cover the CIF or CIP
value plus 10 percent, if the value can be determined. (This article
should be read in detail to understand its implications.)
5. Merchandise description is consistent with the L/C. It lists the
marks and numbers of packages and quantities in accordance with
the other documents.
6. It is dated on or before the date of shipment or indicates that
coverage is established as of the date of shipment.
7. It covers merchandise upon the carrying vessel specified in the
B/L with shipment from the proper point of loading to the proper
destination.
8. It covers all risks specified in the L/C.
9. The amount of the insurance premium agrees with that appearing
on the invoice, if listed.
Transport Documents
The following articles in the UCP deal with transport documents. This
area is one where discrepancies commonly occur. The exporter
should carefully review these sections in consultation with its freight
forwarder to insure that transport document discrepancies do not
occur.
The exporter should make sure that its freight forwarder has a copy
of the L/C before the forwarder books the freight and obtains the
B/L. This should help eliminate obvious discrepancies concerning
markings on the B/L, ports of loading and discharge, shipping terms
and description of goods.
The transport document must be signed by the carrier (or in some
cases an agent of the carrier) and the signature must identify
(usually below it) the name of such carrier (or agent).
For additional information, we suggest that you get a copy of the
most recent UCP Articlces and review the following articles to
familiarize yourself about the types of transport documents and how
they differ. Those UCP Articles include:
Article 26 - Marine/Ocean Bills of Lading
Article 24 - Non-Negotiable Sea Waybill
Article 25 - Charter Party Bill of Lading
Article 26 - Multimodal Transport Document
Article 27 - Air Transport Document
Article 28 - Road, Rail or Inland Waterway Transport Documents
Article 29 - Courier and Post Receipts
Article 30 - Transport Documents issued by Freight Forwarders
Article 31 - “on Deck”, “Shipper’s Load & Count”, Name of Consignor
Article 32 - Clean Transport Documents
Article 33 - Freight Payable/Prepaid Transport Documents
Since we can not go into great detail on any one subject, only a few
items on Marine Bills have been listed below as examples that you
should be familiar with:
Marine Bill of Lading
1. A full set of original bills of lading signed by a named carrier, or
agent, must be presented, or otherwise accounted for in accordance
with the terms of the L/C. It is not acceptable for the B/L to be issued
by a Forwarding Agent, except acting as agent for a named carrier.
2. The bill of lading terms are not altered without authentication by
the issuer.
3. Bill of lading is not a Charter Party Bill of Lading unless
specifically authorized by the L/C.
4. The B/L shows a date of shipment on or before the latest
shipment date authorized in the L/C.
5. The B/L does not evidence transshipment, if prohibited by the L/C.
6. The merchandise description is consistent with the commercial
invoice. The marks and number of packages, weights, dimensions
and quantities are in accordance with other documents.
7. The B/L is “clean”; i.e. it does not contain clauses, which
expressly declare a defective condition of the goods.
8. The B/L should be consigned exactly as per the L/C terms and
endorsed properly, if required.
9. The “notify party” is specified on B/L exactly as per the L/C terms.
10. The B/L should show the loading and discharge ports as
specified in the L/C.
Again, we have only provided you with some examples of areas that
can cause possible problems with export documents that may slow-
down or prohibit you being paid in accordance with the terms of an
L/C. If you are going to be involved in either import or export of
merchandise on a regular basis, you should buy a copy of the UCP
600 and review it thoroughly.
