In the domain of international trade, the establishment of clear and comprehensive sales contracts is crucial for smooth transactions. Simultaneously, the implementation of uniform customs practices, especially concerning documentary credits, plays a vital role in minimizing risks for both importers and exporters.
More importantly, determining an efficient risk management tool is critical in international trade. The rationale is to identify, assess and mitigate the various risks involved in cross border transactions. For instance parties to trade transactions may suffer certain dangers when items are shipped from one country to another, where payment and delivery are separated in time and location.
Some hazards may be on the seller’s side; he or she may suffer certain risks if the buyer’s financial situation changes after the goods have been shipped, causing delay in the receipt of payment.
The buyer on the other hand may also bear some risks when payment is made to the supplier prior to shipment without assessing the risk profile of goods. Following these significant potential risks and challenges such as differences in currencies, laws, market structure, and business culture, risks may be produced as a result.
Consequently, merchants established the use of documentary credit, also known as “Letters of Credit,” as a solution to manage the risks associated with international trade. This mechanism remains the most popular technique to reconcile the diverse economic interests of parties by removing or minimizing risks.
In plain English, documentary credit is a method of compliance in which a party is required to pay the mutually agreed-on amount within the terms of a contract. Given its ability to navigate the challenges presented by a universal setting, the payment method suited the characteristics of international trade. When a seller and a buyer employ documentary credit, it indicates that both parties have agreed to specific payment terms and that a reliable third party—typically a bank—is involved in their business relationship.
SOURCES OF DOCUMENTARY CREDIT LAW
The Uniform Custom Practice ( U C P600) is a set of internationally recognized rules g over ni ng the use of Documentary Credits (letters of credit) in international trade and was established by the International Chamber of Commerce (ICC) . It is recognized as a set of binding rules and standards which only applies to parties involved in a letter of credit transaction.
Another body of law that governs commercial transactions is the Uniform Commercial Code (UCC)..ons Section 5 of the Uniform Commercial Code regulates in instances where documentary credit is issued by a bank and it needs documentary draft or demand for payment, or if such letters of credit is issued by a person other than the bank which requires a title. The scope of application of the UCC is that, it applies to contract of sale of goods, what constitutes acceptance revocation of acceptance by a buyer and basically defines his or her obligations. The UCP includes the model statute of frauds as well as warranties and remedies for the seller in instances the buyer breaches the contract. Essentially, the aim of documentary credit is to reflect the parties’ needs and to protect the interest of the issuer.
THE CONTRACT OF SALE AS THE CENTRAL CONTRACT
The contract of sale is the fundamental agreement of commercial transactions which determines the payment method and the type of credit to be issued. T he contract features negotiation, acceptance, payment and confirmation. The seller or beneficiary may reject a credit issued which may not be in conformity with the contract. The buyer’s bank, , is required to adhere to the prescriptions stipulated in the contract of sale agreed between the seller and the buyer, and there has to be correspondence of the resulting credit to the buyer’s instructions as the applicant for the credit.
DOCUMENTS IN INTERNATIONAL TRADE
International trade involves a wide range of essential documents that facilitate the smooth flow of goods, services and payments across borders
Key documents used in international trade are:
- The sales invoice; usually a signed document is an extract of the sales c o n t r a c t w h i c h summarises the terms of sale. It should include at l east the following details:
- Name of buyer
- Name of seller
- Terms of sale
OTHER SHIPPING DOCUMENTS
The bill of lading is generally considered to be the most important shipping document in international trade. It functions as a document of title and evidence of shipment. Other shipping documents which may be presented in international trade are:
- Certificate of inspection
- Phytosanitary certificate
- Certificate of Origin
- Packing list
It is important to note that the specific documents required may vary based on the nature of goods, countries involved, and any applicable trade agreements or regulations.
PAYMENTS UNDER DOCUMENTARY CREDITS
The provisions of article 9 of the UCP500 stipulates 4 types of payments under documentary credits. Article 10(a) states: “Credit must clearly indicate whether they are available by sight payment, by deferred payment, by acceptance or negotiation.”
- A sight credit refers to t he requirement of immediate payment upon presentation of documents by the beneficiary(seller) to the issuing bank. . In a sight credit transaction, the issuing bank is obligated to make payments as soon as it examines the presented documents and confirms their compliance with the terms and conditions of the letter of credit.
- A deferred payment credit is a type of payment that provides the beneficiary (seller) with the option to receive payment for goods at a later date as defined in the letter of credit, which is often the date of the bill of lading. . A deferred payment credit allows the buyer a grace period and assures the seller that payment will be made on the due date. However, the specific terms and conditions, including the maturity date and any applicable interest rates, are explicitly stated in the letter of credit.
- An acceptance credit also known as a time draft or usance letter of credit allows the issuing bank to accept a time draft drawn by the beneficiary (seller) upon p r e s e n t a t i o n of documents.. It is one under which the issuing and confirming bank undertakes to pay, or that some other drawee bank will accept and pay a bill of exchange payable at a future date.
- Negotiation is the giving of value for draft(s) and/or documents by the bank authorised to negotiate. This form of payment involves the negotiating bank giving value to either drafts or documents presented under a credit without recourse to the drawer. The examination of documents without giving value does not constitute a negotiation.
FORMS OF DOCUMENTARY CREDITS
There are various forms of documentary credits used to facilitate international trade transactions and are basically differentiated by the form in general, characteristics and payment periods.
The following are the types of documentary credits:
- Documentary credit based on its general f orm: This type of documentary credit has two forms namely;
REVOCABLE DOCUMENTARY CREDIT
This type of credit allows one party to cancel the credit at any given time without prior notice to the beneficiary, the applicant, the issuing bank or the confirming bank.
IRREVOCABLE DOCUMENTARY CREDIT
On the other hand, this credit type offers a higher level of security to the beneficiary where modification and cancellations are not allowed. once approval is effected by the beneficiary, the applicant, the issuing bank and or confirming bank if there is any.
- Documentary credits based on payment terms features 2 (two) types namely
Provisions of Article 10 (a) of the UCP requires that all credits must i ndicate whether they are available by sight payment, differed payment, acceptance or negotiation. Under a sight credit, the payment is made to the beneficiary as soon as the required documents are presented and found to be in compliance with the terms and condition of the credit. Uncharacteristics is another type. The types of the documentary credit based on its features have various combinations of characters. Such types could be: Transferable Documentary Credit; Irrevocable Transferable Documentary Credit; Revocable Transferable Documentary
Credit; Red Clauses Documentary Credit etc.
FORMS OF DOCUMENTARY CREDIT CONFIRMED AND UNCONFIRMED
- Obligations and Rights under Documentary Credits
The Uniform Customs and Practices for Documentary Credits UCPDC of 1993 ICC Publication 500 clearly indicates the obligations and rights of parties to Documentary Credits. It is important to note that in documentary credits banks deal in documents and not in goods.
- Obligations of Exporter/Seller
To present documents which on the face conform to the terms and conditions of the Letter of Credit. These documents will typically include invoices, transport documents, insurance documents, inspection certificates and packing lists. To present documents that are on the face consistent with each other.
Ensure that documents are presented as quickly as possible and in any case within the validity of the credit and within the period of time after date of issuance of the transport document which is specified in the credit or applicable under Article 43 of the UCP.
He must note that non compliance with the terms stipulated in the credit means the bank is under no obligation to negotiate the documents.
The exporter must have sufficient time to study the Letter of Credit and request changes where needed.
The exporter should satisfy himself that the terms and conditions and documents called for in the Letter of Credit are in accordance with the sales contract (Article 3 of the UCP). The seller must ensure that he has not been made liable for charges that he has not provided for in making the sale of goods.
Obligations of the Buyer/Importer
The instructions given to the issuing bank must be clear, correct and precise. It must not contain excessive detail. The bank will not be able to check complicated technical specifications etc. The bank similarly cannot guess what the buyer wants.
The terms and conditions of the Letter of Credit must agree with the sales contract on which it is based. He must however note that the undertaking of a bank to pay, accept, negotiate or fulfil any obligation under the credit is not based on the contract but on the credit itself (Article 2 UCP).
Article 21 of the UCP provides that any examination of goods prior to shipment or at the time of shipment must be evidenced by a document. The nature and issuer of this document must be stated in the credit. Buyer must avoid ambiguous terms such as competent, well-known etc Article 20 (UCP).
The credit should not call for documents that the seller cannot provide neither should it set out conditions that cannot be met.
The buyer must clearly indicate who are to bear charges under the credit. This must be in conformity with the underlying contract to avoid unnecessary delays and expenses involved in amendments.
Liabilities and Responsibilities of the Bank
The bank must examine all documents stipulated in the credit with reasonable care to ascertain whether on the face they conform to the terms and conditions of the Letter of Credit. Documents which are internally inconsistent will constitute a discrepancy. Banks are under no obligation to examine documents, which are not stipulated in the credit. They may either return such documents or pass them on without responsibility. The issuing bank, confirming bank or any other nominated bank acting on their behalf shall have a reasonable time not exceeding seven banking days following the day of receipt of the documents to examine the documents and determine whether to take them up or refuse them.
Where a credit contains conditions but does not state the documents to be presented to cover these conditions the bank will consider such conditions as not stated. On receipt of documents the issuing bank/confirming bank if any or a nominated bank acting on their behalf must determine on the basis of the documents alone whether they appear on their face to comply with the Letter of Credit.
If the issuing bank determines that documents presented are discrepant it could do the following:
- Approach the applicant for a waiver of the discrepancies. This should be done within 7 banking days.
- It should within 7 banking days give notice to the bank from which it received the documents or the beneficiary of these discrepancies. This should be by any expeditious means. SHIPPING REVIEW
- The notice must clearly i n d i c a t e t h e discrepancies for which the documents have been refused and whether it is holding the documents at the disposal of or is returning them to the presenter
- If the issuing bank and/or confirming bank if any fails to comply with these provisions, it will be i mpl i ed that the documents are in conformity with the Letter of Credit terms.
- Banks shall not assume liability or responsibility for consequences arising out of the interruption of their business by Acts of G od, riots, civi l c o m m o t i o n s , insurrections, wars or other causes beyond their control
SOME COMMON DISCREPANCIES IN THE LETTERS OF COMMITMENT
- Description of goods on invoice differs from that in the Letter of Credit.
- Shipment made between ports other than those stated in the credit.
- No evidence of goods actually shipped on board.
- Documents inconsistent with each other.
- Marks and numbers differ between documents.
- A b s e n c e of the documents called for in the credit.
- Absence of signatures where required on documents presented.
- Document s not presented in time.
- Late shipment.
- Credit amount exceeded.
- Insurance risks covered not as specified in the credit.
- Clause (unclean) bills of lading presented.
The Uniform Customs and Practice for Documentary Credits, in conjunction with the United Nations Commission on I nternational Trade Law (UNCITRAL) offers the legal f r amework within which international trade contracts can be regulated. While the Uniform Customs and Practice for Documentary Credits exclusively apply to letters of credit, the UNCITRAL regulations cover a larger range of international economic transactions. Other International Chamber of Commerce publications, such as the Uniform Rules for Collections, may be utilized for other specific transactions, such as Bills for Collection.
To ensure compliance and proper protection, economic operators must become acquainted with the regulatory framework for the contracts they sign.
The significance of accurate documentation in the prompt settlement of international commercial transactions cannot be overstated. Banks, in particular, deal with payment documents rather than things.
A correct grasp of the implications of various contracts in international trade will allow both buyers and sellers to adequately cover risks particular to their transactions. This will usually address concerns with sales contracts, insurance documents, various types of letters of credit, and different forms of these credits.
T he dynamic nature of international trade makes it imperative for all operators to both understand contemporary trends and make business sense of the various possible contracts.
By: Kojo Frimpong