Letter of Credit: How to prepare “draft”

Estimated reading time: 8 minutes

In UCP 600 article 2, the ICC indicates that a “Complying presentation means a presentation that is in accordance with the terms and conditions of the credit, the applicable provisions of these rules and international standard banking practice.” 

The beneficiary of a documentary credit must, in order to obtain the expected benefits from the bank, prepare the documents required by the letter of credit in accordance with the hierarchy of letter of credit terms, the provisions of the UCP 600 and the international standard banking practice partially but widely encoded in the ICC publication ISBP 745.

Below is a walk-through on how to prepare the “draft” in accordance with the letter of credit conditions and the above-mentioned provisions.

The “draft”: what is it?

The bill of exchange is a negotiable instrument through which a creditor (drawer) orders a debtor (drawee) to pay a certain sum to the legitimate bearer of the title (beneficiary), either on demand or at a set time. 

The drawee becomes obliged only if they accept the bill of exchange. To be considered legally an undertaking, the document must comply with the requirements of the “applicable bill of exchange law.” Under a letter of credit, usually, the drawer and beneficiary are the same person.

The “applicable bill of exchange law” refers to two major regulatory systems:

1. The British 1882 Bills of Exchange Act referring to the United Kingdom, Ireland and several Commonwealth countries such as Cyprus, Australia, India, Hong Kong, Israel, New Zealand, Malaysia, Pakistan, Philippines, Singapore, Sri Lanka, Bangladesh
2. The Geneva Convention of 1930 (Conventions Providing a Uniform Law for Bills of Exchange and Promissory Notes) refers to the countries of continental Europe, several Latin American countries, the Middle East and Asia (some countries have ratified the Convention, others are inspired to define internal rules).

The Geneva Convention of 1930 is more specific and formal than the “Bill of Exchange Act” of 1882. If a bill of exchange meets the requirements of the Geneva Convention, it automatically meets the requirements of the Bill of Exchange Act of 1882.

Article 1 of the Geneva Convention of 1930 states the following: “A bill of exchange contains:

• The term ‘bill of exchange’ inserted in the body of the instrument and expressed in the language employed in drawing up the instrument;
• An unconditional order to pay a determinate sum of money;
• The name of the person who is to pay (drawee);
• A statement of the time of payment;
• A statement of the place where payment is to be made;
• The name of the person to whom or to whose order payment is to be made;
• A statement of the date and of the place where the bill is issued;
• The signature of the person who issues the bill (drawer).”

The UCP 600, ICC article 2, is dedicated to the definitions and states the following:

“Honour means:

• To pay at sight if the credit is available by sight payment.
• To incur a deferred payment undertaking and pay at tenor if the credit is available by deferred payment.
• To accept a bill of exchange (“draft”) drawn by the beneficiary and pay at tenor if the credit is available by acceptance.”

“Negotiation means the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents under a complying presentation, by advancing or agreeing to advance funds to the beneficiary on or before the banking day on which the reimbursement is due to the nominated bank.”

Therefore, the “draft”, which is issued by the beneficiary “to his own order” (the beneficiary of the bill of exchange coincides with the beneficiary of the credit) is required in the letter of credits available “by acceptance” or “by negotiation”, and sometimes also in the letter of credits available “by payment”, with a request for “sight draft”.

It should be noted that “by acceptance”, letter of credits differ from “by deferred payment” letter of credits only for the use of the “draft” as an instrument to honour the amount to its tenor. 

In order to obtain post-shipment financing, the beneficiary can alternatively endorse the bill of exchange accepted by the bank – under a complying presentation – to third parties or transfer the proceeds of the credit through an “Assignment of Proceeds” to third parties. 

In both cases, the paying bank will fix the amount to the beneficiary or to third parties: to the “assigner” in the case of “by deferred payment” letter of credit or the bearer of the bill of exchange in the case of the letter of credits available “by acceptance”.

Therefore, the only difference between “by acceptance” and “deferred payment” credits relates to the form of the bank’s payment undertaking that will be in line with applicable regulatory practices to eventually discount the bank’s undertaking.

“Draft”: What does the UCP 600 say?

Article 6 of the UCP 600 ICC states that, “A credit must not be issued available by a draft drawn on the applicant.”. Therefore, a credit cannot be issued where the name of the application appears as a “drawee” (field 42A message Swift MT 700).

However, it is considered to be entirely in line if a letter of credit calls for a draft drawn on the applicant under the required documents (and thus in the 46A field of the Swift MT700 message) and this document will be examined only with reference to what is required in the credit and according to article. 14 (f) UCP 600 ICC, which reads as follows: 

“If a credit requires presentation of a document other than a transport document, insurance document or commercial invoice, without stipulating by whom the document is to be issued or its data content, banks will accept the document as presented if its content appears to fulfil the function of the required document and otherwise complies with sub-article 14 (d)”. 

Sub-article 14, point d) states that, “Data in a document, when read in context with the credit, the document itself and the international standard banking practice, need not be identical to, but must not conflict with, data in that document, any other stipulated document or the credit”. 

Therefore, if – always referring to the draft drawn on the applicant under the documents required in a letter of credit – neither the issuer nor the data it must contain are specified, the banks will have to accept a document issued by the beneficiary whose content appears to respect the function of the required document.

In addition, the data indicated therein may not be identical to what is specified in the letter of credit or other required documents, but they should not be in conflict with them.

It’s important to note that the draft must contain all the terms expressly required by a letter of credit. The general conditions that apply to “all documents” does not apply to the “draft”, unless a letter of credit calls for a one to be drawn on the applicant under required documents in the credit. 

The ICC Banking Commission, in the Opinion TA 703rev, has stated that “a draft is not to be considered as one of those required documents unless the credit requires the presentation of a draft drawn on the applicant under “documents required”.

“Draft”: ISBP 745 ICC viewpoint

Below are further indications – not exhaustive – about the correct setting of the “draft” in reference to what is stated in paragraphs B1 – B18 of the ISBP 745:

The tenor of the “draft” must be in line with credit terms. If the credit requires a “draft other than sight or a certain period after sight”, it must be possible to determine the tenor from the data given in the same draft.

For example, if a credit requires a “draft at 60 days after Bill of Lading Date” and the Bill of Lading date is 14/05/2013 (refer to the on-board date and not the date of issue of the Bill of Lading), the tenor must be structured in one of the following ways:

• “60 days after bill of lading date 14 May 2013”;
• “60 days after 14 May 2013”;
• “60 days after bill of lading date” indicating elsewhere in the document: “bill of lading date 14 May 2013”;
• “60 days date” on a “draft” dated the same day as the Bill of Lading date;
• “13 July 2013”, i.e, 60 days after Bill of Lading’s date.

It should be noted that the same principle also applies in the presence of transport documents other than Bill of Lading.

A “draft” must be issued and signed by the beneficiary of the credit and must indicate a date of issue.

If the credit indicates, as a “drawee” of a draft, the Swift code of a bank, the “draft” may indicate such Swift code or the bank’s full name.

If the credit is available by “negotiation” with a nominated bank or “any bank”, the “draft” must be issued to a bank other than the nominated.

If the credit is available by “acceptance” with “any bank”, the “draft” must be issued to the bank that is available to accept the “draft” and therefore, available to act as nominated.

The “draft” is to be issued for the amount required in the presentation. In case of discrepancy between the amount indicated in letters and the amount indicated in figures, the amount indicated in the letters will be examined.

Any correction of data on a draft needs authentication with the addition of the signature or initials of the beneficiary. 

A draft is to be endorsed, if necessary.

Conclusions

In conclusion, it should be emphasised that the documents to be presented in the use of a letter of credit must be prepared in accordance with the terms of the letter of credit, the provisions of the UCP 600 and international banking standard practice, following its hierarchy.

The preparation of the invoice – a document required virtually in all letters of credit is necessary, as we have seen, to comply with various regulatory provisions.