Last month in Trade Finance Global, I offered evidence that although the demise of documentary credits has been anticipated for some time, they are still vital instruments for advancing global trade.
In this second installment of my two-part article, I endeavour to consider the documentary credit from the point of view of an exporter as well as its bank and provide some advice on how to best benefit from the effective use of documentary credits.
Documentary Credits – Exporter and its Bank Perspective
Understanding the independent nature of the documentary credit – the means of payment
The exporter – the beneficiary under the credit – needs to be fully aware that the documentary credit is legally independent of the underlying contract of sale and any other related contracts. The documentary credit stems from the underlying sales contract and is a realization of the respective payment condition. The payment obligation(s) of the obligated bank(s), however, is fully separate and autonomous from the underlying contract, something that brings several advantages. For example, the bank cannot refuse payment based on the insufficiency of the delivery of the goods or services. Unfortunately, this arrangement can also backfire. Consider a situation where the exporter delivers goods in perfect compliance with the contract but payment does not follow or is delayed due to pedantic discrepancies in documents. Most certainly, the exporter would agree that being paid in a timely fashion is the most important aspect of their business!
Consequently, the beneficiary should fully realize that having a documentary credit issued (and possibly also confirmed) by a trustworthy bank(s) is vital. The documentary credit needs to have suitable and clear terms and conditions; thus, it also needs to be clear to the importer – the applicant for the credit – how the credit is to appear when issued. The underlying contract should include sufficient and precise instructions regarding the credit to be issued. These include, above all which bank is to issue it, by when, its validity, latest date(s) for shipment, the period for presentation, and each requested document.
Interestingly, many disputes related to documentary credits centre around whether the credit accurately reflects the contents of the contract or not. This indicates that the terms and conditions of the credit are often not well specified in the contract, or are even clearly conflicting, incorrect, or open to interpretation!
From the beneficiary´s perspective, the documentary credit should be unambiguous, concise, and require the presentation of only a few critical documents to evidence fulfilment of the exporter´s delivery obligation. These should be, in most cases, a commercial invoice, transport document, and certificate of origin, with perhaps also an insurance document, and an inspection (quality) certificate or another certificate depending on the type of commodity sold.
Correct and clear terms and conditions of the documentary credit – a prerequisite for success
The exporter should carefully consider the terms and conditions of the documentary credit when negotiating the contract of sale. It is highly advisable for exporters to consult relevant matters with the parties that are expected to issue the required documents, such as carriers (or their agents, freight forwarders), insurance and inspection companies, and, most importantly, its bankers.
Adequate care and attention prior to issuance are key to success in documentary credit transactions. Unless the documentary credit is workable, with viable conditions, it is unlikely to function as intended for the beneficiary!
To consult with various third parties whose documents the beneficiary would need to present under a credit is also important after the credit is issued and advised. If the credit includes non-standard, unclear conditions, the beneficiary needs to attain clarity and possibly get an amendment to the credit.
Most certainly, the beneficiary needs to have a knowledgeable and helpful banker to provide assistance when necessary. Despite the fact there is no obligation to do so whatsoever under UCP 600, many bankers, when advising credits, would consider a credits’ workability and assist their customers regarding credit terms and conditions and avoiding possible pitfalls.
The beneficiary should possess a working understanding of UCP 600 and ISBP 745, the rules and practices that govern documentary credits. That said, there are some peculiarities that can hardly be known or deduced unless one knows the rules and practices extremely well, including all relevant interpretations such as ICC Opinions.
For instance, would you think that if goods are shipped as evidenced by transport document(s) on more than one means of conveyance, even if shipped from the same place, on the same date, for the same journey and for the same destination, these are considered to be partial shipments?
Or another scenario yielding a possibly unexpected result: “If a drawing or shipment by instalments within given periods is stipulated in the credit and any instalment is not drawn or shipped within the period allowed for that instalment, the credit ceases to be available for that and any subsequent instalment.” Documentary credit standards are not always intuitive!
Time is of the essence
Ideally, the beneficiary should ensure it has sufficient time to produce goods, prepare the shipment, present required documents, and correct documents or get them corrected, if needed. When operating under severe time pressures, it is hardly possible to avoid errors and delays. If a credit is issued and advised with delay, then the importer should be contractually bound to make it available for a longer period with a corresponding longer period for shipment.
The beneficiary should always make sure that the credit is available with its bank, the place for presentation effectively being the counters of his bank. Otherwise, the beneficiary would face the extra risk of presenting documents in time to another (foreign) bank. During this prolonged COVID-19 pandemic, some beneficiaries have learned this lesson the hard way – they have been unable to make a timely presentation of documents to foreign banks (e.g., issuing banks) due to interruption of delivery services (for instance, air transport was unavailable for some time!).
The documentary credit is not only a secured payment instrument but also serves as a financing tool. The exporter might need pre-shipment financing to fund its production and/or shipment of the goods. A documentary credit issued by a creditworthy bank with workable conditions might enable an exporter to obtain a pre-export loan. The documentary credit itself can even include pre-shipment financing in its terms and conditions (so-called “Red Clause” or “Green Clause” credits).
Often an importer would require import financing which can be provided by the exporter in the form of trade credit secured by a deferred payment credit. In the event the beneficiary itself needs funding, such post-shipment financing could be provided in the form of negotiation (if the credit is available by negotiation) or by discounting (with or without recourse). Again, such post-shipment financing can even be incorporated into the terms and conditions of the credit itself, i.e. to be in the form of so-called “post financing” (financing is provided by the nominated (exporter´s) bank, or “UPAS” (i.e. usance credit payable at sight, when financing is provided by the reimbursing or issuing bank).
*Pavel Andrle is an international trainer and consultant. He is founder, owner, and managing director of Trade Finance Consulting, s.r.o., www.tradefinanceconsulting.com. He is the author of recently published practical guide Documentary Credits in Practice – see https://www.tradefinanceconsulting.com/publications/.