Letters of credit - it’s all in the detail

Quite often in life things don’t turn out how we imagine they will, and so good communication and being able to manage expectations – our own and those of others – is an effective approach for success.

In a trade transaction, where any differences in the parties’ interests is obvious, this approach can work very well, especially with a letter of credit (LC).

The pure number of parties involved in an LC transaction – starting with an importer and ending with an exporter, with banks in the middle – may hinder the success of a whole trade deal because each party involved lacks the necessary information to reach the end goal. It’s like several people each having a piece of a jigsaw puzzle but without having the complete picture in front of them.

This often happens because trade parties do not take enough care over the details within the LC and then the banks make an independent decision based on the documents presented, LC terms and UCP rules, taking no notice of the sales contract terms.

As a result, there are a lot of non-complying presentations under LCs. The bankers hear the exporter’s complaints of payment delays and the importer’s dissatisfaction with the banking service, especially when the issuing bank issues an LC that refers automatically to a standardised LC application form without taking into account the applicant’s real trade needs.

Consider the other parties

To avoid this, the importer should take extra care over the LC terms from the outset by taking into account the exporter’s requirements. The exporter, in his turn, must communicate with the importer regarding the LC conditions before the LC is issued.

The importer should not be left alone to deal with the LC, which could result in ambiguous instructions to the issuing bank, documents that have to be signed or countersigned by the applicant, or contract or other terms and documents that bear no relation to the LC itself.

All of this may render the LC unacceptable to the exporter.

The beneficiary’s demands in respect of an issuing/confirming or advising bank need to be understood in the context of an LC structuring. The applicant cannot nominate them at their discretion. Nor can the applicant decide on a bank without communicating it to the beneficiary, as the beneficiary must know what bank risk he is taking. This way the LC will be addressing common concerns of both parties.

Therefore the best way to complete a deal successfully is to get the applicant’s and the beneficiary’s approval of an LC draft before an actual LC issuance.

Acknowledge the banks

Banks play a key role in the life of an LC and they can’t be underestimated. They issue, confirm, advise the LCs, take up and check documents, and make payments.

A well-drafted LC is vital for the issuing bank itself not only as issuer, but also as the party instructing other banks in the LC chain.

And further cooperation between all other banks involved after the LC has been issued means that it reaches the beneficiary more quickly, especially in cross-border transactions where there are different time zones, languages and cultures to contend with.

Always remember that each bank has its own internal rules and regulations over UCP and can stop the transaction at any stage. For example, a confirming bank, having undertaken to honour a complying presentation in addition to that of the issuing bank, bears the risk of non-payment by the issuing bank under the LC due to its poor financial situation or because of country risk.

Furthermore, it will not give its confirmation if such risk cannot be estimated, or if the LC terms could potentially lead to a dispute with the issuing bank regarding the status of the presented documents. An advising bank may not deliver the LC to the beneficiary if it is not the advising bank’s customer or because of compliance or other reasons.

Despite the best efforts of both the applicant and the banks under the LC, the beneficiary still has the right to say no regarding the issued LC, and may not start or may stop shipments because in the long run the deal should meet the beneficiary’s expectations.

Therefore, for it to do so, the beneficiary should be proactive throughout the transaction rather than act once the LC has been issued.