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Documentary letters of credit

Presentation of the general technique | Intervention of a second bank | Legal framework |
Documentary letters of credit and Incoterms | The role played by the documents themselves | Modes of use | Transfers | Costs | Recommendations

The The The The

basic contract documentary letter of credit executors of the documentary letter nature of the commitment made by the issuing bank

The basic contract In the basic sales contract, it is logically speaking when the two parties are sorting out the details of payment that they should have recourse to the principle of payment by means of a documentary letter of credit, and the essential modes of payment inherent in an instrument of this kind. The greatest possible care must be taken when choosing the wording of this clause. It is in fact the basis upon which : the importer will depend when giving his bank instructions as to how the documentary letter of credit is to be drawn up ; and the exporter will decide whether the letter of credit that he receives from the bank is truly in keeping with what was agreed when the basic contract was first drawn up, or with what was subsequently agreed upon, depending on the case.

If you are an exporter, it is of paramount importance that you insist upon a letter of credit, which conforms exactly to the terms as stated in your contract with the importer. In fact, the commitment the bank makes hinges entirely upon the terms as defined in the letter of credit, and there is no way the exporter can prevail upon the bank to digress from these, even by making reference to the basic contract which connects him with the importer in the first place. Pre-printed forms are made available to the purchasers, and these are generally speaking drawn up along the lines of code system, which provides for information stored on computers to be exchanged between banks. But the SWIFT the instructions given when the letter of credit is being drawn up will most often be transmitted to the issuing bank direct by the applicant by post or by facsimile transmission.

The documentary letter of credit

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Note: You will find it easier to make sense of this diagram, if you follow the numbers, which are designed to take you from one step of the transaction to the next.

Once the base contract has been drawn up, the importer will request his bank, which will be known as the issuing bank, to issue a documentary letter of credit made out to the exporter, who will be the beneficiary. The importer will act as the applicant, in keeping with the provisions in the base contract. Once the exporter has been notified of the credit held in his name, he is in a position to put the merchandise in the hands of the haulage contractor who will then expedite it. He then presents the issuing bank with the required documents (most often the bill, the insurance policy document, and the transportation ticket). The bank then first having verified that the documents are as they should be, makes the payment to the exporter. The bank is subsequently reimbursed by the applicant, that is to say the importer, and hands the documents over to him in exchange. Once the importer is in possession of the documents, he is in a position to take delivery of the merchandise, under circumstances which should in theory be in keeping with the provisions described in the base contract. We may note that at every stage of the operation parity has reigned in the way the obligations of the various participants have been executed, both payments and the exchange of documents taking place simultaneously.

In the context of operations involving major export transactions, one must never overlook the fact that one is dealing with a commitment from a foreign bank, and that one is therefore completely exposed to the political risks (coups, the country's possible inability to honour its financial commitments,...) which could make it impossible for that bank to honour its immutable commitment to pay. So we find ourselves faced here with a form of credit that provides good guarantees of payment if one is dealing with an inter-European transaction, but which still has room for improvement if we are dealing with an overseas export order. Having recourse to a second bank is a technique which allows us to provide the exporter with greater security.

The executors of the documentary letter

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The applicant : he is usually the buyer or an intermediary acting on the buyer's behalf (for example: a purchasing or import center). It is he that gives the issuing bank instructions to issue a letter of credit. The beneficiary : the beneficiary of the letter of credit is he in whose favour the documentary (letter of) credit is opened. So we are referring to the vendor. The issuing bank : this is the bank which proceeds to issue the letter of credit on the basis of the instructions that it receives from its client, the applicant. Normally this bank is situated in the applicant's country.

The nature of the commitment made by the issuing bank

1. The irrevocable nature of the commitment The bank makes an irrevocable, or in other words, firm commitment , inasmuch as the documentary letter of credit itself hinges entirely upon the accuracy of the documents it has been specifically appointed to receive. The letter of credit is only valid for a limited period of time, and until this period has expired, the bank's commitment cannot be annulled, or modified, short of prior agreement between all the interested parties, and in particular on the part of the beneficiary.

In practice, an exporter who is asked to accept an amendment to the initial letter of credit, and who does not wish to, should refuse it altogether, so that the original text should prevail unaltered. He should nonetheless pay careful attention to the negotiations in themselves, and always bear in mind that if he isn't a little flexible, the importer can take the same approach when it comes to assessing the validity of the documents that he will be obliged to deliver to him, so that the credit can be made payable. If on the other hand it is the exporter who should wish to make amendments to the letter of credit, he is not allowed to contact the issuing bank. His first step must be to speak to his client who will then in turn notify his bank of any changes that may be agreed to. However it is possible for both parties to agree to make an exception to this rule. They can expressly agree that the letter of credit should be revocable. Should this be the case, the bank is then empowered not to make good the letter of credit should it so choose, without even telling the beneficiary. This type of credit thus offers a great deal of flexibility to the purchaser without offering any real security to the vendor.

Should you find yourself in the position of vendor, we would therefore advise you not to accept a revocable letter of credit, or at least not unless there are very special circumstances.

2. The literal and autonomous nature of the commitment. The use of these two adjectives implies that the banker's commitment to the exporter is necessarily enshrined in the written word. The text used determines the existence of this commitment and fixes its duration (in literal terms), and is executed totally independently of the base contract which defines the relationship between the importer and the exporter, as also of the secondary (and again autonomous) contract which exists between the importer and the bank. Thus the importer is unable to block the bank from carrying out its commitment even if he wishes to allege that the merchandise is of poor quality. In the same way, the banker cannot get out of his commitment by using his client's inability to reimburse him as a pretext, even if the latter should have gone bankrupt after the letter of credit was issued by the bank, and before the beneficiary had collected his dues as described in it. There is one caveat however to the radical nature of the autonomy of the banker's commitment. The banker is in effect empowered to take into consideration any existence of fraud on the part of the exporter, or to demonstrate that the base contract cannot be substantiated, or worse, or that it should be in any way illicit.

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3. The basis of the banker's commitment Opinions are divided over this issue. For some the basis of the banker's commitment is grounded in his unquestioning willingness to make a commitment to the exporter, a willingness that finds expression in the credit that is extended to the same. For others the true basis of the commitment has to be found in the way in which the wills of the banker and the exporter combine. What is the practical point in discussing an issue like this? There is sense in it insofar as it is important to determine the point at which the banker has entered into his commitment. If one adopts the former position, this moment is the date on which the credit advance is expedited. If one adopts the latter, the commitment becomes effective on the day it is accepted, or at the very least, on the day the credit advance is received by the exporter. It is advisable for both parties involved (importer and exporter) to sort this issue out when the base contract is being drawn up, thus making judicious use of their contractual freedom, over an issue which is not in fact a point of law.

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