One

Documentary Credits An
Overview

Chapter outline
1.1
1.2
1.3
1.4
1.5
1.6

Introduction and learning objectives

1.1.1 Introduction
1.1.2 Learning objectives
Brief history
Definition of documentary credit a generic understanding
A basic documentary credit transaction
Generic flow chart of a documentary credit transaction
Questions

1.1 Introduction and learning objectives

1.1.1 Introduction
The aim of this chapter is to introduce the documentary credit specialist to the
concept of a documentary credit by:
u providing some background to its origins, by way of a brief history;
u providing a generic meaning of the word credit as an instrument used in trade;
and
u reviewing a generic flow chart for a documentary credit transaction.
It should be noted that the different types of documentary credit are defined and
explained in Chapter 3.
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Documentary Credits An Overview

The different methods by which payment is made for goods is explained in Section
2.4 of Chapter 2, under the heading Methods of payment. The different methods by
which goods are transported is explained in Chapter 6, under the heading Transport
documents.
This publication is concerned with the use of documentary credits and standby letters
of credit (credits) as a means of settlement for goods, services or performance.
Unless otherwise highlighted within this text, terms such as letter of credit
(LC), commercial credit and documentary credit (DC) refer to an irrevocable
documentary credit. For the sake of consistency, the term documentary credit is
used throughout this text and should be read in the context of the specific type of
credit that is being discussed.

1.1.2 Learning objectives

The learning objectives for the documentary credit specialist are:
u to enable you to understand the term documentary credit in its generic setting;
and
u to review a basic documentary credit transaction.

1.2 Brief history

The term letter of credit was probably first used in connection with travellers letters
of credit, which were widely used in the eighteenth century. These were issued by
banks, in the Western world, to provide their clients with a means of obtaining cash
from overseas banks during the course of a clients foreign travel. This obviated the
need to carry large sums of money upon a clients person and the attendant risks of
robbery or loss.
A prerequisite for the issuance of a travellers letter of credit was a formal letter
of introduction addressed to the issuing banks correspondent or agent abroad.
The letter of introduction would indicate that the client was a valued customer and
request that the correspondent or agent provide any possible assistance. Copies of
the letter of introduction were often sent to the issuing banks correspondent or
agent in advance of the clients scheduled visit.
The travellers letter of credit addressed to a correspondent or agent would be
issued in the form of a letter. It indicated that, in consideration of the correspondent
or agent paying cash to the named client, the issuing bank would honour bills of
exchange drawn by the correspondent or agent on the issuing bank for amounts paid
plus the charges incurred by the correspondent or agent.
The travellers letter of credit indicated a maximum amount available thereunder and
an expiry date. Each correspondent or agent was required to indicate details of the
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Definition of documentary credit a generic understanding

amount(s) paid and the date(s), so that the next correspondent or agent to whom
the client presented the credit would be able to ascertain the balance available to be
drawn.
The client always retained possession of the original credit. Documentary credit
specialists should see the origin of a credit as a letter that was provided by a bank (the
issuing bank) to a correspondent or agent, upon which credit was to be provided to
a named client (the beneficiary). This letter also described how the correspondent
or agent was to obtain reimbursement from the issuing bank. This usually took the
form of a bill of exchange, as indicated earlier. The documentary credit, in its modern
form, developed from these modest beginnings in the mid nineteenth century. It first
appeared, among banks in London in the 1840s, as a vehicle for effecting payment
for foreign trade transactions.
It may well be that, as a result of personal contacts made by travelling as described
above, merchants were able to arrange for goods to be sent from abroad. The
movement of goods from one country to another is more complicated than buying
goods from within a local marketplace. Often, there are specific documents required
for the transport of goods and payment has to be made across borders.
In order to gain a global understanding, interpretation and application of documentary
credit usage, the International Chamber of Commerce (ICC) developed and published
its first version of the Uniform Customs and Practice for Documentary Credits (UCP) in
1933. UCP 600 is the current version of this publication and came into effect on 1
July 2007. These rules are supplemented by the publication of the ICC Uniform Rules
for Bank-to-Bank Reimbursements under Documentary Credits (URR 725), the ICC
Supplement to the Uniform Customs and Practice for Documentary Credits for Electronic
Presentations (eUCP), version 1.1, and the ICC publication International Standard
Banking Practice for the Examination of Documents under Documentary Credits subject
to UCP 600 (ISBP). All of these publications will be covered in some detail within this
publication.
It should be noted that, while the ICC Banking Commission Decision The
Determination of an Original document in the context of UCP 500 sub-article
20(b) (12 July 1999) was specific to an article of UCP 500, part of its content has
been incorporated into UCP 600, article 17, and is equally valid as a resource material
for UCP 600. The Position Papers 1, 2, 3, 4 on UCP 500, issued by the ICC on 1
September 1994, have no application under UCP 600.

1.3 Definition of documentary credit a generic

understanding
A documentary credit, as an instrument of settlement of the payment obligation
between buyer and seller, is also known in the following terms:
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Documentary Credits An Overview

u letter of credit because a credit is issued by an issuing bank and addressed to

a beneficiary in the form of a letter, the term letter of credit (or LC) is often
used. This is probably the most-used form of terminology;
u commercial credit because a credit is issued by an issuing bank in settlement
of a commercial transaction, the term commercial credit is used;
u documentary credit because a credit is issued by an issuing bank and requires
the presentation of stipulated documents for determination of compliance
therewith, the term documentary credit (DC) is used;
u standby letter of credit because a credit is issued by an issuing bank with
the purpose that it is only to be used for settlement if there has been some form
of default or is to act as a form of financial guarantee, the term standby letter of
credit is used.
All four terms generically refer to the same product, which undertakes payment to
the beneficiary provided that the documents stipulated in the credit are presented
and that all terms and conditions of the credit are complied with.
The generic understanding of the meaning of credit is accurately encapsulated in
UCP 600, article 2, under the definition of Credit:
Credit means any arrangement, however named or described, that is
irrevocable and thereby constitutes a definite undertaking of the issuing
bank to honour a complying presentation.
A complying presentation is defined in UCP 600, article 2:
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 key element to remember is that honour (ie, to pay at sight, to incur a deferred
payment undertaking to pay at maturity, or to accept a bill of exchange, or draft,
drawn by the beneficiary and pay at maturity) or negotiation is conditional upon
the presentation of stipulated documents that are in accordance with the terms
and conditions of the credit, the applicable provisions of UCP 600 and international
standard banking practice. This key element is present in a credit irrespective of
whether it is described as a letter of credit, a commercial credit, a documentary
credit or a standby credit.

1.4 A basic documentary credit transaction

An example of a basic documentary credit transaction is given below in its simplest
and most common form, and a documentary credit specialist should note that
variations thereof are explained in the later chapters of this book.
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A basic documentary credit transaction

The structure, which covers the movement of goods, provision of services or other
form of performance, is as follows.
1 The buyer (otherwise known as the applicant) completes a standard
documentary credit application form made available by their bankers,
requesting that the bank (otherwise known as the issuing bank) issue an
irrevocable documentary credit in favour of the seller (otherwise known as the
beneficiary).
The application form, which is submitted to the issuing bank in electronic or
paper form, should specify:
u the documents that are to be presented; and
u the terms and conditions that are to be complied with by the
beneficiary.
It should be noted that, while each bank may maintain its own form of
documentary credit application, the fields to be completed by the applicant
are fairly consistent across all banks and usually follow the SWIFT MT 700
structure.
UCP 600, article 2 (Definitions) provides the meaning of applicant,
for the purpose of those rules, as the party on whose request the
credit is issued.
2 The seller (otherwise known as the beneficiary) dispatches the goods as
required, or provides the requisite services or performance, and presents
the stipulated documents to the issuing bank, a confirming bank, if any, or a
nominated bank (the nominated bank will be any bank if the credit is freely
available). The terms of the documentary credit may include a requirement for
a bill of exchange to be drawn on one of the above banks, in addition to the
presentation of other stipulated documents.
UCP 600, article 2 (Definitions) provides the meaning of beneficiary,
for the purpose of those rules, as the party in whose favour a credit is
issued.
3 The issuing bank issues its irrevocable documentary credit in favour of the
beneficiary and, in so doing, incorporates that banks irrevocable and independent
undertaking to pay the beneficiary, provided that:
u all documents as stipulated in the documentary credit are presented;
and
u all terms and conditions of the documentary credit are complied with.
UCP 600, article 2 (Definitions) provides the meaning of issuing bank,
for the purpose of those rules, as the bank that issues a credit at the
request of an applicant or on its own behalf.
4 The irrevocable undertaking a documentary credit is independent of
the goods, services or performance on which it may be based, including any
contract, pro forma invoice, etc, issued in relation to those goods, services
or performance, even if such reference is made in the documentary credit.
An irrevocable undertaking is enforceable against the issuing bank even if the
applicant is unable or unwilling to reimburse the issuing bank.
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Documentary Credits An Overview

UCP 600, article 2 (Definitions) provides the meaning of credit,

for the purpose of those rules, as any arrangement, however named
or described, that is irrevocable and thereby constitutes a definite
undertaking of the issuing bank to honour a complying presentation.
UCP 600, sub-article 4(a) includes: A credit by its nature is a separate
transaction from the sale or other contract on which it may be based.
Banks are in no way concerned with or bound by such contract, even if
any reference whatsoever to it is included in the credit. Consequently,
the undertaking of a bank to honour, to negotiate or to fulfil any other
obligation under the credit is not subject to claims or defences by the
applicant resulting from its relationships with the issuing bank or the
beneficiary.
5 The advising bank for a cross-border transaction, the issuing bank will usually
request a bank in the beneficiarys country with which it has a correspondent
banking relationship (otherwise known as the advising bank) to advise the
documentary credit to the beneficiary.
UCP 600, article 2 (Definitions) provides the meaning of advising
bank, for the purpose of those rules, as the bank that advises the
credit at the request of the issuing bank.
6 The nominated bank a documentary credit may be made available for
honour:
(i) at the counters of the issuing bank;
or for honour or negotiation:
(ii) at the counters of a specific (named) nominated bank; or
(iii) at the counters of any bank in the case of a freely available credit.
The nominated bank in (ii) is usually (but not necessarily) the advising bank.
UCP 600, article 2 (Definitions) provides the meaning of nominated
bank, for the purpose of those rules, as the bank with which the credit
is available or any bank in the case of a credit available with any bank.
7 The confirming bank (which is often, but need not be, the advising and nominated
bank) provides the beneficiary with an additional irrevocable and independent
bank undertaking, separate from that of the issuing bank. If the documentary
credit is confirmed, it may be made available for honour or negotiation at the
counters of the confirming bank.
UCP 600, article 2 (Definitions) provides the meanings of confirming
bank, for the purpose of those rules, as the bank that adds its
confirmation to a credit upon the issuing banks authorization or request
and of confirmation as a definite undertaking of the confirming
bank, in addition to that of the issuing bank, to honour or negotiate a
complying presentation.
8 The goods if a documentary credit covers the shipment of goods, the goods
are dispatched according to the terms of the documentary credit. The evidence
of shipment of goods is represented by the documents presented under the
documentary credit and the applicant will invariably need these to obtain
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Generic flow chart of a documentary credit transaction

clearance and delivery upon arrival. Payment is exchanged for documents in the
documentary credit cycle provided that the stipulated documents are presented
and that the terms and conditions of the credit are complied with.
9 The documents and payment the nominated bank may honour or negotiate,
provided that a complying presentation has been made. The nominated bank
will, at the same time, dispatch documents to the issuing bank, which will effect
reimbursement according to the instructions of the nominated bank, provided
that the issuing bank is satisfied that the documents represent a complying
presentation. The issuing bank will then forward the documents, other than any
bill of exchange that may have been required, to the applicant against pre-agreed
settlement terms. Often, arrangements within the documentary credit provide
for reimbursement to be obtained by the nominated bank claiming upon a third
bank (otherwise known as the reimbursing bank) or by debiting the account of
the issuing bank that is held with the nominated bank.

1.5 Generic flow chart of a documentary credit

transaction
Figure 1.1 A documentary credit under which an advising and confirming
bank is also the nominated bank

12. Takes
Delivery
10. Documents

Goods

6. Documents

7. Payment

4. Advice of Documentary Credit

5. Shipment/
Dispatch

8. Documents

2. Documentary Credit Application

Buyer (Applicant)

1. Contract

11. Settlement

Seller (Beneficiary)

9. Reimbursement
3. Documentary Credit
Advising/
Confirming Bank

Issuing Bank

Documentary Credits An Overview

1.6 Questions
1
2
3
4

What is the instrument to which the letter of credit can be historically

related?
What is the key element that acts as a prerequisite to trigger a payment in a
usual documentary credit transaction?
Name the three ICC publications/rules that act as a supplement to the UCP
600.
Can you detail the procedural steps involved in a documentary credit issued
in standard or common form?