Documentary credits,

collections and bank

guarantees
Documentary credits, collections and bank
guarantees
This book is aimed primarily at import or export companies purchase
department employees, CFOs, logistics specialists or people who draft
sales contracts and conduct related negotiations. It is also useful reading
for those wanting to reduce risks in any financial relationship (e.g. lease
contracts, purchase or sale of various rights).

The book gives an overview of documentary credits, documentary

collections and bank guarantees, describes their types, advantages,
disadvantages and possibilities of use. Therefore it is suitable for all those
who want to get acquainted with the basics of documentary payments
and guarantees.

Since the topic is very broad we have attempted to introduce the most
important aspects that you must be aware of when using documentary
payments and guarantees. On the issues not touched upon in this
publication our Documentary Payments and Guarantees Department is
always ready to assist you.

Enjoy the book!

Your Swedbank

3
 Methods of payment
In trade transactions goods move from the seller to the buyer, while money
moves from the buyer to the seller. At the time of entering into the contract
of sales it is decided how the settlements must be arranged between the
buyer and the seller. Each method of payment has its advantages and
disadvantages, depending on which party you are, the buyer or the seller.
The most common methods of payment are:

Advance payment The goods are first paid for; thereafter, the goods are shipped
The buyer has to take into account the possibility that
the seller does not ship (the right kind of) goods
the seller fails to meet the agreed deadlines
the seller goes bankrupt

Open account The goods are first shipped; thereafter, the goods are paid for
The seller has to take into account the possibility that
the buyer does not pay
the buyer fails to pay as agreed

Regardless of which of the aforementioned payment methods is used, one of the business partners
is inevitably the weaker side i.e. exposed to certain risks. If the described risks are acceptable for
the parties, everything is fine. If not, a bank as a neutral intermediary can step in with the following
methods of payment which can help better balance the risks between the parties.

Collection The goods are first shipped; thereafter, a collection order along with the
documents is submitted to the buyers bank
the buyer decides whether it wants the goods and is willing to pay for them,
but
the buyer will not receive the documents giving evidence of shipment of goods
before the buyer has agreed to pay for the goods

Documentary credit Documentary credit (= letter of credit or LC) is first issued in favour of
the seller; thereafter, the goods are shipped
the letter of credit cannot be cancelled or amended without the sellers
approval, i.e. the buyer cannot stop the trade or refuse to pay
the seller has to submit to the bank only the documents required by LC,
but
the money is not paid if the documents do not comply with the terms and
conditions of the LC

4
Regardless of which method of payment to use there is always the risk that cannot be hedged entirely
for instance, the risk of not receiving money upon settlements with an open account, the risk of the
goods not being shipped in the case of using documentary credit, etc. With a bank guarantee the bank
covers urgently and following a simple procedure expenses arising from non-performance with breach
of contracts.

Guarantee The bank will be called upon only if the parties run into problems in the course of
performance of the contract and the party receiving the guarantee wants
financial compensation.

5
Collections
Description of collection
In a collection transaction the buyers bank delivers the documents
evidencing the shipment of goods (commercial documents) to the buyer
in accordance with the collection instructions either against payment or
against acceptance. The terms and conditions of collection are established
by the seller and reflected in the collection instructions.
The role of the bank as a neutral intermediary is to introduce the terms and conditions of release of
commercial documents and payment of money. Since the buyer needs the commercial documents in
order to receive and use the goods and the seller does not want to hand them over to the buyer before
the buyer has agreed to pay, the bank as an intermediary assumes the obligation to strictly follow the
sellers instructions regarding how and when to release the documents to the buyer.

The banks obligations upon handling collection are confined to following the terms and conditions of
collection, intermediation of collection to the buyer and secure holding of commercial documents. The
bank does not assume any payment obligation the buyer must pay for the goods. If the buyer refuses
to pay because of lack of funds, or if he does not consent to collection, the seller will not be paid under
the collection process.

For the purpose of regulation and harmonisation of handling collections the International Chamber of
Commerce (ICC) has issued Publication No. 522, ICC Uniform Rules for Collections (URC 522).

7
 Collection process
1. The buyer and the seller agree on the terms and
1
conditions of the trade and that goods are paid for
2 using collection.
2. The seller ships the goods to the buyer.
3. The seller gives the documents relating to the goods
5 6 7 3 9
to its bank (= remitting bank) for collection along with
the instruction specifying the terms and conditions of
release of the documents to the buyer.
4 4. The remitting bank sends the documents by a courier
to the buyers bank (= collecting bank).
8 5. The collecting bank notifies the buyer of the received
collection and the terms and conditions thereof.
6. The buyer consents to the terms and conditions of
collection.
7. The collecting bank hands over the documents to the
buyer in accordance with the collection instructions
either against payment or acceptance.
8. Depending on the terms and conditions of collection,
the collecting bank debits the sum from the buyers
account either immediately (payment at sight) or
on the due date (deferred payment) and makes the
payment to the remitting bank.
9. The remitting bank pays the money to the seller.

8
Collection from the exporters viewpoint
Collection is a reasonable option for the seller if:
the seller trusts the country where the buyer is located (the country is economically and
politically stable);
the seller trusts the buyer;
the seller trusts the buyers solvency.

NB! The buyer can always refuse the collection order, whereas the goods have
usually been shipped to the buyer by the time of submission of the documents
for collection.

If the goods are shipped by train, airplane, truck or post the goods will usually be delivered to the
buyer without the need to present the transport document (provided the goods are consigned to the
buyer). In such cases the buyer therefore does not need the document sent for collection. Only where
the goods are shipped using marine transport and the originals of the negotiable bill of lading are sent
for collection, the buyer will not get the goods right away but will need to present the original bill of
lading.

If the buyer refuses collection, the seller may face a situation where
the goods have to be stored at the destination for a long time;
the seller has to start looking for a new buyer for the goods;
the goods have to be sold at an auction;
the goods have to be returned to the place of departure;
the goods have to be destroyed (e.g. highly perishable goods).

Some of the risks listed can be prevented by using documentary credit instead of collection.

If the buyer sends collection documents for payment, the banks retain control over the documents until
the buyer has paid the collection amount. If the documents are sent for acceptance, the buyers bank
releases them to the buyer against an undertaking to pay at maturity or acceptance of a bill of exchange
and the actual payment on the required due date depends solely on the buyers solvency.

To exert pressure on the buyer the seller may demand that the collecting bank protest the refusal to pay
or accept, which is the prerequisite for claiming payment of the money in a court in most countries and
which results in the disclosure of the party who refused to pay or accept. A protest can be filed if a bill
of exchange has been submitted to the buyer along with the collection documents (see the chapter
titled Bill of Exchange). In Estonia the procedure for protesting bills of exchange is regulated by the
Law of Obligations Act.

If the sums are big and the seller does not completely trust the buyer, the seller may prefer to use
documentary credit.

9
 Collection from the importers viewpoint
For an importer, i.e. the buyer collection involves relatively little risk and constitutes a convenient
method of settlement. In the case of collection the buyer is the one who decides over the documents
compliance or non-compliance with the contract and assumption of the payment obligation. When
refusing the collection documents the buyer can always refuse payment of the service fees relating to
the collection order.

The buyer has an opportunity to see collection documents in the bank before making a decision
regarding payment. The bank however does not have the right to hand over the collection documents
or copies made of them to the buyer before the buyer has consented to the terms and conditions of
collection.
NB! After consenting to collection the buyer must under no circumstances
pay the collection sum to the seller by a payment order! In that case the
transfer would take place outside the collection order and the bank would
be unable to release the documents to the buyer without the approval of
the consignors bank

The submitted bill of exchange can be accepted, i.e. signed in the presence of a bank employee only by a
person authorised by the buyer. Authorised persons can be people who have been specified as members
of the management board of the company in part B of the commercial register.

The seller of the goods may demand that the buyers bank provide an aval for the bill of exchange to
guarantee the payment on due date. If the buyers bank does not agree to provide an aval for the bill of
exchange, the buyer will not have the right to receive the collection documents. For further information
on provision of bill of exchange an aval see the Classification of guarantees by purpose section in the
chapter titled Bank guarantees.

10
Documentary credits
 Description and cornerstones of the
documentary credit
A documentary credit is often named credit, but also known as Letter of
Credit or just LC. In the following the term LC will be used. A bank that
issues an LC (= the issuing bank) is obligated to pay the LC amount to the
seller of the goods (= the beneficiary) if he submits to the issuing bank the
documents listed in the LC in compliance with the terms and conditions
stated in the LC.
The regulatory background for LC is defined and regulated by Publication No. 600 of the
International Chamber of Commerce (2007 edition), the Uniform Customs and Practice for
Documentary Credits (UCP 600).

The uniqueness of LC lies in the fact that not the buyer, but a neutral party (a bank) that assumes the
obligation to pay the seller for the goods. Banks are obligated by law to be transparent in their activities
and not to take too high risks, as a result of which the creditworthiness and liquidity of banks is
considered to be higher than that of other companies. Upon using the LC service, the buyer can improve
its creditworthiness and increase the sellers certainty regarding receipt of the money.

A letter of credit is irrevocable. It cannot be amended or cancelled without the sellers consent. It
gives the seller the certainty that the buyer cannot change its mind with regard to the transaction
or unilaterally amend the terms and conditions to make them more suitable for itself. The irrevocable
nature of LC influences the buyer and the issuing bank to issue such LC that does not need to be
changed or cancelled.

Although LC is usually based on a sales or another contract, it is an independent transaction and no

obligations derive from the contract to the bank which issued the LC (as well as to other banks involved
in handling the LC) even if the text of the credit refers to the contract (Article 4 of the UCP 600).

The seller certifies compliance with the terms and conditions of the LC, submitting the documents listed
in the LC to the bank. The issuing bank must honour the documents complying with the terms and
conditions, i.e. pay their value to the seller by the due date specified in the LC. Thus, banks only examine
the compliance of the documents against the terms and conditions of the LC, but they are not liable
for the goods (services) relating to the documents (Article 5 of the UCP 600).

Banks are not liable for the effectiveness of the documents either. Only the issuer of the document is
liable for it (Article 34 of UCP 600).

The buyer (= the applicant) determines the terms and conditions of the LC. The issuing bank interferes
with the establishment of the terms and conditions only if the buyers instructions are confusing or
ambiguous or do not comply with international rules and practice or if the bank is involved in financing
the transactions associated with the LC. Thus, the buyer and the seller play the greatest role in smooth
progress of the LC transaction before issuing the LC the terms and conditions of the LC have to be
negotiated thoroughly.

12
LC is a precisely regulated and harmonised banking service used throughout the world most of the
banks understand the obligations, examination of documents and other principles of LCs in the same
way. Such commercial LCs, which are not handled in accordance with the UCP rules are extremely rare
in practice.

LC process
1. The buyer and the seller agree on the terms and
1 conditions of the trade and that goods are paid for
using LC.
5
2. The buyer contacts its bank and applies for opening
an LC in favour of the seller. The bank may, but not
have to accept the application. If the bank approves
2 8 9 11 6 4
the application the buyer must give the bank collateral
acceptable to the latter.
10 3. The issuing bank drafts the LC on the basis of the
7 instructions received from the buyer and sends it
electronically (SWIFT message) to the sellers bank
3
(= the advising bank). SWIFT (= The Society for
Worldwide Interbank Financial Telecommunication)
is a member-owned cooperative through which the
financial world conducts its business operations.
4. The advising bank verifies the authenticity of the LC
and advises the seller of the received LC.
5. The seller examines the text of the LC and makes
certain that it complies with the agreement made with
the buyer of the goods. Thereafter the seller ships the
goods to the buyer.
6. The seller presents the documents requested in the LC,
which certify that the seller has fulfilled all the terms
and conditions of the LC to its bank. The sellers bank
may guide the seller in interpretation of the terms and
conditions and issuance of the documents.
7. The sellers bank forwards the documents to the
issuing bank. Thereafter the issuing bank examines the
documents within five working days and decides if
they comply with the terms and conditions of the LC.
8. If the documents comply with the terms and
conditions of the LC, the issuing bank will confirm
acceptance of the documents to the sellers bank
and release the documents to the buyer. With an LC
payable at sight the issuing bank pays the amount
of the LC to the seller (through the sellers bank)
immediately. The buyers consent to the given
operations is not required.
9. The buyer pays the issuing bank the amount paid.
10. The advising bank pays the seller the money after the
payment has accrued.

13
 Why use LC and when?
Being a very flexible payment instrument, LC offers various opportunities
for reduction of risk and spreading it between partners. LC can be compared
to the work of a tailor: the parties get the result that fits their needs.
LC can be used if:
the buyer and the seller do not know each other well enough the other party is unfamiliar, the
cooperation experience is short-term and the trust is little;
one party or both parties are located in an economically or politically unstable country (region);
the legislation of one or another country requires the use of the LC;
the goods constitute a special order or are very specific;
the goods are price-sensitive;
if the buyer or intermediary has no money of its own it can carry out the transaction only by using
the LC;
in the case of deferred payment transactions the LC is suitable for reducing the payment risk and,
where necessary, quicker receipt of the money.

In international business transactions you need to take into account different laws and customs, foreign
exchange risks, foreign government or central bank regulations and decrees, trade embargos and black
lists. Many of these risks can be prevented or reduced by using LCs.
If necessary, LC can be combined with guarantees, invoice discounting,
factoring, etc. If you have little or no experience in using LCs it is wise
to consult a bank before entering into a trade agreement.

14
LC payment methods
LC must specify how it is available: by sight payment, deferred payment,
acceptance or negotiation.
In the LC the issuing bank may authorise another bank (= the nominated bank) to act under the LC, e.g.
to evaluate compliance of the documents submitted by the beneficiary with the terms and conditions
of the LC and to pay the amount of the LC to the beneficiary. This bank may be the advising bank and, in
the case of freely negotiable LCs, a bank chosen by the beneficiary.

The issuing bank may choose not to give such a nomination to other banks.

Payment at sight
The value of the documents is paid to the beneficiary immediately after the documents have been
submitted to the nominated bank and the nominated bank has determined that the documents comply
with the terms and conditions of the LC.

Example: The nominated bank receives the documents Monday, May 2.

On May 5 the bank decides, after examining the documents, that they
comply with the terms and conditions of the LC and makes the payment
value date Monday, May 9.

Usually, the issuing bank pays the nominated bank before having the possibility to examine documents
compliance with the terms and conditions of the LC. Therefore the issuing bank must trust the
nominated bank and its ability to evaluate the compliance of the documents with the terms and
conditions of the LC as well as its ability to return the funds should the documents be refused due to
valid discrepancies.

Deferred payment
The value of the documents is not paid to the beneficiary immediately after presentation of the
documents, but on the date calculated pursuant to the formula specified in the LC.

One of the most common methods of calculation of the due date is the one whereby the agreed period
in days is added to the date of shipment of the goods or to the date of presentation of the documents to
the bank. This way the applicant can defer payment for the goods purchased by the LC until the money
from the resale of the goods is received.

Example: The LC is payable 60 days after loading the goods on board the ship.
The nominated bank receives the documents on May 2. On May 5 the bank
decides, after examining the documents, that they comply with the terms and
conditions of the LC. According to the bill of lading the goods were loaded on
board April 12. The bank is obligated to pay the beneficiary on June 11.

15
 Negotiation
In the case of negotiation the nominated bank pays (or promises to pay) the beneficiary the value of the
documents (or the bill of exchange) before it receives money from the issuing bank.

Example: The LC is payable by negotiation at sight in the sellers bank. The

sellers bank receives the documents on May 2. On May 5 the bank decides, after
examining the documents, that they comply with the terms and conditions of
the LC. The bank agrees to negotiate and pays the money to the beneficiary on
the same date. By mutual agreement the negotiating bank pays the beneficiary
the document amount less interest charged for two weeks. The money accrues
from the issuing bank to the negotiating bank on May 16.

The nominated bank is not obligated to negotiate. Its activities depend on how certain it is in the issuing
bank and the beneficiary. If the nominated bank negotiates the documents, it does so with the right to
claim the money back (right of recourse), i.e. the bank which negotiated the documents can reclaim
the paid sums from the beneficiary if the issuing bank does not pay for some reason. The issuing or
confirming bank does not have the right of recourse (see the chapter titled Confirmed LCs).

Unlike other methods of payment, in case of freely negotiable LCs any bank may be chosen by the
beneficiary (except the issuing bank) as a nominated bank to negotiate. Obviously, the circle of banks
nominated to negotiate can be limited in the terms and conditions of the LC, e.g. to the banks of the
country of location of the beneficiary or a specific bank.

In the case of negotiation the banks usually charge interest on the period that remains between
negotiation and the receipt of money from the issuing bank.

Acceptance
It is a traditional form of deferred payment LCs whereby the beneficiary must, along with other
documents specified in the LC, submit a bill of exchange whose due date is calculated pursuant to the
terms and conditions of the LC.

If the documents presented by the beneficiary are in compliance with the terms and conditions of the
LC, the issuing bank or the nominated bank accepts the bill of exchange, thus undertaking to pay the
amount of the bill of exchange on the due date. If the beneficiary wants to receive money right away, it
can sell the bill of exchange with a discount.

NB! Banks make the LC available in the other bank if

a) the applicant or the beneficiary has requested it;
b) the LC has to be confirmed by the other bank;
c) the LC has to be transferable in another bank;
d) the issuing bank trusts the nominated bank;
e) in the region or country where the seller of the goods is located it is common
practice to use freely negotiable LCs for the purpose of financing.
.

16
Types of LC
Confirmed LC
If the LC has been confirmed, the confirming bank undertakes, in addition to
the issuing bank, to pay for the complying documents.
Sellers who want to avoid the possible political or other risks of the issuing bank or its country of
location should always ask for the confirmation of the LC. Confirmation of the LC also helps to obtain
settlements faster and more conveniently after receiving the payment from the confirming bank the
transaction is over for the seller. Possible disputes between the issuing and confirming bank are no
longer its concern.
NB! The bank is not obligated to confirm the LC. Before asking the buyer
for a confirmed LC the seller should always ask the bank about the possibility
of confirmation.

Transferable LC
A transferable LC gives the intermediary the opportunity to apply to the nominated bank for the
transfer of the LC for the benefit of its supplier. Thus, the intermediary buys the goods using the same
LC that it resells to the buyer.

NB! The seller of the goods (supplier) knows that it deals with an intermediary!

The transferable LC allows for intermediating major goods transactions without making any
investments. The supplier (= the second beneficiary) has to fulfil the terms and conditions of the LC and
submit the documents. The intermediary (= the first beneficiary) replaces only the invoice and bill of
exchange of the second beneficiary (higher by its commission/profit) upon the arrival of the documents
at the transferring bank.

If the terms and conditions of the LC allow for partial consignments, the LC can be transferred to several
second beneficiaries (to the extent of the initial amount or quantity of goods).

If the intermediary would like to build up a transaction using a transferable LC, it must keep in mind that
upon transfer of the LC the terms and conditions of the LC must not be changed, except the
latest shipment date, the validity and the period for presentation of documents (all may be
curtailed) and the amount and the unit price (both may be reduced);
all the documents listed in the letter of credit (incl. transport documents) must be submitted
by the second beneficiary (the first beneficiary may only substitute its own invoice and bill of
exchange for those of the second beneficiary). Therefore, the terms and conditions of the LC
must specify the shipment of the goods directly from the supplier to the buyer.

NB! The LC may be transferred only if it specifically states to be transferable.

This will normally be based on an indication to this effect in the LC application
issued by the buyer.

17
 In the transfer application the intermediary should shorten the period of submission of the documents
and the validity of the LC in such a manner that upon arrival of the documents to the transferring bank
the intermediary would be able to replace the invoice and the bill of exchange submitted by the supplier.

The use of transferable LCs is regulated by an article 38 in the UCP 600.

Back-to-back LC
The bank opens a back-to-back LC at the request of the intermediary in favour of the supplier. This form
of LC is based on and secured by another LC (= the master credit) opened by the buyer in favour of the
intermediary. Unlike the transferable LC, the master credit and the back-to-back LC are two legally
independent LCs, although both are meant for the same transaction.

To reduce the risks banks usually demand that the intermediary provide additional collateral for issuing
such LC.

Since the back-to-back LC formally are two legally independent LCs the back-to-back LC is not
mentioned in the UCP 600.

Revolving LC
In the case of a revolving LC the conditions of the LC are renewed periodically or after a certain event
and the seller of goods can ship another consignment in the amount and on the terms and conditions of
the LC. Since the terms and conditions of the LC are exactly the same in the case of each consignment,
the revolving LC is suitable only in the case of regular consignments which have exactly the same terms.

Red clause LC
LCs of this type allow the seller to receive advance payment before fulfilment of all the terms and
conditions (for acquisition or production of goods, coverage of transportation expenses, etc.). Usually,
to receive such an advance payment some document, for instance, a certificate stating that the goods
complying with the terms and conditions of the LC are in the port or at the storage site (if the advance
payment is necessary for financing transportation) must be submitted. In such an event the seller
receives the remaining amount after shipping the goods to the buyer and submitting all the documents
listed in the LC, including the transport document.

Standby letter of credit

A standby letter of credit is, in essence, a guarantee. This means that the beneficiary demands money
only if the applicant fails to perform its obligation, e.g. does not pay for the goods if the applicant is the
buyer.

The list of documents of such a letter of credit usually contains only a copy of the invoice unpaid by the
buyer and the sellers claim to the bank for payment of the amount of the letter of credit. Transport
documents are rarely requested.

More information on standby letters of credit can be found in the section on guarantees.
18
Trade agreement between the buyer and
the seller
To make the transaction a success and to avoid wasting time and money
on amendment of the terms and conditions the buyer and the seller should
agree on the terms and conditions of the LC in as great detail as possible
before issuance of the LC and preferably set them out in a trade agreement
binding upon both of them.
The recommended list of terms and conditions that are important from the point of view of the LC is as
follows:
description of the goods as long as necessary, but as short as possible (e.g. blue mens socks as
specified in Order No. 123);
quantity of the goods either exact (e.g. 1,250) or more vague (e.g. 1,000 kg +/5%);
price of the goods;
other essential parameters of the goods, which have to be specified in the LC (e.g. highly
perishable goods must be transported in a refrigerated container);
deadlines for shipping the goods and other activities;
means of transport and places of loading and unloading;
delivery terms (e.g. CIF Tallinn, Incoterms 2000);
time of payment for the goods, i.e. whether the documents of the LC are paid for
immediately after their presentation to the bank or the seller gives the buyer some
time to make the payment (e.g. the due date is 90 days after the date of invoicing);
list of the documents of the LC, i.e. these documents that certify the fulfilment of
the terms and conditions of the agreement those needed by the buyer in order to
obtain and clear the goods;
special type of the LC, i.e. whether the LC has to be confirmed or transferable;
the bank to advise the seller of the LC once issued
usually the sellers bank;
the bank (if any) to be nominated to act under the LC,
e.g. to pay the beneficiary.

Depending on the characteristics of the

specific trade it may be necessary to specify
other terms and conditions in the agreement.
If you have little or no experience in using LC-s
and/or transaction complex, it is strongly
advisable to consult a bank before enetring
into the trade agreement.

19
 LC from the buyers viewpoint
In LC settlements the bank pays the LC amount to the seller only if the seller
submits to the bank the document required in the LC and these documents
are in full compliance with the terms and conditions of the LC.
The buyer determines the terms and conditions of the LC. Thus, the LC allows the buyer to dictate
what goods have to be shipped, in what quantity they have to be, and when and where they have to
be shipped. If the terms and conditions (e.g. the price, quantities) have been fixed once they cannot be
amended unilaterally and the beneficiary interested in the sale must fulfil them exactly in order to get
the money.

NB! The seller does not have to use LC! If the seller does not agree with the
terms and conditions and does not ship the goods, the buyers expenses on
the LC may prove to be worthless.

The usage of LC may give the buyer the opportunity to negotiate a lower price, because the closure of
the transaction and receipt of the money are guaranteed to the seller by the issuing bank. LC also allows
the buyer to manage cash flow more flexibly, because upon agreement with the bank the buyer can
postpone its obligation to pay the amount of the LC to the bank to a time that is more suitable for the
buyer.

However, the buyer must take into account that

the banks approval of LC application takes time and requires collateral
the buyer cannot unilaterally cancel the LC or amend the terms and conditions thereof
the LC service is expensive and in any event the buyer is (ultimately) responsible for payment of
all service fees

If the banks involved in the LC settlements do not receive their service fees from the seller for some
reasons regardless of the fact that the terms and conditions of the LC so demand, the issuing bank (and
thereby the buyer) will be liable for payment of all the respective service fees (Article 37(c)).

the payment is made on the basis of the right documents, not the goods

It is important to remember that if the seller submits the documents complying with the terms and
conditions of the LC, the issuing bank will be obligated to pay the amount of the LC to the seller. Thus,
the buyer is obligated to compensate the issuing bank for such payment regardless of whether the
goods shipped or the service provided by the seller complies with the agreement or the expectations of
the applicant or whether the goods have been shipped in compliance with the submitted documents.

upon making the payment decision, the bank will not take into account the terms and conditions
which have not been stipulated in the LC

20
The bank verifies the fulfilment of only those terms and conditions which have been stipulated in the LC
and the fulfilment of which has been certified by the required documents. The bank does not take into
account the fulfilment or non-fulfilment of other terms and conditions (e.g. the terms and conditions of
the trade agreement) and/or other documents.

shipped goods may not comply with the documents submitted

NB! Bank employees cannot be experts in a single chapter of goods or branch

of industry, but are merely LC specialists.

Banks verify the compliance of the documents based on the terms and conditions of the LC, not
the compliance of the goods against the agreement, the standards of the industry, etc. It is the
issuers of the documents (not the banks) that are liable for the correctness of the data contained in the
documents.
If the goods do not meet the expectations, they are not shipped or they are shipped later or otherwise
in conflict with the transport documents, complaints should not be addressed to the bank but the seller
and/or the carrier who has issued the documents.

fraud cannot be precluded entirely

The banks are not liable if the documents which seem to comply with the terms and conditions of the LC
prove to be forged later on. The buyer of the goods itself has to learn to know the other party to the
agreement before it trusts the party!

LC from the sellers viewpoint

For the seller LC gives clarity and certainty about the activities required
for receiving the money and the time of payment: if the seller fulfils the LC
terms and conditions, the issuing bank must pay the money in accordance
with the LC terms.
The main advantage for the seller is the replacement of the buyers payment risk with the
banks payment obligation. Banks better liquidity and the need to retain their international
reputation ensure that they usually perform their obligations accurately.

Secondly, LC is an irrevocable payment obligation of the bank. If the buyer changes its mind after
LC is issued, the buyer and the issuing bank cannot unilaterally amend or cancel the fixed terms
and conditions (e.g. deadlines, quantities) without the sellers consent.

21
 The banks payment obligation can be made even more certain through confirmation. If the seller
cannot evaluate the issuing bank located in another country the seller may demand that the
LC be confirmed by a bank that the seller is more familiar with. In the case of confirmed LC the
confirming bank, in addition to the issuing bank, assumes the irrevocable obligation to pay the
value of the documents complying with the terms and conditions of the LC to the beneficiary. The
seller can consider the transaction completed right after the submission of the documents to the
confirming bank and receipt of the payment or the promise of payment from the bank. Possible
later disputes between the confirming and issuing bank are none of the sellers concern.

The seller can plan the time of accrual of the money exactly. In the UCP and/or international
banking practice there are time standards for examination of documents and making payments,
which banks must follow.

LC allows for better management of cash flow by discounting deferred payments the sellers
bank, using the good name and reputation of the issuing bank as the collateral, pays the seller the
value of the documents along with reasonable interest before the due date of the LC. The seller
should check already before issuing the LC whether its bank agrees to take the risk of the issuing
bank, i.e. to discount the accrual of the LC.

In countries where the government strictly controls import LC is often the only way of getting the
business deal through.

NB! The mere fact that a bank has decided to issue an LC can be considered an
indirect confirmation of the buyers trustworthiness. Banks do not issue LCs
for clients who are not trusted or whose solvency is in doubt.

In addition to many good qualities the seller has to take into account that

the LC service may be considered expensive (at least when compared to other payment
instruments like collections), because the compilation of each LC, considering the terms and
conditions, clarity and unambiguity of the transaction and the international practice, calls
for manual work by specialists such as later handling of documents and verification of their
compliance with the terms and conditions of the LC and the requirements of UCP 600;

The time limits of the LC must be adhered to (e.g. time limits for shipping goods, presentation
of documents, etc.). If the seller exceeds the limits even by one day, the seller loses the right to
receive money from the bank;

formalisation of sales documents is a daily and routine activity for companies, which usually
does not take much time, but formalisation of the documents of LC may well be much more
labour-intense;

the buyer is the one on whose instructions LC is opened. The seller cannot make any amendments
to the LC but refuse the LC and/or negotiate with the buyer;

banks go bankrupt as well (when replacing the buyers payment risk with the payment obligation
of a bank the beneficiary must of course carefully consider that risk as well).

22
Evaluation of terms and conditions of LC
The seller is interested in receiving in a timely manner the payment for
fulfilment of the terms and conditions of the agreement made with the
buyer. The amount of the LC is paid to the seller if the seller fulfils the
terms and conditions specified in the LC (submits the documents). Thus,
for the seller it is very important to review the terms and conditions of the
LC before shipping the goods.
When evaluating the terms and conditions of an LC the seller has to reply at least to the following
questions Yes:
Has the LC been opened or confirmed by the bank that the seller knows and trusts?
Are all the names and addresses correct?
Are the following terms and conditions in compliance with the agreement made with the buyer:
amount and currency of the LC
place and date of expiry
place and manner of payment
all deadlines
description, quantity and price of the goods
delivery terms
payment for bank services

Can the terms and conditions described in the LC for inspection, packaging, transportation, etc.,
be fulfilled?
Can the documents be submitted in the format required by the LC?
Can the documents be certified, attested and legalised in accordance with the requirements?
Can the required transport document and an insurance document be issued according to the terms
and conditions of the LC?

NB! If necessary, consult the carrier and the insurer regarding these issues.

Are the remaining terms and conditions of the LC understandable and can they be fulfilled?
Is the LC issued subject to the rules of UCP 600?

If the LC does not meet the sellers expectation or some condition cannot be fulfilled, the buyer must be
contacted and asked for amendments.

23
 Preparation and presentation of documents
for payment
The seller certifies fulfilment of LC terms and conditions and its right to
the amount of the LC, presenting the documents listed in the LC to the
nominated bank. The nominated bank examines the compliance of the
documents very carefully.
If the seller has submitted documents that seem to contain even minor differences compared to the
terms and conditions of the LC, the issuing (or confirming) bank may refuse to pay, as their payment
obligation is depending on all the terms and conditions of the LC being complied with Banks check the
compliance of the documents with:
terms and conditions of the LC,
requirements of UCP 600,
principles of the international standard banking practice.

NB! There is publication titled International Standard Banking

Practice for the Examination of Documents under Documentary
Credits 2007 Revision for UCP 600 (hereinafter ISBP). The
ISBP can be explained as an official interpretation of the practical
application of the UCP 600. It collects a number of acknowledged
practices within the documentary credit area. The ISBP focuses
mainly on the examination of the documents, and its approach is
very practical ISBP contains, among other things, more detailed
requirements for preparation of the following documents:

Invoice;
Bill of exchange;
Transport documents:
- Multimodal Transport Document
- Bill of Lading
- Charter Party Bill of Lading
- Air waybill
- Road, Rail or Inland Waterway Transport documents;
Insurance documents;
Certificate of origin.

The data in a document need not be identical to, but must not conflict with the data given in other
documents or the terms and conditions of the LC.

Example: The weight of the goods can be shown as 910 kg or 0.91 tons. If in one
place the weight is 910 kg and in another it is 0.9 tons, it is considered to be in
conflict.

24
Before submitting the documents to the nominated bank you should make certain that
the LC has not expired and that the presentation made is within the given deadline (the default
rule is that presentation must be made no later than 21 calendar days after the date of shipment);
the goods have been dispatched within the term permitted in the LC;
the presentation contains the required number of originals and copies of the documents.

NB! At least one original of each required document must be presented.

If the LC in describing how many copies of each document are required, uses
expressions like folds, duplicates, triplicates, then at least one of those copies
must be original, and the remaining may be copies.

the documents have been duly signed, certified, legalised, etc.;

the corrections or amendments made to the documents have been confirmed by the signature of
the issuer;
the data in the documents is in compliance with the data given in the terms and conditions of
the LC and other documents: names, addresses, description of goods, quantities, prices, weight,
volume, notations, etc.;
all such documents, which confirm or certify something have been confirmed by the signature
of the issuer and bear the date of issue;
the documents are in the language in which the LC has been issued or in the language required
in the LC.

Usually, only English language documents are accepted. If a document cannot be made in
English, it must be agreed upon entry into the trade agreement that documents in Estonian,
Russian, etc., are permitted in the LC.

Bill of exchange
A bill of exchange is a document whose issuer (drawer ) claims the amount of the bill of exchange from
the payer of the bill of exchange, (drawee ). A bill of exchange (unlike other documents required in LCs) is
a financial document. you cannot find any connection with the trade or the reason for payment on a bill
of exchange.

A bill of exchange must be presented if LC is payable by negotiation or acceptance. In that case the
LC specifies the requirement of submission of a bill of exchange (field 42C in SWIFT message MT700
of issuing LCs, hereinafter MT700/42C) and the bank that is the drawee (MT700/42A) usually the
issuing or confirming bank.

Often the issuing bank (especially if it is a British bank or former British colony bank) demands a
bill of exchange also in the case of sight payment and although the bill of exchange does not have
any practical meaning in such an event, its submission is necessary for fulfilment of the terms and
conditions of the LC.

25
 A bill of exchange must be signed by the issuer and contain the following data:
it must mention that it is a bill of exchange in the language in which the bill of exchange is issued,
usually draft or bill of exchange;
traditional wording pay the order of ... [name of the beneficiary].

It is necessary that the person indicated as the drawer has assigned the payment to the
intermediary on the reverse side of the bill of exchange, confirming it with their signature,
i.e. specifically to ones own bank (e.g. pay Swedbank) or without specifying the bank (e.g.
pay the submitter of the bill of exchange);

the payer, i.e. the drawee the bank required in the LC;
the issuer of the bill of exchange, i.e. the name and address of the beneficiary exactly in the same
format as in the LC;
the due date in accordance with the terms and conditions of the LC:

at sight in the case of payment at sight or negotiation,

at ... days sight, if the payment is to be made...days after presentation of the documents,
fixed date if the payment is madedays after the date of issue of the transport
document (or another document);

the place and date of issue;

whether it is a sole bill of exchange or, if the bill of exchange has been issued in duplicate, the first
copy or the second copy (two equal copies have to be issued if the issuing bank requires it; only
one is paid);
the amount in numbers;
the amount in words;
the place of payment;
the number of the LC and the issuing bank if the LC demanded showing it on the bill of exchange
(or in all documents).

BILL OF EXCHANGE Place/date of issue: Paikuse, May 07, 2008

At sight please pay against this sole Bill of Exchange

to the order of ourselves the amount of GBP 49.701,50

British Pounds Forty Nine Thousand Seven Hundred One and 50/100

Drawee: Barclays Bank Plc Drawer: O Tipp-Topp

London Paikuse Rural Municipality
Estonia

Payable in Barclays Bank Plc, London

Drawn under Documentary Credit No. BMDC4586221
of Barclays Bank Plc, London

26
 A bill of exchange must be signed by the issuer and contain the following data:
it must mention that it is a bill of exchange in the language in which the bill of exchange is issued,
usually draft or bill of exchange;
traditional wording pay the order of ... [name of the beneficiary].

It is necessary that the person indicated as the drawer has assigned the payment to the
intermediary on the reverse side of the bill of exchange, confirming it with their signature,
i.e. specifically to ones own bank (e.g. pay Swedbank) or without specifying the bank (e.g.
pay the submitter of the bill of exchange);

the payer, i.e. the drawee the bank required in the LC;
the issuer of the bill of exchange, i.e. the name and address of the beneficiary exactly in the same
format as in the LC;
the due date in accordance with the terms and conditions of the LC:

at sight in the case of payment at sight or negotiation,

at ... days sight, if the payment is to be made...days after presentation of the documents,
fixed date if the payment is madedays after the date of issue of the transport
document (or another document);

the place and date of issue;

whether it is a sole bill of exchange or, if the bill of exchange has been issued in duplicate, the first
copy or the second copy (two equal copies have to be issued if the issuing bank requires it; only
one is paid);
the amount in numbers;
the amount in words;
the place of payment;
the number of the LC and the issuing bank if the LC demanded showing it on the bill of exchange
(or in all documents).

BILL OF EXCHANGE Place/date of issue: Paikuse, May 07, 2008

At sight please pay against this sole Bill of Exchange

to the order of ourselves the amount of GBP 49.701,50

British Pounds Forty Nine Thousand Seven Hundred One and 50/100

Drawee: Barclays Bank Plc Drawer: O Tipp-Topp

London Paikuse Rural Municipality
Estonia

Payable in Barclays Bank Plc, London

Drawn under Documentary Credit No. BMDC4586221
of Barclays Bank Plc, London

26
 A bill of exchange must be signed by the issuer and contain the following data:
it must mention that it is a bill of exchange in the language in which the bill of exchange is issued,
usually draft or bill of exchange;
traditional wording pay the order of ... [name of the beneficiary].

It is necessary that the person indicated as the drawer has assigned the payment to the
intermediary on the reverse side of the bill of exchange, confirming it with their signature,
i.e. specifically to ones own bank (e.g. pay Swedbank) or without specifying the bank (e.g.
pay the submitter of the bill of exchange);

the payer, i.e. the drawee the bank required in the LC;
the issuer of the bill of exchange, i.e. the name and address of the beneficiary exactly in the same
format as in the LC;
the due date in accordance with the terms and conditions of the LC:

at sight in the case of payment at sight or negotiation,

at ... days sight, if the payment is to be made...days after presentation of the documents,
fixed date if the payment is madedays after the date of issue of the transport
document (or another document);

the place and date of issue;

whether it is a sole bill of exchange or, if the bill of exchange has been issued in duplicate, the first
copy or the second copy (two equal copies have to be issued if the issuing bank requires it; only
one is paid);
the amount in numbers;
the amount in words;
the place of payment;
the number of the LC and the issuing bank if the LC demanded showing it on the bill of exchange
(or in all documents).

BILL OF EXCHANGE Place/date of issue: Paikuse, May 07, 2008

At sight please pay against this sole Bill of Exchange

to the order of ourselves the amount of GBP 49.701,50

British Pounds Forty Nine Thousand Seven Hundred One and 50/100

Drawee: Barclays Bank Plc Drawer: O Tipp-Topp

London Paikuse Rural Municipality
Estonia

Payable in Barclays Bank Plc, London

Drawn under Documentary Credit No. BMDC4586221
of Barclays Bank Plc, London

26
 A bill of exchange must be signed by the issuer and contain the following data:
it must mention that it is a bill of exchange in the language in which the bill of exchange is issued,
usually draft or bill of exchange;
traditional wording pay the order of ... [name of the beneficiary].

It is necessary that the person indicated as the drawer has assigned the payment to the
intermediary on the reverse side of the bill of exchange, confirming it with their signature,
i.e. specifically to ones own bank (e.g. pay Swedbank) or without specifying the bank (e.g.
pay the submitter of the bill of exchange);

the payer, i.e. the drawee the bank required in the LC;
the issuer of the bill of exchange, i.e. the name and address of the beneficiary exactly in the same
format as in the LC;
the due date in accordance with the terms and conditions of the LC:

at sight in the case of payment at sight or negotiation,

at ... days sight, if the payment is to be made...days after presentation of the documents,
fixed date if the payment is madedays after the date of issue of the transport
document (or another document);

the place and date of issue;

whether it is a sole bill of exchange or, if the bill of exchange has been issued in duplicate, the first
copy or the second copy (two equal copies have to be issued if the issuing bank requires it; only
one is paid);
the amount in numbers;
the amount in words;
the place of payment;
the number of the LC and the issuing bank if the LC demanded showing it on the bill of exchange
(or in all documents).

BILL OF EXCHANGE Place/date of issue: Paikuse, May 07, 2008

At sight please pay against this sole Bill of Exchange

to the order of ourselves the amount of GBP 49.701,50

British Pounds Forty Nine Thousand Seven Hundred One and 50/100

Drawee: Barclays Bank Plc Drawer: O Tipp-Topp

London Paikuse Rural Municipality
Estonia

Payable in Barclays Bank Plc, London

Drawn under Documentary Credit No. BMDC4586221
of Barclays Bank Plc, London

26
Invoice
For the invoice it is important that
it has been issued by the seller (the beneficiary). The sellers name must be exactly in the same
form as specified in the LC (MT700/59); the sellers location (address) must be in the country
specified in the LC;
it contains the signature of the seller if a signed invoice has been required in the LC;
it has been issued to the buyer (the applicant), whereby the buyers name must be in the form
specified in the LC (MT700/50), the buyers location must be in the country specified in the LC;
the description of the goods (MT700/45A) must comply with the LC exactly, whereby the invoice
must reflect the goods actually sent, the actual quantity and the actual price.
Additions are permitted if they are not in conflict with the terms and conditions of the LC.

Example: Goods can be sent in batches and the description of goods in the LC is
as follows: 5555 pairs of blue mens socks and 6666 pairs of red womens
socks. In the first batch only goods of the first variety are sent and their
quantity is smaller than the total quantity specified in the order. A sufficient
description on the invoice is: 4444 pairs of blue mens socks.

the delivery terms are in accordance with the terms and conditions of the LC, whereby the total
amount of the invoice must contain transport and insurance fees (if any) in accordance with the
delivery terms;
the total amount and the unit price of the goods are in accordance with the terms and conditions
of the LC and the goods actually sent;
all other data (numbers, weight, notations, etc.) are in accordance with (and not in conflict with)
the terms and conditions of the LC and the documents required in the LC;
the permitted quantity of the goods has not been exceeded and other goods which have not been
listed in the LC have not been sent.

Example: Free samples or advertising materials added to the goods free of

charge must not appear from the invoice (unless called for by the LC).

Combined transport bill of lading

Transport is considered multimodal or combined if it involved at least two modes of transport (e.g. road
and maritime transport).

The most common multimodal transport document is the multimodal or combined transport bill of
lading which grants title to the goods. Unless otherwise required in the LC, all originals issued must be
submitted to the bank.

The following must be specified in the document:

the shippers name (the shipper does not have to be the beneficiary of the LC);
the carriers name and identification that it is the carrier of the goods (e.g. carrier: ABC Shipping
Inc.);

27
 the name and signature of the issuer of the document, whereby the issuer must identify himself
or herself next to the signature as:
the carrier of the goods or
the captain of the vessel (master) or
o the agent of the carrier or master (e.g. XYZ Ltd. as agents for the carrier ABC Shipping
Inc.);

NB! If the masters signature is identified as master (captain) or if the

agent is signing on behalf of the master, then the name of the master
need not be stated.

the place of loading and unloading in full conformity with the terms and conditions of the LC;
the consignee in full conformity with the LC; depending on the terms and conditions of the LC,
the following must be specified in the document with regard to the consignee:
name, or
to order of [name] if the given consignee must have the opportunity to assign the title to
the goods, or
to order (without name) if the shipper assigns the title to the goods to the person
submitting the document confirming the title to the goods on the reverse of the bill of
lading (endorsement);

the carriers notation regarding acceptance of the goods for carriage or notation on
board and the date of acceptance for carriage or loading on board (the notation regarding
acceptance for carriage or loading on board may be pre-printed on the document form in that
case the date of issue of the document is enough);
the date of issue of the document;
a notation about payment of the carriage charges in accordance with the delivery terms
specified in the LC: freight prepaid, if the seller pays the carriage charges (CIF, CFR, etc.), freight
collect, if the buyer has to pay the carriage charges (FAS, FOB, FCA, etc.);
the terms and conditions of the carriage contract or a reference to their existence in other
sources (banks examine the existence of the terms and conditions of the carriage contract, not
their content).

The following must not appear from the document:

The goods have been sent using only one type of transport;
the goods have been loaded on the deck of the vessel;
the goods have been or the packaging has been damaged (i.e. the bill of lading contains respective
notations);
that the document has been issued subject to a charter party.

28
Marine/Ocean bill of lading
A bill of lading is a transport document used in the case of maritime transport, which involves the title
to the goods (the consignee must submit the original of the bill of lading to the carrier in order to receive
the goods). Unless otherwise required in the LC, all originals of the bill of lading must be submitted to
the bank (usually three).
 The following must be specified in the bill of lading:
the shippers name (the shipper does not have to be the beneficiary of the LC);
the carriers name and confirmation that it is the carrier of the goods (e.g. carrier: ABC Shipping
Inc.);
the name and signature of the issuer of the bill of lading, whereby the issuer must identify himself
or herself next to the signature as:
the carrier of the goods or
the captain of the vessel (master) or
the agent of the carrier or master (e.g. XYZ Ltd. as agents for the carrier ABC Shipping Inc.);

NB! If the masters signature is identified as master (captain) or if the

agent is signing on behalf of the master, then the name of the master
need not be stated.

the port of loading and unloading in full conformity with the terms and conditions of the LC;
the consignee in full conformity with the LC; depending on the terms and conditions of the LC,
the following must be specified in the bill of lading with regard to the consignee:
name, or
to order of [name] if the given consignee must have the opportunity to assign the title to
the goods, or
to order (without name) if the shipper assigns the title to the goods to the person
submitting the document confirming the title to the goods on the reverse of the bill of
lading (endorsement);

the assignment of the title to the goods (endorsement), if required in the LC; the endorsement
may be:
to the named party (endorsed to [name]), or
blank endorsed;

the name of the vessel;

notation on board and the date of loading the goods on board (the notation regarding loading
on board may be pre-printed on the form of the bill of lading in that case the date of issue of the
bill of lading is enough);
The notation on board must clearly show that the goods have been loaded to the vessel in the
port of loading specified in the LC.
a notation about payment of the carriage charges in accordance with the delivery terms
specified in the LC: freight prepaid, if the seller pays the carriage charges (CIF, CFR, etc.), freight
collect, if the buyer has to pay the carriage charges (FAS, FOB, FCA, etc.);
in the case of container transport the number(s) of the container(s);
the terms and conditions of the carriage contract or a reference to their existence in other
sources (banks examine the existence of the terms and conditions of the carriage contract, not
their content).

The following must not appear from the bill of lading:

that the goods have been loaded on the deck of the vessel;
that the goods have been or the packaging has been damaged (i.e. the bill of lading contains
respective notations);
that the bill of lading is issued subject to a charter party.

NB! If the parties want to use a charter party, it must be

specified in the LC!
30
Road or rail transport document
In Europe the usual transport document in the case of international road transport is the consignment
note CMR and the copy for sender can be submitted to the bank. CMR is an abbreviation of the
Convention on the Contract for the International Carriage of Goods by Road (Geneva, 1956).

In the case of rail transport the rail transport consignment note is issued. Usually that would be a CIM
consignment note (a transport document issued subject to the 1999 Uniform Rules Concerning the
Contract of International Carriage of Goods by Rail). The duplicate thereof is submitted to the bank.

The following must be specified in the consignment note:

the shippers name (the shipper does not have to be the beneficiary of the LC);
the carriers name and identification that it is the carrier of the goods (e.g. carrier: ABC
Shipping Inc.);
the name and signature of the issuer of the consignment note, whereby the issuer must
identify himself or herself next to the signature as:
the carrier of the goods or
the agent of the carrier (e.g. XYZ Ltd. as agents for the carrier ABC Inc.).

NB! In the case of rail transport any signature or stamp of the railway company
will be accepted as evidence that the document has been signed by the carrier

the place of loading and unloading in full conformity with the terms and conditions of the LC;
the consignees name in full conformity with the LC;
the carriers notation regarding acceptance of the goods for carriage;
the date of issue of the consignment note or the date of acceptance of the goods for carriage;
a notation about payment of the carriage charges in accordance with the delivery terms
specified in the LC: freight prepaid, if the seller pays the carriage charges (CIP, CFR, etc.), freight
collect, if the buyer has to pay the carriage charges (FAS, FCA, etc.).

The consignment note must not contain any notations regarding the defective condition of the goods
or packaging.

31
 Air waybill
An air waybill is a document covering the carriage of goods by plane from one airport to another. The
original for shipper, usually original No. 3 of the air waybill remains with the seller for submission to
the bank.

The following must be specified in the waybill:

the shippers name (the shipper does not have to be the beneficiary of the LC);
the carriers name and identification that it is the carrier of the goods (e.g. carrier: ABC Shipping
Inc.);
the name and signature of the issuer of the waybill, whereby the issuer must identify himself or
herself next to the signature as:
the carrier of the goods or
the agent of the carrier (e.g. XYZ Ltd. as agents for the carrier ABC Inc.);

the airport of loading and unloading in full conformity with the terms and conditions of the LC;
the consignees name in full conformity with the LC;
the carriers notation regarding acceptance of the goods for carriage;
the date of issue of the waybill or the date of acceptance of the goods for carriage;
a notation about payment of the carriage charges in accordance with the delivery terms
specified in the LC: freight prepaid, if the seller pays the carriage charges (CIP, CFR, etc.), freight
collect, if the buyer has to pay the carriage charges (FAS, FCA, etc.);
the terms and conditions of the carriage contract or a reference to their existence in other
sources (banks verify the existence of the terms and conditions of the carriage contract, not their
content).

The waybill must not contain any notations regarding the defective condition of the goods
or packaging.

32
Insurance document
All originals of the insurance document (insurance policy or certificate) must be submitted to the bank.

The insurance document must:

be issued and signed by the insurance company, the underwriter or their agents and/or their
proxies, whereby the issuer must be identified next to the signature as:
the insurer (insurance company or underwriter), or
the agent of the insurer (e.g. ZYX Ltd. as agents for the insurance company/underwriter
CBA Inc.);
the authorised representative of the insurer (e.g. Mr. Smith as proxy for the insurance
company/underwriter CBA Inc.);

indicate the sum insured;

be in the same currency as the LC;
have entered into force not later than on the date when the goods were loaded, accepted for
carriage or shipped according to the transport document. The issue date of the document must
not be later than the date of shipment (unless it appears from the document that the insurance
cover is effective from a date not later than the date of shipment);
cover at least 110% of the CIF or CIP value of the insured goods (unless another sum insured
has been specified in the LC);
cover all the risks specified in the LC;
describe the shipment of the goods (place of departure and destination, description of the goods,
type of transport, in the case of marine/ocean transport the name of the vessel) in full conformity
with the terms and conditions of the LC and other documents;
specify that the insurance cover is valid at least starting from the place of loading the goods up to
the place of unloading the goods as specified in the LC;
show as the assured or insured (unless otherwise required in the LC):
the applicant of the LC (buyer),
the holder of the insurance document (the holder of this policy), or
someone else, if the person has assigned the LC to the applicant or the holder of the
insurance document by his or her endorsement on the reverse of the insurance document.

33
 Other documents
If the LC requires other documents such as the certificate of origin, quality certificate, packing list,
weight certificate, etc., besides the transport and insurance documents and the invoice, it must be kept
in mind in preparation of these documents that
the content of the document must comply with the requirements of the LC; if the content or
wording of the document has not been determined in the LC, it may be formulated in any manner,
provided that it is not in conflict with other required documents and seems to fulfil the function of
the document (e.g. the certificate of origin shows the country of origin of the goods, etc.);
the document must have been issued by the institution or agency specified in the LC;
if the issuer of the document has been specified vaguely in the LC (e.g. official, local, competent,
independent or other similar person or agency), the document may be issued by anyone except
the beneficiary (seller) itself;
if the LC does not specify the issuer of the document at all, the document may be issued by
anyone, including the beneficiary itself.

In the case of some documents there are restrictions with regards to the issuer or contents
of the document already in the name of the document (GSP certificate of origin, EUR 1
certificate, export licence, etc.);

the document may be issued before the date of issuing the LC, but not later than on the date
of presentation of the documents.

Documents not complying with the terms

and conditions of the LC
If the documents are discrepant they do not comply with the terms and conditions of the LC, the seller
of the goods has to choose between one or several steps:
to amend the documents not complying with the terms and conditions of the LC. It is possible only
in the following events:
there is time for re-presentation of the documents;
the documents contain formal, not material errors (e.g. if the goods have been shipped late,
you cannot change the actual date of shipment with an earlier date);

ask the issuing bank (who will in turn ask the buyer) whether acceptance of the documents as
presented would be possible;
send the documents to the issuing bank as presented and hope that the issuing bank and the
buyer of the goods consent to the payment (it is advisable to negotiate with the buyer of the
goods directly at the same time);
demand that the buyer amend the terms and conditions of the LC. At the same time you have to
take into account that making changes takes time. The buyer or the issuing bank may also refuse
amendment of the LC.

The buyer of the goods and the issuing bank make a decision about acceptance of the
discrepant presentation of documents, whereby the issuing bank has the right to refuse
payment in the case of the buyers consent. In the worst case the documents are refused
by the issuing bank and returned to the presenter without payment which effectively
34 means a refusal of the goods.
Bank guarantees
 Independent bank guarantee
An independent bank guarantee is the banks obligation to pay the
beneficiary of a guarantee an indemnity to the extent of the sum specified
in the guarantee if the beneficiary presents a correct demand.
An independent bank guarantee is not legally bound to a contract, etc., concluded by the parties and
the terms and conditions of which call for a guarantee, although factually there is a connection.

The bank cannot guarantee that the beneficiarys partner will perform its obligations. An independent
bank guarantee does not presume that the bank is the judge in disputes over performance or non-
performance of a contract there are courts or arbitration for that purpose. The bank is involved as the
guarantor in a transaction with the sole purpose of providing financial security. A bank guarantee gives
the beneficiary the security that if the agreement is not performed for any reason, the beneficiary shall
be entitled to quick monetary compensation.

Bank guarantees are actively used in national as well as international business and other activities.
Guarantees are an effective means of hedging risk for exporters and importers and other clients doing
business.

The bank issues the guarantee in favour of the beneficiary upon request of its client (= the principal)
and will make the payment, provided that the beneficiary submits the demand to the bank within the
prescribed time and all the terms and conditions of the guarantee have been fulfilled.

Bank guarantees have a documentary nature like LCs, i.e. a payment under a guarantee is made only if
the beneficiary submits to the bank the document(s) enlisted in the guarantee.

36
Using guarantees in business transactions
Business transaction involving a guarantee
I. Business transaction is concluded correctly

1
1. The buyer and seller of the goods agree that the
4 buyers bank secures the buyers obligation to
5, 6 pay for the goods with a payment guarantee
given to the seller.
2. The buyer applies to the bank for a payment
2 9 7 3 8 guarantee in favour of the seller.
3. The buyers bank gives the seller a payment
guarantee either by mail or via the sellers bank
by a SWIFT message.
4. The seller ships the goods to the buyer and
issues an invoice (and other documents
accompanying the goods) to the buyer.
5. The buyer pays for the goods by the due date
according to the invoice.
6. The buyer has performed its contractual
obligations before the seller, the seller has no
complaints against the buyer and thus the
guarantee expires without being used.

II. The buyer does not pay for the goods

If the events specified in clauses 1-4 above have occurred, but no money accrued on the due date:

7. The seller demands that the buyers bank pay the payment guarantee, presenting a written demand
to the sellers bank along with a copy of the unpaid invoice.*
8. The buyers bank examines whether the demand complies with the guarantee and if it does, pays the
requested sum to the seller immediately.**
9. The buyers bank has notified the buyer of the demand and offsets the paid amount with the buyer
when making the payment. Also, if the buyer does not have any money the buyers bank will pay the
amount of the demand to the seller in any case.

* The documents, which must be submitted in addition to the guarantee demand, must be enlisted in
the guarantee.
** The guarantee amount is paid usually within three to five working days, unless otherwise specified
in the guarantee.

37
 Laws and rules
The handling of bank guarantees is usually regulated by local laws, i.e. those
of the country of location of the bank that issued the guarantee. In Estonia
guarantees are regulated by the Law of Obligations Act.
There are also international rules which are used by agreement. In that case the guarantee must contain
a reference to such rules and the parties proceed from these rules in their guarantee operations. Local

supreme) or if the dispute over the guarantee cannot be resolved between the parties and it is referred
to court.

The most popular rules are as follows: Publication No. 758 of the International Chamber of Commerce
of 2010 (Uniform Rules for Demand Guarantees, i.e. URDG 758) a new version of it is being prepared;
International Standby Practices ISP98 made jointly by the International Chamber of Commerce and
the Institute of International Banking Law & Practice, which is the most popular in the United States.

Swedbank issued international guarantees usually in accordance with the requirements of URDG 758
and Estonian laws and national guarantees in accordance with Estonian laws.

38
Classification of guarantees by purpose
Although a bank guarantee is separate transaction from the contract signed
by the principal and beneficiary, its purpose is to ensure performance of
a specific contractual obligation. Thus, the guarantee must describe this
purpose, i.e. say what the guarantee is meant for. For instance, if the seller
is waiting for a guarantee from the buyers bank, which would secure the
buyers contractual obligation to pay for the goods, the wording of the
guarantee says so.
Upon payment of guarantee demands, banks do not ask questions about the actual performance or
non-performance of the contractual obligation. Nevertheless, the exact wording of the purpose of
the guarantee is useful for the beneficiary, principal and the guarantor: the probability of submission
of false demands decreases, because everyone can see what contract (agreement, order, etc.) and
obligation are involved.

Payment guarantee
For sellers, it is essential to reduce the payment risk of the buyer(s). For that purpose, a payment
guarantee that guarantees the seller payment for goods if the buyer has not fulfilled its payment
obligations by the due date is used. The amount of a payment guarantee is usually the value of the
goods and the due date to which a certain number of days for making a demand have been added
is the term of validity.

Bid, tender guarantee

The aim of a tender guarantee is to secure compensation to a party notifying of an invitation to tender if
the tenderer changes or cancels its tender or refuses to conclude an agreement and/or provide required
additional guarantees after having accepted the tender. The amount of a tender guarantee is set out in
the tender conditions, being usually 2-5% of the tender value. In general, tender guarantees are short-
term.

Advance payment guarantee

An advance payment guarantee ensures compensation to the payer to the extent of the advance
payment if the seller does not send the goods (or if less goods than agreed are sent) or does not provide
the service or perform other contractual obligations after having received the advance payment. The
amount of an advance payment guarantee is the amount of the advance payment and the expiry date
is usually the date of receipt of goods or provision of the service or other date or a certain number of

39
 Performance guarantee
The aim of a performance guarantee is to guarantee compensation for a party to the agreement if the
counterparty does not perform its contractual obligations (for example, delivery of goods, performance
of work, provision of services, etc.). The amount of a performance guarantee is agreed between the
parties. Usually, a performance guarantee is 5-20% of the contract value. The date of expiry of the
guarantee is the due date of performance of the obligation specified in the contract to which a certain
number of days has been added for submission of the demand.

Guarantee for warranty obligations

A guarantee for warranty obligations secures compensation to the recipient of a guarantee if any
defects appear in delivered goods, constructions, etc. The amount of a guarantee is agreed in an
agreement and the date of expiry depends on the field of activity, the object of guarantee, etc.

Aval
A bill of exchange or draft guarantees the recipient of a payment under the bill of exchange, i.e. the
drawer compensation if the payer of the bill of exchange or draft, i.e. the drawee, does not redeem the
bill of exchange or draft on the due date, i.e. does not make the payment. Both the acceptance of the
drawee and the banks aval is noted on the bill of exchange with a relevant note and signatures.

Operations of the bill of exchange are regulated by the laws of different countries. In Estonia bills of
exchange/drafts are regulated by the Law of Obligations Act.

Other guarantees
The guarantees described so far help to hedge the most common risks, but there are many other
different risks, for instance, the incorrect loan repayment risk, risk of late payment of rent, the risk of
non-payment of customs duties risk, etc., for covering of which banks issue corresponding guarantees.

40
Direct guarantees and counter-guarantees
The guarantors issue most of the guarantees directly to the beneficiaries.
Such guarantees are called direct guarantees. A direct guarantee may be
given on paper or sent electronically to the intermediating bank whose
obligations are confined to identification of the authenticity of the direct
guarantee and notification of the beneficiary of the guarantee.
In the case of a direct international guarantee the guarantor and the beneficiary are usually from
different countries. Therefore it is important for the parties to the contract to conclude an agreement on
what rules and laws the issued guarantee must comply with before the guarantee is issued.

Often exporters and importers face the demand of the foreign partner that the guarantee must be
issued by a local bank of the other party, not the principals bank. Usually, the reason for such demand
is the fact that the beneficiary does not know the bank that issued the guarantee or the respective
country well enough and does not want to risk with such bank or the laws of another country. It is also
more complicated to manage ones affairs with a bank that is not located in the home country and with
which you cannot communicate in the native language. In many countries limits have been established
to certain transactions regarding the bank issuing the guarantee, i.e. a guarantee of the bank of the
country of location of the beneficiary is required. In that case the principals bank, i.e. the foreign
bank gives a counter-guarantee to the local bank who, according to the instructions of the counter-
guarantee and on the basis thereof, issues its direct guarantee to the beneficiary. Regardless of the
type of the direct guarantee the counter-guarantees are usually payment guarantees payable on first
demand.

Example: A Latvian state agency invites an international public tender for

purchasing equipment and one of the documents to be submitted is a tender
guarantee issued by a Latvian bank. In the name of an Estonian company which
submits its tender a Latvian bank issues a direct guarantee to the Latvian state
agency, which is secured by a counter-guarantee given to the Latvian bank by
an Estonian bank.

41
 Standby letters of credit
A standby letter of credit is a special form of an independent guarantee,
which looks like LC, but is still a guarantee. The standby letter of credit was
introduced in the United States as an alternative to the guarantee which
the local banks had long been prohibited to issue.
Similarly to the guarantee the standby letter of credit is used for securing the performance of any
contractual obligations. For instance, in the case of a sales transaction the buyer pays the seller for the
shipped goods using an ordinary bank transfer outside the letter of credit. The seller submits documents
to the bank for payment only if the buyer fails to perform its obligation to pay for the goods purchased.

The difference between the standby letter of credit and the bank guarantee lies in the fact that it is
handled by different rules: either UCP 600 or ISP98 (International Standby Practices ISP98 of the
International Chamber of Commerce). The content of the obligation is the same as that of the bank
guarantee, i.e. to indemnify the party to the extent of the amount specified in the standby letter of
credit if the other party fails to perform its contractual obligations.

42
 Guarantee payment mechanism
The most common payment mechanism is payment on first demand.

In the case of the first demand guarantee, to obtain the indemnity the beneficiary does not have to
submit any other documents than
a written demand
or
a written demand and a confirmation that the principal has not fulfilled its obligations. In the
confirmation the beneficiary must indicate what contractual obligations the principal has failed
to perform.

The bank is obligated to pay the amount of the demand to the beneficiary immediately after receiving
the demand complying with the terms and conditions of the guarantee. The guarantee payable on first
demand is internationally the most common type of guarantee.

A second type of payment mechanism is where the beneficiary has to,

besides the written demand, submit other documents listed in the
guarantee attesting the non-performance of the contract.

The principal does not have to worry about the fact that the beneficiary submits the demand without
the slightest obligation to certify the foundedness of the demand. The beneficiary, in turn, knows that if
the demand and other documents complying with the terms and conditions of the guarantee have been
submitted to the bank, the bank will be obligated to make the payment.

The sub-type of the second type is guarantees, which require documents issued by an
independent third party, e.g. a tender guarantee with the requirement to submit a notary
publics certificate that the principal of the guarantee won the tender, but refused to enter into
the contract. This type of guarantee gives the principal a greater certainty against unfounded
guarantee demands.

In the case of the third type of payment mechanism along with the
presentation of a written demand the beneficiary must submit a court
judgment or arbitration award to the guarantor by which the principal has
been found guilty of a breach of the contract against the beneficiary.
Since the bank is not involved in the court dispute and the banks payment mechanism is triggered by
the submission of a claim complying with the terms and conditions of the guarantee (a court judgment
or arbitration award along with a written demand), it is nevertheless an independent guarantee. Such
guarantees may be issued pursuant to the requirements of URDG 458 or ISP98 as well.

Guarantees of the third type are used rarely.

44
Submission of demands
If the beneficiary submits a payment demand it means that the beneficiary
exercises its right under the guarantee to receive the indemnity.
Before submission of the demand the beneficiary must be convinced that
the guarantee is still valid and the beneficiary is able to send the demand documents to the
address specified in the guarantee by the right time (i.e. on or before the date of expiry);
the amount of the demand does not exceed the guarantee amountt;
the demand has been made in writing (phone call, e-mail or fax are unacceptable);
the demand refers to the guarantee number and underlying document of the transaction
(contract, order, etc.);
the demand has been signed by the authorised representative of the company;
all other documents and confirmations required in the guarantee (e.g. confirmation of the breach
of the terms and conditions of the contract) are available;
all other terms and conditions of the guarantee have been or can be fulfilled.

After receipt of the demand, the obligations of the bank that issued the guarantee are as follows:
to make certain that the demand was filed by the beneficiary. For instance, in the case of
international guarantees it is common that the guarantee contains the requirement to submit
the demand through the local bank who, in turn, has to notify the guarantor that the payment
demand was signed by the authorised representative of the beneficiary;
to verify the compliance of the payment demand with the terms and conditions of the
guarantee;
to verify the existence of other documents required in the guarantee and their compliance
with the terms and conditions of the guarantee;
to verify whether the payment demand has been submitted in a timely manner.

After the aforementioned examination and a positive result (i.e. all terms and conditions of the
guarantee have been fulfilled) the bank must pay the sum of the demand to the beneficiary.

NB! The pay or extend clause

If the beneficiary would like to extend the validity of the guarantee, it may
submit to the bank the pay or extend demand. The purpose of submitting
such a demand is not to receive indemnity for the breach of the contract, but
the desire to achieve amendment of the date of expiry of the guarantee. Only
if the guarantee is not extended, the guarantor has to pay the sum of the
demand. It is a prerequisite that that pay or extend demand comply with
the terms and conditions of the guarantee, otherwise the guarantor may
refuse to both extent and pay.

45
 Expiry of guarantees
A guarantee expires in the following events:

the date of expiry;

upon full payment of the sum of the guarantee;
upon cancellation of the guarantee.

Counter-guarantees expire upon full payment of the sum of the guarantee or cancellation of the
guarantee, but there are two dates of expiry in the case of counter-guarantees: the date of expiry of the
direct guarantee and the date of expiry of the counter-guarantee, which is usually longer than the date
of expiry of the direct guarantee (usually by 14 calendar days). Thus, the obligation of the bank which
issued the counter-guarantee and that of the principal does not expire before the date of the counter
guarantee is over and no demands were submitted during that time.

The laws of some countries do not allow for acceptance of direct and counter-guarantees with a fixed
date of expiry as a result of which the validity of such guarantees does not expire before the beneficiary
of the direct or counter-guarantee has official confirmed the cancellation or expiry of the guarantee.

46
 A bill of exchange must be signed by the issuer and contain the following data:
it must mention that it is a bill of exchange in the language in which the bill of exchange is issued,
usually draft or bill of exchange;
traditional wording pay the order of ... [name of the beneficiary].

It is necessary that the person indicated as the drawer has assigned the payment to the
intermediary on the reverse side of the bill of exchange, confirming it with their signature,
i.e. specifically to ones own bank (e.g. pay Swedbank) or without specifying the bank (e.g.
pay the submitter of the bill of exchange);

the payer, i.e. the drawee the bank required in the LC;
the issuer of the bill of exchange, i.e. the name and address of the beneficiary exactly in the same
format as in the LC;
the due date in accordance with the terms and conditions of the LC:

at sight in the case of payment at sight or negotiation,

at ... days sight, if the payment is to be made...days after presentation of the documents,
fixed date if the payment is madedays after the date of issue of the transport
document (or another document);

the place and date of issue;

whether it is a sole bill of exchange or, if the bill of exchange has been issued in duplicate, the first
copy or the second copy (two equal copies have to be issued if the issuing bank requires it; only
one is paid);
the amount in numbers;
the amount in words;
the place of payment;
the number of the LC and the issuing bank if the LC demanded showing it on the bill of exchange
(or in all documents).

BILL OF EXCHANGE Place/date of issue: Paikuse, May 07, 2008

At sight please pay against this sole Bill of Exchange

to the order of ourselves the amount of GBP 49.701,50

British Pounds Forty Nine Thousand Seven Hundred One and 50/100

Drawee: Barclays Bank Plc Drawer: O Tipp-Topp

London Paikuse Rural Municipality
Estonia

Payable in Barclays Bank Plc, London

Drawn under Documentary Credit No. BMDC4586221
of Barclays Bank Plc, London

26
 A bill of exchange must be signed by the issuer and contain the following data:
it must mention that it is a bill of exchange in the language in which the bill of exchange is issued,
usually draft or bill of exchange;
traditional wording pay the order of ... [name of the beneficiary].

It is necessary that the person indicated as the drawer has assigned the payment to the
intermediary on the reverse side of the bill of exchange, confirming it with their signature,
i.e. specifically to ones own bank (e.g. pay Swedbank) or without specifying the bank (e.g.
pay the submitter of the bill of exchange);

the payer, i.e. the drawee the bank required in the LC;
the issuer of the bill of exchange, i.e. the name and address of the beneficiary exactly in the same
format as in the LC;
the due date in accordance with the terms and conditions of the LC:

at sight in the case of payment at sight or negotiation,

at ... days sight, if the payment is to be made...days after presentation of the documents,
fixed date if the payment is madedays after the date of issue of the transport
document (or another document);

the place and date of issue;

whether it is a sole bill of exchange or, if the bill of exchange has been issued in duplicate, the first
copy or the second copy (two equal copies have to be issued if the issuing bank requires it; only
one is paid);
the amount in numbers;
the amount in words;
the place of payment;
the number of the LC and the issuing bank if the LC demanded showing it on the bill of exchange
(or in all documents).

BILL OF EXCHANGE Place/date of issue: Paikuse, May 07, 2008

At sight please pay against this sole Bill of Exchange

to the order of ourselves the amount of GBP 49.701,50

British Pounds Forty Nine Thousand Seven Hundred One and 50/100

Drawee: Barclays Bank Plc Drawer: O Tipp-Topp

London Paikuse Rural Municipality
Estonia

Payable in Barclays Bank Plc, London

Drawn under Documentary Credit No. BMDC4586221
of Barclays Bank Plc, London

26
 A bill of exchange must be signed by the issuer and contain the following data:
it must mention that it is a bill of exchange in the language in which the bill of exchange is issued,
usually draft or bill of exchange;
traditional wording pay the order of ... [name of the beneficiary].

It is necessary that the person indicated as the drawer has assigned the payment to the
intermediary on the reverse side of the bill of exchange, confirming it with their signature,
i.e. specifically to ones own bank (e.g. pay Swedbank) or without specifying the bank (e.g.
pay the submitter of the bill of exchange);

the payer, i.e. the drawee the bank required in the LC;
the issuer of the bill of exchange, i.e. the name and address of the beneficiary exactly in the same
format as in the LC;
the due date in accordance with the terms and conditions of the LC:

at sight in the case of payment at sight or negotiation,

at ... days sight, if the payment is to be made...days after presentation of the documents,
fixed date if the payment is madedays after the date of issue of the transport
document (or another document);

the place and date of issue;

whether it is a sole bill of exchange or, if the bill of exchange has been issued in duplicate, the first
copy or the second copy (two equal copies have to be issued if the issuing bank requires it; only
one is paid);
the amount in numbers;
the amount in words;
the place of payment;
the number of the LC and the issuing bank if the LC demanded showing it on the bill of exchange
(or in all documents).

BILL OF EXCHANGE Place/date of issue: Paikuse, May 07, 2008

At sight please pay against this sole Bill of Exchange

to the order of ourselves the amount of GBP 49.701,50

British Pounds Forty Nine Thousand Seven Hundred One and 50/100

Drawee: Barclays Bank Plc Drawer: O Tipp-Topp

London Paikuse Rural Municipality
Estonia

Payable in Barclays Bank Plc, London

Drawn under Documentary Credit No. BMDC4586221
of Barclays Bank Plc, London

26
 A bill of exchange must be signed by the issuer and contain the following data:
it must mention that it is a bill of exchange in the language in which the bill of exchange is issued,
usually draft or bill of exchange;
traditional wording pay the order of ... [name of the beneficiary].

It is necessary that the person indicated as the drawer has assigned the payment to the
intermediary on the reverse side of the bill of exchange, confirming it with their signature,
i.e. specifically to ones own bank (e.g. pay Swedbank) or without specifying the bank (e.g.
pay the submitter of the bill of exchange);

the payer, i.e. the drawee the bank required in the LC;
the issuer of the bill of exchange, i.e. the name and address of the beneficiary exactly in the same
format as in the LC;
the due date in accordance with the terms and conditions of the LC:

at sight in the case of payment at sight or negotiation,

at ... days sight, if the payment is to be made...days after presentation of the documents,
fixed date if the payment is madedays after the date of issue of the transport
document (or another document);

the place and date of issue;

whether it is a sole bill of exchange or, if the bill of exchange has been issued in duplicate, the first
copy or the second copy (two equal copies have to be issued if the issuing bank requires it; only
one is paid);
the amount in numbers;
the amount in words;
the place of payment;
the number of the LC and the issuing bank if the LC demanded showing it on the bill of exchange
(or in all documents).

BILL OF EXCHANGE Place/date of issue: Paikuse, May 07, 2008

At sight please pay against this sole Bill of Exchange

to the order of ourselves the amount of GBP 49.701,50

British Pounds Forty Nine Thousand Seven Hundred One and 50/100

Drawee: Barclays Bank Plc Drawer: O Tipp-Topp

London Paikuse Rural Municipality
Estonia

Payable in Barclays Bank Plc, London

Drawn under Documentary Credit No. BMDC4586221
of Barclays Bank Plc, London

26