Wednesday, April 1, 2015

Documentary Credits – Why they are actually not credits

Oftentimes, the name of a financial instrument gives you a first hint of what it is and how it works. Sometimes, however, you are better off not to think too much about the name. The documentary credit, also called letter of credit, is a good example for the latter.

What is a documentary credit?

A documentary credit helps an importer paying an exporter. It engages the Issuing Bank to pay upon timely presentation of documents. However, a documentary credit is separate from its underlying sale or other contract. In clear, banks are not concerned or bound by such contract.

Even though we talk about a “credit”, there is usually no credit involved at all. Only exceptionally, the parties opt for deferred payment.

By definition, a UCP 600 letter of credit is irrevocable even if the parties are silent in that regard. What’s the point for an exporter to accept a bank’s engagement if the latter is not bound to execute it?

UCP 600 Rules – When and Why?

The International Chamber of Commerce (ICC) has developed common rules for letters of credit. They are called Uniform Customs and Practice for Documentary Credits (UCP). The current version of 2007 is labeled “UCP 600”.

For UCP 600 Rules to be applicable, the parties must refer to them in their letter of credit.

Who does what?

  • The Applicant is the party on whose request the credit is issued. It is, in fine, bound by paying its intermediary banks.
  • The Issuing Bank must honor the credit if the stipulated documents are presented to the Nominated Bank or the Issuing Bank.
  • The Nominated Bank can honor the credit and, thus, replace the Issuing Bank vis-à-vis the Beneficiary. However, the Nominated Bank is not obliged to do so.
  • The Confirming Bank must honor the credit if the stipulated documents have been presented to the Confirming Bank or the Nominated Bank.
  • The Advising Bank advises the credit to the Beneficiary without any undertaking to honor or negotiate. Advising means the Advising Bank has checked the apparent authenticity of the credit or any amendment. An Advising Bank may utilize the services of another bank (the “Second Advising Bank”).
  • The Beneficiary is the party in whose favor a credit is issued.

To amend a documentary credit, Issuing Bank, Confirming Bank, and Beneficiary must agree on such amendment.

How goods become documents

If you are selling potatoes on a market, you hand over the potatoes to your client and, in return, receive the money. If you want to export a whole bunch of potatoes to a distributor abroad, the problem is that you are not face-to-face with your buyer. A bank will pay you here. However, to avoid handing over your potatoes to the bank which then hands them over to the buyer, you will replace the potatoes by documents showing that you have actually delivered them to the buyer.

Banks deal with documents and not with goods, services or performance to which the documents may relate.”

UCP 600 rules provides for different types of documents:

  • Commercial Invoice
  • Transport Document
  • Bill of Lading
  • Non-negotiable Sea Waybill
  • Charter Party Bill of Lading
  • Air Transport Document
  • Road, Rail, or Inland Waterway Transport Documents

How a documentary credit can benefit a third party

If a credit has been expressly designated as “transferable”, the Beneficiary can transfer it in whole or in part to a second beneficiary. However, if the credit has not been structured as “transferable”, the Bank is not obliged to accept another beneficiary.

By definition, a second beneficiary cannot transfer the credit any more.

A documentary credit without (paper) documents?

The ICC has set up specific eUCP rules for electronic letters of credit or mixed electronic and paper letters of credit. These rules namely

  • specify the format of electronic letters of credit;
  • define the date of issuance as the date of sending the letter of credit;
  • explain how to handle corrupted files (basically not handling but re-sending them); and
  • exclude any liability of the bank for the authenticity of the sender.


ICC Publication No. 600 – Uniform Customs and Practice for Documentary Credits, 2007 Revision (UCP 600)