Letter of Credit

The buyer applies to its bank to issue a credit in the seller’s favour. The credit states an amount, an expiry, and — crucially — the list of documents that must be presented and what each must say. The seller ships the goods, assembles the documents, and presents them. The bank examines them against the credit’s terms, and if they conform, it pays.

Applicant

The buyer, who asks its bank to issue the credit and is ultimately liable to reimburse it.

Issuing bank

The bank that issues the credit and undertakes to pay against a conforming presentation. Its undertaking is its own, not a guarantee of the buyer.

Beneficiary

The seller, in whose favour the credit is issued and who presents the documents.

Advising bank

A bank in the seller’s country that advises the credit to the beneficiary, satisfying itself as to its apparent authenticity without adding an undertaking of its own.

Confirming bank

A bank that adds its own undertaking to that of the issuing bank, where the credit permits. This gives the seller a payment obligation from a bank in a jurisdiction and of a standing it may prefer.

Nominated bank

A bank authorised by the credit to receive the presentation and to pay, incur a deferred payment undertaking, accept, or negotiate under it.

The confirmation point is where the credit does its most specific work. An unconfirmed credit leaves the seller relying on a bank in the buyer’s country, with whatever country and institutional risk that carries. A confirmed credit puts a second bank’s promise alongside it. Whether confirmation is available and what it costs are commercial matters between the parties and their banks.

The independence principle means that the bank’s undertaking is not conditioned on the performance of the sale contract. If the buyer believes the goods are defective, that is a dispute under the sale contract, to be pursued against the seller. It does not entitle the buyer to instruct the bank not to pay against conforming documents, and the bank is not a forum for the argument.

The documentary principle means the bank looks at paper. It checks that the documents required by the credit have been presented, that they say what the credit requires them to say, and that they are consistent with one another on their face. It does not inspect the cargo, verify that the certificates are truthful, or confirm that the goods match their description. A presentation of conforming documents obliges payment even if the underlying shipment is in some way unsatisfactory — and a presentation of discrepant documents may be refused even if the cargo is perfect.

The practical life of a documentary credit is largely about discrepancies. A presentation that does not comply with the credit’s terms can be refused, and the refusal need not be justified by any complaint about the goods. Dates that do not sit right, a description that does not match the credit’s wording, a document missing an endorsement, a presentation made after the permitted period — any of these can put payment in question.

Where a presentation is found discrepant, the standard rules provide for the bank to give notice within a defined period, expressed in banking days, and to state the discrepancies. What follows is negotiation: the discrepancies may be corrected if time allows, or the applicant may be asked to waive them. The seller who assumed a credit meant certain payment discovers at that point that the certainty was conditional on its own documentary precision.

Documentary credits are long established in bulk commodity trade, and they fit it for structural reasons. The documents in these trades are unusually good at standing in for the goods: a transport document representing a cargo at sea, an insurance policy over it, an inspection certificate on quality and weight, and official attestations on health status together describe the consignment closely enough that a bank can transact against them. The same document set is what allows a cargo to be sold on while afloat.

• The document list is where the buyer’s real protections sit — an inspection certificate is required, not implied
• Official certificates issued by authorities in the exporting country may be called for, and their issue is outside either party’s control
• A credit calling for a transport document showing goods on board interacts awkwardly with delivery terms under which the seller does not contract the carriage
• Partial shipments, tolerances on quantity, and expiry dates matter more where a cargo loads over a period rather than at an instant

The interaction between the credit’s document list and the delivery term the contract names is the recurring friction. The credit is drafted by reference to the sale contract but operates independently of it, and a document the credit demands is not necessarily a document the delivery term puts the seller in a position to obtain. Reconciling the two is a drafting exercise for the parties and their banks, not a feature of either instrument.