Documentary credit and UCP

By K P Kaphly

The Uniform Customs and Practices for documentary credit (UCP) of the International Chamber of Commerce (ICC) have received worldwide recognition as a main guideline to banks in operating documentary credits in the settlement of payment in international commercial transactions. As the name itself suggests, it is designed to achieve uniformity in the banking practices relating to payments in foreign trade. Most of the letters of credit (L/C) or documentary credit received and issued by the commercial banks in Nepal specifically refer to the UCP as the governing instrument of an L/C.

Countries may exercise different rules and regulations dealing in trade, foreign exchange, transportation, and insurance. For instance, the current banking regulations in Nepal allows exports on Free On Board (FOB) and other terms, but imports on only CIF/C&F terms. In other words, separate payment for freight in imports is not permitted. Similarly, exports are allowed against an advance payment or L/C, but advance payment is not permissible in imports. On the other, several countries including India permit exports even on collection or payment on delivery basis. The UPC establishes common banking principles and practices for settling payments in the international trade.

Generally four types of payment mechanism are used in foreign trade, open account, collection, documentary credit and advance payment. The open account and documentary collection are used especially when buyers and sellers are well known to each other as the exporter assumes maximum risk. Similarly, the risk to the buyer is maximum under the advance payment. Therefore, the documentary credit that provides safety and balanced risk to the both parties is widely used by traders for effecting payments in trade.

The UCP was first published by the ICC in 1936 and then amended periodically in 1951, 1962, 1974, 1983 and 1993. The revisions were made to response to the need for standardising and accommodating new trading and payment practices brought by changes in, among others, the information technology, multimodal transport and containerisation. The latest version of 1993 is termed after the ICC's publication number as UCP 500.

International trade requires flow of goods from exporter to importer against payment from importer to exporter. It is natural that the exporter does not want to hand over the goods to the buyer or his nominated carrier without being assured of being paid for it. On the other, the importer also does not want to pay before having control over the goods. When the goods move for delivery from the exporter's place, it is evidenced by documents that will give title to the goods and demonstrate constructive delivery. The importer and exporter use the documents of title representing the goods in order to synchronise the delivery of goods with the correspondent payment. The importer's bank pays the exporter through its advising bank against production of such documents in compliance with terms stipulated in the L/C.

The documentary credit is an undertaking issued by a bank for the account of the buyer (the applicant) to pay the beneficiary (the seller/exporter) the value of the draft and/or documents provided that the terms and conditions of the Credit are complied with. The issuing bank will authorise its advising bank to pay the exporter as per the terms of the L/C. The L/C normally specifies documentary requirements for commercial, regulatory, insurance and transport purposes, such as invoice, packing list, certificate of origin, transport document, insurance policy and photosanitary certificate. After examining the documents as per the L/C stipulations, the advising bank releases the payment to the exporters and sends the documents to the issuing banks for transferring the title to the goods to the importer.

The prime advantage is that the exporter can rely on the bank without worrying much about the standing of the foreign buyer. But he must be sure of meeting all the stated terms of the Credit for exercising his right to demand payment from the bank. Therefore, a documentary credit carries the following characteristics:

*It is an arrangement by banks for the settlement of payment in international commercial transaction,

· It provides a form of security for the parties involved,

· It ensures payment provided that the terms and conditions of the Credit are fully met, and

· It means that the payment is based on documents only, and not on merchandise or services involved.

The implications and risks involved in the documentary credit point out to the need for the importer to check on the credibility of a new exporter, and also for the exporter to examine the Credit for conforming to the sales contract and clarity for proper compliance with the stipulated terms and conditions.

The UCP 500 introduces some major changes that included recognition of various types of transport documents and facilitation measures. It has provided that in the absence of a clear expression, the documentary credit is taken as Irrevocable Credit, and stressed on the need to avoid excessive details. The banks will not examine documents which are not specified in the Credit, and that such examination and refusal of documents will have to be completed within seven banking days.

Unless otherwise stated in the credit, the onboard bill of lading that traditionally uses the critical point at the ship's rail under the FOB, C&F and CIF terms is no longer required. Recognition has been given to various types of transport documents, such as marine/ocean bill of lading, non-negotiable sea waybill, charter party bill of lading, multimodal transport document, air transport document, road/rail/inland waterways transport documents, courier and post receipts and transport documents issued by freight forwarders.

It further mentions that any 'no-transhipment' provisions in a Credit can be ignored if the goods are containerised and whole transport is covered by one contract of carriage. However, the transport document must include the name of the carrier. The weight declaration in the transport document is also accepted as a certification. The description in the commercial invoice has to tally with the description in the Credit whereas other documents are required to ensure consistency. Moreover, the importer's bank is required to accept invoices prepared by reprographic or computerised system, and documents may be signed by any mechanical or electronic method of authentication, unless otherwise mentioned.

Despite years of practice and clear guidelines in operating documentary credits, it is not without problems to banks and traders. It has been found that new or experienced manufacturers or traders, large or small located in developed or developing countries often make mistakes when preparing and negotiating a documentary credit. As payments against the Credit is subject to compliance with the stipulated terms, the discrepancy in documentation leads to refusal or postponement of payment.

The experience of the L/C operating banks in Nepal also reveals that a large number of documents in exports are received faulty most of which, depending upon a case, have to be accepted conditionally as 'discrepant documents'. Most of such discrepancies relate to the late shipment or late presentation of documents. Some of the documents are not prepared and produced in number as specified in the L/C. Sometimes the goods description in the invoice does not correspond to that in the L/C, and documents are found not consistent with one another. As a result payments are refused or delayed forcing banks to make frequent contacts with the issuing/advising foreign banks to process early negotiation. Therefore, it is very important that the importers and exporters must clearly understand and follow terms and conditions of a documentary credit.