The Guide to Documentary Credits PART 1

Contents iii The Guide to Documentary Credits Lakshman Wickremeratne & Michael Rowe This edition updated by Stephen Berrisford CDCS Contents page The guide to documentary credits iv Apart from any fair dealing for the purpose of research or private study, or criticism or review, as permitted under the Copyright, Designs and Patents Act 1988, this publication may be reproduced, stored or transmitted, in any form or by any means, only with the prior permission in writing of the publisher, or in the case of reprographic reproduction in accordance with the terms and licences issued by the Copyright Licensing Agency. Enquiries concerning reproduction outside those terms should be addressed to the publisher?s agents at the address below: Institute of Financial Services IFS House 4-9 Burgate Lane Canterbury Kent CT1 2XJ T 01227 818649 F 01227 479641 E editorial@ifslearning.com Institute of Financial Services publications are published by The Chartered Institute of Bankers, a non-profit making registered educational charity. The Chartered Institute of Bankers believes that the sources of information upon which the book is based are reliable and has made every effort to ensure the complete accuracy of the text. However, neither CIB, the authors nor any contributor can accept any legal responsibility whatsoever for consequences that may arise from errors or omissions or any opinion or advice given. Typeset by Kevin O?Connor Printed by Antony Rowe Ltd, Wiltshire ? Institute of Financial Services/Chartered Institute of Bankers 2003, with the exception of North and South America wherein copyright lies with the International Financial Services Association ISBN 0-85297-720-4 Contents v Acknowledgements ? To Wicky for providing such comprehensive material to update and to all of those acknowledged as providing input into the first edition. ? To Philip Blake and Jo Richardson of the ifs Publishing Department for keeping me on schedule. ? To all of my friends and colleagues who have been part of the CDCS journey to date especially those international trade banking volunteers who continue to be actively involved in the maintenance and development of the qualification framework, particularly: ? Maria Adamczyk CDCS ? Lowell Campbell CDCS ? Steve Cooke CDCS ? Barbara Lotrionte CDCS ? David Morish CDCS ? Rita Nielsen CDCS ? Tineke Overvliet CDCS ? Victor Pena CDCS ? Steve Thompson CDCS ? Gareth Watts CDCS ? Charnell Patrick Williams CDCS ? Paul Williamson CDCS ? To Dan Taylor for his unfailing support, encouragement and good humour. The guide to documentary credits vi Contents vii Preface Documentary Credit Specialists should be aware that there are constantly changing issues that have implications on documentary credit operations. These include new legal cases in various jurisdictions around the world, ICC DOCDEX decisions, ICC Banking Commission Opinions and ICC Banking Commission Decision Papers. It is advantageous for anyone working in documentary credit operations to keep themselves current on these issues that impact operations. Below is a partial list of where current information on these issues is available: Websites Sources ? International Chamber of Commerce – www.iccwbo.org ? DC Pro – www.dcpro.com ? Institute of International Banking Law and Practice – www.iiblp.org ? International Financial Services Association – www.ifsaonline.org ? Institute of Financial Services – www.ifslearning.com Publication Sources ? ICC DC Insight (Available by subscription from the ICC – www.iccbooks.com) ? Documentary Credit World (Available by subscription – www.dcworld.com) ? ICC publications of Official Opinions (Available from the ICC – www.iccbooks.com) ? Annual Survey of Letter of Credit Law and Practice (Available from the Institute of International Banking Law and Practice – www.iiblp.org) The guide to documentary credits viii Contents ix Contents 1 Documentary credits – an overview 1 2 The sales agreement 9 3 Documentary credits – types, uses and characteristics 37 4 Parties to documentary credit transactions – roles and responsibilities 135 5 Issuance and amendment 173 6 Transport documents 197 7 Other documents 299 8 Presentation, examination and settlement/rejection 345 9 Bank-to-bank reimbursements under documentary credits 427 10 Related products 455 11 Risk issues 469 Recertification guidelines 481 Bibliography 489 Index 493 CDCS STUDY GUIDE The guide to documentary credits x Contents page Chapter One 1 – Documentary credits – an overview 1 One Documentary credits – an overview Chapter Outline 1 Introduction and Learning Objectives 2 Brief History and the Basic Documentary Credit Operation 3 Generic Flow Chart of the Documentary Credit Process 4 Definitions – A Generic Understanding 5 Questions 1 Introduction and Learning Objectives 1.1 Introduction The aim of this chapter is to introduce the Documentary Credit Specialist to the concept of a Documentary Credit by: - providing the necessary background by way of a brief history - a generic flow chart of the Documentary Credit process - a generic meaning of the word Credit as an instrument used in trade It should be noted that the different types of Documentary Credits are defined and explained in Chapter 3. Contents page The guide to documentary credits 2 1.2 Learning Objectives The learning objectives are: (i) To enable the Documentary Credit Specialist to understand the term Documentary Credit in its generic setting (ii) To introduce the Documentary Credit Specialist to the basic Documentary Credit process 2 Brief History and the Basic Documentary Credit Operation 2.1 Brief History The term …Letter of Credit? was perhaps first used with Traveller?s Letters of Credit issued by banks in the western world to provide their clients with a means of obtaining cash from banks abroad for use during their foreign travel and so obviating the need to carry large sums of money upon their person with the attendant risks of loss or robbery. A prerequisite of such Traveller?s Letters of Credit which were issued in the eighteenth century was a formal letter of introduction addressed to the Issuing Bank?s correspondents and agents abroad. The letter of introduction addressed to the correspondents or agents would indicate that the client/traveller was a valued customer and requested the correspondents or agents to provide any possible assistance. Often copies of the letter of introduction were sent ahead of the traveller to the correspondents or agents. The Traveller’s Letter of Credit – addressed to correspondents/agents would be issued in the form of a letter. It indicated that in consideration of such correspondents and agents paying cash to the named client, the Issuing Bank would pay bills of exchange drawn by the correspondent/agents on the Issuing Bank for amounts paid plus correspondents/agents charges. The Traveller?s Letter of Credit indicated a maximum amou nt available under the Credit and expiry date of the Credit. Each correspondent/agent was required to indicate details of amounts paid and the dates so that the next correspondent/agent to whom the client presented the Letter of Credit would be able to ascertain the balance available to be drawn. The client always retained possession of the original Credit. The Documentary Credit Specialist should see the origin of the Letter of Credit in that a …letter? is provided by the Issuing Bank to correspondents and agents upon the basis of which …credit? is to be provided. It also described how the correspondent/agent was to obtain reimbursement from the Issuing Bank and this usually took the form of a bill of exchange 1 – Documentary credits – an overview 3 as indicated earlier. The Documentary Credit in its modern form developed from these beginnings in the mid-19th century. It first appeared as a vehicle for effecting payments on foreign trade transactions among banks in London in the 1840s. It may well be that as a result of personal contacts made by travelling as described above or by other means, merchants were able to arrange for goods to be sent from abroad. The movement of goods from one country to another is more complicated than buying goods from within the local marketplace. Often there are documents required for the transport of goods and payment has to be made across borders. In order to gain a global understanding, interpretation and application of Documentary Credit usage the International Chamber of Commerce (ICC) developed and published their first version of the Uniform Customs and Practice for Documentary Credits (UCP) in 1933. UCP 500 is the current version of this publication and since its introduction in 1993 has been supplemented and amplified by the ICC Banking Commission in their decision on the determination of an …Original? document in the context of UCP sub-Article 20b, the publication of their Uniform Rules for Bank to Bank Reimbursements under Documentary Credits (URR), their Supplement to UCP500 for electronic presentations (eUCP), and, most recently their International Standard Banking Practice for the examination of documents under Documentary Credits (ISBP). All of these are covered in some detail within this Study Text, as are the four Position Papers issued by the ICC after the last UCP revision. The subject matter of these Position Papers, however, has been subsequently covered by individual ICC Opinions. The different methods by which payment is made for goods are explained in Section 4 of Chapter 2 under the heading …Methods of Payment?. The different methods by which goods are transported are explained in Chapter 6, Transport Documents. This publication is concerned with the use of Documentary Credits and Standby Letters of Credit (Credits) as a means of settlement for goods, services and/or other performances. 2.2 The Basic Documentary Credit Operation This is outlined below in its simplest and most common form and Documentary Credit Specialists should note that variations of this common form are explained in the later chapters of this publication. The basic operation, which covers the movement of goods, services and/or other performances, is as follows: ? The Buyer (as Applicant) completes a standard bank application form requesting the Applicant?s bank (as Issuing Bank) to issue an Irrevocable Credit in favour of the seller (the Beneficiary). The guide to documentary credits 4 The application form should specify: (a) the documents that have to be presented (b) the terms and conditions that have to be complied with. ? The Issuing Bank issues its Irrevocable Credit in favour of the Beneficiary incorporating the bank?s irrevocable and independent undertaking to pay the Beneficiary. - provided all documents as stipulated in the Credit have been presented and - all terms and conditions of the Credit are complied with. ? The Irrevocable Undertaking A Documentary Credit is independent of goods, services and/or other performances and any other consideration outside the actual Credit as issued and is an undertaking which is enforceable against the Issuing Bank even if the buyer is unable or unwilling to pay the Issuing Bank. ? The Advising Bank In the case of an international transaction, the Issuing Bank usually asks a bank in the seller?s coun try with which it has a correspondent banking relationship (the Advising Bank) to notify the Credit to the Beneficiary. ? The Nominated Bank The Credit may be payable (i) at the counters of the Issuing Bank or (ii) at the counters of a specific Nominated B ank in the seller?s country or (iii) at the counters of any bank in the case of a freely negotiable Credit. The Nominated Bank in (ii) above is usually (but not necessarily) the Advising Bank. Where the Credit is confirmed by a bank in the seller?s country, the Credit may be payable at the counters of the Confirming Bank. The Confirming Bank (which is often the Advising/Nominated Bank but not necessarily so) provides the Beneficiary with an additional irrevocable and independent bank undertaking separate from that of the Issuing Bank. ? The Seller (as Beneficiary) Dispatches the goods as required and presents the stipulated documents to the Nominated Bank whether it be the Issuing Bank, a specific Nominated Bank (any bank if the Credit is freely negotiable) or Confirming Bank if any. The stipulated documents may include a bill of exchange to be drawn on a bank as indicated in the Credit. ? The Documents and Payment The Nominated Bank may pay the Beneficiary provided the stipulated documents have been presented and the terms and conditions of the Credit have been complied with. The Nominated Bank would, at the same time, dispatch documents to the Issuing Bank, which would effect reimbursement, provided 1 – Documentary credits – an overview 5 the stipulated documents have been presented and the terms and conditions of the Credit have been complied with. The Issuing Bank would then forward the documents, other than for any bill of exchange that may have been required, to the buyer against agreed settlement terms. Often, arrangements within the Credit provide for reimbursement to be obtained by the Nominated Bank claiming upon a third bank. ? The Goods The goods which are represented by the documents are dispatched by the seller to the buyer, who will frequently need these to obtain clearance and delivery. Payment is exchanged for documents in the Documentary Credit cycle provided the stipulated documents are presented and the terms and conditions of the Credit are complied with. 3 Generic Flow Chart of the Documentary Credit Process Figure 1.1: Summary of procedure where the Advising/Confirming Bank is the Nominated Bank The guide to documentary credits 6 4 Definitions – A Generic Understanding A Documentary Credit as an instrument of settlement of the payment obligation between buyer and seller is also known in the following terms: Letter of Credit – As a Credit is issued by the Issuing Bank and addressed to the Beneficiary in the form of a …letter?; the term Letter of Credit is often used. Commercial Credit – As a Credit is issued by the Issuing Bank in settlement of a commercial transaction; the term …Commercial Credit? is also used. Documentary Credit – As a credit is issued by the Issuing Bank and requires the presentation of stipulated documents for compliance, t he term …Documentary Credit? is used. Standby Letter of Credit – As a credit is issued by the Issuing Bank to be used for settlement only where there has been some form of default or financial guarantee the term …Standby Letter of Credit? is used All four terms generically refer to the same product which undertakes payment to the Beneficiary on the conditions that the documents stipulated in the Credit are presented and all terms and conditions of the Credit are complied with. The generic understanding of the meaning of Credit is accurately encapsulated in Article 2 of UCP 500, the text of which is given below: Article 2 – Meaning of Credit For the purposes of these Articles, the expressions “Documentary Credit(s)” and “Standby Letter(s) of Credit” (hereinafter referred to as “Credit(s)”), mean any arrangement, however named or described, whereby a bank (the “Issuing Bank”) acting at the request and on the instructions of a customer (the “Applicant”) or on its own behalf, i. is to make a payment to or to the order of a third party (the “Beneficiary”), or is to accept and pay bills of exchange (Draft(s)) drawn by the Beneficiary, or ii.authorises another bank to effect such payment or to accept and pay such bills of exchange (Draft(s)), or iii. authorises another bank to negotiate, against stipulated document(s), provided that the terms and conditions of the Credit are complied with. 1 – Documentary credits – an overview 7 For the purposes of these Articles, branches of a bank in different countries are consider ed another bank.” The key elements within the above text are that payment/acceptance or negotiation is conditional upon: ? the presentation of stipulated documents and ? provided that the terms and conditions of the Credit are complied with These two key elements are present in the Credit product irrespective of whether the product is termed a Letter of Credit, a Commercial Credit, Documentary Credit or a Standby Credit. Unless otherwise noted throughout this text any of the terms ie, …Letter of Credit?,…Commercial Credit? and …Documentary Credit?, refer to an irrevocable commercial Documentary Credit or Standby Letter of Credit. The term …Credit? refers to the type of Documentary Credit used in the specific context. 5 Questions 1. What is the instrument to which the Letter of Credit can be historically related? 2. What two key elements are a prerequisite to trigger the exchange of payment for goods in the usual Documentary Credit cycle? 3. What two key elements provide commonality to the terms: ? Letters of Credit ? Commercial Credit ? Documentary Credit ? Standby Letters of Credit The guide to documentary credits 8 Contents page Next chapter 2 – The sales agreement