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Guide to DocumentaryCredits

FourthEdition

Contributingeditor:Gary Collyer

ISBN 978-1-84516-467-6

9 781845 164676


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The ifs School of Finance is a not-for-profit professional body andregistered charity, incorporated by RoyalCharter.


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The Institute of Financial Services is a division of the ifs School ofFinance, a

registered charity, incorporated by Royal Charter.

The Institute believes that the sources of inforation upon !hich the boo" is based

are reliable and has ade every effort to ensure the coplete accuracy of the te#t.

$o!ever, neither the Institute, the author nor any contributor can accept any legal

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oissions or any opinion or advice given.

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Copyright

ifs School of Finance iii

ICC Uniform Rules for Bank-to-Bank Reimbursements under

ocumentar!Credits 200"Re#ision

ICC (ublication ?o. 73@ IS1? *7+-*3-+/3-66/@-6

Copyright > 366+ International Chaber of Coerce AICCB,(aris &ll rights

reserved.ICC Uniform Customs and $ractice for ocumentar!Credits

ICC (ublication ?C 866 IS1? *3-+/3-)3@7-4

Copyright > 3668, International Chaber ofCoerce

ICC International Standard Bankin% $ractice for the &'aminationofocuments Under ocumentar! Credits 2013 Re#ision for UC$(00

ICC (ublication ?C 7/@ IS1? *7+-*3-+/3-6)++-/

Copyright > 36)9 International Chaber of Coerce AICCB,(aris

&vailable at!!!.iccboo"s.co

#tracts fro IS( *+ > )**+ Institute of International 1an"ing
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)uide to ocumentar!

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a!D (ractice, Inc. &ll Rights Reserved. Reproduction of any part ofthis !or" by any eans !ithout e#press !ritten perission isprohibited. For further inforation about IS(*+ or its Efficial

Coentary, see!!!.iiblp.org


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CopyrightNote to students

For the purpose of consistency this study te#t refers todocuentary credit. $o!ever, 'C, letter of credit, C or

credit are also !idely used in the sae conte#t asdocuentary credit. Students should decide on their o!npreference for describing the product.


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Content

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) 1asic principles of docuentary credits )

3 The sales contract )@

9 'ocuentary credits: types, uses

and characteristics @@/ Issuing a docuentary credit )39

@ &dvising a docuentary credit )/)

8 Shipent of goods and preparationof docuents )@)

7 Insurance docuents )+@

+ Financial, coercial and otherofficial docuents )*7

* #aination of docuents 33@

)6 Settleent 377

)) Ether products relating to adocuentary credit 969

)3 &nalysis of ICC rules 9)7

)9


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Chapter)

Basic principles ofdocumentary credits

Learningobecti!es

This chapter includes a brief history of the docuentarycredit. It also provides a short introduction to the roles andresponsibilities of the ore coon entities that participatein a docuentary credit.

1y the end of this chapter, students should be ableto:

describe the origins of a docuentarycredit

define a docuentarycredit

describe the ain responsibilities of an applicant anda beneficiary

identify the types of role perfored by ban"s in

a docuentary credit and their ain responsibilities and outline the structure and flo! of a basic docuentary

credit transaction.

"." Briefhistory

$istorians have been able to trace the use of letters of creditbac" as early as ancient gypt and 1abylon. $o!ever, it !asnot until the eighteenth and nineteenth centuries that theter letter of credit becae !idely used and recognised.


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'uring this period it !as coon for erchants to see" out ne!ar"ets and a"e use of the trading opportunities offered bysuch ar"ets. In order to provide their clients !ith a eans ofobtaining cash during their overseas travels, ban"s in the;estern !orld introduced the concept


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Briefhistor!

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of a travellers letter of credit. This docuent avoided the needfor ban" clients to carry large sus of oney, !hich could be lostor stolen.

In addition to the travellers letter of credit it !as usual fora foral letter of introduction to be addressed to the ban"soverseas correspondent or agent. This letter, usually sent inadvance of travel, !ould indicate that the client !as a valuedcustoer of the ban". It !ould also re%uest that thecorrespondent or agent provide the client !ith any necessaryassistance.

& travellers letter of credit !as, literally, in the for of a letter.It indicated that the issuing ban" !ould honour bills of e#changedra!n on it by the correspondent or agent in respect ofaounts paid to the naed traveller, plus any charges incurredby the correspondent or agent. There !ould also be an indicationof a a#iu aount that could be dra!n and an e#piry date.

ach correspondent or agent !as re%uired to indicate on theoriginal letter of credit details of aounts paid and the relevantdates. The client al!ays retained possession of the original letterof credit.

The origins of the docuentary credit began !ith a letter

provided by a ban" to a correspondent or agent. =ponproduction of that letter, credit !as provided to a naed clientin the for of oney. Fro the )+/6s, docuentary creditsbegan to serve as a eans of facilitating payent for foreigntrade transactions. It ay !ell be that, as a result of personalcontacts ade during their travels, erchants !ere able toarrange for goods to be sent fro overseas.

Ene of the oldest available e#aples of a travellers-type letterof credit can be found in the archives of the =S ibrary of

Congress. It !as issued in ;ashington on / 5uly )+69 and signedby the then (resident of the =nited States, Thoas 5efferson. It!as provided to e#plorers Captain


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1* Basic +rinci+les of documentar!

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those dangers and reach the (acific ocean, you ay find itiprudent to haard a return the


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Briefhistor!

sae !ay, and be forced to see" a passage round by sea,in such vessels as you ay find on the ;estern coast.1ut you !ill be !ithout oney, !ithout clothes, D othernecessaries as a sufficient supply cannot be carried !ith

you fro hence. Jour resource in that case can only bein the credit of the =S for !hich purpose I herebyauthorise you to dra! on the Secretaries of State, of theTreasury, of ;ar D of the ?avy of the =S according as youay find your draughts !ill be ost negociable, for thepurpose of obtaining oney or necessaries for yourself Dyour en: and I solenly pledge the faith of the =nitedStates that these draughts shall be paid punctually at thedate they are ade payable. I also as" of the Consuls,agents, erchants D citiens of any nation !ith !hich

!e have intercourse or aity to furnish you !ith thosesupplies !hich your necessities ay call for, assuring theof honorable and propt retribution. &nd our o!n Consulsin foreign parts !here you ay happen to be, are herebyinstructed D re%uired to be aiding D assisting to you in!hatsoever ay be necessary for procuring your returnbac" to the =nited States. &nd to give ore entiresatisfaction D confidence to those !ho ay be disposed toaid you, I Thoas 5efferson, (resident of the =nited Statesof &erica, have !ritten this letter of general credit for you!ith y o!n hand, and signed it !ith y nae....

Th: 5efferson

In order to obtain global understanding and a cooninterpretation and application of docuentary credits, theInternational Chaber of Coerce AICCB developed andpublished its first version of the Uniform Customs and $racticefor ocumentar! Credits Aore coonly "no!n as =C(B in)*99 AICC publication =C( +3B. Subse%uent revisions occurred

in )*@) A=C( )@)B, )*83 A=C( 333B,)*7/ A=C( 3*6B, )*+9 A=C( /66B, )**9 A=C( @66B and 3667A=C866B. =C( 866 is the current version and cae into effect on )5uly3667. These rules are suppleentedby:

ICC Uniform Rules for Bank-to-Bank ReimbursementsUnder

ocumentar! Credits A=RR73@B

ICC Su++lement to the Uniform Customs and $racticefor

ocumentar! Credits for &lectronic $resentation Ae=C(B


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versiKn).) and

International Standard Bankin% $ractice for the &'aminationof

ocuments Under ocumentar! CreditsAIS1(B.


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Briefhistor!

"."." #so de las reglas y de otraspublicaciones de la $CC dentro de estete%to de estudio

Todas las publicaciones %ue se tratan en este te#to de estudio sepueden obtener en la librerLa online de la ICC en:http:MM!!!.iccboo"s.coM$oeM$oe.asp#o desde las oficinas olocales de la ICC. l capLtulo )3 de este te#to de estudio analiaen detalle las disposiciones de las =C( 866, e=C(, IS1( 7/@, =RR73@ e IS1( *+. Todos los detalles de las publicaciones pertinentesa la ICC u otros organisos se encuentran recogidas en la1ibliografLa.

".& Definici'n de cr(ditodocumentario

n tNrinos uy sencillos, un crNdito docuentario es uncoproiso irrevocable eitido por un banco por el cual secoproete a realiar el pago al denoinado coo beneficiariosiepre y cuando se presenten los docuentos estipulados en elcrNdito cupliendo las condiciones y tNrinos del crNdito.

#C) *++, articulo &un OcrNditoP es todo acuerdo, coo%uiera%ue se denoine o describa, %ue es irrevocable y por el %ue seconstituye un coproiso fire del banco eisor para honraruna presentaciKn confore.

l iso artLculo define el tNrino OpresentaciKn conforePcoo Ouna presentaciKn %ue estQ en conforidad con lostNrinos y las condiciones del crNdito segn las disposiciones

aplicadas de este reglaento y de la prQctica bancariainternacional.

& pesar de %ue cual%uier banco puede eitir un crNditodocuentario cual%uier epresa o persona puede actuar cooeisor. Si un eisor debe dispone de los edios financieros paracuplir con los tNrinos asuidos en el crNdito docuentariopuede deterinar %uiNn es el beneficiario. l beneficiario deberQsolicitar el asesoraiento de los bancos sobre la idoneidad deleisor de un crNdito docuentario, ya %ue pueden e#istir

diversos riesgos %ue deben ser obHeto de e#aen. (or eHeplo ladisponibilidad de divisas, riesgos polLticos y la solvencia deleisor son los probleas potenciales %ue pueden afectar acual%uier pago debido al benficiario. (ara los efectos de estudiorecogido en este te#to nos centrareos en los crNditosdocuentarios %ue son eitidos por bancos.
http://www.iccbooks.com/Home/Home.aspxhttp://www.iccbooks.com/Home/Home.aspx


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".- )artes inter!inientes en uncr(dito documentario, funcionesy responsabilidades

n este apartado se e#ponen las principales funciones delordenante y del beneficiario. TabiNn se detallan el tipo defunciones %ue son realiadas por parte de los bancos y de susresponsabilidades en sun funciones.

".-." rdenante /tambi(n conocido comocomprador o importador0

#C) *++, art1culo & define al OordenanteP coo Ola parte %uesolicita eitir el crNditoP. Cabe sealar %ue el ordenante es elresponsable de copletar el forulario de solicitud para laeisiKn, o la odificaciKn de un crNdito docuentario, no es unaparte del crNdito docuentario.

l uso del tNrino OparteP en la definiciKn del ordenante no estQdestinada a iplicar %ue el ordenante es una parte del crNdito

docuentario. s a fin de refleHar el concepto de OordenantePcoo una entidad distinta a la de clientes reales del banco. neste sentido cabe sealar:

a interacciKn entre el ordenante y su banco, es anterior a laeisiKn de un crNdito docuentario, estQ fuera del conte#tode las =C( 866.

Tras la eisiKn de un crNdito docuentario, el ordenantepodrQ solicitar posteriorente una odificaciKn de sustNrinos y condiciones, o proporcionar un levantaiento delas discrepancias %ue han sido identificadas por el bancoeisor. l banco eisor no estQ obligado a aceptar o a toarnota de la solicitud o de la renuncia.

stas cuestiones se analian con ayor detalle Qs adelante eneste te#to de estudio.

a principal responsabilidad de un ordenante es rellenar elforulario de solicitud del crNdito en su banco. Cada banco

tendrQ su propio estilo de forulario de solicitud, aun%ue loscapos individuales suelen seguir la estructura de un ensaHeS;IFT


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$arties in#ol#ed in a documentar! credit, and their roles and

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l principal propKsito de un crNdito docuentario es pagar lacopra del ordenante, y no la de investigar o adinistrar elcorrespondiente contrato de copraventa o pro fora. (or lotanto al copletar el forulario de solicitud, el ordenate debe:

(roporcionar a su banco instrucciones claras y precisas,evitando toda fora de abigedad en la descripciKn de lostNrinos y condiciones %ue debe cuplir la parte delbeneficiario.

Tener conociiento de los docuentos %ue son necesariospara la iportaciKn de las ercancLas, o para evidenciar laentrega de los servicios o prestaciones %ue debe facilitar elbeneficiario.

(roporcionar detalles sobre el tipo, eisiKn Asi procedeB y elcontenido de la inforaciKn de los docuentos %ue se han depresentar. sto incluye cual%uier referencia a lasespecificaciones y re%uisitos de calidad %ue deben evidenciaruno o Qs de esos docuentos.

specificar %ue productos re%uieren o estQn suHetos a unafora de inspecciKn, indicar claraente el tipo de docuentoy, en su caso, el nobre o el tipo de epresa Apor eHeplo, lapresentaciKn de un certificado de control e#pedido por una

epresa de inspecciKn o de calidad, indicando o no el nobrede la epresaB.

&segurarse de %ue todas las condiciones, y los docuentos%ue se solicitan, estQn de acuerdo con el contrato decopraventa o pro fora acordados con el beneficiario.

ste forulario de solicitud, una ve terinado y aprobado, biensea de fora online o rellenado y firado de fora anual por elordenante, actuarQ coo una solicitud de su banco A%ue se darQa conocer coo banco eisorB para eitir un crNdito

docuentario irrevocable a favor del beneficiario designado. asolicitud se puede presentar de fora electrKnica o en papel.

".-.& Beneficiario /tambi(n conocidocomo !endedor o e%portador0

#C) *++, article & defines a beneficiary as the party in!hose favour a credit is issued.

& beneficiary should revie! the docuentary credit upon itsreceipt to deterine if its ters and conditions are acceptable. Ifnot, the beneficiary should contact the applicant and re%uest anaendent. It is advisable that only !hen the docuentarycredit is in an acceptable for should the beneficiary


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coence or arrange anufacture, production or shipent ofthe goods, or provide the re%uired service or perforance.


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".-.&.& Bancoa!isador

#C) *++, art1culo & define a un Obanco avisadorP coo Oel

banco %ue avisa el crNdito a peticiKn del banco eisorP. (ara unaoperaciKn tranfronteria, un banco eisor suele transitirelectrKnicaente, o enviar, un crNdito docuentario a un bancodel paLs del beneficiario con el %ue antiene una relaciKn debanco corresponsal, siendo este banco el %ue avisa albeneficiario. ste banco es conocido coo Obanco avisadorP.

a transisiKn de un crNdito docuentario a travNs de un bancoavisador se realia ediante un ensaHe S;IFT


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presentation.

& ban" that adds its confiration to a docuentary credit, uponthe authorisation or re%uest of an issuing ban", provides abeneficiary


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!ith an additional irrevocable and independent underta"ing thatis separate fro that of the issuing ban". If confiration isadded, the docuentary credit should be ade available !iththe confiring ban" for honour or negotiation.

It is coon for a confiring ban" to also be an advising andnoinated ban".

".-.-

Goods

;hen a docuentary credit covers the purchase of goods,those goods are to be shipped or dispatched according to theters and conditions specified. Shipent or dispatch !ill beevidenced by the docuents re%uired by, and presented under,the docuentary credit. &n applicant !ill usually re%uire thesedocuents to obtain clearance and delivery of the goods uponarrival. ;hen copleting a docuentary credit applicationfor, one of the fields to be copleted by the applicant is thedescription of the goods, services or perforance. verydocuentary credit should contain a description that concisely

describes !hat is re%uired to be shipped, dispatched or renderedby the beneficiary.

".-.3 Documents, settlement andreimbursement

#C) *++, art1culo & define el tNrino OhonrarP.

#C) *++, art1culo &4 Definici'n de5honrar6

a. pagar a la vista si el crNdito es disponible para pago ala vista.

b. contraer un coproiso de pago diferido y pagar alvenciiento si el crNdito es disponible para pago diferido.

c. aceptar una letra de cabio AOgiroPB librada por elbeneficiario y pagar al venciiento si el crNdito esdisponible para aceptaciKn.

l iso artLculo define el terino OnegociaciKnP.


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#C) *++, article &4 Definici'n de 5negociaci'n6

. . . la copra por el banco designado de giros Alibradossobre un banco distinto del banco designadoB yModocuentos al aparo de una presentaciKn confore,anticipando o


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acordando anticipar fondos al beneficiario el o antes del dLahQbil bancario en %ue el banco designado deba serreebolsado.

;hile a noinated ban" ay choose !hether to honour ornegotiate under a docuentary credit, a noinated ban"that is also a confiring ban" ust honour or negotiate.$onour or negotiation is effected provided a coplyingpresentation has been ade by or on behalf of the beneficiary.=pon honour or negotiation, a noinated ban" is re%uired todispatch the docuents to the issuing ban" according to theinstructions stated in the docuentary credit.

Reiburseent that is due to a noinated ban" for any

honour or negotiation ade to a beneficiary is effected inaccordance !ith the reiburseent condition that should bespecified in the docuentary credit. This ay, for e#aple, allo!for the noinated ban" to:

debit an account of the issuing ban" that is held !iththe

clai reiburseent fro another ban" A"no!n as areibursing ban"B or to clai fro a funding institution such

as the ;orld 1an" or

be reibursed by the issuing ban" !hen it is deterined bythe thatthe docuents represent a coplying presentation.

'ocuents, other than any bill of e#change that ay have beenre%uired, are released to an applicant against preagreedsettleent ters.

".3 7tructure of a basicdocumentary credittransaction

The structure of a basic docuentary credit transaction, !hichcovers the oveent of goods, is described in Figure ).).There are a nuber of variations to this structure and these aree#plained later in this study te#t.

& trade transaction !ill norally begin !ith the establishent ofa purchase or sale contract, or pro fora invoice, bet!een abuyer and seller. &ongst other details such as the nature ofthe goods, the aount, the buyers and sellers naes, etc, thecontract or pro fora invoice !ill indicate the ters of payent.


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For the e#aple in Figure ).), the contract or pro fora indicatesa docuentary credit as the chosen ethod of settleent.


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Goods

8.'ocuentos

7.(ago

/

.&visodecrN

dito

docuentario

)6.

'ocuentos

)).

Settleent

3.

'ocuentarycredit

application

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Figure "." 7tructure of a basic documentary credit transaction

UendedorAbeneficiarioB ). Contrato

Coprador AordenanteB

@. ShipentMdispatch

)3. Ta"esdelivery

+. 'ocuentos

*. Reebolso

9. Credito docuentario

1ancoavisadorMconfirador

1anco eisor


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8e!iew 9uestions

The follo!ing %uestions are designed to enable you to assessyour understanding of the topic that you have Hust studied.

). ;hat triggers settleent under a docuentary creditV

a. evidence of shipent of the goods

b. letter of introduction

c. handingoverofthedocuentstoanapplicant d. presentation of coplying docuents by

the beneficiary.

3. ;ho is it that underta"es to a"e payent under adocuentary creditV

a. The applicant.

b.The advising ban".

c.The issuing ban".

d.Thenoinatedban". 9. ;hich one of the follo!ing is not a party to a docuentary

creditV

a. The confiring ban".

b.The beneficiary.

c.The applicant.

d.Theissuingban". /. ?ae the ain purpose of a docuentary credit.

a.Tounderta"epayenttoabeneficiary. b.Togiveshippinginstructionstoabeneficiary. c. To eliinate ris" in perforance under the purchase

or sale contract.

d.Toensuretheapplicantreceivestransportdocuents.


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@. ;hich of the follo!ing settleent types are associated !iththe definition of honourV

&.

(ayent.1.&cceptance.

C. 'eferred

payent. '.

?egotiation.

a. &,Cand'

b. &, 1 and C

c. &, 1 and '

d. 1,Cand'


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Re#ie


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2* /he sales


sales agreeent, an e#port contract or a foreign salesagreeent. For the purpose of consistency, this study te#t refersto sales contract. &ll other agreeents and procedurescoonly used in international trade result fro the

perforance of this contract or agreeent.

For e#aple, the t!o essential ters of a sales contract arethe sellers underta"ing to provide the goods to a buyer and thatbuyers underta"ing to pay the agreed price in return. In theconte#t of an e#port sale, the first of these usually involves theconclusion of a contract !ith a carrier to transport the goodsfro the country of the seller to that of the buyer. The buyersunderta"ing a"es it necessary for it to arrange payentthrough the ban"ing syste.

The payent echaniss coonly used in cross-bordertrade transactions, including docuentary credits, are brieflye#ained and copared later in this chapter. Etherprocedures related to the e#port sale and the payentoperation soeties include governent re%uireents,

such as custos procedures ande#change control regulations.

& docuentary credit is an underta"ing separate fro the sale

or other contract on !hich it ay be based. This essentialcharacteristic and its conse%uences !ill be covered in furtherdetail throughout the study te#t, but in coercial Arather thanlegalB ters, docuentary credits are issued to facilitateperforance of the buyers payent obligation to a seller.

This chapter e#plores the relationship bet!een the seller andbuyer. It identifies the "ey decisions that need to be ade byboth parties in a sales contract, including the decision as to thechoice of payent echanis. It concludes !ith the assuption

that the parties choose a docuentary credit and identifiesthe ain %uestions to be ans!ered !hen issuing it.

&.& 7alescontract


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Sales


that covers cross-border sales contracts. This eans thee#ecution of an international sales contract is li"ely to begoverned by provisions that !ill differ fro one country to thene#t, reflecting the different coercial la!s in each country.


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2* /he sales

This situation provides significant scope for uncertainty in theevent of adispute bet!een a seller and a buyer. Resolving suchdisputes can be tie-consuing and costly, especially if they areto be resolved in court or via arbitration. In e#tree cases, sales

contracts can be deeed null and void, !ith a conse%uent lossfor both parties.

This potential for confusion a"es it vital for a seller and buyerto reach agreeent over the precise content of the salescontract.

1an"s play no role in the negotiation of the sales contract, !hichis signed only by the seller and buyer.

&.&." Content of a salescontract

The "ey eleent of any sales contract is the agreeent of abuyer to pay a seller an agreed price for a specified %uantityof goods. In any countries, this siple agreeent is sufficientto constitute an iporte#port contract. In other !ords, thecontract does not need to be a lengthy or foral docuent to

be legally enforceable. Contracts also do not need to be forallynotarised. &n agreeent cane%ually be reached in a telephoneconversation or via an eail or fa# essage.

In practice, a sales contract !ill contain ore detail than the%uantity of goods and the sale price. It !ill usually also coverrelated ites such as the tie period for delivery, the ethod ofpayent and the anner in !hich the goods are to be delivered,usually by reference to a trade ter Aor an ICC Incoter seesection 3.9B. Soe contracts !ill also specify !hich countrys

la! !ill apply and !hich court or arbitration syste hasHurisdiction to hear any clais in the event of a dispute.

Rather than use a sales contract, a seller !ill often send thebuyer a pro fora invoice containing the details of the goodsand their unit prices, before the transaction is concluded.Siilarly, a buyer ay send the seller a purchase orderconfiring its coitent to purchase certain goods at anagreed price and on specific ters.

&.&.& Contract terms andconditions


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Sales

Sales contracts are usually agreed bet!een a seller and buyeracting in their noral course of business, rather than bet!eenprivate individuals.


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2* /he sales

!hich they norally conduct business and !ill typically beincluded by reference in a sales contract.

(robles can arise, ho!ever, because there are li"ely to be

soe differences bet!een the standard ters of the seller andthose of the buyer. The t!o parties ay !ell e#change thesestandard ters during precontract negotiations. If thedifferences are not resolved at this stage, probles can ariselater if there is a dispute. This is because it can be difficult toestablish !hich set of conditions Aif eitherB applies to thetransaction.

In e#tree cases, the dispute !ill be ta"en to court, !here aHudge or arbitrator ight decide that no contract !as ever

concluded because the seller and buyer did not agree on theapplicable conditions. In practice, ho!ever, a Hudge is li"ely totry to see" a resolution by deterining one or other set ofconditions applies or, even, that both sets of conditions apply tothe e#tent that they do not conflict.

&.&.- Law go!erningcontracts

In ost cases, sales contracts are governed, at least in part, bythe la!s of the country of one of the parties involved. Theseller and buyer ay theselves agree !hich la! is to apply byincluding a specific provision in the sales contract.

If there is no such agreeent or provision then a Hudge orarbitrator, in the case of a dispute, ay first have to deterinethe governing la!. In these circustances, a Hudge or arbitrator!ill often decide to apply the la! of the country ost connected

!ith the contract, !hich ay be the country to !hich the goodsare being delivered. The use of trade ters AIncoters, seesection 3.9B deterines the point at !hich delivery is deeedto have occurred. For e#aple, a seller fulfils its deliveryobligation !hen the goods are loaded on board a ship at thenaed port of loading under both CIF Acost, insurance andfreightB and FE1 Afree on boardB Incoters.

There have been a nuber of attepts to introduce aninternational la! for e#port sales. The latest is the )*+6 =nited

?ations Convention on Contracts for the International Sale ofGoods ACISGB. It provides a standardised set of legal rules foriporte#port transactions. &s of


36/689

Use of Incoterms in

ifs School of Finance 3)

&.&.3 Checklist for an effecti!e sales agreement

In addition to deterining the %uantity of goods and any unitprice, a seller and buyer should agree the follo!ing points to

iniise the ris" of dispute and thereby establish theappropriate Incoter:

the ters of delivery of thegoods

the point at !hich the ris" in respect of goods passes froseller to buyer

!ho should clear goods through custos and up to !hatpoint

!ho arranges for insurance for the carriage of goods and upto !hat point

!hat precise ris"s to the goods need to be covered andspecifically sho!n as covered on the insurance docuent

!hat coercial docuents are needed and !hat shouldbe sho!n on the and

!hether any other docuents Asuch as inspection certificatesBare needed and !ho is to issue the.

&.- #se of $ncoterms intrade

Ene of the challenges in any sales contract is to ensureboth parties understand their responsibilities. These include the

payent of carriage, insurance, loading and unloading costs,iport and e#port ta#es, and any other associated costs. achof these !ill be the responsibility of either the seller or buyer.The buyer needs to understand these responsibilities to be ableto calculate the full purchase price and the seller needs to beable to provide an accurate sales price. The chance of dispute isiniised !hen the parties share the sae understanding oftheir respective responsibilities.

Ene of the best !ays to iniise the chance of disputes

in both doestic and international trade is to use Incoters. TheInternational Chaber of Coerce AICCB first publishedIncoters in )*98, and over tie they have becoe theaccepted international standard for trade ters referred to insales contracts.


37/689

2* /he sales


The current version of Incoters, Incoters 36)6, cae intoeffect on ) 5anuary 36)). The full version is provided in ICC(ublication ?o. 7)@. Incoters 36)6 have been designed toreflect changes in coercial practices that have occurredsince the last revision


38/689


Use of Incoterms in

in 3666. These include reference to electronic alternatives topaper docuentation, cargo insurance clauses, and also theestablishent of t!o ne! Incoters '&T Adelivered atterinalB and '&( Adelivered at placeB ters.

&.-." 7cope of$ncoterms

Incoters deal solely !ith the rights and responsibilities ofparties involved in the delivery of goods sold under a contractof sale. They do not e#tend to other contracts, such asinsurance, carriage and payent, although the particular

Incoter used ay have iplications for such contracts.

For e#aple, Incoter CFR Acost and freightB iplies carriage !illbe effected by sea. This eans that either a bill of lading, acharter party bill of lading or a non-negotiable sea !aybill shouldbe re%uested. =nder adocuentary credit, the type of transportdocuent called for shouldcoply !ith the stated Incoter.

&.-.& $ncotermcategories

There are )) Incoters, !hich are for use in doestic andinternational transactions. ach one sets out the obligations ofthe seller and buyer under the sales contract and indicates thepoint at !hich responsibility is transferred fro seller to buyer.The sellers obligations escalate fro 4; Athe iniuB to ''(Athe a#iuB. &ny obligation that does not appear in aparticular Incoter is the responsibility of the buyer, unless thecoercial contract states other!ise.

The )) Incoters are divided into 3 groups: 7 are suitable forany ode or odes of transport the reaining / apply to seaand inland !ater!ay transport only. ;hen incorporating anIncoter into a sales contract, the seller and buyer should ta"ecare to ensure that the ter selected is appropriate to theagreed point of delivery and the ode of transportation to beused. The )) Incoters are as follo!s:

Group ): Rules for any ode or odes oftransport:

4; Ae# !or"sB

FC& Afree carrierB


39/689

ifs School of Finance3/

2* /he sales

C(T Acarriage paid toB


40/689


41/689


2* /he sales

of transport is used.


42/689


43/689

:able &.& FC; $ncoterm

F8EE C;88$E8

FC; insert named +lace of deli#er! Incoterms 2010

E%cro $mcro

Deli!ery occurs ;hen #cro td delivers thegoods to

the carrier or anotherperson

noinated by Icro at#cros

preises or anothernaed place.FC&

re%uires #croto clear the goods for

e#port, !here applicable. #crohas

no

obligation to clear the goods foriport or to pay any iportdutyor for

any

iport or custos foralities.

Licences,

authorisations,

security

clearancesand

other

formalities

If applicable, #cro ustobtainat its

o!n ris" ande#pense any e#port

licence orother official authorisation

and carry out all custosforalities

necessary for thee#port of the

goods.

If applicable, it is up to Icroto

obtain at its o!n ris" ande#pense

any iport licence orother official

authorisation and carry out all

custosforalities for the iport of

thegoods and for their transportthrough any country.

Contract of

carriage

and

insurance

#cro has no obligation toIcroto

a"e a contract ofcarriage.

$o!ever, if re%uestedby Icro or if

it is coercial practice and Icro

does not give an instruction to the

contrary in due tie, #croay

contract for carriage onusual ters

at Icros ris"

and e#pense. In either case,#cro

ay decline to a"e thecontract of

carriage and, if itdoes, should notify

Icro proptly.#cro has noobligation

to Icro to a"e acontract of

insurance. $o!ever, #cro ust

provide Icro, at their re%uest, ris"

and e#penseAif anyB, !ith inforation

thatIcro needs for

obtaining insurance.

Icro ust contract at its o!n

e#pense for the carriage of thegoods

fro the naed place ofdelivery,

e#cept !hen a contract of carriage is

ade by #cro. Icro has no

obligation to#croto a"e a contract

ofinsurance.

Deli!ery

documen

t

#cro ust provide Icro, at#cros

e#pense, !ith the usualproof that the

goods have beendelivered.#cro

ust provide assistance to Icro at their

re%uest, ris" and e#pense inobtaining a

transportdocuent.


44/689

cro ust

cept the

of of

ivery

vided. In the

se ofa

cuentary

dit, the

uired

cuent and

e ters and

nditions for

issuance

ould be

arly

ecified.


45/689

:able &.-. C): $ncoterm

C;88$;GE );$D :

C): insert named +lace of destination Incoterms 2010

E%cro $mcro

Deli!er

y

occurs

;hen #cro td delivers the goods to thecarrier

or another person noinated by#cro at an

agreed place Aif any suchplace is agreed

bet!een the partiesBand#cro ust contract

for and pay the cost of carriage necessary to

bring thegoods to the naed place of

destination.;hen C(T is used, #crofulfils its

obligation to deliver !hen it hands the goodsover to the carrier andnot !hen they reach

Icro Inc at theplace of destination.

Licences,

If applicable, #cro ust obtain at itso!nris"

If applicable, it is up to Icro

authorisations, and e#pense any e#port licence orotherofficial

to obtain at its o!n ris" and

security

clearance

s and

other

formalitie

s

authorisation and carry out all custos

foralities necessary for the e#port ofthe goods,

and for

their transport through any countryprior

to delivery.

e#pense any iport licenceor

other officialauthorisation and

carry out all custosforalities for the iportof the

goods and for theirtransport

through any country.

Contract of

carriage

and

insurance

#cro ust contract or procure acontract for

the carriage of the goodsfro the agreed point

of delivery, ifany,at the place of delivery to the

naed place of destination or, ifagreed,any

point at that place. Thecontract of carriage

ust be ade onusual ters at #cros

e#pense and provide for carriage by the usual

routeand in

a custoary anner. If a specific pointisnot

agreed or is not deterined bypractice, #cro

ay select the point ofdelivery and the point at

the naedplace of destination that best suits its

purpose.#cro has no obligation toIcroto

a"e a contract of insurance.

Icro has no obligation to#cro

to a"e a contract of carriage

or of insurance.


46/689

:able &.-. /cont.0 C): $ncoterm

Deli!ery

documen

t

If custoary, or at Icros re%uest,#croust

provide Icro, at #crose#pense, !ith the usual

transport docuentWsX for the agreed ode of

transport. This transport docuent is tocover

the contracted goods and be dated!ithin the

period agreed for shipent. Ifagreed or

custoary,

the docuent ust also enable Icro to

clai the goods fro the carrier at the

naed place of destination and enable it to

sell the goods

in transit by the transfer of thedocuentto a

subse%uent buyer or bynotification to thecarrier. ;hen such a transport docuent is

issued in negotiable for and in several

originals,a full

set of originals ust be presented toIcro.

Icro ust accept the

transport docuent provided.

In the

case of a docuentary

credit, the re%uired

docuent and the tersand

conditionsfor its issuance

shouldbe clearly specified.

:able &.3. C$) $ncoterm

C;88$;GE ;ND $N7#8;NCE );$D :

C$) insert named +lace of destination Incoterms 2010

E%cro $mcro

Deli!ery occurs ;hen #cro td delivers the goodstothe

carrier or another personnoinated at an

agreed place Aif anysuch place is agreed

bet!een thepartiesB and #cro ust

contract for and pay the cost of carriage

necessary

to bring the goods to the naedplace of

destination.;hen CI( isused,#cro fulfils its

obligation todeliver !hen it hands the

goods over to the carrier and not !hen they

reach

Icro Inc at the place of destination.

Licences,

authorisations

security

clearancesandother

formalities

If applicable, #cro ust obtain at itso!n

ris" and e#pense any e#portlicence or other

official authorisationand carry out all

custos foralities necessary for the e#port

of the goods,and for their transportthrough

any country prior to delivery.

If applicable, it is up toIcro

to obtain at its o!nris" and

e#pense any iport licence or

other official authorisation and

carry out all custosforalities

for the iportof the goods and

for their transport through any


47/689

untry.


48/689

:able &.3. /cont.0 C$) $ncoterm

Contract of

carriage

and

insurance

#cro ust contract or procure acontract

for the carriage of thegoods fro the

agreed point ofdelivery, if any, at the place

of delivery to the naed place of

destination

or, if agreed, any point at that place.The

contract of carriage ust beade on usual

ters at #crose#pense and provide for

carriage bythe usual route and in a

custoary anner. If a specific point is not

agreed or

is not deterined by practice,#cro

ay select the point ofdelivery and thepoint

at the naed place of destinationthat

best suits its purpose.Inaddition, #cro

ust obtain at itso!n e#pense cargo

insurance coplying at least !ith the

iniu cover as provided byClauses

ACB of the Institute Cargo Clauses A


49/689

:able &.3. /cont.0 C$) $ncoterm

Deli!ery

documen

t

If custoary, or at Icrosre%uest,

#cro ust provideIcro, at #cros

e#pense,

!ith the usual transport docuentWsXfor the

transport contracted.This transport docuent

ust cover thecontracted goods and be

dated !ithin the period agreed for shipent.

If agreed or custoary, the docuentust

also enable Icro to clai the goodsfro

the carrier at the naed placeofdestination

and enable the to sellthe goods in transit

by the transfer ofthe docuent to a

subse%uent buyer or by notification to thecarrier.

;hen such a transport docuent isissued

in negotiable for and in several originals, a

full

set of originals ust be presented toIcro.

Icro ust accept the

transport docuent provided.

In the

case of a docuentary

credit, the re%uired

docuent and the tersand

conditionsfor its issuance

shouldbe clearly specified.

:able &.?. D;: $ncoterm

DEL$@E8ED ;: :E8A$N;L

D;: insert named terminal at +ort or +lace of destination Incoterms 2010

E%cro $mcro

Deli!ery occurs ;hen #cro td places thegoods,

once unloaded fro thearriving

eans of transport, at the disposal of

Icro Inc at anaed terinal at the

naedport or place of destination.

Licences,

authorisations,

security

clearancesand

other

formalities

If applicable, #cro ust obtainat its

o!n ris" and e#pense anye#port

licence and other officialauthorisation

and carry out allcustos foralities

necessary for the e#port of the goods

and for their transport through any

country prior to delivery otherthan

the country of destination.

If applicable, Icro ustobtain at

its o!n ris" ande#pense any iport

licence orother official


custosforalities for the iport

ofthe goods and for their transport

through anycountry.


50/689

:able &.?. /cont.0 D;: $ncoterm

Contract of

carriage

and

insurance

#cro ust contract at its o!n


to the naed terinal atthe port or

place

of destination. If a specificterinal

is not agreed or is notdeterined by

practice, #croay select the

terinal at theport or place of

destinationthat best suits its

purpose.#cro has no obligationto

Icro to a"e acontract of

insurance.


to a"e a contract ofcarriage or

of insurance.

Deli!ery

documen

t

#cro ust provide Icro, at

#cros e#pense, !ith adocuent

enabling Icro tota"e delivery of

the goods.

Icro ust accept thedelivery

docuent provided.In the case of

a docuentarycredit, the

re%uired

docuent and the ters and

conditions for its issuanceshould be

clearly

specified.

:able &.*. D;) $ncoterm

DEL$@E8ED ;: )L;CE

D;)insert named +lace of destination Incoterms 2010

E%cro $mcro

Deli!ery occurs ;hen #cro td places thegoods at

the disposal of IcroInc on the

arriving eans of transport ready forunloading at the naed place of

destination.

Licences,

authorisations,

security

clearancesand

other

formalities


o!n ris" and e#pense anye#port

licence and other officialauthorisation

and carry out allcustos foralities

necessary for the e#port of the goods

and for their transport through any

country prior to delivery otherthanthe country of destination.

If applicable, Icro ustobtain at

its o!n ris" ande#pense any iport

licence orother official


custosforalities for the iport

ofthe goods and for their transport

through anycountry.


51/689

:able &.*. /cont.0 D;) $ncoterm

Contract of

carriage

and

insurance



to the naed place ofdestination or to

the agreed point, if any, at the naed

place of destination. If a specific point

is

not agreed or is notdeterined

by practice, #croay select the

point

at the naed place ofdestination

that best suits itspurpose.#cro has

no obligation to Icro to a"e a

contractof insurance.



of insurance.

Deli!ery

documen

t



enabling Icro to ta"e delivery of

the goods.

Icro ust accept thedelivery

docuent provided.In the case of

a docuentarycredit, the

re%uired



clearly

specified.

:able &.. DD) $ncoterm

DEL$@E8ED D#: );$D

DD) insert named +lace of destination Incoterms 2010

E%cro $mcro

Deli!ery occurs ;hen #cro td places thegoodsat the disposal ofIcro Inc,

cleared for iporton the arriving

eans of

transport, ready for unloading at the

naed place of destination.

Licences,

authorisations,

security

clearancesandother

formalities


o!n ris" and e#pense anye#port and

iport licence andother official

authorisation andcarry out allcustos foralities necessary for the

e#port of the goods, for their

transportthrough any country and for

their iport.

If applicable, Icro ustprovide

assistance to #cro at#cros

re%uest, ris" ande#pense in

obtaining any iport licence or otherofficial authorisation for the iport of

the goods and for theirtransport



52/689

:able &.. /cont.0 DD) $ncoterm

Contract of

carriage

and

insurance



to the naed place ofdestination or to

the agreed point, if any, at the naed

place of destination. If a specific point

is

not agreed or is notdeterined

by practice, #croay select the

point

at the naed place ofdestination

that best suits itspurpose.#cro has

no obligation to Icro to a"e a

contractof insurance.



of insurance.

Deli!ery

documen

t



enabling Icro tota"e delivery of

the goods.

Icro ust accept the proof of

delivery provided. In the case ofa

docuentary credit, there%uired


conditions for itsissuance should be

clearlyspecified.

&.-.-.& Group &4 8ules for sea and inlandwaterway transportonly

These Incoters ay be used only for sea or inland!ater!ay transport.

:able &.. F;7 $ncoterm

F8EE ;LNG7$DE 7$)

F;7 insert named +ort of shi+ment Incoterms 2010

E%cro $mcro

Deli!ery occurs ;hen #cro td places thegoods

alongside the vesselAegon a %uay

or

a bargeB noinated by Icro Inc at the

naed port of shipent.

Licences,

authorisations,

security

clearancesand

otherformalities If applicable, #cro ustobtainat its o!n ris"

ande#pense any e#port licence orother official

authorisation and carry out all custos

foralities necessary for thee#port of the


53/689

ods. If applicable, it is up to

Icrotoobtain at its o!n

ris" ande#pense any

iport licence orother

official authorisation and

carry out all custosforalities for the iport of

thegoods and for their

transport through any

country.


54/689

:able &.. /cont.0 F;7 $ncoterm

Contract of

carriage

and

insurance

#cro has no obligation toIcro

to a"e a contract of carriage

or insurance.



fro the naed port ofshipent,

e#cept !here the contract of carriage

is ade by #cro.Icro has no

obligationto#cro to a"e a contract

ofinsurance.

Deli!ery

documen

t

#cro ust provide Icro, at#cros

e#pense, !ith the usualproof that the

goods have beendelivered. =nless

such proof is a transport docuent,

#cro ust provide assistance to

Icro at Icros re%uest, ris" and

e#pense in obtaining a transport

docuent.






clearlyspecified.

:able &.. FB $ncoterm

F8EE N B;8D

FB insert named +lace of destination Incoterms 2010

E%cro $mcro

Deli!ery occurs ;hen #cro td delivers thegoods

on board the vesselnoinated by

Icro Inc at thenaed port of

shipent

or procures the goods already so

delivered.

Licences,authorisations,

security

clearancesand

other

formalities

If applicable, #cro ustobtainat itso!n ris" ande#pense any e#port




goods.

If applicable, it is up to Icrotoobtain at its o!n ris" ande#pense




thegoods and for their transport


Contract of

carriage

andinsurance

#cro has no obligation toIcro


of insurance.



fro the naed port ofshipent,e#cept !here the contract of carriage

is ade by #cro.


55/689

:able &.. /cont.0 FB $ncoterm

Deli!ery

documen

t

#cro ust provide Icro at#cros

e#pense !ith the usualproof that the

goods have beendelivered. =nless

such proof is a transport docuent,

#cro ust provide assistance to

Icro at Icros re%uest, ris" and

e#pense in obtaining a transport

docuent.






clearlyspecified.

:able &."+. CF8 $ncoterm

C7: ;ND F8E$G:

CF8 insert named +ort of destination Incoterms 2010

E%cro $mcro

Deli!ery occurs ;hen #cro td delivers thegoods on

board the vessel orprocures the

goods already sodelivered.;hen CFR

is used, #cro fulfils its obligation to

deliver !hen it hands the goodsover

to the carrier and not!henthey reachIcro Inc attheplace of destination.

Licences,

authorisations,

security

clearancesand

other

formalities

If applicable, #cro ustobtainat its

o!n ris" ande#pense any e#port




goods.

If applicable, it is up to Icroto

obtain at its o!n ris" ande#pense




thegoods and for their transport


Contract of

carriage

and

insurance

#cro ust contract or procurea

contract for the carriage ofthe

goods fro the agreedpoint of

delivery, if any, at theplace of

delivery to the

naed port of destination or, if

agreed, any point at that port.The

contract

of carriage ust be ade onusual

ters at #crose#penseandprovide for carriage by the usual

route ina vessel of the type

norallyused for

the transport of the type ofgoods

sold. #cro has noobligation to Icro to a"eacontract of insurance.


56/689


57/689

:able &."+. /cont.0 CF8 $ncoterm

Deli!ery

documen

t

#cro ust, at its o!n e#pense,

provide Icro !ithout delay!iththe

usual transport docuent for the

agreed

port of destination.Thistransport

docuent ustcover the contract

goods, bedated !ithin the period

agreed for shipent, enableIcro

to clai the goodsfro the

carrier

at the port of destination and,unless

other!ise agreed, enableIcro to sell

the goods intransitby the transfer ofthe docuent to a subse%uentbuyer

or by notification to thecarrier.

;hen such a transport docuentis

issued in negotiable for andin

several originals, a full set oforiginals

ust be

presented to the buyer.

Icro ust accept thetransport

docuent provided. In the case of

a docuentary credit, the

re%uired



clearly specified.

:able &."". C$F $ncoterm

C7: $N7#8;NCE ;ND F8E$G:

C$F Winsert naed port of destinationX Incoters 36)6

E%cro $mcro

Deli!er

y

occurs

;hen #cro td delivers the goods onboard the

vessel or procures the goodsalready so

delivered.;hen CIF is used,#cro fulfils its

obligation to deliver!henit hands the goods

over to thecarrier and not !hen they reach

IcroInc

at the place of destination.

Licences,

;here applicable, #cro ust obtain atitso!n

If applicable, it is up to Icro

authorisations, ris" and e#pense any e#port licenceorother

to obtain at its o!n ris" and

security

clearances and

other

formalitie

s

official authorisation and carry out allcustos

foralities necessary for thee#port of the

goods.

e#pense any iport licenceor

other officialauthorisation and

carry out all custos

foralities for the iportof the

goods and for theirtransport


58/689

ough any

untry.


59/689

:able &."". /cont.0 C$F $ncoterm

Contract of

carriage

and

insurance

#cro ust contract or procure acontract for

the carriage of the goodsfro the agreed

point of delivery, ifany, at the place of

delivery to

the naed port of destination or, ifagreed, any

point at that port. Thecontract of carriage ust

be ade onusual ters at #cros e#pense and

provide for carriage by the usual routeina

vessel of the type norally used forthe

transport of

the type of goods sold. #cro ustobtain at its

o!n e#pense cargo insurance coplying at

least !ith theiniu cover provided byClauses ACB of the Institute Cargo Clauses

A


60/689

Table 3.) Table 3.)) in the previous sub-section illustrate ho!the rights and responsibilities of the seller and buyer varydepending on the Incoter used. =nderstanding the liits ofeach partys responsibilities is crucial !hen negotiating theprecise ters of a


61/689

2* /he sales

sales contract, especially !hen payent is due under adocuentary credit.

Sellers agree to payent under a docuentary credit because a

ban" gives an underta"ing that payent !ill be ade, as longas the docuents presented confor to its re%uireents. Thisunderta"ing is independent of the buyers ability to pay. &t theoutset of any contract negotiation, the seller should scrutinisethe ters of a docuentary credit to a"e sure, aongst otheraspects, that it confors to the Incoter %uoted in the salescontract. For e#aple, a seller should not indicate thepresentation of an air !aybill if the Incoter is designed for seashipent. Siilarly, a buyer should not re%uire that an insurancedocuent be presented if the Incoter identifies that the seller is

not responsible for insuring the goods.

&ny conflict bet!een the Incoter, the docuentary credit andthe sales contract can result in delays in the issuance of,advising of or payent under a docuentary credit. &ny delays!ill have a financial cost as a iniu the ipact of the delayon cash flo!. In e#tree cases, if the ters of the docuentarycredit cannot be coplied !ith because of such conflict, a ban"!ill not be in a position to honour or negotiate.

&.3 )aymentterms

1y agreeing to buy goods fro the seller, the buyer underta"esto pay for the on delivery or as other!ise agreed in the salescontract. This payent obligation fors part of the sales contractitself. This section outlines the ters of payent coonlyused for e#port sales.

There are four ain settleent ters, ranging fro payent inadvance to open account trading. =nder payent in advance,the buyer is e#posed to the ost ris". In open accounttrading, the seller is e#posed to the ost ris". In both cases,ban"s have no role in the transaction, other than in processingthe payent. For both docuentary collections Asee section3./.9B and docuentary credits Asection 3./.3B, ban"s act asinterediaries in the transaction, !ith responsibilities forchannelling the docuents bet!een the buyer andseller.


62/689


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nonetheless gives the seller a easure ofsecurity for payent.The sellers interest is best served !here the buyer is not able toobtain possession of the goods !ithout


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the presentation of the docuents that are sent through theban"ing syste. The full security of a docuentary collectionapplies only if the transport docuent is a negotiable bill oflading and M or if the goods are consigned to the ban" in the

iporting country, !ith the consent ofthat ban".If the seller has agreed to supply the goods on short-ter credit,it can stipulate that the docuents be handed over against thebuyers acceptance of a bill of e#change or signature on aproissory note. The seller ay be able to discount the bill ornote in return for an iediate payent.The international rulesgoverning collections are the ICC Uniform Rules for Collections,(ublication ?o. @33.

&.3.3 pen accounttrading

;hen business is conducted on open account ters, the sellerdispatches goods to the buyer !ithout any guarantee ofpayent. En dispatch, the seller sends the buyer an invoiceAtogether !ith other appropriate docuentsB for payent on anagreed date or at the end of an agreed period. For e#aple, the

agreed period ight be for payent to be ade at the end ofthe onth follo!ing the onth of shipent. The buyer a"esarrangeents to pay on the relevant date according to theters of the sale contract. The buyer ay use any appropriatepayent ethod, such as an international ban" transfer or ban"draft, absent any specific re%uest of the seller.

Epen account trading is ost coonly used !hen thet!o copanies concerned have a long-established tradingrelationship. For e#aple, transactions bet!een sellers and

buyers in countries in !estern urope and the =S& are oftenconducted on this basis. Sellers ay also use open accounttrading to secure contracts !ith parties in soe developingcountries !here docuentary credit ters have applied in thepast.

Epen account trading offers several advantages in particular, itis siple to adinister and involves inial ban"ing fees orother costs. The syste is particularly attractive to buyersbecause it affords the the opportunity of e#aining the

goods before they have to a"e payent. Sellers using openaccount ethods obtain no security for payent and have to relyentirely on the credit!orthiness andgood faith of the buyer. Thisay be contrasted !ith the situation under docuentary creditsand docuentary collections, in !hich the seller obtains the


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security of a ban" underta"ing or a ban" retaining control overthe docuents that relate to the shipent. The only involveentby ban"s in open account trading is in the transfer of funds onbehalf of the buyer to the seller.


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&s an e#aple, a seller in one country ay contract to shipachine parts to a buyer in another country. (ayent is to ta"eplace 86 days fro the date of shipent. The seller dispatchesthe goods and sends the shipping docuents to the buyer. Thesedocuents include a bill of e#change dra!n on the buyer,

payable to the seller at the end of


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!ith the dra!ee being a ban". A&n e#aple of a sipleproissory note is sho!n in Figure 3.3.B


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Figure &.& ;n e%ample of a simple promissory note

&.?.& Legal re9uirements go!erningnegotiable instruments

In ost countries, negotiable instruents are governed bydetailed legislation. This varies fro one country to another,although a set of international conventions dra!n up in Geneva

in the )*96s provide a coon for for a large nuber ofuropean systes.

The =2 applies its o!n legislative rules, and these haveinfluenced other countries !ith systes based on nglish legalprinciples. In the =S&, the =nifor Coercial Code providesdetailed la! on negotiable instruents. These sources providethe ain sets of rules on negotiable instruents. In addition,the =? Coission on International Trade a! A=?CITR&B hasdeveloped a odel la! for international negotiable instruents.

?egotiable instruents have special legal effects thatconcern the rights and obligations of third parties, as !ell asthe party that originally created the. For this reason,docuents have to confor to strict re%uireents in order tobe legally accepted


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as negotiable instruents. These re%uireents are established innational legislation and in applicable international conventions.Typically, the re%uireents are that they ust be in !rittenfor andbear a signature, and a payent underta"ing or order

ust be e#pressed in unconditional ters.

&.?.&." Legal re9uirements relating to billsof e%change

=nder a bill of e#change, the dra!er !rites and signs the billinstructing the dra!ee a ban" in the case of docuentarycredits to pay a specified su of oney either to a third party or

to the dra!er Athe payeeB. The bill ay either call forpayent on presentation A"no!n as a sight draftB or on aspecified future date or adeterinable event A"no!n as a tenoror usance draftB.

#nconditional terms the payent order ust beunconditional.

& tenor draft ay be presented to the dra!ee foracceptance. The dra!ee accepts the draft by signing eitheron the bac" or front, according to local custo and la!.

&cceptance constitutes an unconditional underta"ing to paythe draft at aturity.

Negotiable the payee and subse%uent holders cannegotiate Aoften referred to as a discount ofB the bill. Thiseans that they cansell their rights in the bill to a third party,!hich then becoes the holder. In return for a"ingiediate cash payent, the party buying the bill oftenpays less than the face value of the bill. This differencebet!een the aount paid and the full aount payable on thebill at a later date represents the third-party purchasersinterest charge, opportunity costs and assuption of ris".

:ransferable or payable to bearer drafts arenorally ade payable to a particular party and, if so, aretransferred by endorseent and delivery. The latter is thelegal ter for the physical handing over of the docuent.They can also be ade payable to bearer that is, the personduly holding the bill at any particular tie. In this event, theydo not nae the bearer and they are transferred by deliveryalone.

&.?.&.& Legal re9uirements relating to che9uesand promissory notes


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The legal structure of a che%ue is siilar to that of a bill ofe#change. =nli"e a bill of e#change, ho!ever, a che%ue ust bedra!n on a ban" andit is payable upon presentation to that ban".


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& proissory note also has ost of the sae features as a bill ofe#change. The essential difference is that it is not an order toanother party to pay, but a direct proise of payent by theparty !ho signs the note A"no!n as the a"erB. In the sae

!ay as the bill of e#change, it ust be dra!n up in unconditionalters.

&.?.-

;!alisation

In soe countries, a ban" or other party can guarantee payent

of a draft or proissory note by giving its aval. 1y signing thenote in this !ay on the bac", the ban" or other organisationcoits itself unconditionally to pay should the a"er or dra!eedefault. This practice is !ell established by legislation in osturopean countries in particular, those that have adopted the Geneva Convention but there is no precise e%uivalent in legal systes based onnglish la!.

The benefit of an aval is transferred autoatically !hen the note

is negotiated. &ccordingly, the use of an aval is a particularlyconvenient !ay of dealing !ith coercial paper under!rittenby ban"s in the secondary ar"ets. ach person in the chaincan clai against previous holders and the dra!er if the draft isnot honoured, !hether or not it has been accepted. & partynegotiating a draft thus ac%uires a right of recourse in case ofdishonour Aie non-payentB against the party endorsing thedraft and to previous endorsers. The ere dra!ing up of a bill ofe#change does not oblige the dra!ee to pay. The dra!ee isbound by the bill only upon acceptance.

&.?.3 Concept of holder in duecourseH

& vital concept in enforcing payent under negotiableinstruents is that of the holder in due course. &sentioned above, such instruents are legally separate fro

any underlying transaction. $olders ac%uire their right to claipayent fro endorseent and delivery of the instruent. Theirrights are not generally affected by disputes on the rights and!rongs of any coercial contract that led to the instruentbeing granted.


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To benefit fully fro the protection, the holder ust be aholder in due course. This eans that the holder ust haveta"en the instruent in good faith !ithout notice of any defectin its title. =nder nglish la!, for instance, the holder is fullyprotected only if, in addition, it gave valuable consideration norally oney payent for the instruent. Suppose a thiefsteals a bill of e#change and


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forges an endorseent on it: under nglish la!, the dra!er andendorsers prior to the forged endorseent are no longer liableto subse%uent holders. ater endorsers ay still be liable tosubse%uent holders.


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Forfaitin%

The seller and buyer agree the ters of sale. This includesthe granting of ediu-ter credit to the buyer for e#aple,over a period of five years !ith %uarterly repayents. &t thesae tie, the seller chec"s !ith the forfaiter a ban" or

specialist institution in its o!n country

that finance !ill beavailable for the transaction. The buyer accepts a series ofdrafts or signs a set of proissory


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notes corresponding to the instalent dates for repayent ofthe agreed credit. These bills or notes are guaranteed by thebuyers ban". This ta"es the for either of a separateguarantee or of a special endorseent on the bill or note, "no!n

as an aval. Rights to payent under docuentary credits arealso soeties accepted as security in forfaiting deals.

Consider an e#aple of !here the buyer is receiving credit frothe forfaiter. The seller presents accepted bills or notes to aforfaiter. The latter buys the fro the seller for iediatediscounted cash payent. The discounted su received by theseller corresponds to the sale price agreed !ith the buyer. Thedifference bet!een that aountand the total for !hich the billsor notes have been dra!n up is the interest payent to be

ade by the buyer in return for being granted credit ters.The difference bet!een the discounted price paid and the totalsu payable to the forfaiter under the bills or notes representsthe forfaiters profit. The forfaiter can either hold the bills ornotes and present the for payent on the aturity dates, orsell the in the secondary ar"ets that e#ist for trading in suchinstruents.

&n essential eleent of forfaiting is that the forfaiter buys thebills or notes fro the seller !ithout recourse to the seller. This

eans that the forfaiter Anot the sellerB bears the loss if thebuyer and the guaranteeing ban" default or if, for any reason,funds cannot be transferred out of the buyers or guaranteeingban"s country.


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Choosin% a documentar! credit as the method of

&.." Benefits for the beneficiary

The beneficiary receives an irrevocable underta"ing of anissuing ban" Aand the separate underta"ing of a confiring

ban", in the case of a confired docuentary creditB that it !illreceive payent, provided the follo!ing conditions are satisfied:

docuents are presented as stipulated in the docuentarycredit

and

all the ters and conditions of the docuentary creditare coplied !ith.

The issuing ban" or confiring ban" underta"ing isaddressed directly to the beneficiary and is legally binding. Theissuing ban" or confiring ban" effects settleent !ithoutrecourse to the beneficiary, !hich eans that the settleent isfinal and there can be no clai upon the beneficiary for refund orrepayent.

&..& Benefits for the

applicantThe buyer, as applicant for a docuentary credit, has theunderta"ing of the issuing ban" that no payent !ill be adeunder it unless the beneficiary has:

presented the docuents as stipulated thereinand

coplied !ith all its ters andconditions.

The applicants andate to the issuing ban" is on the abovebasis. In vie! of the cofort provided to both the beneficiary andthe applicant by the independent underta"ing of a ban",docuentary credits are often apreferred ethod of payent ininternational trade.

&..- ;utonomy of the documentary

credit

'ocuentary credits are used in international trade becausepayent is ade on the basis of the presentation of coplying


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docuents. &n issuing ban" is only re%uired to a"e payent ifall the ters of the docuentary credit are et. There is noresponsibility on an issuing ban" to assess !hether or not theters of the contract have been et. This is the autonoy of thedocuentary credit.

This autonoy of the docuentary credit has been upheldin the courts of any countries. &ny party see"ing toobtain an


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inHunction preventing a ban" fro honouring its obligationsunder a docuentary credit often finds it very difficult. This caneven be true !hen there has been fraud and the granting of aninHunction is appropriate.

The autonoy of docuentary credits is evidenced in #C)*++ articles &, 3, ?, and . These articles are e#ainedin detail in Chapter )3.

&..3 8oles, responsibilities and risksin!ol!ed in usingdocumentarycredits

It is iportant to recognise that, although docuentarycredits provide cofort to both applicant and beneficiary, therespective interests and the ris"s they face in both thedocuentary credit and the underlying transaction reaindifferent. Their interests differ in t!o "ey!ays:

Cash flow the beneficiary usually !ants to collect payentas soon as possible. The applicant norally !ishes to delaypayent until the latest possible tie.

Documents

the applicant !ill !ant to a"e sure thedocuents received are as stipulated in the docuentarycredit. This is certainly the case if the applicant has sold theiported goods and ultiate payent depends on correctdocuentation. The beneficiary !ill !ant to a"e sure all thestipulated docuents can be presented as soon as possibleafter the dispatch of the goods or copletion of thetransaction. The beneficiary !ill be concerned about thepossibility of payent being delayed because of potentialdiscrepancies in these docuents.

These different interests are reflected in the different ris"s to!hich the t!o parties are e#posed.

&..3." 8isks faced by anapplicant

&n applicant faces the follo!ingris"s:

Non2deli!ery of goods goods ay not be deliveredbecause of fraud by the beneficiary. In such circustances,the applicant ay reain liable to reiburse the issuing ban"for conforing docuents.


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7hort2shipment or shipment of inferior goods goodsay be short-shipped Aa lesser %uantity than orderedB or thegoods ay


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be of inferior %uality, despite the presentation of docuentsthat coply !ith the ters and conditions of the docuentarycredit. In this event, an applicant ay suffer a loss on theeventual sale of the goods. The sae ris" also applies if the

goods are received late and the applicant is unable to sellat the price originally anticipated. To iniise losses beingsustained for these reasons, it is iportant that the applicanta"es every attept to establish the bona fides and thetrading record of the beneficiary before entering into adocuentary credit transaction. In this respect, soecofort ay be gained by obtaining a ban" or credit agencystatus report on the beneficiary. It ay also be appropriateto re%uire an independent preshipent inspection of thegoods, via one of the docuents called for in the docuentary

credit.

Goods recei!ed by applicant before documentsrecei!ed by the issuing bank if an applicant has tota"e delivery of the goods by the use of a shippingguarantee, this !ill norally re%uire it to authorise payentunder the docuentary credit not!ithstanding anydiscrepancy in the docuents !hen they are received.

Loss or damage to goods in transit if goods are lost

or daaged in transit, the o!ner of the goods at the tie ofsuch occurrence !ill loo" to its insurers for financialrecopense. 1oth parties should ensure they fully understand!hich party is responsible for arranging insurance !henagreeing the ters of the sales contract, for e#aple via theuse of an Incoter, !hich should be reflected in thedocuents called for under the credit. The applicant should besatisfied that the level of cover arranged provides anappropriate level of protection.

Foreign e%change risk if the currency of the

docuentary credit is not the applicants operating currency,there ay be a difference in e#change rates bet!een thetie the docuentary credit !as issued Aor the tie of theunderlying agreeentB and the tie at !hich settleent isre%uired. If the oveent is unfavourable to the applicant,it ay have to pay ore than the anticipated price,reducing its profit argin or incurring a loss. &n applicantcan protect against this ris" by entering into a for!ardforeign e#change contract or by buying an option. & for!ardforeign e#change contract has the effect of fi#ing the future

e#change rate A!hich could be at a higher rate than thear"et rate at the tie of settleentB.

Failure of issuing bank in the event of the failure ofthe issuing ban", the applicant ay be re%uired to pay the


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beneficiary directly. This ay result in the applicant effectivelypaying t!ice,


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if it had already deposited funds !ith the issuing ban" to eetits liability under the docuentary credit.

Fraud the applicant also faces the ris" that payent!ill be obtained for non-e#istent or !orthless erchandiseagainst presentation of forged or falsified docuents.

&..3.& 8isks faced by a beneficiary

& beneficiary faces the follo!ing ris"s:

Failure to comply with documentary creditconditions a docuentary credit is a substantialsafeguard of payent for the beneficiary. The ain ris" for

the beneficiary is that the noinated ban" or issuing ban"!ill refuse payent because the docuents do not coply!ith the ters and conditions of the docuentary credit. &beneficiary can iniise this ris" by reading thedocuentary credit carefully as soon as it is received. Itshould then iediately re%uest an aendent if any of theconditions appear to vary fro the sales contract or if thebeneficiary !ould find it difficult to satisfy any of thoseconditions. &ny aendent should be received before thegoods are shipped, or the service or perforance is provided.

If the beneficiary ships goods before receipt of a re%uiredaendent, it faces the ris" that, if the issuance of theaendent is delayed, it ay not be able to a"e acoplying presentation.

Failure of, or delays in payment from, the issuing bank in the case of an irrevocable, but unconfired,docuentary credit, the beneficiary incurs the ris" of failure ofthe issuing ban" together !ith the country ris" relating to thecountry in !hich the issuing ban" is located. This poses a

potential proble !here the country concerned lac"sade%uate foreign e#change reserves. If an issuing ban"becoes insolvent, its underta"ing is placed in Heopardy andthe beneficiary ay need to rely on payent for the goodsbeing received direct fro the applicant. In the case of countryris", payent ay be prevented or delayed by incidents suchas balance of payents difficulties affecting the country ofthe issuing ban" or by governent restrictions on transferof funds outside the country. & beneficiary can itigate theseris"s by obtaining a confiration of the docuentary credit by

a ban" located in its o!n country.

Credit issued by a party other than a bank the ris"sto a beneficiary, as outlined above, ay increase if the issuerof the docuentary credit is not a ban". If a beneficiary has


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any doubts as to the status of the issuer of a docuentarycredit or if it


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is clearly issued by a non-ban"ing institution, it shoulde#ercise caution before shipping the goods and placingreliance on the docuentary credit as its guarantee ofpayent. The ICC 1an"ing Coission issued an opinion on

this subHect on 96 Ectober 3663 under the reference R@6@.

Fraud there is also the ris" that the docuentary credititself ay be forged. This ight induce a beneficiary to shipgoods or perfor a service against an apparent ban"underta"ing to pay that, in fact, does not e#ist. In this event,the beneficiary !ill have no enforceable clai against thenaed ban" because either that ban" did not issue thedocuentary credit or the ban" does not e#ist.

Foreign e%change risk if the currency of the

docuentary credit is not the beneficiarys operatingcurrency, there ay be a difference in e#change ratesbet!een the tie the docuentary credit !as issued Aor thetie of the underlying agreeentB and the tie at !hichsettleent is re%uired. If the oveent is unfavourable to thebeneficiary, it ay receive less than the anticipated price,reducing its profit argin or incurring a loss. & beneficiarycan protect against this ris" by entering into a for!ardforeign e#change contract or by buying an option. &for!ard foreign e#change contract has the effect of fi#ing

the future e#change rate A!hich could be at a lo!er ratethan the ar"et rate at the tie of settleentB.

&..3.- Generalrisks

There are also ore general ris"s that affect all parties to adocuentary credit. The best !ay to avoid becoing involvedin a fraudulent transaction or falling foul of legislative and

regulatory re%uireents is siply to "no! your custoer. Theold a#i If goods are being offered for sale at a price that istoo good to be true, then it probably is too good to be true is agood yardstic": if follo!ed, it ay save a good deal ofebarrassent and financial loss that could prove disastrous toa copany.

;ide-ranging legislation is aied at the prevention of oneylaundering, transferring the proceeds of drug traffic"ing and thefunding of terrorist activity. egislation varies in content and

application fro country to country, but as the globalcounity see"s to control and eradicate such activities, there isan increasing responsibility on ban"s to understand better !hotheir custoers are and the true nature of their businesses.


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1an"s that fail to underta"e the re%uired levels of due diligencerun the ris" of incurring severe


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penalties fro their local regulatory or legislative bodies. This ise#ained in ore detail in Chapter )9.

Ether general ris"s include thefollo!ing:

7o!ereign and regulatory risks sovereign andregulatory ris" is the ris" that perforance of thedocuentary credit ay be prevented by governent actionoutside the control of the parties. This ay occur, forinstance, if a governent iposes foreign payentrestrictions or iport M e#port prohibitions after a docuentarycredit has been issued, but before it has been fully perfored.This ris" ay also be referred to as country ris".

Legal risks

the sovereign and regulatory ris"s referredto above ay provide a disruption of the docuentarycredit by events outside the frae!or" of thedocuentary credit operation itself. In contrast, legal ris"sconcern the possibility that perforance of a docuentarycredit ay be disturbed by legal action relating directly to theparties, and to their rights and obligations under thedocuentary credit.

Ene e#aple of this latter type of ris" is if a dispute arises undera sales contract bet!een the applicant and beneficiary. Theapplicant ay start a court action against the beneficiary. Inthe course of these proceedings the applicant ay obtain acourt order, such as an inHunction, that prevents the issuingban" fro paying under the docuentary credit pending theresolution of the dispute. This places the issuing ban" in asituation in !hich it cannot honour its obligation. The legal ris"ay be coplicated by the fact that docuentary credittransactions invariably involve parties in t!o or ore differentcountries.

&. $ssuance of a documentarycredit

It is a buyers responsibility to re%uest the issuance of adocuentary credit. The tie !hen it should be opened shouldbe detailed in the sales contract. If no date is indicated, adocuentary credit should be issued so as to be in the hands of

the beneficiary prior to the earliest date of any specifiedshipent date.

1eneficiaries often use docuentary credits opened in theirfavour as thebasis for obtaining ban" finance. This finance ay


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be necessary to enable the to ship the goods. &s a result, thebeneficiary is under no obligation to do anything until thedocuentary credit is issued.

Students should not be concerned !ith the legal reedies thatan applicant and beneficiary ay have against each other, butsiply


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Issuance of a documentar!

!ith the fact that an applicant has a responsibility to arrange forthe docuentary credit