Payment defaults under LCs

Bangladesh Bank has recently issued a circular underscoring the importance of prompt payment of import bills under letters of credit (LCs). Non-payment of these bills, the circular added, tarnishes the image of the country and raises the cost of imports because, apprehending the risks of non-payment, foreign suppliers often insist on adding confirmation of reputable banks abroad as a token of guarantee of payment. This reputation, or the lack of it, also translates into higher costs for the merchandise apart from limiting the scope for buying at competitive prices. On the other hand, defaults by a few importers and their bankers impose an additional burden on the entire business community engaged in foreign trade.
Non-payment of import bills is a serious issue that needs more than gentle reminder. At the root of the problem is the ignorance of a section of the trade and some of the bank officials regarding the guiding principles of LCs and their lackadaisical attitude regarding fulfillment of contractual obligations under them. I have heard many bank officials, even those at the high levels, talking about non-funding or off-balance sheet activities like issue of bank guarantee, performance bond and letters of credit as an opportunity to earn money through 'sale of paper'. What many of them forget is that the 'potential risks' of this 'paper' are as real as those against cash credits. So, unmindful of the perceived risks, they lower their guards for assessment of the creditworthiness and reputation of the clients and assume obligations without collateral security and adequate margins, often without any margin. However, they begin to feel the pinch and remain clueless when the customers do not come forward to fulfill their part of the obligations. It is then that the bank officials who sponsored the 'sale of paper', starts dilly-dallying to avoid payments against their LCs or guarantees to earn a respite from the scrutiny of the Credit Committee or the Board of Directors. Sometimes, they even encourage the clients to collect injunctions from a lower court to withhold payment.   
The system of import on credit terms, especially by the garment sector, has spawned serious unethical practices in the trade and banking arena. Many importers, often in collusion with their bankers, do not pay the suppliers on flimsy grounds like poor quality or quantity of materials received. The refusal to pay militates against the spirit of the Uniform Customs and Practices (UCPDC) for Documentary Letters of Credit of the International Chamber of Commerce. Under the UCPDC the LC opening bank cannot renege on its obligation to pay if the documents are apparently in order, even though the quality, quantity etc are not in accordance with the contracts between the buyers and sellers. This dictum follows from the well-known principle that 'banks deal in documents and not in goods'. It means, if there is any dispute concerning quality, quantity or anything else that does not show up in the documents, it must be settled by the buyer with the seller mutually or, if need be, through legal means.
The starting-point for understanding the true nature of LCs, the following are some important guiding principles of the UCPDC, 600 that must be borne in mind by everyone connected with foreign trade or financing of this trade:
n Letters of credit are separate transactions from the sales or other contracts on which they are based, and banks are in no way involved with or bound by such contracts, even if reference to them is included in the letter of credit. It means that banks are concerned only with broad terms of the contract embodied in the LC, like brief description of the merchandise, its quantity and unit and total price, country of origin, last dates of shipment and negotiation and terms of shipment e.g. FOB or CFR (Free on Board or Cost and Freight). The obligations of the issuing and negotiating banks do not extend beyond ensuring compliance with these terms and that too on the basis of documents produced.    
n In letters of credit transactions, all parties deal with documents and not with the underlying contracts to which the documents may relate. It means that the bank would not verify the contents of consignments but would go by the description of the merchandise mentioned in the bill of lading and other shipping documents.
n Before payment or acceptance of drafts is effected, banks bear the responsibility for examining the documents to ensure that they appear on their face to be in accordance with the terms and conditions of the letter of credit.
n Banks bear no responsibility for the form or genuineness of documents; for the goods described in the documents; or the performance of the seller of the goods.
The following are some of the suggestions to avoid the stigma of defaults against letters of credit:
(1) The banks should be reminded to promptly settle the payments on due dates against the bills accepted by them. If they have any problem with discrepancies in the documents regarding the quantity, quality or other aspects of the consignments, that should be sorted out before accepting the bills. If any branch is found to be unnecessarily sitting on the accepted bills beyond the due dates, its Authorized Dealership license may be suspended.
(2)    The Bangladesh Garment Manufacturers and Exporters Association (BGMEA) and Bangladesh Knitwear Manufacturers and Exporters Association BKMEA, whose members account for most of the defaults, may organise training and orientation programmes for the officials of the apparel units on various aspects of exports and imports including the laws, regulations and customs at the domestic and international levels. It will also strengthen their hands to deal with unscrupulous buyers who try to defraud or extract heavy discounts on flimsy grounds.
(3) The Bangladesh Bank (BB) may organise training programmes and seminars for banks to underline the importance and ways of handling international payments.
(4) A law may be enacted to prohibit the courts from issuing injunctions to stall payments towards international obligations. I think there was an order from the High Court to this effect sometimes in the eighties. It could be dug out and circulated for guidance of all concerned.
The writer is a former Executive Director of Bangladesh Bank. [email protected]