Payments in international trade
Sunday, 30 August 2009
MS Siddiqui
LETTER of Credit (LC), introduced to early in the 20th century, continues to play a critical role in international trade. The letters of credit, an important payment mechanism, helps eliminate certain risks. About 60 per cent of payments against international trade are executed through LCs although their use is reducing day by day to avoid formalities.
LCs are based on two fundamental principles: The autonomy of the LC and doctrine strict compliance.
The autonomy of the LC principle: The LC is disassociated from the actual sales and other contracts and, thus, is not affected by any problems and disputes related to the contracts or dissatisfactions between the exporter and the buyer. The main and only agreement that is arranged between the exporter and the bank, is the LC. The bank is only concerned with one problem -- to check whether the documents presented by the seller comply with those specified in the LC. Because of the autonomy of a LC, the buyer's bank is therefore absolutely bound to honour the LC by paying the seller upon presentation of proper documents, notwithstanding any dissatisfaction from the buyer in relation to the sales contract or any dispute between the buyer and seller. The buyer's complaint about the export cannot suspend payment of the LC. The same principle applies in case of sellers bank. The buyers and their bank have right to take legal action against buyer's bank for dishonouring drafts against a LC because of complaints about the quality of the exported goods. The only case where a bank may refuse payment is in case of fraud or forgery in the transaction.
The principle of strict compliance requires exporter to respect the written terms "to the letter" of the LC. If any discrepancy or inconstancy occurs between the documents presented by the exporter and what is actually specified in the LC, the bank can refuse payment. Therefore, with an LC, the importer has the protection of the bank strictly controlling the documents, and the exporter has the protection of getting paid if all documents comply with the LC. But the problem is how strict should be the compliance. Some courts insist upon literal compliance, so that a misspelled name or typographical errors may be a divergence to refuse payment. Others accept payment upon substantial compliance with documentary requirements. However, one should keep in mind that the bank may insist on strict compliance with all the requirements of the LC, and therefore the beneficiary must be able to provide prompt documentation within validity of LC for presentation. The exporter has very limited defence to protect himself, he should check with his bank whenever he has any doubts in interpreting unclear items in the LC. The exporters are facing critical problems to understand LCs from Bangladesh since most of the banks do not follow uniform customs and practices for documentary credit (UCP) 500. The banks and importers have many agenda and they put arbitrary conditions and use non-traditional language in the LC. They usually do not comply with 'Indent' or 'Proforma Invoice' which is truly an agreement of purchase.
The International Chamber of Commerce (ICC) promotes international trade, investment and market economy system worldwide. It makes rules that govern the conduct of business across borders, provides essential services, the foremost among them being the ICC International Court of Arbitration.
The ICC continuously modifies and develops the trade finance mechanism to add to the measure of security to trade transactions, particularly between importers and exporters from different countries, and to assert sufficient pressure in case of any violation or non-performance of the trade contract. The LC calls for the participation of a third party, which is the bank. The bank provides additional security for both parties. It plays the role of an intermediary, by assuring the seller that he will be paid if he provides the bank with the required documents, and by assuring the buyer that his money will not be paid unless the shipping documents evidencing proper shipment of his goods are presented. There are initially three parties involved in documentary credit; the issuer (issuing bank), the account party (buyer/applicant), and the beneficiary (seller). Three agreements represent the relationship between the parties, a trade contract between buyer and seller (Indent or Proforma Invoice or any formal agreement), the documentary credit between the issuing bank and the seller (LC), and a reimbursement agreement between the issuing bank and the buyer. Although the three agreements are related to the same transaction, each of them is independent, and the breach of one agreement may not constitute breach of another agreement. There are strict requirements that govern the formulation of documentary credit. The ICC is the organisation which has developed the most extensive and most commonly applied rules, models, and materials related to documentary credit.
International Commerce term (Incoterms) and the Uniform Customs and Practice for Documentary credit (UCP) are the most well-known products of ICC in relation to international trade practices. Their objective is to facilitate trade, increase the efficiency and decrease the cost of international transactions by promoting the standardisation of international banking and commercial practices and procedures.
ICC published in 1936 a set of rules specifying contract obligations and assigning the responsibilities of buyers and sellers involved in international trade in order to facilitate communication and trading among the stakeholders. The incoterms have been updated regularly since, most recently in 1990, with 13 standardised foreign sales terms, to reflect new techniques of international trade. Incoterms are uniform sales terms used in foreign trade and are accepted by the banks as legal terminology for LC transactions. They provide clear explanations as to the terms of sales and obligations of the parties to a LC, in terms cost like goods, transportation, insurance etc. Incoterms are the international standard used in the sales transaction and shipping documentation. It defines the seller's and buyer's responsibilities for expenses and division risks of transactions in relation to the transport of the goods being traded.
Incoterms provide generally three basic information. It defines at which place the risks of cargo loss and damage is transferred from the seller to the buyer during transport operations, how costs resulting from the transport operation are shared between the buyer and seller, that is, cost of dispatch, carriage and delivery, customs clearance for export and import, service or assistance rendered by one party to the other, and insurance. It also defines who will provide the required documents that is transport document, proof of delivery, certificate of inspection, insurance, etc.
The incoterms are in synchronisation with the Vienna Convention, the UN law on contracts covering the international sales of goods. Since incoterms are not law, they must be written into a sales contract in order to be bound to a contract. It should be noted that incoterms are flexible and can be further defined to suit the mutual interest of the buyer and the seller.
UCP is a set of standard rules and practices for bankers to govern trade transactions set by ICC. The UCP describes customary practices and standard performance for letters of credit and provides a comprehensive and practical aid to bankers and all businesses involved in international trade. The UCP lays down a code of practice for issuing the LC. For many years, most documentary credit transactions were carried out in accordance with the "Uniform Customs and Practice for Documentary Credits" with a few exceptions like Bangladesh. LCs are reviewed by all banks according to these rules, and persons dealing in LCs should be well-aware of them. At present UCP 500 is in practice and the ICC is now in actively promoting UCP 600. At the international conference on Basel II in Switzerland, the immediate past governor of Bangladesh Bank promised to introduce Basel II, which is to promote the UCP 600.
UCP is in the process of updating to enhance international trade and facilitate the use of LCs by reducing the level of discrepancies and disputes. It should be noted that not all banks in the world conform to the UCP rules but, in principle, it is clearly stated in UCP 500 that UCP rules apply to a documentary credit when they are included in the contract. Therefore, it is always preferable to refer to the UCP when setting up a contract. The practice is yet to start in Bangladesh. But it is observed that some of the local banks now incorporate a clause of application of UCP in transactions.
Insurance coverage is a requisite for any international trade transaction since international shipments represent a high degree of risk. Bad weather conditions, rough handling, and other common perils to shipment make marine insurance an important protection for exporters and importers. The long distance shipment, the prolonged transit time, and the transportation by more than one carrier which, in turn, means many loadings and unloadings, lead to extensive possibilities for goods to be easily damaged or lost. Banks ask for the precondition of insurance coverage for a loan extended to the transaction.
There is the possibility of two types of loss in a sales contract -- the loss due to damage to goods in transit, and the loss generated by non-performance of the contract. The insurance coverage certificate or marine cargo insurance is a document certifying that the goods are insured for shipment and, therefore, covered for losses or damage sustained during shipment. (The writer, a guest teacher at Leading University, can be reached at e-mail:
shah@banglachemical.com)
LETTER of Credit (LC), introduced to early in the 20th century, continues to play a critical role in international trade. The letters of credit, an important payment mechanism, helps eliminate certain risks. About 60 per cent of payments against international trade are executed through LCs although their use is reducing day by day to avoid formalities.
LCs are based on two fundamental principles: The autonomy of the LC and doctrine strict compliance.
The autonomy of the LC principle: The LC is disassociated from the actual sales and other contracts and, thus, is not affected by any problems and disputes related to the contracts or dissatisfactions between the exporter and the buyer. The main and only agreement that is arranged between the exporter and the bank, is the LC. The bank is only concerned with one problem -- to check whether the documents presented by the seller comply with those specified in the LC. Because of the autonomy of a LC, the buyer's bank is therefore absolutely bound to honour the LC by paying the seller upon presentation of proper documents, notwithstanding any dissatisfaction from the buyer in relation to the sales contract or any dispute between the buyer and seller. The buyer's complaint about the export cannot suspend payment of the LC. The same principle applies in case of sellers bank. The buyers and their bank have right to take legal action against buyer's bank for dishonouring drafts against a LC because of complaints about the quality of the exported goods. The only case where a bank may refuse payment is in case of fraud or forgery in the transaction.
The principle of strict compliance requires exporter to respect the written terms "to the letter" of the LC. If any discrepancy or inconstancy occurs between the documents presented by the exporter and what is actually specified in the LC, the bank can refuse payment. Therefore, with an LC, the importer has the protection of the bank strictly controlling the documents, and the exporter has the protection of getting paid if all documents comply with the LC. But the problem is how strict should be the compliance. Some courts insist upon literal compliance, so that a misspelled name or typographical errors may be a divergence to refuse payment. Others accept payment upon substantial compliance with documentary requirements. However, one should keep in mind that the bank may insist on strict compliance with all the requirements of the LC, and therefore the beneficiary must be able to provide prompt documentation within validity of LC for presentation. The exporter has very limited defence to protect himself, he should check with his bank whenever he has any doubts in interpreting unclear items in the LC. The exporters are facing critical problems to understand LCs from Bangladesh since most of the banks do not follow uniform customs and practices for documentary credit (UCP) 500. The banks and importers have many agenda and they put arbitrary conditions and use non-traditional language in the LC. They usually do not comply with 'Indent' or 'Proforma Invoice' which is truly an agreement of purchase.
The International Chamber of Commerce (ICC) promotes international trade, investment and market economy system worldwide. It makes rules that govern the conduct of business across borders, provides essential services, the foremost among them being the ICC International Court of Arbitration.
The ICC continuously modifies and develops the trade finance mechanism to add to the measure of security to trade transactions, particularly between importers and exporters from different countries, and to assert sufficient pressure in case of any violation or non-performance of the trade contract. The LC calls for the participation of a third party, which is the bank. The bank provides additional security for both parties. It plays the role of an intermediary, by assuring the seller that he will be paid if he provides the bank with the required documents, and by assuring the buyer that his money will not be paid unless the shipping documents evidencing proper shipment of his goods are presented. There are initially three parties involved in documentary credit; the issuer (issuing bank), the account party (buyer/applicant), and the beneficiary (seller). Three agreements represent the relationship between the parties, a trade contract between buyer and seller (Indent or Proforma Invoice or any formal agreement), the documentary credit between the issuing bank and the seller (LC), and a reimbursement agreement between the issuing bank and the buyer. Although the three agreements are related to the same transaction, each of them is independent, and the breach of one agreement may not constitute breach of another agreement. There are strict requirements that govern the formulation of documentary credit. The ICC is the organisation which has developed the most extensive and most commonly applied rules, models, and materials related to documentary credit.
International Commerce term (Incoterms) and the Uniform Customs and Practice for Documentary credit (UCP) are the most well-known products of ICC in relation to international trade practices. Their objective is to facilitate trade, increase the efficiency and decrease the cost of international transactions by promoting the standardisation of international banking and commercial practices and procedures.
ICC published in 1936 a set of rules specifying contract obligations and assigning the responsibilities of buyers and sellers involved in international trade in order to facilitate communication and trading among the stakeholders. The incoterms have been updated regularly since, most recently in 1990, with 13 standardised foreign sales terms, to reflect new techniques of international trade. Incoterms are uniform sales terms used in foreign trade and are accepted by the banks as legal terminology for LC transactions. They provide clear explanations as to the terms of sales and obligations of the parties to a LC, in terms cost like goods, transportation, insurance etc. Incoterms are the international standard used in the sales transaction and shipping documentation. It defines the seller's and buyer's responsibilities for expenses and division risks of transactions in relation to the transport of the goods being traded.
Incoterms provide generally three basic information. It defines at which place the risks of cargo loss and damage is transferred from the seller to the buyer during transport operations, how costs resulting from the transport operation are shared between the buyer and seller, that is, cost of dispatch, carriage and delivery, customs clearance for export and import, service or assistance rendered by one party to the other, and insurance. It also defines who will provide the required documents that is transport document, proof of delivery, certificate of inspection, insurance, etc.
The incoterms are in synchronisation with the Vienna Convention, the UN law on contracts covering the international sales of goods. Since incoterms are not law, they must be written into a sales contract in order to be bound to a contract. It should be noted that incoterms are flexible and can be further defined to suit the mutual interest of the buyer and the seller.
UCP is a set of standard rules and practices for bankers to govern trade transactions set by ICC. The UCP describes customary practices and standard performance for letters of credit and provides a comprehensive and practical aid to bankers and all businesses involved in international trade. The UCP lays down a code of practice for issuing the LC. For many years, most documentary credit transactions were carried out in accordance with the "Uniform Customs and Practice for Documentary Credits" with a few exceptions like Bangladesh. LCs are reviewed by all banks according to these rules, and persons dealing in LCs should be well-aware of them. At present UCP 500 is in practice and the ICC is now in actively promoting UCP 600. At the international conference on Basel II in Switzerland, the immediate past governor of Bangladesh Bank promised to introduce Basel II, which is to promote the UCP 600.
UCP is in the process of updating to enhance international trade and facilitate the use of LCs by reducing the level of discrepancies and disputes. It should be noted that not all banks in the world conform to the UCP rules but, in principle, it is clearly stated in UCP 500 that UCP rules apply to a documentary credit when they are included in the contract. Therefore, it is always preferable to refer to the UCP when setting up a contract. The practice is yet to start in Bangladesh. But it is observed that some of the local banks now incorporate a clause of application of UCP in transactions.
Insurance coverage is a requisite for any international trade transaction since international shipments represent a high degree of risk. Bad weather conditions, rough handling, and other common perils to shipment make marine insurance an important protection for exporters and importers. The long distance shipment, the prolonged transit time, and the transportation by more than one carrier which, in turn, means many loadings and unloadings, lead to extensive possibilities for goods to be easily damaged or lost. Banks ask for the precondition of insurance coverage for a loan extended to the transaction.
There is the possibility of two types of loss in a sales contract -- the loss due to damage to goods in transit, and the loss generated by non-performance of the contract. The insurance coverage certificate or marine cargo insurance is a document certifying that the goods are insured for shipment and, therefore, covered for losses or damage sustained during shipment. (The writer, a guest teacher at Leading University, can be reached at e-mail:
shah@banglachemical.com)