Letters of Credit

• A Letter of Credit is a payment term generally used for international

sales transactions. It is basically a mechanism which allows
importers/buyers to offer secure term of payment to
exporters/sellers in which a bank (or more than one bank) gets
involved. The technical term for Letter of Credit is “Documentary
Credit”.

• Documentary Credits are the most common method of payment for

goods in international trade and have been described by the English
Judges as the “ Life blood of international trade”
Step-by-step process:

•Buyer and seller agree to conduct business. The seller wants a letter of credit to guarantee
payment.

•Buyer applies to his bank for a letter of credit in favor of the seller.

•Buyer's bank approves the credit risk of the buyer, issues and forwards the credit to its
correspondent bank (advising or confirming). The correspondent bank is usually located in
the same geographical location as the seller (beneficiary).

•Advising bank will authenticate the credit and forward the original credit to the seller
(beneficiary).

•Seller (beneficiary) ships the goods, then verifies and develops the documentary
requirements to support the letter of credit. Documentary requirements may vary greatly
depending on the perceived risk involved in dealing with a particular company.
•Seller presents the required documents to the advising or confirming bank to be
processed for payment.

•Advising or confirming bank examines the documents for compliance with the terms and
conditions of the letter of credit.

•If the documents are correct, the advising or confirming bank will claim the funds by:

• Debiting the account of the issuing bank.

• Waiting until the issuing bank remits, after receiving the documents.

• Reimburse on another bank as required in the credit.

•Advising or confirming bank will forward the documents to the issuing bank.

•Issuing bank will examine the documents for compliance. If they are in order, the issuing
bank will debit the buyer's account.

•Issuing bank then forwards the documents to the buyer.

Please note these images have been taken directly from internet for teaching purposes
Please note these images have been taken directly from internet for teaching purposes
• The Uniform Customs and Practice for Documentary Credits (UCP) is a set of
rules on the issuance and use of letters of credit. The UCP is utilized by bankers
and commercial parties in more than 175 countries in trade finance.

• Historically, the commercial parties, particularly banks, have developed the

techniques and methods for handling letters of credit in international trade finance.
This practice has been standardized by the ICC (International Chamber of
Commerce) by publishing the UCP in 1933 and subsequently updating it
throughout the years. The ICC has developed and molded the UCP by regular
revisions, the current version being the UCP600. The result is the most successful
international attempt at unifying rules ever, as the UCP has substantially universal
effect. The latest revision was approved by the Banking Commission of the ICC at
its meeting in Paris on 25 October 2006. This latest version, called the UCP600,
formally commenced on 1 July 2007.
There are various types of LCs. Such as;

• Revocable Letter of Credit

• Irrevocable Letter of Credit

• Confirmed Letter of Credit

• Unconfirmed Letter of Credit etc…..

Revocable Letter of Credit

A revocable credit can be cancelled or amended by the bank that it issued

at any time for any reason with out prior notice to the beneficiary. This
kind of LC is disadvantageous for the exporter. Latest version of UCP
(UCP 600) does not cover revocable LCs.

✓Cape Asbestos Co Limited vs Lloyds Bank

Irrevocable Letter of Credit
Irrevocable LC is a LC which cannot be amended or cancelled by the issuing bank
except with the explicit agreement of all parties involved. It provides greater security
of payment to the beneficiary of the letter ,who is commonly the seller in a
transaction. (Refer Article 9 and 10 of UCP 600)

The contracts created when an irrevocable credit is issued are separate and
autonomous from each other and from the underlying contract between the
beneficiary and applicant.
✓ Cie Continnentale d’ Importation vs Ispahani Ltd (1960)1 Llioyd’s Report 293
✓ Maran Road vs Austin Taylor and Co. Limited (1975) 1 Lloyds Rep
✓ Discount Records Limited vs Barclays Bank Limited
Confirmed Letter of Credit

A confirmed LC is a LC in which the seller or exporter has payment

guarantee from a second bank. (confirming bank). Accordingly, if the first
bank fails to pay then the payment will be done by the second bank.
This is required when the seller is not satisfied with the creditworthiness
of the first LC. (Technically issuing bank)

Unconfirmed Letter of Credit

A LC is considered unconfirmed if the first letter of credit is not backed

by a second guarantee.
Parties to Letter of Credit

Applicant
Applicant is the party who opens Letter of Credit. Normally, buyer of goods is the applicant who opens
letter of credit. (Article 2)

Beneficiary
Beneficiary is the party who will be paid under the LC. Usually the seller in the commercial sale
contract.(Article 2)

Issuing Bank
Issuing Bank is the bank who opens letter of credit. Letter of credit is created by issuing bank who takes
responsibility to pay on receipt of documents from supplier of goods (beneficiary under LC) (-Article
2/Article 7)
Advising Bank
Advising bank is the bank that advises the credit at the request of the issuing bank-
(Article 2/Article 9)

Nominated Bank
Nominated bank is the bank with which the credit is available or any bank in the case
of a credit available with any bank.(Article 2/Article 12)

Confirming Bank
Confirming bank is the bank that adds its confirmation to a credit upon the issuing
bank authorization or request. In case the issuing bank fails to perform the act
confirming bank will pay the beneficiary. (Article 2/Article 8/Article 10 (b))
Negotiating Bank

Negotiating Bank, who negotiates documents delivered to bank by beneficiary of LC.

Negotiating bank is the bank who verifies documents and confirms the terms and
conditions under LC on behalf of beneficiary to avoid discrepancies

Reimbursing Bank
Reimbursing Bank is one of the parties involved in an LC. Reimbursing bank is the
party who authorized to honor the reimbursement claim of negotiation/ payment/
acceptance. (URR 725 or UCP 600 Article 13)
UCP 600-Articles

Application of the UCP

• In principle, UCP apply only if the parties have incorporated them into their contract.(Article 1)

A comprehensive definition for LC is found in the “Uniform Customs and Practice for
Documentary Credit (UCP) 600,where it is provided.

Article 2

“Credit(s)”, mean any arrangement, however named or described, that is irrevocable and thereby
constitutes a definite undertaking of the issuing bank to honour a complying presentation.
Article 1 : Application of UCP

Article 2 : Definitions of Advising bank, Application, Banking day, Beneficiary, Complying

presentation, Confirmation , Confirming bank, Credit, Honour, Issuing bank, Negotiation, Nominated
Bank, Presentation, Presenter.

Article 3 : Interpretations of some terms like from, after, before, between, till, untill, to, first half and
second half of the month, beginning middle and end of the month

Example: first half of the month means 1st to 15th day

2nd half of the month means 16th to last day of the months all dates inclusive.
beginning of the month means: 1st to 10th,
middle of the month means: 11th to 20th day
end of the month means : 21th to the last day of the month, all dates inclusive.

Article 4: Credit v. Contracts

Article 5: Documents v. Goods, Services or Performance
Article 6: Availability, Expiry Date and Place for Presentation
Article 7 : Issuing Bank Undertaking
Article 8 : Confirming Bank Undertaking
Article 9 : Advising of Credits and Amendments
Article 10 : Amendments
Article 11 : Teletransmitted and Pre-Advised Credits and Amendments
Article 12 : Nomination
Article 13 : Bank-to-Bank Reimbursement Arrangements
Article 14 : Standard for Examination of Documents
Article 15 : Complying Presentation
Article 16 : Discrepant Documents, Waiver and Notice
Article 17 : Original Documents and Copies
Article 18 : Commercial Invoice
Article 19: Transport Document Covering at least Two Different Modes of
Transport
Article 20: Bill of Lading
Article 21: Non-negotiable sea waybill
Article 22: Charter Party Bill of Lading
Article 23: Air Transport documents
Article 24: Road, Rail or Inland Waterway Transport Documents
Article 25: Courier Receipt, Post Receipt or Certificate of Posting
Article 26: On Deck, Shipper's Load and Count, Said by Shipper to Contain and
Charges Additional to Freight
Article 27: Clean Transport Document
Article 28: Insurance Document and Coverage
Article 29: Expiry date of credit
Article 30 : Tolerance in Credit Amount, Quantity and Unit Prices
Article 31 : Partial Drawings or Shipments
Article 32 : Instalment Drawings or Shipments
Article 33 : Hours of Presentation
Article 34 : Disclaimer on Effectiveness of Documents
Article 35 : Disclaimer on Transmission and Translation
Article 36 : Force Majeure
Acts of God, riots, civil commotions, insurrections, wars, acts of terrorism
or by any strikes or lockouts or any other causes beyond its control.
Article 37 : Disclaimer for acts of an Instructed party
Article 38 : Transferable Credits
Article 39 : Assignment of Proceeds
The concept of LC is based on two fundamental principles.

1.The Autonomy of the Credit

2.The Doctrine of Strict Compliance
1.Autonomy of Credit

• The Autonomy principle which is fundamental to documentary credits means that a

letter of credit is a separate transaction from the sale or other contract on which it
may be based and banks are in no way concerned with or bound by such contracts,
even if the LC contains a reference to such contracts. (4 a) The Letter of Credit
transaction is thus a paper transaction. This requirement clearly spelt out in Article 4
and 5. (Article 4 and 5)

• Accordingly, payment by the issuer is based solely on a determination of the

conformity of the documents presented by the claiming beneficiary, against the
terms and conditions of the LC without reference to the underlying contract.
The principle of “Autonomy of Credit” is not absolute. There are exceptions to
the rule.

1.Fraud Exception
2.Supervening Illegality
Where there is a fundamental mistake that renders the credit voib ab initio (to be
treated as invalid from the outset)

• National Infrastructure Development Company Limited v Banco Santander S.A. [2017]

EWCA Civ 27 and Petrosaudi Oil Services (Venezuela) Ltd v Novo Banco S.A. &
Others [2017] EWCA Civ 9.,Bankers Trust Co. vs State Bank of India (1991) 2 Lloyds
Rep 443, Inflatable Toy Company Limited vs State Bank of New South Wales (1994) 34
NSWLR 243,United City Merchants (Investments) Limited vs Royal Bank of Canada
(1983) 1 AC
2.Doctrine of Strict Compliance

• In general, Doctrine of Strict Compliance referred to as a legal principle which

provides that the bank is entitled to reject documents which do not strictly comply
with the terms of the credit. The doctrine provides that in order to receive the
payment from the bank the seller/beneficiary is required to tender documents
which are in conformity with the terms of the letter of credit.

• The principle of doctrine of strict compliance was first formulated in 1927 by an

English court in Equitable Trust Company of New York v Dawson Partners
Ltd.(1927)
"It is both common ground and common sense that in such a transaction the
accepting bank can only claim indemnity if the conditions on which it is
authorized to accept are in the matter of the accompanying documents strictly
observed. There is no room for documents which are almost the same, or which
will do just as well. Business could not proceed securely on any other lines. The
bank's branch abroad, which knows nothing officially of the details of the
transaction thus financed, cannot take upon itself to decide what will do well
enough and what will not.”

-Viscount Sumner J-
✓ Equitable Trust Company of New York v Dawson Partners Ltd [1927] 2 Lloyd’s Rep 49,52 per Viscount
Sumner
• It aims to protect the buyer who has neither the opportunity to examine the
physical goods nor to supervise the process of loading the goods in the sellers
country due to geographical distance.

• This principle also benefits the seller by providing fast payment. The seller does
not have to wait until the goods shipped safely reach the buyer before claiming
payment. The seller can claim the payment for the goods sold by presenting to
the bank the documents required by the buyer once the goods have been shipped
to the buyer

• And under this principle of strict compliance the bank is at liberty to reject the
documents which do not strictly complied with the terms of the credit.
• Apart from the buyer and seller, the bank also benefits from the application of
the principle of strict compliance. The bank will be protected from any legal
repercussions as long as the payment to the seller was made upon strict
compliance of sellers documents.

Relevant ICC Rules

• Article 14 (a)
• Article 14 (d) - The Doctrine of Strict Compliance has been relaxed by the
provisions introduced by the UCP 600.

(The above provision eliminates the narrow provision of Article 13 (a) of the UCP 500 which stated
that documents which are inconsistent with one another will be treated as non compliant. The
introduction of the new provision of the UCP 600 reduces the complexity presented by the strict
compliance principle. It signifies that as long as the contents of the documents are not contrary to
the LC, the bank will accept documents as in compliance.)
• Article 14 (e)

• Article 14 (f)

• ISBP (International Standard Banking Practice) 745 Para A23

(It is a publication of ICC. It offers crucial guidance on the documents presented

against LC.ISBP does not change UCP 600 rules when it comes to LC. However, it is

a valuable guide to UCP.)

• Article 14 (j)
✓ J H Rayner and Co. vs Hambros Bank Limited (1943)
✓ Moralice London Limited vs ED and F man (1954)
✓ Midland Bank vs Seymour (1955)2 Lloyds Report
✓ English, Scottish & Australia Bank Limited vs Bank of South Africa (1922)
✓ Philadelphia Gear Corporation vs Central Bank (1983)
✓ United Bank Limited vs Banque Nationale de Paris (1992)
✓ Glencore International AG vs Bank of China (1996)
✓ NEC Hong Kong Ltd v. Industrial and Commercial Bank of China &
Another (Hong Kong, 2006)

.
Incoterms
• Incoterms (International Commercial Terms) are a set of rules which define
the responsibilities of sellers and buyers for the delivery of goods under sales
contracts. They are published by the International Chamber of Commerce (ICC)
and are widely used in commercial transactions. (Incoterms 2020 rules are the
latest revision of international trade terms published by the International
Chamber of Commerce (ICC) )

• The Incoterms rules are accepted by governments, legal authorities, and

practitioners worldwide for the interpretation of most commonly used terms in
international trade.
• They are intended to reduce or remove altogether uncertainties arising
from differing interpretation of the rules in different countries. As such
they are regularly incorporated into sales contracts worldwide.

• Incoterms® are used in both international and domestic contracts.

They clearly define the buyer and sellers responsibilities, risks, and costs.
They are reviewed and updated every ten years
Sea and Inland Waterway Transport

• FAS - Free Alongside Ship - Seller is responsible for delivering goods at the port
alongside the vessel. From this point, onwards risk and cost transfer to the buyer.

• FOB - Free On Board - Seller is responsible for goods loaded onboard the vessel.
Risk and cost are transferred as soon as the goods have been loaded on board the
vessel.

• CFR - Cost and Freight - Seller covers freight costs to the named port of
destination or place. Risk is transferred as soon as the goods have been loaded on
board the vessel.

• CIF - Cost, Insurance, and Freight - Seller covers insurance and freight costs to
the named port of destination or place. Risk is transferred as soon as the goods
have been loaded on board the vessel. Seller is required to obtain the minimum
insurance cover complying with Institute Cargo Clauses (C) in the buyer's name.
Any Mode of Transport

• EXW - Ex Works - Seller is only responsible for having the goods packed made available at the seller's
premises. The buyer bears the full risk and costs from there to the destination - including the loading of the
cargo.
• FCA - Free Carrier - Seller is only responsible for delivery to the named place. The seller is responsible for
the loading. Risk and cost are transferred to the buyer as soon as delivered at the named place. Unloading is
the buyer's responsibility.
• CPT - Carriage Paid To - Seller arranges the transportation and costs to the named destination. Risk is
transferred to the buyer once delivered at the first carrier.
• CIP - Carriage and Insurance Paid to - Seller arranges the transportation, costs, and insurance on behalf of
the buyer to the named place at the destination. Risk is transferred to the buyer once delivered at the first
carrier. The seller must obtain extensive insurance cover complying with insurance Cargo Clauses (A) or a
similar clause in the buyer's name.
• DAP - Delivered at Place - Seller delivers the goods to the agreed place at the destination. Seller assumes all
costs and risks until the goods are ready for unloading at the named place of destination.
• DPU - Delivered at Place Unloaded - Seller assumes all costs and risks until the goods are unloaded at the
agreed named place of destination. The buyer is responsible for import customs formalities.
• DDP - Delivery Duty Paid - Seller delivers goods to the agreed place destination. Seller assumes all costs -
including import formalities and risks until the goods are ready for unloading at named place of destination.
FOB, "Free On Board", is a term in international commercial law
specifying at what point respective obligations, costs, and risk
involved in the delivery of goods shift from the seller to the buyer
under the Incoterms standard. FOB is only used in non-
containerized sea freight or inland waterway transport.
FOB – Free on Board (named port of shipment)

• Under FOB terms the seller bears all costs and risks up to the point the goods are
loaded on board the vessel.

• The seller's responsibility does not end at that point unless the goods are
"appropriated to the contract" that is, they are "clearly set aside or otherwise
identified as the contract goods".

• Therefore, FOB contract requires a seller to deliver goods on board a vessel that is
designated by the buyer at the particular port. In this case, the seller must also
arrange for export clearance. On the other hand, the buyer pays cost of marine
freight transportation, bill of lading fees, insurance, unloading and transportation
cost from the arrival port to destination.
• The term ‘free’ refers to the supplier’s obligation to deliver goods to a specific
location, later to be transferred to a carrier.

• In other words, the supplier is “free” of responsibility. ‘On board’ simply means
that the goods are on the ship.

• As such, FOB shipping means that the supplier retains ownership and
responsibility for the goods until they are loaded ‘on board’ a shipping vessel.
Once on the ship, all liability transfers to the buyer.
Example:

1. You purchase goods from a supplier in China and agree to FOB

shipping terms. The next three steps of the process are carried out
at the supplier’s expense.
2. Your goods are packaged and loaded onto a truck (or another form
of transportation) at the supplier’s warehouse (or another facility).
3. The truck brings the goods to the port.
4. The goods are loaded on board the shipping vessel.
5. Once aboard, the rest of the journey from China is now your
liability and your expense. Anything that happens from this point is
on you.
Duties of the Seller in FOB

(A) Supply the contracted goods in conformity with the contract of sale and deliver the goods on
board the vessel named by the buyer at the named port of shipment;
(B) Bear all costs and risks of the goods until such time as they shall have onboarded the vessel. In
other words, once goods are loaded to the vessel title to the property passes to the buyer and so risks
too;
(C) Provide at his own expense the customary clean shipping documents as proof of delivery of
goods;
(D)Provide export license and pay export duty, if any ; and
(E) Pay loading costs.

This means that the total price quoted by the seller will be lower as it only includes the price of the goods, in-
land transportation, export documentation and other charges incidental to the export up to the placing of the
goods on board ship. The seller is absolved from all liability once the goods placed on board ship which is an
advantage as he does not need to worry about freight, insurance and destination costs as long as he tenders the
necessary documents to the buyer, hence the main difference with a CIF Contract.
Duties of the Buyer in FOB

A) Reserve the necessary shipping space and give due notice of the same to the
exporter;
(B) Bear all costs and risks of the goods from the time when they shall have effectively
loaded to the vessel;
(C) Pay freight;
(D)Pay unloading costs and
(E) Pay the price as provided in the contract to exporter.

The FOB Contract is advantageous to the buyer as in that he controls the movement
of the goods from the time of shipment and he can negotiate reduced insurance and
freight charges when they contract with companies that they frequently do business
with.
Passing of Risk in FOB Contracts
• The general rule in Sec 21 of the SOGO applied to FOB contracts and risk prima facie passes with
property so that risk normally passes to the buyer when the goods are loaded to the vessel. Thus in
Pyrene & Co Ltd v Scindia Steam Navigation Co Ltd the tender was at the sellers risk when it was
dropped during loading prior to crossing the ship’s rail.(The notion of ship rail is not applicable now)

• Risk of loss may also remain with the seller by virtue of the provisions of Section 32 of the SOGO.

Section 32 (3) provides that:

“where goods are sent by the seller to the buyer by a route involving sea transit under circumstances in which it is usual to
insure, the seller must give to the buyer such notice as will enable the buyer to insure them during the sea transit”

If the seller fails to supply such information, the goods are at his risk during the sea transit. It has been
argued that s32(3) can have no application to FOB sales because the contract requires the seller to deliver
the goods “free on board” and delivery to a carrier is normally deemed to be delivery to the buyer.
However, Section 32 (2) applies where the seller makes a contract of carriage on behalf of the
buyer – .i.e. in cases of, “classic FOB” contracts and where the seller takes on additional duties –
and requires him to make “such contract as is reasonable having regard to the nature of the goods
and the circumstances of the case.” If the seller fails to do so, and the goods are lost or damaged
during transit, the buyer may either decline to treat delivery to the carrier as delivery to himself or
claim damages from the seller.

What is reasonable will depend on the circumstances of the cases. In the alternative, risk may pass
to the buyer prior to shipment.

In J & J Cunningham Limited v Robert A Munro & Co Limited (1922) it was suggested that
if the goods deteriorate because of the buyer’s delay in giving the seller shipping instructions, or
because the buyer induces the seller to deliver goods to the port before the goods can be loaded
the buyer would be liable for such deterioration; he would be entitled to reject the goods for non-
compliance with the implied conditions as to quality in the SOGO, but would be liable to the
seller in damages for the deterioration.
CIF Contracts ( Cost, Insurance and Freight)

This type of contract resembles the FOB “with additional services” and is the most
comprehensive and widely used international export trade contracts and embodies three
different contracts. A Cost, Insurance and Freight (CIF) contract is an agreement to sell
goods at a price inclusive of the cost of the goods, insurance coverage and freight.

1. Contract of sale between seller and buyer.

2. Contract of carriage (seller/carrier and buyer/carrier).

3. Contract of marine insurance.

• In a CIF contract, the price paid by the buyer would normally be inclusive of all
costs up to the agreed port of destination at which point the buyer has a duty to
receive the goods. This type of contract frees the buyer form the seller’s local
export customs. Also, this eases the work burden on the buyer of arranging for
insurance and freight as he might find it difficult in a foreign country.

• This type of contract is advantageous to the seller as he is more conversant with

the local export customs and would negotiate reduced rates on insurance and
freight as a regular exporter and hence reducing the costs for the importing party.
“a CIF contract is a type of contract which is more widely and more
frequently in use than any other contract used for purposes of sea borne
commerce. An enormous number of transactions, in value amounting to
untold sums, are carried out every year under CIF contracts. The essential
characteristics of this contract have often been described. The seller has to
ship or acquire after that shipment the contract goods, as to which, if
unascertained, he is generally required to give a notice of appropriation. On
or after shipment, he has to obtain proper bills of lading and proper policies
of insurance. He fulfils his contract by transferring the bills of lading and
the policies to the buyer.”
Lord Wright in Ross T Smyth and Co. Limited vs TD Bailey Sons and Company (1940) 56
TLR 825
The seller’s obligations
• Ship the goods as described in the contract and within agreed shipping period

• Arrange for marine insurance.

• To enter into a contract of carriage with a carrier who is able to deliver the
goods to the port of discharge and obtain a bill of lading evidencing the
contract of carriage by sea.

• Procure a contract of carriage.

• Produce a commercial invoice.

• Tender the documents to the buyer to effect payment.

The Buyer’s obligations

• To accept the documents.

• Receive the goods at agreed port of destination.

• Bear all costs incidental to the export (custom dues at port of entry)

The buyer has to accept the documents even though the goods have not arrived at the
port of destination and without knowing as to the condition of the goods at sea as the
buyer is protected against damage or loss whilst in transit.

The CIF is advantageous to the buyer as the documents could be used as security to
obtain bank credit or could sell the goods whilst on high seas if they are for trade
purposes.
Passing of Risk in CIF contracts

• CIF contracts are exceptions to the general rule in Section 21 of the SOGO.

• Property under a CIF contract passes at the time the buyer pays and takes
up the documents, the goods deemed to be at the buyers risk from the time of
shipment (The risk of loss or damage to the goods passes when the goods
are on board the vessel)

• The buyer takes the benefit of the contract of carriage and policy of insurance
and is therefore able to claim, either under the contract or the policy, in respect
of damage or loss from the time of shipment.

(However, the buyer is expose to risks which are not covered by the contract of
carriage or insurance.)
***Important
This is not a complete note and only a guideline
to study. Many other examples and cases (which
are not listed in this ppt) have been discussed
during lectures. In addition, you are advised to
go through relevant recommended books,
articles and cases for further knowledge.