Letters of Credit: 10 common mistakes

If you are being paid by Letters of Credit (L/C), you are going to want to make sure you negotiate your way around the potential pitfalls of this international trade payment method and ensure everything runs smoothly.  (If you’re new to L/C’s please read our Letters of Credit Beginner’s Guide).  Read on for frequent mistakes and errors that are often made and how you can avoid them;

1. Failing to negotiate the terms of Letters of Credit during the negotiation of the sales contract.

Who pays which banking charges? When will the goods be available to ship?  What are the customer’s documentary requirements?  What is the Country of Origin of the goods?  These are examples of aspects that should be considered and agreed before concluding a sales agreement involving an L/C.  The answers to these and other questions will affect the terms and timescales involved.

2. Not considering the costs incurred by Letters of Credit before concluding a sales contract.

Once you’ve shaken hands on a deal with your customer, you’re not going to want to ask them to change any terms of your agreed contract at a later date.  If you haven’t thought about how much it’s going to cost to be paid by an L/C, chances are the opportunities to recoup any costs relating to a Letter of Credit payment are gone.  Try and build in some additional cost at an early stage if you know the payment method is going to be by L/C.

3. Failing to ask for a draft L/C to be made available for review before it is issued by the opening bank.

This is a golden opportunity to check and resolve any terms or conditions that are unworkable or not consistent with the contract of sale before the L/C is issued and becomes operative.  Changes to the content of an L/C are far easier to implement at the draft stage in terms of both time and cost.  Amendments to operative (i.e. formally issued) L/Cs usually take longer and are more costly.

4. Not reviewing Letters of Credit when they are received.

You reviewed and approved a draft so the operative L/C will have the same terms and conditions, right?  Not necessarily.  We’ve seen many situations where a draft has been agreed with an internal department within the buyer’s company.  Then, when the Issuing Bank gets hold of it, they start adding a few of their own terms that you weren’t expecting!  Always check the formal Letter of Credit advice once received, to make sure there aren’t any nasty surprises lurking within.  Particularly if any changes result in unworkable terms.

5. Shipping goods before receiving a clean and workable Letter of Credit.

This is a big no-no and one of the first rules of L/C shipments!  Until you have received a clean and workable Letter of Credit, you have no payment security.  So why would you go ahead and ship the goods?!  What if the L/C arrives and it contains unworkable terms or conditions that weren’t agreed?  You risk incurring extra time and cost burdens or possibly worse.  Without exception, we never recommend shipping goods without being in receipt of workable Letters of Credit.

6. Not making sure the documentary requirements are consistent with the Incoterms in the sales contract.

We’ve had reputable banks claim that they don’t recognise a Forwarder’s Cargo Receipt as an acceptable alternative to a transport document but they should!  If the Incoterm is FCA Seller’s Premises, you shouldn’t be expected to have to submit an Air Waybill or Bill of Lading.  If your customer’s forwarder is responsible for shipping the goods and issuing the transport document, why should you have to rely on a document you have no control over to claim your payment?

That said, sellers should be aware that the latest version of Incoterms (the 2020 version), allows for an optional mechanism to be used in certain situations.  Subject to agreement between the buyer and seller beforehand, a Bill of Lading with an on-board notation can be included in the L/C documentary requirements for FCA shipments.  This is applicable for FCA Seller’s Premises shipments where the seller’s location is inland.

7. Not being able to adhere to all of the terms and conditions contained within the Letter of Credit.

Hopefully, you can!  However, even if you have reviewed the terms of the L/C prior to it being issued, sometimes it can be tricky to be 100% certain that the terms are workable.  Particularly if the reviewer in question is not familiar with UCP600 and ISBP (International Standard Banking Practice).  These are the two publications which govern all aspects of L/Cs and set out the standard by which L/C documents are examined.  Knowledge and experience of these documents is strongly advised for checking Letter of Credit terms and conditions.  Unworkable terms can also be fairly well hidden from the less experienced L/C checker!

8. Having the documents prepared by someone not experienced with Letters of Credit and the associated rules and regulations.

With Letter of Credit documentation, the person preparing the documentation needs to have experience with L/C documentary presentations and, following the previous point, an in-depth understanding of UCP600 and ISBP.  Without this knowledge and experience, the risk of adding to the statistic of presenting discrepant documents is high!  On a more basic level, attention to detail, particularly with regards to consistency of information throughout the documents, is paramount when preparing L/C documentation.

9. Lack of communication with 3rd parties involved in the L/C process.

Transport documents, 3rd party Inspection Certificates, Installation Certificates and Bank Guarantees are all examples of 3rd party documents that can be required under a Letter of Credit.  The content of these documents, to whatever extent, L/C Beneficiaries have less control over.  If Letters of Credit call for a 3rd party document to be presented for payment, it is vital that communication with the issuing party is proactive and forthcoming.  We recommend, wherever possible, providing a compliant template for third party documents. Otherwise, the risk of being stuck with a non-compliant document is increased.  It can also be necessary to talk to such 3rd parties prior to acceptance of L/C terms, so you are prepared and confident the L/C conditions can be met.

10. Not querying discrepancies if you believe them to be invalid.

If a bank that is checking your L/C documents highlights a discrepancy, most would tend to accept it.  However, a Discrepancy Notice can and should be challenged if it is felt to be unjustified.  We have had many situations where we have successfully disputed discrepancies which are invalid or not consistent with UCP600 or ISBP.  Overzealous or less experienced document checkers within banks can on occasion refuse documents on incorrect grounds, so it pays to query it.

Managing Letters of Credit and making documentary presentations day in, day out, has given us the knowledge and experience to avoid these common mistakes before they occur.  We have extensive knowledge of UCP600 and ISBP so that when we make a presentation or review an L/C, we don’t fall foul of any veiled conditions that those less experienced with L/Cs might do.

This also means we can make a guarantee to submit complaint documents, meaning you get paid as quickly and smoothly as possible.  Making errors with Letters of Credit cost time and money and can affect cash flow. To eliminate this risk, get in contact with us to discuss our bespoke Letter of Credit management services.