A Sales Agreement/Contract between a buyer and seller consists of a number of terms, the most essential being the seller’s agreement to provide goods to the buyer and the buyer’s agreement to pay the agreed price in return. There is also an agreement (either the buyer or seller’s responsibility) to arrange a contract with a carrier to transport the goods, and for the buyer to arrange payment through a financial, usually banking, system. Sometimes the payment is effected through a Letter or Documentary Credit.
Although a Letter of Credit (the Credit) is part of the sales contract between buyer and seller, it is considered a separate undertaking from the sales/export agreement. This is an important distinction which is detailed in Article 4 of UCP 600.
What this means is that the bank making the payment under a Credit is not interested in the Sales contract i.e. the types of goods or services being provided. Their only interest is in the wording of the Credit and the documents that are presented to them for checking, a point detailed in Article 5 of UCP 600.
Therefore, for the Seller to get paid, they must complete documents in accordance with the Credit’s conditions, but, unlike the banks, they will also have to ensure that they also complete all aspects of the sales contract.
Problems arise when the sales contract is not carefully considered (often due to lack of knowledge about shipping practices, local legislation affecting international trade or customs procedures in the country of import) and there are internal discrepancies between aspects of the contract and the conditions of the Credit. Sometimes these discrepancies can be so problematic that they make it impossible for the Seller to submit compliant documents.
Therefore, both the Beneficiary and the Applicant must ensure that they have considered all aspects of the supply and shipment beforehand and have specified in their contract the responsibilities of each party. Please note that the contract does not have to be a formal (or lengthy) document to be legally enforceable. Very often, the contract is agreed through a series of e-mails and/or other methods of communication and the issuance of a pro-forma invoice.
1. Who is responsible for shipping the goods and the point at which the risk passes from seller to buyer.
2. Who is responsible for clearing the goods through both export and import customs formalities and hence bears responsibility for the payment of any due taxes or duties.
3. Who is responsible for the Goods in Transit insurance and to what level of cover.
4. To determine which commercial documents are required and what information is required to be shown.
5. To determine whether any other documents are needed and who is responsible for issuing such documents.
It is often through the use of Incoterms (International Commercial Terms) that the first four issues are determined, although ultimately the terms of the contract itself will take precedence. The next article in this series will deal with how the use of particular Incoterms can affect both the Applicant and Beneficiary of a Credit.
The last issue is sometimes the most problematic, since, very often, necessary documents required by either the Beneficiary or the Applicant to complete their part of the Sales Contract is not asked for, or required under the Credit. Since there is an attitude (most prevalent in less experienced exporters) that if it is not detailed in the Credit, a document is not required for the shipment, then this can be an area where problems arise. Again, this will be discussed in greater detail in a later article.
This is the fifth article in the series on Getting paid with Letters of Credit.