Letter of Credit Discrepancy: a Worked Example

A letter of credit is separate from the sale behind it. The bank has not promised that the goods are good; it has promised to pay against documents that comply. Most credits incorporate the ICC's rules, UCP 600, which apply because the credit says so and are not legislation in New Zealand, Australia or the UK. The examiner decides on the documents alone and on their face.

The standard is commonly called strict compliance, although UCP 600 itself does not use the phrase, and an ICC Banking Commission paper accepts that a defined meaning cannot be read out of the rules. Under the rules, data in a document need not be identical to the credit or to other documents, but must not conflict. ICC practice guidance treats a typing error that does not change the meaning as harmless, and a wrong model number as a discrepancy. English law states the test firmly. The House of Lords said in 1927 that documents which are almost the same will not do, and English courts have not adopted a looser rule of substantial compliance, though obvious typing errors have been treated as falling outside it. A careful reader treats the requirement as exacting while knowing it is not a demand for mirror images.

The ICC groups common faults as timing (expiry, latest shipment, the presentation period) and poor preparation: conflicting data, missing documents, unauthenticated alterations, missing endorsements, a goods description that does not follow the credit, wrong ports, an insurance document dated after shipment. Where a credit requires a transport document and states no period, UCP 600 sets 21 calendar days after shipment, and in every case not later than expiry.

There are four ways out. The exporter can correct and re-present, if the credit and the presentation period are still open. The buyer can waive. The credit can be amended, which needs the issuing bank, any confirming bank and the exporter to agree. Or the documents can be sent on for collection or approval, which leaves the bank's promise out of it altogether.

A tannery, constructed for this page like every figure in it, sells finished hides for US$640,000 under a sight credit requiring presentation within 14 days of shipment and expiring on 30 April. It ships on 9 April, so its last day is 23 April. Its bank has advanced 85% of the invoice at 8%, on the strength of the credit. The tannery presents on 21 April. Four banking days later, on 27 April, a notice of refusal arrives listing two faults: the invoice says finished bovine leather where the credit says full-grain bovine leather, and the insurance certificate is dated 10 April, a day after shipment, with nothing on it to show cover began by 9 April.

Both documents could be fixed in an afternoon. It does not help. The presentation window closed on 23 April, so a corrected set would now be late, which is a further discrepancy. Everything rests on the buyer, leather prices have softened, and the buyer offers to waive in return for 4% off. Payment arrives on 23 May, 26 days later than planned.

The price reduction and the margin are the example's. A buyer may waive for nothing, or decline. The point is the sequence. For those 26 days the bank's advance had no issuing bank behind it, only the buyer's goodwill and the tannery's own balance sheet.

A discrepancy concerns paper. Short of fraud, a buyer who is unhappy with the hides has no ground to stop a complying presentation, and an issuing bank has no ground to refuse because the goods were poor. The reverse is the trap: goods can be perfect and the documents can still fail.

A waiver also differs from an amendment. An amendment changes the terms, generally before the presentation, and the bank's undertaking continues on the new terms. A waiver accepts a fault after the event and is the applicant's to give; the issuing bank then decides whether to accept it. A confirmed credit offers no shelter here, because a confirming bank's undertaking also depends on a complying presentation.

DEFINED IN ONE PARAGRAPH → · LC DISCOUNTING, THE PRODUCT FILE → · BANK GUARANTEE VS LETTER OF CREDIT →

A lender financing against letters of credit is lending on an undertaking that exists only if the back office performs. It therefore asks for the presentation history: how many sets went in, how many came back, what the faults were and how long they took to clear. A small exporter with a clean record and a large one with repeated timing faults are different risks on the same product.

A record of repeated waivers needs reading carefully. If the buyer overlooks a fault every time, the sale has been working like a collection with a letter of credit's cost, and the exporter's payment has rested on the buyer's willingness all along. Many banks offer to check documents before they go, which moves the discovery of the fault to a date when it can still be corrected. The ICC puts much of the problem upstream too, in credits badly drafted and documents badly prepared, so an exporter that reviews each credit on receipt, and asks for changes before shipping, takes out a good part of the risk before anyone has to examine anything.