DISCOUNTING A DEFERRED PAYMENT UNDERTAKING

QUESTION

Dear Mr. Old Man,

I have a question regarding the discounting of documents under a letter of credit.

Normally, when discounting documents under an LC, banks require the presentation of a draft (bill of exchange) as a mandatory document. However, in the case of an LC available by deferred payment, where no draft is required, is it still necessary to present a draft for the discounting process?

My understanding is that banks often retain drafts to facilitate secondary market transactions such as forfaiting. However, Article 7(a)(vi) of UCP 600 provides that reimbursement under a deferred payment LC must be made at maturity, regardless of whether the nominated bank has prepaid or purchased the undertaking. The issuing bank’s reimbursement obligation is independent of the nominated bank’s prepayment to the beneficiary.

Therefore, it seems to me that requiring a draft under a deferred payment LC is unnecessary, since there is no “acceptance” of a draft—only the incurring of a deferred payment undertaking.

So my question is: Is it reasonable for a bank to require a draft in order to discount documents under a deferred payment LC?

I look forward to your guidance. Thank you very much.

N.

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ANSWER

Hi N.,

You’ve raised a very good and relevant question.

As you correctly mentioned, a letter of credit available by deferred payment does not require the presentation of a draft. In such cases, what’s being discounted is not a draft, but rather the deferred payment undertaking incurred by the nominated bank. This is known as the discounting of a deferred payment undertaking, not the discounting of a bill of exchange.

Importantly, only the nominated bank that has incurred the deferred payment obligation can discount its own undertaking. If a non-nominated bank  wishes to discount, it must either be authorized by the issuing bank or the nominated bank – whichever incurred the deferred payment – or take the risk on a with recourse basis.

Now to your key point: is it reasonable for a bank to request a draft when discounting under a deferred payment LC?

According to UCP 600 Article 2, “Negotiation” refers to the purchase of drafts and/or documents under a complying presentation. This means a discounting operation may involve a draft—but not necessarily. In a deferred payment LC, no draft is required or expected.

To further support this, we can look at the ICC Banking Commission’s Guidance on the Use of Drafts under Documentary Credits, which clearly discourages the inclusion of drafts unless there is a genuine commercial, legal, or practical reason. The ICC warns that drafts are often redundant, unnecessary, and a common source of discrepancies.

Therefore, requiring a draft under a deferred payment LC — where none is called for — is both unjustified and contrary to ICC best practices. It may lead to confusion or even rejection of documents due to discrepancies.

That said, some banks may still ask for a draft for internal procedures, especially if they wish to package the transaction for the secondary market (e.g., forfaiting). However, this is a bank-specific operational choice and not something that should be imposed on the beneficiary unless explicitly required in the credit terms.

Lastly, just for your reference: under UCP 600 Article 12(b), when an issuing bank authorizes a nominated bank to incur a deferred payment undertaking, it also authorizes that bank to prepay or purchase that undertaking — this is what is understood in banking practice as “discounting”.

I’ve written a number of articles on this topic in relation to the Banque Paribas vs. Banco Santander case, which helped shape this clarification in UCP 600. You can find them by searching:

“Mr. Old Man” + “Banco Santander” on Google.

Hope this helps clarify the issue!

Best regards,

Mr. Old Man