“UNFAIR” LETTERS OF CREDIT *

Nguyen Huu Duc

Aqua-product exporters trading with EU, North America and some other markets have to reluctantly accept letters of credit where the compliance of documents alone is not enough to guarantee that they receive payment for the goods shipped.

This type of letter of credit normally contains a clause that allows the issuing banks to deliver the documents to the applicant “free of payment” for the purpose of customs clearance and inspection by the competent authorities. The issuing bank undertakes to effect payment upon receipt of the applicant’s notice that the goods have passed the inspection of relevant authorities. Their obligation under the credit will cease if they receive notice of rejection from the applicant or fail to receive any notification within a certain number of days from the day the document release.

TYPICAL “UNFAIR CLAUSES”

I would like to call them “unfair clauses” rather than “soft clauses”.

For the purpose of illustration, I wish to quote here two typical causes, one from a letter of credit issued by a bank in Egypt and the other from a letter of credit issued by a bank in the United States.

The clause in the letter of credit issued by a bank in Egypt:

‘We shall remit to you the value of documents presented only provided fulfillment of the following two conditions: (1) Documents received by us strictly comply with the terms and conditions of the credit; and (2) Our receipt of the applicant’s instruction letter evidencing that the required goods have been released and accepted by the Egyptian Health Authorities… Negotiating bank schedule must state the following clause “The issuing bank is authorized to deliver the documents to the applicant free of payment without any liability and engagement on their part to return the documents to us”.’

The question here is: What if the applicant fails “on purpose” to present the instruction letter within the expiry date of the letter of credit?

The clause in the letter of credit issued by a bank in the United States:

‘USFDA inspection is a condition of this credit that we will deliver any documents presented under this credit “free of payment” to the applicant for the purpose of inspection and clearing by the USFDA. We will release the documents against a trust receipt signed by the applicant undertaking to have the merchandise inspected by the USFDA and notify us upon passage or rejection of the same. Upon receipt of the applicant’s notice of USFDA approval, the relative draft will be honoured. If we receive a notice of rejection from the applicant or fail to receive any notification within 30 days from the receipt date we will notify the remitting bank or beneficiary accordingly, and shall have no further responsibility therein. ’

Better but still far from a fair undertaking that is acceptable to the beneficiary. Again, what if the applicant fails “on purpose” to present his notice of USFDA approval?’

The fact that aqua products imported to EU countries and North American countries must undergo strict inspection by the food inspection authorities of those countries is a compulsory condition that exporters trading with these markets have no choice but to accept. However, it is quite risky for the beneficiary to accept a letter of credit that contains either of these above unfair clauses. Should he accept it, he would be exposed to the risk of non-payment or delayed payment and limited access to bank finance.

Risk of non-payment or delayed payment:

Under this type of letter of credit the issuing bank’s payment obligation towards the beneficiary depends mainly on whether or not the applicant is willing to provide the issuing bank with his payment instruction or the notice of approval by the inspection authorities prior to the expiry date of the letter of credit or within the specified time. If the applicant, for some reason, fails to present an such instruction or notice of approval, the issuing bank’s payment obligation will cease. If this is the case, the beneficiary will face a substantial risk of non-payment or delayed payment from the applicant.

Limited access to bank finance:

The beneficiary may have limited access to bank finance as banks may be unwilling to provide pre-export finance against or refuse to negotiate the documents drawn under these unfair letters of credit.

SUGGESTION FOR A FAIR AMENDMENT

ISBP (ICC Publication 681) paragraphs 4 warns that a letter of credit should not require presentation of documents that are to be issued or countersigned by the applicant and that if a letter of credit issued including such terms, the beneficiary must either seek amendment or comply with them and bear the risk of failure to do so.

It is suggested that the above clause be removed to ensure the principle of ‘independence’ of the letter of credit or at least be reconstructed in a fairer manner so as to guarantee the interests of all parties involved:

• The goods are to be inspected by the competent authorities as they must be.

• The issuing bank must honour in either of the following cases: (1) where the applicant presents the notice of approval issued by the competent authorities; (2) where the applicant fails to present the notice of rejection issued by the competent authorities within the time frame stipulated in the letter of credit. Upon receipt of the notice of rejection (if any) the issuing bank must inform the presenter of the same and send a copy of such a notice to the presenter if required.

Accordingly the clause (e.g., issued by the U.S bank) may be reconstructed as follows:

“Upon receipt of the documents complying with the terms and conditions of the credit, we (issuing bank) will deliver the documents to the applicant for the purpose of inspection and clearing by the USFDA against a trust receipt signed by the applicant undertaking to have the merchandise inspected by the USFDA and provide us with a notice of USFDA approval or rejection. We undertake to honour upon occurrence of either of the following events whichever comes first:

(i)Upon receipt of a notice of US-FDA approval from the applicant; or

(ii) On the 30th day from the date of trust receipt in case the applicant fails to present a notice of USFDA rejection.

If we receive a notice of USFDA rejection from the applicant within 30 days from the receipt date we will notify the remitting bank or beneficiary accordingly, and shall have no further responsibility therein. We will also send a copy of the notice of rejection to the remitting bank if required”.

LAST BUT NOT LEAST

My observation at our letter of credit department has shown that there are still letters of credit that do not include such unfair clauses. Instead, these letters of credit would require the beneficiary to present a guarantee or a certificate certifying that in the case the goods are rejected by the inspection authorities, the applicant is responsible for shipping the goods back to the beneficiary and the beneficiary will refund to the applicant the total amount paid under the letter of credit plus ocean freight within a certain number of days, say 15 days from the date the goods arrives at destination port. The shipment shall be automatically considered as the imported shipment in the applicant’s country if the beneficiary does not receive any information from the applicant about its inspection status.

This type of arrangement requires a high degree of trust between the beneficiary and the applicant, as well as a regular and good business relationship between them.
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• Article was published in Trade Services Update Volume 12, Issue 5, September – October 2010