WHETHER PAYMENT BY LC IS  SAFE  FOR THE SELLER?

QUESTION

Dear Mr. Old Man,

I hope this email finds you well. I discovered your blog yesterday and I found it incredibly helpful. I have a couple of questions I’d like to ask, if you don’t mind.

1. It is my understanding that sellers can only lose money on an LC transaction due to their own errors, like presenting the wrong documents or late document presentation. Given this, I don’t think buyers can easily cheat sellers using LCs. However, I might be wrong. Based on your personal experience, is it possible for a buyer to cheat the seller on an LC transaction? If yes, how?
2. I have never sold on an LC before. What are some common mistakes that beginners often make? Some tips and tricks would be appreciated.

Thank you very much, Mr. Old Man.

I hope you enjoy your post-retirement life so far.

Tengku

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ANSWER

Hi,

I must confirm to you that for the seller, LC is the second safest payment method after cash in advance. You cannot always ask the buyer to pay in advance before shipment unless you are the only supplier and there are no other sellers. Therefore, once payment in advance is not acceptable, you should accept payment by LC if you want to sell the goods.

LC is not a payment commitment of the buyer (applicant) but a payment commitment of the LC issuing bank. Accordingly, the issuing bank is obliged to pay when the presented documents are complying with the terms and conditions of the LC. If the presented documents contain discrepancies, the issuing bank may refuse and advise the same to the presenter and the applicant.

LC is a payment instrument, not a refusal instrument. Therefore, in most cases where the presented documents contain discrepancies and are rejected by the issuing bank, the buyer usually waives the discrepancies, accepts payment and takes up the documents to take delivery of the goods. There are also cases where the buyer rejects the discrepant documents, especially where the price of the goods at the time of arrival at the port drops too low, leading to the buyer suffering a loss if he accepts the documents to receive the goods. In this situation, the buyer can ask the beneficiary to accept the price reduction, then he can accept the documents and make payment.

However, LC is not 100% safe. For the seller , LC also has potential risk of non-payment arising from the following risks:

Risk of the issuing bank: The issuing bank with poor financial standing may be unable to pay the LC. To avoid this risk, the seller may request the LC to be confirmed by a leading bank in the US or EU.

Country risk: The unstable economic and political situation of the country where the issuing bank is domiciled may affect the issuing bank’s ability to pay LC. To avoid this risk, the seller may request the LC to be confirmed by a leading bank in the US or EU.

Risk of documentation: LC contains some terms and conditions or soft/trap clauses that the seller is unable to present the documents complying with such terms and conditions or clauses. To avoid the risk of documentation, the seller needs to request an LC with easy-to-follow terms and conditions, simple documentation… When receiving the LC, the seller needs to check the LC terms and conditions to make sure that he can comply with its terms and conditions. If he finds that there are terms and conditions (and even trap clauses) that he cannot comply, for example, the shipment period is too tight (he cannot effect shipment in time) or the presentation period is too short (he cannot present the document timely) …, he can request amendment(s) to the LC.

Risk of fraud: The fraudulent buyer sends a fake LC directly to the seller who does not know anything about the LC. Accordingly, the seller is required to effect shipment and send the required documents including the bill of lading issued to the order of the buyer to the address specified by the buyer. To avoid the risk of fraud, LC and amendments thereto must be advised through the advising bank which is the seller’s bank. By advising the LC or amendment, the advising bank signifies that it has satisfied itself as to the apparent authenticity of the LC and amendment…

Another trick is that the fraudulent buyer opens an LC with some clauses that prevent the seller from making a complying presentation while 1/3 of the original bill of lading issued to the buyer’s order is required to be sent directly to the buyer. If this is the case, the buyer can take delivery of the goods while the issuing bank refuses the discrepant documents and does not pay the LC. To avoid this risk, the seller never agrees to send 1/3 original bill of lading consigned to or made out to order or to the order of the buyer and request an amendment if the LC contains some terms and conditions that the seller cannot comply.

In foreign trade, regardless of the payment method used, the seller needs to perform KYC, assess the buyer’s financial capacity to apply the appropriate payment method. If paying by LC, the seller consults his bank to ensure that the issuing bank is good and has the financial capacity to pay the LC.

There are some types of LC, e.g., LC available by (sight) payment, LC available by negotiation, LC available by acceptance, LC available by deferred payment… I recommend you choose LC available by negotiation.

LC is a safe payment method for both the buyer and the seller, so it is often chosen as a reliable payment method in large transactions. You said you have never sold goods with payment by LC. I think you should start learning about this popular payment method.

Good luck.

Best regards,

Mr. Old Man

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QUESTION

Hi Mr. Old Man,

Thank you for the thorough explanation. I have some follow-up questions.

1. Can the buyer reject the documents if there is a small typo that doesn’t actually affect the transaction significantly? For example, a simple typo on the goods description.
2. You wrote: “There are also cases where the buyer rejects the documents, especially where the price of the goods at the time of arrival at the port drops too low…“. But this can only happen if the issuing bank and the buyer find discrepancies in the documents, right? If none, the buyer doesn’t have any standing to reject the documents, does he?
3. I believe the advising bank would check for any discrepancies before sending the documents to the issuing bank. Wouldn’t any discrepancies be solved between the issuing bank and the seller first before the documents are delivered to the issuing bank?

Thank you.

Tengku

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ANSWER

Hi,

1/ With regard to misspellings or typing errors, I would like to quote herewith ISBP 821 paragraph A21:

A23) A misspelling or typing error that does not affect the meaning of a word or the sentence in which it occurs does not make a document discrepant. For example, a description of the goods shown as “mashine” instead of “machine”, “fountan pen” instead of “fountain pen” or “modle” instead of “model” would not be regarded as a conflict of data under UCP 600 sub-article 14 (d). However, a description shown as, for example, “model 123” instead of “model 321” will be regarded as a conflict of data under that sub-article.

So, the answer is YES and NO, depending on specific misspellings or typing errors.

2/ I meant the cases where the presented documents are discrepant while the price of the goods on arrival goes down, the buyer may take advantage of this situation to force the seller to reduce prices before he accepts the documents.

3/ Yes, the seller’s bank would check the documents and ask the seller to correct the discrepancies if any before sending the documents to the issuing bank. There are discrepancies that can be corrected, but there are discrepancies that cannot be corrected, e.g., late shipment, late presentation… There are situations where documents presented by the seller to the presenting bank contain discrepancies which cannot be corrected. At the seller’s request, the presenting bank may contact the issuing bank (before sending the documents to the issuing bank) to request that such discrepancies be waived. The issuing bank will usually ask for the buyer’s opinion and confirm its agreement to waive such discrepancies if the buyer agrees to waive such discrepancies.

Where the presented documents contain discrepancies, the issuing bank would accept the discrepant documents when the buyer waives such discrepancies. However, there are cases where the issuing bank refuses the documents even if the buyer agrees to waive the discrepancies.

Best regards,

Mr. Old Man