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Trade finance and international trade

While a seller (the exporter) can require the purchaser (an importer) to prepay for goods shipped, the purchaser (importer) may wish to reduce risk by requiring the seller to document that the goods have been shipped. Banks may assist by providing various forms of support. For example, the importer's bank may provide a letter of credit to the exporter (or the exporter's bank) providing for payment upon presentation of certain documents, such as a bill of lading. The exporter's bank may make a loan (by advancing funds) to the exporter on the basis of the export contract.

Other forms of trade finance can include export credit insurance, export factoring, forfaiting and others. In many countries, trade finance is often supported by quasi-government entities known as export credit agencies that work with commercial banks and other financial institutions.

In short, trade finance means money lent to exporters or importers.

A bill of lading (sometimes referred to as a BOL,or B/L) is a document issued by a carrier to a shipper, acknowledging that specified goods have been received on board as cargo for conveyance to a named place for delivery to the consignee who is usually identified. A through bill of lading involves the use of at least two different modes of transport from road, rail, air, and sea. The term derives from the verb "to lade" which means to load a cargo onto a ship or other form of transport.

A bill of lading can be used as a traded object. The standard short form bill of lading is evidence of the contract of carriage of goods and it serves a number of purposes:

* It is evidence that a valid contract of carriage, or a chartering contract, exists, and it may incorporate the full terms of the contract between the consignor and the carrier by reference (i.e. the short form simply refers to the main contract as an existing document, whereas the long form of a bill of lading (connaissement intégral) issued by the carrier sets out all the terms of the contract of carriage);

* It is a receipt signed by the carrier confirming whether goods matching the contract description have been received in good condition (a bill will be described as clean if the goods have been received on board in apparent good condition and stowed ready for transport); and

* It is also a document of transfer, being freely transferable but not a negotiable instrument in the legal sense, i.e. it governs all the legal aspects of physical carriage, and, like a cheque or other negotiable instrument, it may be endorsed affecting ownership of the goods actually being carried. This matches everyday experience in that the contract a person might make with a commercial carrier like FedEx for mostly airway parcels, is separate from any contract for the sale of the goods to be carried, however it binds the carrier to its terms, irrespectively of who the actual holder of the B/L, and owner of the goods, may be at a specific moment.

Main types of bill

Straight bill of lading

This bill states that the goods are consigned to a specified person and it is not negotiable free from existing equities, i.e. any endorsee acquires no better rights than those held by the endorser. So, for example, if the carrier or another holds a lien over the goods as security for unpaid debts, the endorsee is bound by the lien. Although, if the endorser wrongfully failed to disclose the charge, the endorsee will have a right to claim damages for failing to transfer an unencumbered title.

Also known as a non-negotiable bill of lading; and from the banker's point of view this type of bill of lading is not safe.

Order bill of lading

This bill uses express words to make the bill negotiable, e.g. it states that delivery is to be made to the further order of the consignee using words such as "delivery to A Ltd. or to order or assigns". Consequently, it can be endorsed by A Ltd. or the right to take delivery can be transferred by physical delivery of the bill accompanied by adequate evidence of A Ltd.'s intention to transfer.

Bearer bill of lading

This bill states that delivery shall be made to whosoever holds the bill. Such bill may be created explicitly or it is an order bill that fails to nominate the consignee whether in its original form or through an endorsement in blank. A bearer bill can be negotiated by physical delivery.

Surrender bill of lading

Under a term import documentary credit the bank releases the documents on receipt from the negotiating bank but the importer does not pay the bank until the maturity of the draft under the relative credit. This direct liability is called Surrender Bill of Lading (SBL), i.e. when we hand over the bill of lading we surrender title to the goods and our power of sale over the goods.

("Guide to Trade Terms" (PDF). pp. pp. 64. http://ww2.westpac.com.au/documents/pdf/wibnz/guide-to-trade-terms-payables. Retrieved 2007-12-13.)

Other terminology

A sea or air waybill is a non-negotiable receipt issued by the carrier. It is most common in the container trade either where the cargo is likely to arrive before the formal documents or where the shipper does not insist on separate bills for every item of cargo carried (e.g. because this is one of a series of loads being delivered to the same consignee). Delivery is made to the consignee who identifies himself. It is customary in transactions where the shipper and consignee are the same person in law making the rigid production of documents unnecessary.

The UK's Carriage of Goods by Sea Act 1992 creates a further class of document known as a ship's delivery order which contains an undertaking to carry goods by sea but is neither a bill nor a waybill.

A straight bill of lading by land or sea, or sea/air waybill are not documents of title to the goods they represent. They do no more than require delivery of the goods to the named consignee and (subject to the shipper's ability to redirect the goods) to no other. This differs from an "order" or "bearer" bill of lading which are possessory title documents and negotiable, i.e. they can be endorsed and so transfer the right to take delivery to the last endorsee.

A sample of the issues

In most national and international systems, a bill of lading is not a document of title, and does no more than identify that a particular individual has a right to possession at the time when delivery is to be made. Problems arise when goods are found to have been lost or damaged in transit, or delivery is delayed or refused. Because the consignee is not a party to the contract of carriage, the doctrine of privity of contract states that a third party has no right to enforce the agreement. However, whether this is a problem to the consignee depends on who owns the goods and who holds the risks associated with the carriage. This will be answered by examining the terms of all the relevant contracts. If the consignor has reserved title until payment is made, the consignor can sue to recover his or her loss. But if ownership and/or the risk of loss has transferred to the consignee, the right to sue may not be clear in contract, although there could be remedies in tort/delict (the issue of risk will have been most carefully considered to decide who should insure the goods during transit). Hence, a number of international Conventions and domestic laws specifically address when a consignee has the right to sue. The legal solution most often adopted is to apply the principle of subrogation, i.e. to give the consignee the same rights of action held by the consignor. This enables most of the more obvious cases of injustice to be avoided.

In the municipal law of the U.S., the issue and enforcement of bills which may be documents of title, is governed by Article 7 of the Uniform Commercial Code. However, since bills of lading are most frequently used in transborder, overseas or airborne shipping, the laws of whatever other countries are involved in the transaction covered by a particular bill may also be applicable including the Hague Rules, the Hague-Visby Rules and the Hamburg Rules at international level for shipping, The Warsaw Convention for the Unification of Certain Rules for International Carriage by Air 1929 and The Montreal Convention for the Unification of Certain Rules for International Carriage by Air 1999 for air waybills, etc. It is customary for parties to the bill to agree both which country's courts shall have the jurisdiction to hear any case in a forum selection clause, and the municipal system of law to be applied in that case choice of law clause. The law selected is termed the proper law in private international law and it gives a form of extraterritorial effect to an otherwise sovereign law, e.g. a Chinese consignor contracts with a Greek carrier for delivery to a consignee based in New York: they agree that any dispute will be referred to the courts in New York (since that is the most convenient place — the forum conveniens) but that the New York courts will apply Greek law as the lex causae to determine the extent of the carrier's liability.

Letter of credit

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After a contract is concluded between buyer and seller, buyer's bank supplies a letter of credit to seller.

Seller consigns the goods to a carrier in exchange for a bill of lading.

Seller provides bill of lading to bank in exchange for payment. Seller's bank exchanges bill of lading for payment from buyer's bank. Buyer's bank exchanges bill of lading for payment from the buyer.

Buyer provides bill of lading to carrier and takes delivery of goods.

A standard, commercial letter of credit is a document issued mostly by a financial institution, used primarily in trade finance, which usually provides an irrevocable payment undertaking.

The LC can also be the source of payment for a transaction, meaning that redeeming the letter of credit will pay an exporter. Letters of credit are used primarily in international trade transactions of significant value, for deals between a supplier in one country and a customer in another. They are also used in the land development process to ensure that approved public facilities (streets, sidewalks, stormwater ponds, etc.) will be built. The parties to a letter of credit are usually a beneficiary who is to receive the money, the issuing bank of whom the applicant is a client, and the advising bank of whom the beneficiary is a client. Almost all letters of credit are irrevocable, i.e., cannot be amended or cancelled without prior agreement of the beneficiary, the issuing bank and the confirming bank, if any. In executing a transaction, letters of credit incorporate functions common to giros and Traveler's cheques. Typically, the documents a beneficiary has to present in order to receive payment include a commercial invoice, bill of lading, and documents proving the shipment was insured against loss or damage in transit. However, the list and form of documents is open to imagination and negotiation and might contain requirements to present documents issued by a neutral third party evidencing the quality of the goods shipped, or their place of origin.

Terminology

The English name "letter of credit" derives from the French word "accreditation", a power to do something, which in turn is derivative of the Latin word "accreditivus", meaning trust. S.'The Application any defence relating to the underlying contract of sale. This is as long as the seller performs their duties to an extent that meets the requirements contained in the LC.

How it works

A business called the InCosmetika from time to time imports goods from a business called BLISS, which banks with the ABC Bank. InCosmetika holds an account at the Commonwealth Bank. InCosmetika wants to buy $500,000 worth of merchandise from BLISS, who agrees to sell the goods and give InCosmetika 60 days to pay for them, on the condition that they are provided with a 90-day letter of credit for the full amount. The steps to get the letter of credit would be as follows:

* InCosmetika goes to The Commonwealth Bank and requests a $500,000 letter of credit, with BLISS as the beneficiary.

* The Commonwealth Bank can issue an LC either on approval of a standard loan underwriting process or by InCosmetika funding it directly with a deposit of $500,000 plus fees which are typically between 1% and 8% of the face value of the LC.

* The Commonwealth Bank sends a copy of the LC to the ABC Bank, which notifies BLISS that payment is available and they can ship the merchandise InCosmetika has ordered with the full assurance of payment to them.

* On presentation of the stipulated documents in the letter of credit and compliance with the terms and conditions of the letter of credit, the Commonwealth Bank transfers the $500,000 to the ABC Bank, which then credits the account of BLISS for that amount.

* Note that banks deal only with documents required in the letter of credit and not the underlying transaction.

* Many exporters have mistakenly assumed that the payment is guaranteed after receiving the LC. The issuing bank is obligated to pay under the letter of credit only when the stipulated documents are presented and the terms and conditions of the letter of credit have been met.

Availability

LC being an irrevocable undertaking of the issuing bank makes available the Proceeds, to the Beneficiary of the Credit provided, stipulated documents strictly complying with the provisions of the LC, UCP 600 and other international standard banking practices, are presented to the issuing bank, then:

* i.if the Credit provides for sight payment - by payment at sight against compliant presentation

* ii.if the Credit provides for deferred payment - by payment on the maturity date(s) determinable in accordance with the stipulations of the Credit; and of course undertaking to pay on due date and confirming maturity date at the time of compliant presentation

* iii.a.if the Credit provides for acceptance by the Issuing Bank - by acceptance of Draft(s) drawn by the Beneficiary on the Issuing Bank and payment at maturity of such tenor draft, or

* iii.b. if the Credit provides for acceptance by another drawee bank - by acceptance and payment at maturity Draft(s)drawn by the Beneficiary on the Issuing Bank in the event the drawee bank stipulated in the Credit does not accept Draft(s) drawn on it,

or by payment of Draft(s) accepted but not paid by such drawee bank at maturity;

* iv. if the Credit provides for negotiation by another bank - by payment without recourse to drawers and/or bona fide holders, Draft(s) drawn by the Beneficiary and/or document(s) presented under the Credit, (and so negotiated by the nominated bank )

* Negotiation means the giving of value for Draft(s) and/or document(s) by the bank authorized to negotiate, viz the nominated bank. Mere examination of the documents and forwarding the same to LC issuing bank for reimbursement, without giving of value / agreed to give, does not constitute a negotiation.

Some of the Documents Called for under a LC

* Financial Documents

Bill of Exchange, Co-accepted Draft

* Commercial Documents

Invoice, Packing list

* Shipping Documents

Transport Document, Insurance Certificate, Commercial, Official or Legal Documents

* Official Documents

License, Embassy legalization, Origin Certificate, Inspection Cert , Phyto-sanitary Certificate

* Transport Documents

Bill of Lading (ocean or multi-modal or Charter party), Airway bill, Lorry/truck receipt, railway receipt, CMC Other than Mate Receipt, Forwarder Cargo Receipt, Deliver Challan...etc

* Insurance documents

Insurance policy, or Certificate but not a cover note.

Legal principles governing documentary credits

One of the primary peculiarities of the documentary credit is that the payment obligation is abstract and independent from the underlying contract of sale or any other contract in the transaction. Thus the bank's obligation is defined by the terms of the credit alone, and the sale contract is irrelevant. The defences of the buyer arising out of the sale contract do not concern the bank and in no way affect its liability.[1] Article 4(a) UCP states this principle clearly. Article 5 the UCP further states that banks deal with documents only, they are not concerned with the goods (facts). Accordingly, if the documents tendered by the beneficiary, or his or her agent, appear to be in order, then in general the bank is obliged to pay without further qualifications.

The policies behind adopting the abstraction principle are purely commercial and reflect a party's expectations: firstly, if the responsibility for the validity of documents was thrown onto banks, they would be burdened with investigating the underlying facts of each transaction and would thus be less inclined to issue documentary credits as the transaction would involve great risk and inconvenience. Secondly, documents required under the credit could in certain circumstances be different from those required under the sale transaction; banks would then be placed in a dilemma in deciding which terms to follow if required to look behind the credit agreement. Thirdly, the fact that the basic function of the credit is to provide the seller with the certainty of receiving payment, as long as he performs his documentary duties, suggests that banks should honour their obligation notwithstanding allegations of misfeasance by the buyer. [2] Finally, courts have emphasised that buyers always have a remedy for an action upon the contract of sale, and that it would be a calamity for the business world if, for every breach of contract between the seller and buyer, a bank were required to investigate said breach.

The "principle of strict compliance" also aims to make the bank's duty of effecting payment against documents easy, efficient and quick. Hence, if the documents tendered under the credit deviate from the language of the credit the bank is entitled to withhold payment even if the deviation is purely terminological.[3] The general legal maxim de minimis non curat lex has no place in the field of documentary credits.

The price of LCs

All the charges for issuance of Letter of Credit, negotiation of documents, reimbursements and other charges like courier are to the account of applicant or as per the terms and conditions of the Letter of credit. If the LC is silent on charges, then they are to the account of the Applicant. The description of charges and who would be bearing them would be indicated in the field 71B in the Letter of Credit.

Legal Basis for Letters of Credit

Although documentary credits are enforceable once communicated to the beneficiary, it is difficult to show any consideration given by the beneficiary to the banker prior to the tender of documents. In such transactions the undertaking by the beneficiary to deliver the goods to the applicant is not sufficient consideration for the bank's promise because the contract of sale is made before the issuance of the credit, thus consideration in these circumstances is past. In addition, the performance of an existing duty under a contract cannot be a valid consideration for a new promise made by the bank: the delivery of the goods is consideration for enforcing the underlying contract of sale and cannot be used, as it were, a second time to establish the enforceability of the bank-beneficiary relation.

Legal writers have analyzed every possible theory from every legal angle and failed to satisfactorily reconcile the bank's undertaking with any contractual analysis. The theories include: the implied promise, assignment theory, the novation theory, reliance theory, agency theories, estoppels and trust theories, anticipatory theory, and the guarantee theory. [4] Davis, Treitel, Goode, Finkelstein and Ellinger have all accepted the view that documentary credits should be analyzed outside the legal framework of contractual principles, which require the presence of consideration. Accordingly, whether the documentary credit is referred to as a promise, an undertaking, a chose in action, an engagement or a contract, it is acceptable in English jurisprudence to treat it as contractual in nature, despite the fact that it possesses distinctive features, which make it sui generis.

A few countries including the US (see Article 5 of the Uniform Commercial Code) have created statutes in relation to the operation of LCs. These statutes are designed to work with the rules of practice including the UCP and the ISP98. These rules are practice are incorporated into the LC transaction by agreement of the parties. The latest version of the UCP is the UCP600 effective July 1, 2007[5]. The previous revision was the UCP500 and became effective on 1 January 1994. Since the UCP are not laws, parties have to include them into their arrangements as normal contractual provisions.

International Trade Payment methods

* Advance payment (most secure for seller)

Where the buyer parts with money first and waits for the seller to forward the goods

* Documentary Credit (more secure for seller as well as buyer)

subject to ICC's UCP 600, where the bank gives an undertaking (on behalf of buyer and at the request of applicant ) to pay the shipper ( beneficiary ) the value of the goods shipped if certain docs are submitted and if the stipulated terms and conditions are strictly complied.

Here the buyer can be confident that the goods he is expecting only will be received since it will be evidenced in the form of certain docs called for meeting the specified terms and conditions while the supplier can be confident that if he meets the stipulations his payment for the shipment is guaranteed by bank, who is independent of the parties to the contract.

* Documentary collection (more secure for buyer and to a certain extent to seller)

subject to ICC's URC 525, sight and usance, for delivery of shipping documents against payment or acceptances of draft, where shipment happens first, then the title documents are sent to the [collecting bank] buyer's bank by seller's bank [remitting bank], for delivering documents against collection of payment/acceptance

* Direct payment (most secure for buyer)

Where the supplier ships the goods and waits for the buyer to remit the bill proceeds, on open account terms

Risk situations in LC transaction

General Risks

* If goods are being offered for sale at a price that is too good to be true, then it probably is too good to be true'

Fraud Risks

* The payment will be obtained for nonexistent or worthless merchandise against presentation by the Beneficiary of forged or falsified documents.

* Credit itself may be forged.

Sovereign and Regulatory Risks

* Performance of the Documentary Credit may be prevented by government action outside the control of the parties.

Legal Risks

* Possibility that performance of a Documentary Credit may be disturbed by legal action relating directly to the parties and their rights and obligations under the Documentary Credit

Force Majeure and Frustration of Contract

* Performance of a contract - including an obligation under a Documentary Credit relationship - is prevented by external factors such as natural disasters or armed conflicts

Risks to the Applicant

* Non-delivery of Goods

* Short Shipment

* Inferior Quality

* Early /Late Shipment

* Damaged in transit

* Foreign exchange

* Failure of Bank viz Issuing bank / Collecting Bank

Risks to the Issuing Bank

* Insolvency of the Applicant

* Fraud Risk, Sovereign and Regulatory Risk and Legal Risks

Risks to the Reimbursing Bank

* no obligation to reimburse the Claiming Bank unless it has issued a reimbursement undertaking.

Risks to the Beneficiary

* Failure to Comply with Credit Conditions

* Failure of, or Delays in Payment from, the Issuing Bank

* Credit Issued by Party other than Bank

Risks to the Advising Bank

* The Advising Bank's only obligation - if it accepts the Issuing Bank's instructions - is to check the apparent authenticity of the Credit and advising it to the Beneficiary

Risks to the Nominated Bank

* Nominated Bank has made a payment to the Beneficiary against documents that comply with the terms and conditions of the Credit and is unable to obtain reimbursement from the Issuing Bank

Risks to the Confirming Bank

* If Confirming Bank's main risk is that, once having paid the Beneficiary, it may not be able to obtain reimbursement from the Issuing Bank because of insolvency of the Issuing Bank or refusal of the Issuing Bank to reimburse because of a dispute as to whether or not payment should have been made under the Credit

Risks in International Trade

* A Credit risk risk from change in the credit of an opposing business.

* An Exchange risk is a risk from a change in the foreign exchange rate.

* A Force majeure risk is 1. a risk in trade incapability caused by a change in a country's policy, and 2. a risk caused by a natural disaster.

* Other risks are mainly risks caused by a difference in law, language or culture. In these cases, the cargo might be found late because of a dispute in import and export dealings.

See also

* Uniform Customs and Practice for Documentary Credits

* Buyer's Credit

Uniform Customs and Practice for Documentary Credits

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This article is an orphan, as few or no other articles link to it. Please introduce links to this page from other articles related to it. (October 2009)

The Uniform Customs and Practice for Documentary Credits (UCP) is a set of rules on the issuance and use of letters of credit. The UCP is utilised by bankers and commercial parties in more than 175 countries in trade finance. Some 11-15% of international trade utilises letters of credit, totalling over a trillion dollars (US) each year.

Historically, the commercial parties, particularly banks, have developed the techniques and methods for handling letters of credit in international trade finance. This practice has been standardized by the ICC (International Chamber of Commerce) by publishing the UCP in 1933 and subsequently updating it throughout the years. The ICC has developed and moulded the UCP by regular revisions, the current version being the UCP600. The result is the most successful international attempt at unifying rules ever, as the UCP has substantially universal effect. The latest revision was approved by the Banking Commission of the ICC at its meeting in Paris on 25 October 2006. This latest version, called the UCP600, formally commenced on 1 July 2007.

ICC and the UCP

A significant function of the ICC is the preparation and promotion of its uniform rules of practice. The ICC's aim is to provide a codification of international practice occasionally selecting the best practice after ample debate and consideration. The ICC rules of practice are designed by bankers and merchants and not by legislatures with political and local considerations. The rules accordingly demonstrate the needs, customs and practices of business. Because the rules are incorporated voluntarily into contracts, the rules are flexible while providing a stable base for international review, including judicial scrutiny. International revision is thus facilitated permitting the incorporation of the changing practices of the commercial parties. ICC, which was established in 1919, had as its primary objective facilitating the flow of international trade at a time when nationalism and protectionism threatened the easing of world trade. It was in that spirit that the UCP were first introduced - to alleviate the confusion caused by individual countries' promoting their own national rules on letter of credit practice. The aim was to create a set of contractual rules that would establish uniformity in practice, so that there would be less need to cope with often conflicting national regulations. The universal acceptance of the UCP by practitioners in countries with widely divergent economic and judicial systems is a testament to the rules' success.

UCP600

The latest revision of UCP is the sixth revision of the rules since they were first promulgated in 1933. It is the fruit of more than three years of work by the ICC's Commission on Banking Technique and Practice.

The UCP remain the most successful set of private rules for trade ever developed. A range of individuals and groups contributed to the current revision including: the UCP Drafting Group, which waded through more than 5000 individual comments before arriving at this final text; the UCP Consulting Group, consisting of members from more than 25 countries, which served as the advisory body; the more than 400 members of the ICC Commission on Banking Technique and Practice who made pertinent suggestions for changes in the text; and 130 ICC National Committees worldwide which took an active role in consolidating comments from their members.

During the revision process, notice was taken of the considerable work that had been completed in creating the International Standard Banking Practice for the Examination of Documents under Documentary Credits (ISBP), ICC Publication 645. This publication has evolved into a necessary companion to the UCP for determining compliance of documents with the terms of letters of credit. It is the expectation of the Drafting Group and the Banking Commission that the application of the principles contained in the ISBP, including subsequent revisions thereof, will continue during the time UCP 600 is in force. At the time UCP 600 is implemented, there will be an updated version of the ISBP to bring its contents in line with the substance and style of the new rules.

Comment:

Note that UCP600 does not automatically apply to a credit if the credit is silent as to which set of rules it is subject to. A credit issued by SWIFT MT700 is no longer subject by default to the current UCP - it has to be indicated in field 40E, which is designated for specifying the "applicable rules".

Where a credit is issued subject to UCP600, the credit will be interpreted in accordance with the entire set of 39 articles contained in UCP600. However, exception to the rules can be made by express modification or exclusion. For example, the parties to a credit may agree that the rest of the credit shall remain valid despite the beneficiary's failure to deliver an instalment. In such case, the credit has to nullify the effect of article 32 of UCP600, such as by wording the credit as: "The credit will continue to be available for the remaining instalments notwithstanding the beneficiary's failure to present complied documents of an instalment in accordance with the instalment schedule."

eUCP

The eUCP was developed as a supplement to UCP due to the strong sense at the time that banks and corporates together with the transport and insurance industries were ready to utilise electronic commerce. The hope and expectation that surrounded the development of eUCP has failed to materialise into day to day transactions and its usage has been, to put it mildly, minimal. Owing to this lack of usage, it was felt that this was not the right time to incorporate the eUCP into the UCP600 and it will remain as a supplement albeit slightly amended to identify its relationship with UCP600.

An updated version of the eUCP came into effect on 1 July 2007 to coincide the commencement of the UCP600. There are no substantive changes to the eUCP, merely references to the UCP600.

CDCS

The Certified Documentary Credit Specialist is a qualification awarded by IFSA US and IFS UK and endorsed by ICC Paris as the only International qualification for Trade Finance Professionals, recognising the competence, and ensuring best practice. It requires Re-Certification every Three years. UCP 600 rules will be included from April 2008 examinations only. CDCS requires some 4-6 months of independent study and a pass in 3 hour examination of 120 multiple choice questions as well as 3 in basket exercises with questions which demonstrate skill in real-world applications of UCP.