How much thought do you give to the underlying contract delivery terms when requesting letters of credit from overseas buyers?
The Incoterms® rules, published by the International Chamber of Commerce, define the responsibilities of seller and buyer in respect of cost, risk and other obligations whilst goods are in transit. Whilst these rules do not make reference to payment terms or methods, it is vitally important that traders select an Incoterms® rule which works best within the overall transaction. In the case of letters of credit, we strongly suggest to exporting companies that they avoid the following rules:
EXW, FCA, FAS, FOB
as the responsibility for arranging the main international transport and therefore production of transport documents will rest with the buyer, thus reducing the exporter’s control over presenting documents complying with the L/C terms.
We therefore advise that CPT, CIP, CFR or CIF are considered as each of these Incoterms® rules state that whilst the seller legally delivers the goods at the point of export, they are responsible to arrange and pay for the transportation to the country of destination, thus using their own carrier or freight forwarder. The buyer is legally responsible for the goods in terms of risk, once the goods are in the hands of the first carrier or on board the vessel at the port of export (in the case of non-containerised goods shipped under CFR / CIF agreements).
What about the ‘D’ Terms?
I was recently delivering a letter of credit programme for a large client in the medical & healthcare sector.
As is usual with in-company training, I asked for copies of a couple of examples of L/Cs to be forwarded to me in advance to use as the basis for case studies and discussion. The company provided me with a draft of a high value letter of credit from a buyer in Egypt and I immediately noticed that the Incoterms® rule specified under the goods description under field 45A (SWIFT MT700 format) was DAP (buyer’s premises).
DAP (Delivered At Place) states that the seller not only arranges and pays for the transportation of the goods to the named place, but is also responsible up to that point for the goods in terms of risk of loss or damage. Legal delivery in this case is therefore not completed until the goods arrive at the named place in the country of destination.
As with the ‘E’ and ‘F’ rules (from the seller’s perspective), we would normally discourage buyers from incorporating a ‘delivered’ (‘D’) rule into a contract wherein the payment method is stated as being by letter of credit. Under conventional L/C structures, a seller will normally present documents to the bank and possibly receive payment from the bank (assuming documents comply with the terms), soon after shipment, and therefore prior to fulfilment of delivery obligations.
In this case, the buyer attempted to mitigate the risk of failure by the seller to deliver goods correctly, by incorporating under field 46A (documents required) an “acceptance certificate” to be signed by the buyer (or named representative) following arrival of the goods at their premises in Egypt.
This documentary requirement was in direct conflict with the stated presentation period (Field 49), which called for the beneficiary (seller) to present documents to the UK negotiating bank within 21 days after the date of the transport document. How could this possibly be achieved, given that in the underlying contract, the buyer was allowed 3 weeks following arrival of the goods to produce and sign the acceptance certificate?!!!!
This tale reminds us again of the scenario referred to in our previous article ‘Do Letters of Credit Work?’ when we highlighted the risks of buyers being in control of producing documents required for presentation to the bank by the seller.
I am (almost) sure that an advising bank would notice these terms and if requested to confirm the L/C would refuse to do so on the basis of unworkability, referring back to the issuing bank for clarification.
We have suggested that our client reverts to the buyer as soon as possible to renegotiate the delivery and / or L/C terms to ensure that they maximise the potential of presenting complying documents and receiving a timely payment.
Updates
January 2020: The ICC have recently published the revised Incoterms® 2020 rules. Although there have been some changes to the format and content, the risks and considerations referred to in our above article remain highly relevant.
April 2020: In the light of the current restrictions imposed by governments and local authorities during the COVID-19 pandemic, we are now providing our popular and highly practical programmes via our “virtual classroom”, allowing colleagues and teams to access training wherever they may be located.
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