How to offload the risk of non-payment under LCs
Letters of credit (LCs) sometimes fail to deliver on the purpose for which they are chosen over other international trade settlement payment options because payment under LCs is subject to the beneficiary’s presentation of documents that comply strictly with the terms and conditions of documentary credit, and the smallest discrepancy in one of the documents would make the LC vulnerable to the risk of non-payment. Although most presentations under documentary credits are discrepant, applicants normally accept the discrepancies and facilitate release of payment to the beneficiaries.
Even after meeting an importer’s expectations in terms of quality of goods, the exporter carries most of the risk of non-payment and other risks associated with the presentation of a discrepant or non-compliant document until the funds are realised. These risks include the probability of goods getting damaged at port, added demurrage/detention costs and a delay in the working capital cycle. In addition to this, each discrepant presentation attracts a penalty of USD50–120, depending on the bank.
In addition to what is normally checked when undertaking a credit, the following need to be kept in mind at different stages of credit to avoid discrepancies in documents presented:
1. Dates/periods/place of expiry
- Exporters are the best to ascertain when production/procurement will happen and how soon the shipment can be effected. The date and place of expiry, latest shipment date, presentation period and shipment schedule, if any, should be acceptable to both the importer and the exporter.
- When deciding on these dates, it is vital that the exporter take into account potential delay due to scarcity of raw material, labour or other factors that could cause a delay in shipment. It is advisable to keep a sufficient buffer when finalising the latest shipment date and expiry date of the LC unless it is not possible to do so.
- Late presentation is one of the most common discrepancies. The presentation period should always be the difference between the expiry date of the LC and the latest shipment date.
LC expiry date = Latest shipment date + Presentation period
This relieves the exporter from the fear of late presentation even if the shipment is effected on the last date of shipment. There is opportunity for presentation of documents to the nominated bank until the expiry date if presentation is made within “n” number of days, as mentioned under field 48 on presentation period.
- It is imperative to keep the place of expiry as the exporter’s country, unless otherwise required. This allows the beneficiary to present the documents to the bank nominated in his country until the expiry date.
- The shipment schedule under the LC should be managed carefully. This applies to all instalments/shipments under the LC. Goods not being shipped within the period allowed for one instalment makes the credit unavailable for that and any subsequent instalment.
2. Pre-preparation checks
- Insist on providing a draft of the LC before final issuance to avoid additional fees such as amendment fees and amendment advising fees.
- Check if all dates are as agreed between applicant and beneficiary.
- Note partial shipment and transhipment to ensure shipment is compliant.
- The description of goods in the LC should be in line with the contract between applicant and beneficiary.
- Documents called for under field 46A should be checked thoroughly and should be the only ones the exporter is able to arrange.
- Additional conditions under field 47A should be checked for workability. Ensure all the conditions are achievable and would not be a problem when documents are presented.
- In the event it is not possible to comply with a date, document or condition mentioned in the LC, ensure the necessary amendment without any deviation.
- In the event a condition or clause is not clear, seek clarification from the credit-issuing bank.
3. Document preparation checks
- Complete all the documents mentioned in the LC; ensure you do not miss any.
- Ensure all the documents are signed or authenticated by the required party.
- The description of goods in the invoice must correspond with that appearing in the LC.
- To avoid conflict of data, keep minimal information on all documents — information that is relevant to the document and the details required as per the LC.
- Ensure all documents are presented in the required number of originals and copies.
- Ensure the requirement of mentioning the LC number/invoice number/contract number or any other information on a document is adhered to.
How Acuity Knowledge Partners can help
With more than 20 years of experience in serving our 350+ clients across the globe, we have extensive knowledge of supporting the banking sector and delivering in line with sector standards. The following are some of the best-in-class advantages we offer:
- Access to a cost-effective team of certified document checkers
- Hassle-free transition for smooth operations
- Comprehensive mentorship and monitorship programme
- Top tools to ace client relationships
- High level of efficiency and quality
- Tailor-made solutions for banks and export houses
- Assistance with document preparation for exporters
- Superior data confidentiality at our offices that meet international standards
- End-to-end solutions for trade finance
About the Author
Rohan has 12+ years of experience in International Trade Finance, Treasury services & Liability operations. Apart from end-to-end trade finance deliverables, he has been part of many trade operations projects and processes where he was responsible for carrying out pilots, developing SOPs, and setting up teams for final delivery. Rohan is a commerce graduate with an MBA in Finance from Lal Bahadur Shastri Institute of Management, Delhi.
Originally published at https://www.acuitykp.com