🔴 Documentary Credit in 10 Questions
...and their answers
The Documentary Credit, or Letter of Credit (they are the same thing), is the safest method of payment—but also the most complex. The curious, and in some ways frustrating, aspect is that its complexity does not so much arise from its intrinsic technical features, but rather from the way in which the bank responsible for making the payment examines the documents submitted by the beneficiary.
Anyone who has dealt with a Letter of Credit has noticed the meticulous scrutiny applied by the bank to the submitted documents.
It often appears that the bank’s main aim is not to ensure the correct execution of the transaction, but rather to find even the slightest discrepancy in order to raise a query and process the payment on a “with recourse” basis rather than definitively.
Many details of the Letter of Credit are already familiar to exporters and those involved in international trade, but I believe it is worthwhile to revisit the topic through a kind of summary sheet that can support correct usage and help avoid uncertainty and delays in receiving payment.
Here are the 10 key questions—and their answers—for using a Letter of Credit effectively:
1. What is the purpose of a Documentary Credit?
The purpose of a Documentary Credit is to reduce or eliminate the risks for both buyer and seller. The seller’s risk is not being paid; the buyer’s risk is not receiving the goods or receiving goods different from those ordered.
Both the applicant (the foreign buyer) and the beneficiary (the exporter) must fully understand all the terms and conditions indicated in the Credit.
To properly interpret the terms of a Documentary Credit, one must be familiar with the Uniform Customs and Practice for Documentary Credits, known as UCP 600. This is a set of rules (not laws) developed by the International Chamber of Commerce to standardise the use of Documentary Credits in international payments.
A working knowledge of the International Standard Banking Practice (ISBP) is also recommended, as it can help avoid issues arising from differing interpretations by the bank’s foreign trade department.
2. What is the UCP 600?
As mentioned, Documentary Credits are governed by an international code of conduct drawn up by the International Chamber of Commerce, called the Uniform Customs and Practice for Documentary Credits (UCP).
These rules were introduced to overcome the differences between national regulations concerning Letters of Credit. The UCP provides an international standard which, when accepted by the parties, becomes binding.
First published in 1933 and revised five times since, the latest version is known as UCP 600, consisting of 39 articles that define the framework for handling Letters of Credit.
3. Who are the parties involved in a Documentary Credit?
It is essential to know the parties involved in a Documentary Credit transaction. Article 2 of the UCP outlines them:
Applicant: The foreign buyer who requests their bank to issue a Letter of Credit in favour of a seller (exporter).
Issuing Bank: The bank that issues the Credit on behalf of the applicant.
Advising Bank: The bank that, at the request of the issuing bank, notifies the beneficiary that a Letter of Credit has been issued in their favour.
Confirming Bank: A bank that adds its confirmation to a Credit, thereby assuming joint responsibility for payment with the issuing bank.
Nominated Bank: The bank authorised by the issuing bank to carry out the payment or other action required by the Credit, i.e. the bank where the beneficiary presents the documents.
Beneficiary: The party in whose favour the Credit is issued—i.e. the exporter or supplier of the goods.
4. What are the best practices for managing a Documentary Credit?
The applicant (foreign buyer) should follow three key rules:
The instructions given to the issuing bank must be clear, precise, correct, and not excessively detailed.
The purpose of the Credit is to facilitate payment—not to control the transaction.
The Credit must not request documents that the seller cannot provide, nor set conditions the seller cannot meet.
The beneficiary (the seller), upon receipt of a Credit, must verify, among other things:
That the goods can be shipped from the port of loading to the stated destination;
That goods and unit prices are correct;
That the amount of the Credit is correct;
That the contractual terms (agreed prior to issuance) are reflected in the Credit;
That the required documents can be obtained in the required form and time frame;
That names and addresses are accurate;
That the shipment and expiry dates provide sufficient time for shipping and preparing documents.
5. What are the common discrepancies found in Letters of Credit?
According to the ICC, approximately 70% of initial document presentations under Letters of Credit are rejected due to discrepancies—documents that, in the bank’s view, do not meet the terms and conditions of the Credit.
The decision to accept or reject documents often lies with a single document examiner and is based on their personal knowledge, experience, and judgment.
The most common discrepancies include:
Data inconsistencies
Missing documents
Late presentation
Late shipment
Expired Credit
Corrections not authenticated by the document issuer
Missing approvals
Goods description not matching the Credit
Incorrect port of loading or discharge
Insurance cover dated after the shipment date
Missing or undated/unsigned “Goods On Board” notation.
6. What is a “compliant presentation” and which documents are usually required?
A compliant presentation is one that meets the terms and conditions of the Credit, the applicable rules, and the International Standard Banking Practice (UCP 600, Article 2).
As stated in the ISBP 821E (currently in force), Preliminary Consideration (iv), the applicant and the beneficiary should collaborate in determining which documents are required, who must issue them, their content, and the time required for their preparation.
Only those documents essential to the transaction (e.g., for customs clearance and transport) should be requested.
If possible, limit requirements to an invoice and a transport document.
7. What law applies to a Documentary Credit?
The UCP 600 does not specify any governing law. Nonetheless, a Credit may include such a provision—though this is rare.
The reason for this omission lies in the autonomous nature of the Credit: it is independent of the underlying sales contract and any related agreement between the parties.
In case of dispute, the applicable law is usually determined by the court and is generally that of the jurisdiction most closely connected with the Credit’s performance.
8. Does the bank check the goods?
No. Banks deal with documents only, not with the goods to which the documents refer (UCP 600, Article 5).
Moreover, Article 4a states that a Credit is a separate transaction from the sale contract or any other underlying agreement.
Any disputes arising from the contract of sale are outside the bank’s remit and concern.
9. What should the applicant (foreign buyer) pay attention to when requesting a Credit?
Issuing a Letter of Credit is never a mere formality or routine. It always requires careful attention to detail and should not contain ambiguous or multi-interpretive clauses.
The applicant must ensure that the instructions provided to the issuing bank fully reflect their needs regarding documentary requirements, enabling a smooth importation process and sufficient guarantee regarding the goods’ quality and type.
The contents of the sales contract, proforma invoice or purchase order agreed with the seller should be reflected in the issuing instructions, even if those documents are not directly mentioned in the Credit.
10. Why might a bank refuse to honour documents—and what happens if it does?
When documents are presented under a Credit, the bank assesses them against the Credit’s terms and conditions, UCP 600 (if applicable), ISBP, and the information provided in the documents.
If the documents are not compliant, they are considered discrepant, and a discrepancy notice (or “query”) is issued.
Each discrepancy must be clearly explained by the bank, indicating the exact reason why the documents have been refused.
We may conclude that the Documentary Credit is a payment instrument offering a high level of security for both contracting parties.
Unfortunately its effectiveness is sometimes undermined by excessive formalism in document examination and by a tendency to focus more on identifying discrepancies than on facilitating payment.
Nevertheless, a well-structured Documentary Credit, supported by proper collaboration between buyer and seller and a solid understanding of the applicable rules (UCP 600 and ISBP), remains the most secure payment instrument in international trade.
By mastering its use, exporters and importers alike can avoid unpleasant surprises and significantly reduce the risks associated with cross-border transactions.
Roberto Coppola
