A Weakness of Irrevocable Letters of Credit

Letters of Credit (Documentary Credits) can be complicated.  Submitting compliant documentation is always a challenge.  In some circumstances, however, even when everything has been done correctly, problems can arise.  This article is about a problem we faced with a Documentary Credit submission.

We recently completed a Letter of Credit shipment to Ethiopia. The Letter of Credit was not confirmed since it had been issued by a regular customer and through The Commercial Bank of Ethiopia as usual. On submission of conforming documents, the advising bank, Barclays, tried to collect funds from Lloyds bank, as per Letter of Credit instructions, but were advised that the procedure of authorisation for payment had not been completed and Lloyds had not received any such instruction from The Commercial Bank of Ethiopia. Several days later, after a great deal of pressure from the Ethiopian customer The Commercial Bank of Ethiopia sent authorisation for payment to Lloyds. Unfortunately, it was not usable because the Letter of Credit number quoted on the authorisation message did not match the Letter of Credit number on the original Letter of Credit.

It was subsequently found the The Commercial Bank of Ethiopia had made a typing mistake on their original Swift message and had typed 01 at the end of their Letter of Credit instead of 07, the correct number. Three weeks after it should have been paid, the funds were received.

There are some lessons to be learnt from this experience.

First, Irrevocable Letters of Credit are only as good as the procedures operated by the opening bank. When they go wrong the Letter of Credit payment evolves, essentially, into a collection payment and all the risks that entails. Therefore, the only guaranteed way of getting payment is to have a Confirmed Letter of Credit. Part of the problem with Confirmed Letters of Credit is the cost, so it is good practice to ensure that the contract price covers the cost of obtaining payment through Confirmed Letters of Credit. Another problem is that in some countries it is impossible to get a Confirmed Letter of Credit issued. In these circumstances, talk with the advising bank on ways of protecting the guarantee.

Secondly, Ethopian Letters of Credit issued by The Commercial Bank of Ethiopia always end with the year in which the Letter of Credit was issued. Therefore, if an Ethiopian Letter of Credit is received and the last two digits do not correspond to the year of issue, it would be good practice to just check with the issuing bank whether the Letter of Credit number is correct. It is much easier to do this before documents are submitted than afterwards.

Third, ensure that the payment schedules detailed in the Letter of Credit actually exist before shipping the goods. Although this could be costly, since the banks concerned may charge for the messsages sent, it is less costly than finding on presentation that the Letter of Credit’s guarantee of payment no longer exists because of a clerical error by the opening bank.

Maria Narancic from Point to Point Export Services is an independent international trade adviser who assists organisations world wide with their international trade projects, documentation, Documentary Credits and import/export training.  She is based in the United Kingdom.  If you require any further assistance with the matters mentioned above, please do contact us by e-mail on info@point-point.com or check out other international trade articles on the Point to Point Export Services website at www.point-point.com
 

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