Letters of Credit and ICC Incoterms 2010

 

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The terms and documentation requested under a Letter of Credit must match the details of the Export Sales Contract.  Factors such as, who is responsible for the freight, goods in transit insurance and customs clearance and what type of documents are required by the Applicant must be clearly agreed prior to shipment of the goods.

One internationally accepted series of sales terms, which clarify the positions of buyer and seller (Beneficiary and Applicant) during the shipment process, are the International Chamber of Commerce (ICC) Incoterms, the most recent version being Incoterms 2010.

Incoterms are an internationally recognised series of sales terms which detail out the costs, responsibilities and risks for the buyer and seller relating to the shipment of the goods purchased.

There are 11 Incoterms in the 2010 version and these are

Ex-Works (EXW),

Free Carrier (FCA), Free Alongside Ship (FAS), Free on Board (FOB),

Carriage Paid To (CPT), Carriage and Insurance Paid to (CIP), Carriage and Freight (CFR), Carriage, Insurance and Freight (CIF),

Delivered at Terminal (DAT), Delivered at Place (DAP) and Delivered Duty Paid (DDP).

(For more details on these terms please check out articles on Incoterms in the Export/International Transport section of the Point to Point Export Services website).

So does it matter which sales term is used with a Documentary Credit?

Actually yes.

Although technically any of the above sales terms can be used with a Documentary Credit, there are risks to both the Beneficiary and the Applicant when incorporating certain sales terms into the contract.  Therefore, the type of Incoterm used should be carefully considered prior to inclusion in the Sales Contract.

Once the Incoterm has been incorporated into the Sales Contract it becomes a legally valid term.  It is not necessary to use the ICC Incoterms, but they are useful.  The only exception here is with Sales Contracts to the Ukraine, where it is a Ukrainian legal requirement to always include the ICC Incoterms in all contracts.

A Documentary Credit guarantees payment to the Beneficiary as long as the goods are shipped and the correct documentation is presented to either the Confirming/Advising/Negotiating/Issuing bank.

Consequently, one of the proofs that the Beneficiary needs to provide to the bank are the original shipping documents, such as a Bill of Lading (for sea freight and waterways shipments), Air Way Bill (for shipments by air), Truck receipts (for truck shipments), etc.  These are the documents, issued by a verified third party, which are provided by the Carrier when goods are exported from Country A to Country B.

If the sales terms EXW, FCA, FAS or FOB are used in the contract, then this means that the Buyer (Applicant) is responsible for arranging the freight.  Consequently, the Applicant will enter into a contract with the transport company/carrier to carry the goods from the country of export to the country of import.  Since it is the Applicant who is arranging the freight, it is the Applicant who has the legal right to the transport documents, even if the Beneficiary is shown as the shipper of the goods.

So, if the Applicant does not give permission to the transport company to release the original transport documents to the Beneficiary, how does the Beneficiary present these to the bank in order to get paid?  Usually the Applicant does give permission to the carrier for the documents to be released to the Beneficiary, but it is a risk which needs consideration.

With regards to FOB terms and Charter Party agreements, the Seller/Beneficiary needs to be aware that if the Buyer/Applicant defaults on payment of freight charges to the Carrier, then the Seller is liable for these charges.

If the sales terms DAT, DAP or DDP are used in the contract, then this means that the Beneficiary pays all freight charges and is responsible for delivering the goods to specific places: to a terminal with DAT, to any place agreed in the contract in the country of import with DAP, and to any place in the country duty cleared with DDP.

With both DAT and DAP, but particularly DAP, the Beneficiary has not completed their contract to deliver until they have presented the goods at the location agreed ready for unloading.  Meanwhile, they need to give the Applicant the original shipping documents so that the Applicant can complete the customs formalities.

Unfortunately, they also need to give the same documents to the freight forwarder/clearance agent to arrange onward delivery once the goods have been customs cleared.  Since the original transport documents have been sent to the Applicant via the banking system, it can often be difficult for the Beneficiary to complete their part of the contract with regards to delivery in the time scales involved.

The problem here is if the Applicant, or the Issuing Bank, requires documentary proof that the goods have been delivered as per the contractual terms.  If so, usually the only document acceptable is a signed receipt (often from the Applicant).  However, if the Beneficiary needs to submit a signed receipt as part of the documentary submission, this can only be done after the goods have been cleared through customs.  Which means (potentially) that the original shipping documents would have to be sent to the Applicant and could not be presented as part of the Documentary Credit presentation.

It is possible to arrange the issuance of documents so that all parties obtain original documents to complete their responsibilities under the Sales Contract.  However, this can get messy and, in some countries, the local laws may prohibit the original shipping documents going to more than one party.

Even if a signed receipt is not requested, and the Beneficiary collects their funds under the Documentary Credit (as long as they submit conforming documents), they could then find themselves committed to additional charges and responsibilities which could seriously affect the final profit margin.  Charges such as demurrage or storage due to delays in moving the goods from a Customs warehouse or container yard is the most common expense, but there are others.

DDP has an additional problem.  The Beneficiary is responsible for Customs clearing the goods.  The problem here is that an increasing number of countries (including the UK) now require all importers to be registered.  It is not a difficult procedure as long as the person/organisation registering lives in the country.  If they don’t registration can be incredibly difficult and expensive.  So unless the Beneficiary is registered to import into the country of import, engaging in a DDP contract could be highly problematic.

Please note that the Incoterms FAS, FOB, CFR and CIF should only be used with bulk shipments sent by sea.  All other forms of transport, including container sea freight shipments should use the other incoterms.

Therefore, for shipments which are not bulk shipments, the two incoterms which carry less problems for Documentary Credit shipments are CPT and CIP.

Unfortunately, it is not always possible to request CPT and CIP in all international contracts where the payment term is a Documentary Credit.  But if any of the other incoterms are used then a risk assessment should be carried out by both Beneficiary and Applicant and both parties should ensure that the conditions of Incoterm used is clearly reflected in both the contract and the terms of the Documentary Credit itself.

Please note that it is very important that the most applicable incoterm for the shipment is used.  Using an incorrect incoterm, such as FOB when the shipment is actually a CPT shipment, could result in Transit insurance being invalidated, for example.

This is the sixth article in the series of How to Get Paid using Letters of Credit.

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 to access other articles on International Trade matters please do check out our website at www.point-point.com.

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