Mitigating fraud with Letters of Credit

Although Letters of Credit should guarantee that the right goods are shipped and the shipper gets paid, Letters of Credit can still be used fraudulently.  This article discusses what happens when the shipper acts in a fraudulent manner and what precautions can be put into place to mitigate this type of risk.

A trade contract between a company in Pakistan and one in Hong Kong was concluded for the supply to Pakistan of Prime Steel Coils worth USD 226,000.  A documentary credit was issued by the Pakistan company and the goods were shipped.  The documents were presented to the negotiating bank and found to be in order.  The payment from the issuing bank was sent out in October 2013.

The goods cleared Pakistan Customs in November 2013 but on delivery the customer found that, instead of steel coils, the containers actually contained cement slabs.

One of the questions asked at the time involved clarification regarding the Issuing and Advising bank’s liability in this matter.  Essentially, if all the banks had acted in good faith and not been negligent or aware that any fraud may have taken place at the time of advising and negotiating the documentary credit, then no further recourse can be held against any bank in the documentary credit chain.  The Pakistan customer must now take the matter to the Hong Kong courts and to try and gain back their funds from the fraudulent beneficiary. Unfortunately, in this particular case, not only has the customer lost their initial outlay for the goods, but they have also been penalised with clearance costs, duty and other taxes on import.

So what precautions can other organisations take to avoid getting involved in similar fraudulent transactions?

The first thing in any contract is to check (if this is possible) the average pricing of similar cargoes.  If a deal is being offered that seems to be too good to be true, then additional checks must be undertaken, because this might be a sign of fraud.

One of the best ways to avoid a situation such as the one reported above, is to request that an inspection certificate from pre-inspections agencies (e.g. Bureau Veritas, Intertek or SGS) is issued prior to shipment.  If there is a requirement for a pre-shipment inspection that includes certifying that the goods entering the container are those purchased, then the chance of fraud is reduced substantially. Another document that could be requested on shipment is a Certificate of Conformity, again issued by a recognised verification agency.  In some countries, these systems are now part of Government initiatives to halt such fraudulent practices, but in parts of the world where such stringent conditions are not a matter of national law, then the buyer can ask for them to be initiated privately.

Secondly, it is always a good idea to take photographs of the containers when they arrive and as they are being unloaded, to have a visual record of the goods that have actually arrived.  If possible, obtaining a third party verification, from the importing Customs authority if able, would be of great assistance in any subsequent court case.  The objective of this action is to provide evidence that the goods arriving are or/are not those ordered.

Thirdly, if the goods being shipped are Capital equipment, then the importer could request that, as part of the contract, a Standby Letter of Credit is issued as a performance guarantee.  Please note that in some countries a Standby Letter of Credit is not acceptable, in which case a Performance Bond could be requested.  However, also note that because Performance Bonds are themselves vulnerable to fraud, that the supplier may not agree to issue one even if it means losing the order.

The last point, unfortunately, is one which has to now be considered with all trades. Although the above measures may make a lot of sense when dealing with a contractor for the first time, it seems to be less important when dealing with an established supplier. However, there is a growing body of evidence which seems to suggest that fraudsters are getting much more sophisticated in their operations and actually providing quality and to specification goods on the first few shipments before enacting a big fraud.  The only advice that can be given is that once a procedure has been set up, it should be followed on all shipments, even those from established sources.

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 subject matter above, please do contact us by e-mail on info@point-point.com or check out our other articles on International Trade on the Point to Point Export Services website at www.point-point.com
 

 

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