Reproduced with permission of 11 Vindobona Journal of International Commercial Law & Arbitration (1/2007) 1-10
Roberto Bergami [a1]
1. INTRODUCTION AND BACKGROUND
'A letter of credit is a complex, practical instrument whose governing principles have developed over time as a result of customary banking practice'.
This paper considers the implications of the new letter of credit rules, effective from 1 July 2007: Uniform Customs and Practice for Documentary Credits, 2007 Revision, (referred here as UCP 600), particularly as these relate to exporters. The usage of letter of credit transactions is firstly quantified (in value), together with the development of the codification of the rules of the modern day letter of credit. The contractual obligations and the current operational mechanisms are presented next, followed by discussion on the lead up to, and the implementation of the changes brought about by the UCP 600.
Letter of credit transactions have been among the most popular international methods of payment, because they provide a relative degree of protection for both sellers and buyers. They are particularly suited to high-risk, high-value situations, and where a lack of trading history exists. It has been estimated that the value of letter of credit business is above one trillion USD per annum. Because letter of [page 1] credit transactions are pedantic in their documentary requirements, they can be notoriously difficult -- particularly for the exporter -- due to the high level of documentary compliance required by the banks prior to the payment of funds. The International Chamber of Commerce (ICC) estimates that non-compliance in exporter documentation exists in about 70% of transactions, and this comes at a cost for the exporter. It has been estimated that in the UK alone, the cost of documentary discrepancies is in the order of £113 million per annum. Understanding the rules that govern these transactions therefore would seem to be the first step in 'getting it right'.
The Uniform Regulations for Commercial Documentary Credits of 1929 was the first attempt by the ICC to codify letter of credit rules, as private contract law. However, this first set of rules was introduced into banking practice in Belgium and France only, with banking associations in other countries willing to adopt them only after certain amendments. This resulted in the 1933 Uniform Customs and Practice for Commercial Documentary Credits. Subsequently these rules were revised in 1951.
The Uniform Customs and Practice for Documentary Credits issued in 1962 was perhaps the first set of rules to gain global acceptance. These rules have also been subject to regular updates, in 1971, 1983, 1993 (the current rules in force at the time of writing this paper, referred to as UCP 500 ) and the new rules -- the UCP 600 -- to apply from 2007. It is outside the scope of this paper to consider the changes made to the seven revisions issued since 1929. This paper considers the changes to UCP 500 that will be effective with the new UCP 600, applicable from 1 July 2007.
2. LETTER OF CREDIT OPERATIONS
Prior to considering the changes in detail, it would be of benefit to counsel advising a client to have the letter of credit operations contextualised. Figure 1 below shows the contractual arrangements that arise from a letter of credit transaction. Following the contract, the importer applies for the letter of credit to [page 2] be established. The issuing bank (importer's bank) provides the payment undertaking to the beneficiary (seller), as represented by contract number three.
This undertaking by the bank is one of the major reasons why sellers use letters of credit, as it allows the credit standing of the buyer to be substituted with that of their bank - a much more attractive credit risk proposition. Contracts four and five are service contracts between the exporter and the banks, and these do not influence the strength of contract number three.
Figure 1: Typical contracts arising from a letter of credit transaction 
[Flow-chart not reproduced]
It is important to note that these transactions are documentary by their very nature, meaning that all parties involved in the transaction deal in documents only and not goods. In other words, the documents (deemed to represent the goods) are what the banks are interested in, and documentary compliance means -- in the context of contract number three -- payment assurance in accordance with the letter of credit rules. The letter of credit undertaking is given against the ability to exchange documents for funds. Banks undertake this exchange unquestionably only when there is 100% documentary compliance. Less than 100% documentary compliance may mean a delay in the settling of the transaction, or worse still, a bad debt. It is [page 3] therefore important that when providing advice, counsel ensures the client understands the importance that banks place on documentary compliance.
In their details, variations on letter of credit requirements are as infinite as imagination itself. However, the basic principles of the letter of credit mechanics remain the same. The complexities of the letter of credit transaction can be observed in Figure 2.
Figure 2: Typical letter of credit cycle - deferred payment option 
[Flow-chart not reproduced]
From the exporter's point of view there are two critical points: step four and step six. Step four indicates receipt of the letter of credit by the exporter. Counsel should advise the client to thoroughly check the letter of credit to ensure it complies with the terms and conditions of the contract. If the letter of credit does [page 4] not match the contract, counsel should advise the client to seek an amendment from the buyer, prior to the despatch of any goods. It is important that this check is done prior to the despatch of the goods, otherwise the exporter may have a weakened bargaining position. Step six represents the presentation of the required document to the bank. This is where exporters experience the majority of problems. As highlighted earlier, up to 70% of transactions have documentary discrepancies. The problem in part seems to be with the different interpretations placed on the letter of credit rules by the various parties. At times, competing agendas also contribute to the 'manufacture' of discrepancies by the issuing bank if for no other reason than to delay payment. For example, the issuing bank when accepting the application from the buyer (step two) may decide to take less than 100% security against the letter of credit. On receipt of document from the exporter (via the seller's bank) with seemingly compliant documents, the buyer advises their bank that they do not have enough funds to cover the purchase. The issuing bank is unwilling to advance funds for goods it does not want and so 'invents' a discrepancy, often not with the intent to default on payment, but with the purpose of delaying payment. The bank achieves this by querying aspects of the documents -- causing messages to go back and forth between the issuing bank, the exporter's bank and the exporter. By the time the 'problem' has been resolved some time later, the importer now has accumulated enough funds to settle the transaction and the money is transferred to the seller. There is a hidden cost in this situation, and this is represented by the delay in receipt of funds by the exporter. There is a cash flow issue associated with this delay and additionally there is the opportunity cost of the delay in receiving the funds. Counsel should advise the client to exercise the utmost care with documentary compliance to reduce the possibility of this situation developing.
The issue of documentary compliance has been a real problem for the letter of credit market. As mentioned earlier, the cost of rectifying problems is significant in cost and there is the real risk of non-payment for not getting it right. This is what the ICC in part sought to address as it progressed through three years of review to deliver the UCP 600.
3. THE CHANGES TO THE RULES
The UCP 600 has 39 articles, whereas the UCP500 has 49. It is beyond the scope of this paper to analyse all of the changes that were made between the UCP 500 and the UCP 600, but rather to concentrate on the most important aspects of change and the likely results of the implementation of the new rules. It is worth noting that, notwithstanding the fact that the UCP 600 has been issued, there is still a degree of confusion and concern over its interpretation and implementation. Discussion and examples of how the UCP 600 may affect traders is outlined below. [page 5]
This is a new helpful addition to the rules. Interestingly, the definition of 'Complying Presentation'  alters the current notion of compliant documents. The UCP 600 defines such a presentation as one that 'is in accordance with the terms and conditions of the credit, the applicable provisions of these rules and international standard banking practice'. This definition does not specifically refer to the International Standard Banking Practice published by the ICC or any published standard for that matter. This issue has possibly been the most contentious of the UCP 500 and is further discussed below at Art. 13.
3.2 Article 4 UCP 500 v Article 4 UCP 600
The independence principle has been retained in the new rules. The letter of credit is separate from, and not subject to the contract of sale, insofar as banking operations are concerned.
Given that typically banks are not party to the contract of sale, this separation seems logical. To highlight the need for this separation, the UCP 600 has sought to reinforce this principle by the addition of sub-article (b): 
An issuing bank should discourage any attempt by the applicant to include, as an integral part of the credit, copies of the underlying contract, proforma invoice and the like.
The wording chosen for this article does place an absolute ban on the practice of including extraneous material and it may be impossible for the issuing bank to effectively prevent this. Counsel should advise the client to ensure that a 'workable' letter of credit is received, that is, one that does not have overly onerous and extremely detailed requirements, as this is likely to lead to an unnecessary documentary burden and increase the risk of non-compliance and therefore payment delays or bad debts. If a letter of credit is received that incorporates such extraneous material, counsel should advise the client to seek the removal of the requirements imposed by such extraneous material through an amendment to the original letter of credit by the buyer, and this must be done prior to the despatch of the goods.
3.3 Article 5 UCP 500 v Article 5 UCP 600
The words 'in credit operations all parties concerned' has been substituted by the word 'banks'. This is a clearer definition and reinforcement of the role of banks in the transaction -- they will only deal with documents. [page 6]
3.4 Article 13 UCP 500 v Article 14 UCP 600
Sub-article (a)  retains the words 'on their face'. This is even though its meaning in English is unclear and it cannot be translated into some languages. The reason for the retention of this expression is certainly unclear, as it appears that the Consulting Group deemed this expression superfluous and decided to remove it on an 18-5 vote, but apparently that vote was ignored in the final version. This does not change current banking practices, but fails to clarify exactly the meaning of the expression 'on its face' and questions this in the light of international standard banking practice as discussed below.
Sub-article (b)  allows banks less time to check documents for compliance - five days instead of the current seven days. This is good news for exporters, as it potentially lessens delays in payments, particularly when letters of credit are drawn at sight and payable at the counters of the issuing bank.
Sub-article (d)  refers to international standard banking practice when checking data on documents. This is a fundamental issue that is linked to the issue of the UCP 500. When the UCP 500 was issued in 1993, Art. 13  (in part) read 'compliance [...] shall be determined by international standard banking practice as reflected in these articles'. The problem was that no such reference actually existed. The world had to wait until 2003 for the ICC to publish the International Standard Banking Practice (ISBP).
In a curious twist, the ICC deemed the ISBP voluntary and therefore banks could adopt it if they so desired. To make the ISBP even less authoritative, it was given guideline status. In checking documents, banks could use the ISBP for clarification, but decisions as to compliance or non-compliance still must be made in accordance with the UCP alone. In fact, when a bank decides that documents do not comply, it must advise the presenter of such documents of the breach of the UCP, not the ISBP. Given that the ISBP is linked to the UCP 500, there is a strong argument for refuting any assertion that Art. 16 UCP 600 refers to the existing ISBP. [page 7]
Initially the ICC were not going to revise the ISBP, as during the review process there was a drive to have these principles incorporated into the new rules. This did not happen and some argue that 'it is not sensible to revise the ISBP until there is some experience of how the new UCP is working'. The question now becomes once again, which rules are being used and will a revised version of the ISBP become available before the UCP 600 rules become effective? It appears that indeed the ISBP is being revised, but this will not be made available until after the UCP 600 is invoked  and furthermore, its authoritative status has not yet been decided.
Counsel should advise a client to seek information from the banks in relation to the standards being applied to determine documentary compliance. Sub-article (d) makes attempts to water down the practice of inventing discrepancies mentioned earlier in the paper. In some parts of the world, this is indeed common practice and this was openly disclosed at an ICC meeting in 2005 where there were 'a number of very frank admissions from some banks in Asia that re-examination of documents represented a very significant source of income'. The wording used in the UCP 600 appears to take less of a strict compliance approach, but that is entirely dependent on the 'standard' the document checker applies. There are still ample opportunities for 'mischievous checking' practice to develop. As the UCP 600 rules are not yet in place, it is not currently possible to predict the outcome of the implementation of this sub-article.
Sub-article (j)  indicates that the addresses of the seller and buyer need not be the same as in the letter of credit, provided they are in the same respective country. Furthermore, contact details - such as telephone numbers, fax numbers, e-mail addresses and the like -- will not be checked unless they form part of either the consignee, or notify party detail on a transport document in which case they must be as stated in the letter of credit. Although this may seem a small issue, a discrepancy on transport document data is a common problem for exporters. Counsel advising the client should highlight the importance of the accuracy of transport document data to avoid non-compliance.
3.5 Article 14 UCP 500 v Article 16 UCP 600
This article prescribes the path banks must follow in the light of discrepant documents. The current rules (Art. 14 UCP 500) place complete control of the process in the hands of the issuing bank when discrepant documents have been [page 8] presented. Essentially, the issuing bank at its discretion may approach the buyer to seek a written waiver of the discrepancies - in other words, a formal written acceptance that payment may be released notwithstanding errors in the documentation. The bank needs to do so to protect its interest by virtue of contract number two shown above in Figure 1. The letter of credit having been applied for and having been issued will require the applicant to pay/reimburse the bank against documents presented. If those documents are non-compliant, the bank will not be able to demand the funds from the applicant because the documents would be in breach of the requirements on the initial letter of credit application. Therefore, the issuing bank seeks 'permission' to accept the documents from the applicant and pay against them.
Article 14 UCP 600 introduces a new option without disturbing the existing framework. It does so by allowing the exporter an opportunity to provide prior instructions to the bank in case of discrepant documents. The exporter may now request that the issuing bank consult with them prior to approaching the importer for a waiver of the discrepancies. This is an important consideration for the exporter, because the price of the goods sold may have appreciated between the date of shipment and arrival of the documents at the counters of the issuing bank. The exporter under such circumstances has an opportunity to gain additional revenue. Counsel advising the client should ensure that the option provided under Art. 16 UCP 600 is invoked against every letter of credit transaction to provide for an opportunity to increase revenue where possible. It does not seem that there are any disadvantages in invoking such action.
3.6 Article 37 UCP 500 v Article 14 UCP 600
The UCP 500 adopted the doctrine of strict compliance insofar as the description of the goods on the commercial invoice was concerned. The UCP 600 appears to have diluted this requirement. Article 37 UCP 500 states (in part) 'the description of the goods on the commercial invoice must correspond with the description in the credit'. The UCP 600 does not carry such a statement and therefore there is a presumption that the document checker will adopt a more flexible approach in determining documentary compliance. This should hopefully result in fewer discrepancies and be to the benefit of the exporter.
The ICC is now in the midst of producing a commentary on the new rules and this is due to be published ahead of the UCP 600 effective date. The commentary may well be a means by which certain quarters of industry will be appeased and specific matters of concern clarified. It appears that the UCP 600 has failed to consider the implication of the new transport document requirements. For example, the International Federation of Freight Forwarders Associations (FIATA) [page 9] transport documents commonly in use and widely accepted internationally would cease to be so. Another example is provided by the idea of a bill of lading being a 'document of title'. Whilst this principle may be well accepted in Anglo-Saxon law concepts, in China such a concept does not exist.
A letter of credit is a useful tool that can reduce financial risk, but it will only be used to its full potential where traders and exporters in particular have confidence in it. This confidence comes from a degree of certainty about documentary compliance. If the exporter does not have faith in the process, the exporter will find alternate means of trade finance.
The UCP 500 needed updating. The problems of the past have included uncertainty for traders in relation to meeting documentary compliance. The issue of international standard banking practice was only partially addressed by the ICC, and even then it was ten years late in entering the marketplace.
The UCP 600 is an attempt to soften the doctrine of strict compliance and provide a better avenue for exporters in achieving compliance and having a greater say in the way discrepant documents may be handled. This is a move in the right direction for traders.
The UCP 600 does not appear to be perfect, and as pointed out earlier, there are issues surrounding the notions of 'on its face' and 'document of title' as examples. A commentary may provide some assistance in this respect.
The challenges that the UCP 600 present are not to be underestimated. The first of those challenges will be the need for staff training at all levels -- the banks, the traders and the service providers. Such training will take time and come at considerable cost to industry. It is too early to say whether these rules and the revised ISBP will actually deliver as promised.
It would be advisable for counsel in providing advice to the client in the early stages of the implementation of the UCP 600 to seek the co-operation of their bank to collectively agree on how the new rules will be interpreted. Where trade is conducted in high-risk situations, this co-operation might need to extend to the overseas bank and counsel may need to encourage the seller to seek clarification on what would be acceptable documentation that would be deemed as compliant. [page 10]
a1. Roberto Bergami, CDCS, Senior Lecturer, School of Applied Economics, Institute for Community Engagement and Policy Alternatives, Victoria University, Melbourne, Australia.
1. Kingman-Brundage, J., and Schulz, S.A., The Fundamentals of Trade Finance, 1986, John Wiley & Sons, New York, at p. 66.
2. International Chamber of Commerce (2006), Publication Number 600, ICC Services, Paris.
3. Klein, C.H., Letter of Credit Law Developments, 2006, Jenner & Block, at p. 1, available at: ‹http://www.jenner.com/files/tbl_ s18News/RelatedDocuments147/2050/Klein_Letter_of_Credit_Law_Developments_ 2006.pdf›.
4. ICC Thailand, Examination of Documents Waiver of Discrepancies and Notice Under UCP500, 2002, available at: ‹http:// www.iccthailand.or.th/article2.asp?id=9›.
5. SITPRO Ltd., Report on the Use of Export Letters of Credit 2001/2002, 2003, SITPRO Ltd., London, at p. 2.
6. Wheble, B.S., 'Uniform Customs and Practice for Documentary Credits' (1971) 4(2) Cornell International Law Journal, at p. 97.
7. Ibid, at p. 98.
8. International Chamber of Commerce, Uniform Customs and Practice for Documentary Credits, ICC Publication Number 500, ICC Publishing S.A., Paris.
9. In this paper the following words are used interchangeably and are given the same meaning: exporter, seller and beneficiary; importer, applicant and buyer.
10. Bergami, R., International Trade: A Practical Introduction, 2004, Eruditions Publishing, Melbourne, at p. 23.
11. Bergami, R., 'The Link Between Incoterms 2000 and Letter of Credit Documentation Requirement and Payment Risk' (2006) 1(4) The Journal of Business Systems, Governance and Ethics, at p. 53.
12. Supra fn 2, at p. 17.
13. Ibid, at p. 20.
14. Ibid, at p. 26.
15. International Chamber of Commerce, The Insight Interview: Ole Malmqvist Candid Views From a Member of the UCP Drafting Group, 2005, available at: ‹http://www.iccbooks.com/Home/OleMalmqvistInterview.aspx›.
16. Department of Policy and Business Practices, Commission on Banking Technique and Practice: Meeting on 21 and 22 May at Paris, France (Document Number 470/1003), 2003, International Chamber of Commerce, Paris, France, at p. 6.
17. Supra fn 2, at p. 26.
18. Ibid, at p. 26.
19. Supra fn 8, at p. 19.
20. Kreitman, R., 'UCP 600: The End in Sight?' (2006) Mantissa Support, at p. 2, available at: ‹http://www.mantissa.co.uk/Support/nextucp3a.htm›.
21. International Chamber of Commerce, 'UCP Update: UCP 600 Unanimously Approved' (2006) 12(4) DCInsight, October-December, at p. 2.
22. Supra fn 20, at p. 2.
23. Supra fn 2, at p. 27.
24. Supra fn 8, at p. 44.
25. Supra fn 16, at p. 8.