Export Letters of Credit

Faulty letters of credit are a common problem for companies involved in international trade. The eight steps outlined in this article can help companies reduce errors in the documentation required for letters of credit, easing the way for smooth payment.

Many exporters make mistakes when preparing letters of credit. Whether they are manufacturers or merchants, new to exporting or experienced firms, large in size or small, located in developed or developing countries, they tend to make the same errors.

Payment is subject to compliance. A discrepancy in documentation leads to non-compliance, and non-compliance results in non-payment. Surveys suggest that letters of credit are often rejected because of errors in preparation. Payment is refused or delayed as a result.

Faulty documentation is a major risk in accepting letters of credit. Another major risk is fraudulent documentation. Letters of credit are safe against commercial risks if irrevocable, and against political risks if confirmed.

Firms should aim for error-free documentation. They should make it company policy and develop strategies to eliminate all errors before presenting letters of credit for payment. Below are eight steps to adopt that can help firms move towards this goal.

Step 1. Organize the firm for export activities.

Proper organization and division of labour within a firm is the first step towards proper documentation. Errors are bound to occur where staff are not well-organized and trained.

One option is to create separate departments for export marketing and export administration. The division of labour will involve coordination and cooperation between the two departments. Error-free documentation is a combined effort of both these departments.

Assign the task of obtaining letters of credit to the export marketing department, and the task of ensuring compliance with letters of credit received to the export administration department. The administration department, however, should approve letters of credit first, in order to ensure that compliance will be possible. The exporting marketing department should ensure that the letters of credit they obtain are convenient and can be complied with economically. The export administration department should work to ensure timely and correct compliance, which establishes credit-worthiness among buyers. This in turn will help the export marketing department obtain more business letters of credit.

Step 2. Negotiate letter of credit conditions in the contract.

Negotiate letter of credit terms and conditions as part of sales contracts, and include the agreement in writing in the sales contract. Contract negotiation is a stepping stone to proper and easy compliance. If you have a "just send me a letter of credit" approach, you may receive a letter of credit containing terms and conditions with which you cannot comply.

Make sure your firm has a policy for negotiating letter of credit terms. The policy should aim to offer or accept during negotiation only the terms that suit your business capabilities and needs. For example, do not offer or accept an INCOTERM like Delivery Duty Paid, which involves customs clearance in the buyer's country by the exporter, if your business is not able to implement this INCOTERM.

Negotiate feasible deadlines and flexible terms wherever possible. For example, negotiate "any port" instead of a specific port for shipment purposes. Flexibility makes compliance easier.

Once your company has established a policy, entrust the task of negotiating letter of credit terms to the export marketing department. Good negotiation by the export marketing department will make compliance by the export administration department convenient and timely.

Step 3. Examine the letter of credit.

Carefully examine the letter of credit received for conformity to the sales contract and clarity. Set a policy for amending or rejecting a letter of credit. Then establish a checklist. A clear letter of credit leads to correct compliance. A defective letter of credit does not.

The export administration should examine the letter of credit and may seek the assistance of the export marketing department if amendment is required, in order to contact the buyer and the issuing banker.

Step 4. Plan for compliance.

Proper planning is necessary for proper compliance. Plan for arranging the stipulated products and documents. Plan for timely delivery and presentation.

This is a crucial step, for which the export administration department must have capability. The export manager must be competent for this task. He should have the skills of organizing and coordinating activities to implement the plan. He must have managerial skills to arrange resources such as adequate funds, competent staff, efficient technology and efficient procedures.

Step 5. Be aware of the most common mistakes in document preparation.

When it comes to preparing documents, be sure you have adequate technology and competent staff for this purpose. Use the box (see below) of common mistakes to prevent or rectify them. The box is based on information from surveys, as well as a close look at the publication Uniform Customs and Practice 500, (UCP) which is published by the International Chamber of Commerce (ICC). (See especially Articles 20 and 21)

Step 6. Review documents before presenting them.

Despite every effort to produce flawless documentation at the time of document preparation, some mistakes may occur in the documents that you must identify and eliminate at the document examination stage.

Examine the documents for accuracy with the help of a checklist, such as the one on page 15. The checklist must reflect UCP requirements.

Dates and signature

Examine closely the date (particularly on the certificate of inspection and the insurance document), signature (particularly on the transport document) for authenticity and consistency. The date must indicate the required compliance. If the letter of credit specifies that certain documents must be signed, then the signature must appear. The signature must be made by the right issuer, by the right method, at the right place and in the right form.

To repeat, the documents must be complete, consistent with one another and in compliance with the letter of credit and UCP. To ensure consistency, do use a checklist. Any original document required by the letter of credit should appear to be original. (See ICC's clarifications on Article 20b if questions arise.) Strictly comply with the letter of credit and UCP, as the bank examiner will adhere to the rule of strict compliance when examining the documents.

It is better to prevent or eliminate an error before presentation than to rectify it after presentation, or to find yourself later defending it as an immaterial error. Depend upon good documentation, not on the mercy of a bank examiner or buyer. The examiner may not ignore an error that you think is trivial or immaterial, and the buyer may not waive an error as you expect.

Step 7. Present documents appropriately.

Present the documents within the stipulated presentation time, at the right place and within banking hours. Remember: Proper time management for proper compliance.

Step 8. Monitor regularly.

Good monitoring is necessary to ensure compliance. Take action if implementation goes off course. If you fear an unexpected delay while implementing the letter of credit, seek an amendment to extend the time limits. If you face any problems in compliance, alert the buyer.

The export marketing department and export administration department should organize their respective roles to contribute to the implementation of the compliance plan.

The bottom line: improved documentation leads to improved cash flow.

Ravi Mehta is a columnist for trade magazines, specializing in letters of credit, and a manager for an Indian bank. Based in the United States, he can be contacted by e-mail at: aea16@hotmail.com