A documentary credit is an undertaking issued by a bank, on behalf of the buyer (importer), to the seller (exporter), to pay for goods and/or services, provided that the seller presents documents which comply fully with the terms and conditions of the documentary credit.

A variety of terms and abbreviations are used in documentary credit operations to describe or refer to the documentary credit itself. Generic descriptions such as "Documentary Credit", "DC", "credit", "Letter of Credit" and "L/C" carry the same meaning and are interchangeable. Other much used terms such as "irrevocable documentary credit", "confirmed irrevocable letter of credit" or "CILC" have a more specific meaning and need to be used in the right context.

Similarly, the commercial parties are known by a variety of names. The buyer may be described as "applicant" or "importer" and the seller as "beneficiary", "exporter" or "supplier".

The following notes cover the key areas to consider on the application form and should help you to establish a clear and concise instruction.

Provide the full name and postal address to ensure proper delivery to the beneficiary. Include a telephone, fax or telex number if requested to do so by the beneficiary.

These are important considerations because they determine when and where documents are to be presented and, for certain types of credit, whether there is any liability to pay interest.

When a credit is stated to expire at the counters of the issuing bank, documents must be received by the issuing bank on or before the date specified. If it expires in the country of the beneficiary, conforming documents must be presented to the nominated bank on or before that date. If the date falls on a weekend or bank holiday, UCP500 allows presentation to be made on the next working day.

The application form provides a list of the basic documents that are called for in a typical documentary credit transaction. The precise requirements of each document should be detailed accurately and concisely with additional documents being called for as necessary.

Where you are dealing with a new supplier or where the quality of the goods is critical, you should consider calling for an inspection certificate issued by an independent body or by a representative of your company. This will go some way to ensuring that you receive the precise goods you require.

When documents are received by your bank, they are checked against the terms of the documentary credit, including any amendments, and against the requirements of UCP500. If the documents are in order, they are released to you and payment to the seller is arranged according to the credit terms.

Unless you have made arrangements with your bank your account is debited immediately (for sight drafts) or on the due date (for usance drafts).

Documentary credits are completely separate transactions from the underlying commercial contracts on which they may be based. However, the importance of the commercial contract to the documentary credit process cannot be over emphasized. It is usually at the contract negotiation stage that the responsibilities of each party are defined, the price and terms of payment are agreed upon and the mode of transport is determined. As far as possible, the terms and conditions of the documentary credit should also be agreed at this stage.

Each element of the contract needs to be accurately reflected in the subsequent documentary credit to ensure that the transaction can be completed successfully, without creating undue difficulty for either party.

In documentary credit operations, banks deal only with documents and not with the goods to which the documents relate. Any disagreements arising from contracts or disputes relating to the goods or services supplied must be dealt with directly between buyer and seller.

According to UCP500 (Article 10), documentary credits may be made available in one of four ways.

By Sight Payment
Payment is made to the seller locally, upon presentation of conforming documents. A sight draft is usually called for although payment can be made against documents alone. If payment to the seller is made before your account is debited, interest will be charged from the date of payment to the date that the paying bank is reimbursed. If you wish, you can authorize the paying bank to claim payment by teletransmission and have your account debited upon receipt of the claim. In most cases this will be several days before you receive the documents.

By Deferred Payment
This type of credit does not require the presentation of a draft. Payment is made at a future date, usually fixed in the documentary credit as a specific number of days from the date of dispatch of goods or from the date of presentation of the documents.

By Acceptance
This type of credit requires presentation of a usance draft drawn on the bank nominated as accepting bank. The draft is accepted by the bank payable at a future date, usually fixed in the documentary credit as a specific number of days from the date of dispatch of goods or from the date of presentation of the documents.

By Negotiation
Sight or usance drafts may be drawn and negotiated by a bank. The credit may be made freely negotiable with any bank, or negotiation may be restricted to a bank nominated by the issuing bank. Under this type of credit, the seller is responsible for any negotiation interest unless you specifically authorize the negotiating bank to charge interest to your account.

A bank facility (credit line) for documentary credits is required before any instructions can be issued. The terms of the facility will establish any conditions that might apply to your documentary credits (e.g. a maximum validity period or maximum usance term) as well as a limit for the value of credits you can have outstanding at any one time.

You may need to issue a documentary credit weeks or months in advance of shipment to allow the seller time to purchase raw materials, manufacture the goods and organize delivery. This period (prior to presentation of documents) is often referred to as "the DC lead time". When assessing the level of facilities required, you need to consider your maximum potential period of liability, i.e. the validity period plus any usance period, as well as the anticipated turnover for which credits will need to be issued.

As far as your suppliers will allow, you should keep the validity period and any extended credit terms as short as possible. This will reduce the overall level of facilities required and, because bank charges are levied for the duration of the bank’s commitment, will keep the costs of the transaction down.

When checking the documents, your bank may note discrepancies between the documents and your stated terms and conditions or between the documents themselves. In these circumstances, you will be notified as soon as possible and given the opportunity to determine whether or not to take up the documents despite the discrepancies. Discrepant documents can still be rejected even if funds have already been paid to the seller.

If the documents are to be rejected, your bank is obliged to issue its notice of rejection to the presenting bank without delay. This must occur no later than 7 banking days after the date your bank received the documents although, in practice, it is usually much earlier than this. (A typical presentation of documents will be processed in 2/3 banking days). If you agree to take up the documents, your bank will advise the presenting bank that its presentation has been honored despite the discrepancies. The documents will then be released to you so that you can take delivery of the goods from the carrier.

All documentary credits should be handled according to the International Chamber of Commerce (ICC) code of practice known as the "Uniform Customs and Practice for Documentary Credits". These were developed with the assistance of banks and other interested parties to achieve uniformity of interpretation of documentary credit terms and conditions and are regularly reviewed. The current code is defined in the 1993 revision, ICC Publication No. 500 and is commonly referred to as UCP500.

A documentary credit which follows the code should bear a clause to the effect that it is subject to UCP500. However, documentary credits issued via the inter-bank computer network - SWIFT - need not carry such a clause as they are automatically subject to the version of UCP in place on the date of issue of the credit.

HSBC will be pleased to provide you with a copy of the current Uniform Customs and Practice for Documentary Credits (ICC Publication No. 500).

About
When referring to the amount or the quantity of items or the unit price of the goods, "about" means plus or minus 10%. See Article 39 of UCP500.

Acceptance
A written undertaking on the face of a bill of exchange to pay the bill amount on the due date. An alternative name for an accepted bill of exchange.

Accepting Bank
The bank which accepts a draft drawn under a documentary credit.

Amendment
An alteration to the terms and conditions of the credit, issued at the request of the applicant.

Bill of Exchange
A written order for payment. It is usually referred to as a draft.

Confirming Bank
A bank which adds its own undertaking to that of the issuing bank. The confirming bank is usually the advising bank.

Draft - See Bill of Exchange.

Drawee
The party to whom a draft is addressed and who is expected to accept and/or pay it upon presentation.

Drawer
The party who issues a draft. Usually the beneficiary of the credit.

Drawing
A presentation of documents under a credit.

Due Date
The date on which a usance draft or a deferred payment becomes due for payment.

Endorsements
Signing of a document (e.g. draft, insurance document or bill of lading) usually on the reverse to transfer title to another party. Documents are often endorsed in blank to permit any future holder to gain title.

Maturity - See due date.

Negotiation
The giving of value for a draft or documents which, under the credit terms, the issuing bank has undertaken to pay.

Negotiating Bank
The (nominated) bank which negotiates a presentation under a documentary credit. Usually located in the country of the seller.

Nominated Bank
The bank nominated in the documentary credit to pay, accept, negotiate or incur a deferred payment undertaking.

Paying Bank
The bank which is to effect payment under the documentary credit. It can be the issuing bank itself or nominated bank, usually the advising or confirming bank.

Reimbursing Bank
Normally a third party bank chosen by the issuing bank to honor claims made by the paying/negotiating bank under a letter of credit.

Settlement
Payment, deferred payment, acceptance or negotiation under a documentary credit.

Sight ("On demand")
If a credit provides for payment or negotiation "at sight", the issuing or confirming bank is obliged to pay/negotiate upon presentation of conforming documents.

SWIFT
Society for Worldwide Inter-bank Financial Telecommunication the secure computer network used to transmit documentary credits and other forms of international messages between banks.

Tenor
The period of time for which a draft is drawn. The tenor may be at sight or usance.

UCP500
The Uniform Customs and Practice for Documentary Credits, ICC Publication No. 500.

Usance
The credit period granted by the exporter to the importer and reflected in the documentary credit terms, e.g. 30 days after Bill of Lading date, 60 days sight, 90 days after shipment date.

Validity
The period, from the date of issue until the date of expiry, for which the credit is valid.

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