An analysis of key changes under ucp 600 compared to ucp 500 and recommendations for better ucp 600 application.doc

An analysis of key changes under ucp 600 compared to ucp 500 and recommendations for better ucp 600 application

1 Relevant of the study

It is generally accepted that international trade transactions naturally carry morerisks than domestic ones due to differences in practice, culture, business processes, lawsand regulations It is, therefore, important for traders to ensure that goods are dispatchedand payment is made complying with the contract provisions One effective solution fortraders dealing with these risks has been documentary credit (D/C) or letter of credit(L/C) Despite of its complexity in compliance and high cost, L/C still enjoys popularitydue to its safety with banks’ participation It has been described as “the life blood ofinternational commerce” (D’Arcy, Murray & Cleave 2000, p 166) and the importance ofL/C in trade transactions is evidenced by its global acceptance, with an estimated usagein excess of 1 trillion USD per annum (SITPRO Ltd, 2003)

For more than 70 years, the International Chamber of Commerce ICC has

formulated the so-called UCP-The Uniform Customs and Practice for DocumentaryCredits The first attempt to codify letter of credit practice started in 1929 when ICCintroduced its “Uniform Regulations and Commercial Documentary Credits” Although

the failure to gain wide acceptance, these rules provided a foundation for furtherdevelopments Then, in 1933, ICC issued “The Uniform Customs and Practice forCommercial Documentary Credits” and this set of rules received formal acceptance inmore than 40 countries all over the world It is, however, not until the issue of UCP in1962, that global acceptance took place Since then the rules has been regularly updated

in 1974, 1983 (UCP 400), 1993 (UCP 500) and now we have the sixth Revision-UCP 600which came into effect in July 2007.

From the fact that the old revision-UCP 500 has reached a ten year cycle ofusage and during its lifetime, it was proved to be more and more outdated, over-complicated and ambiguous which led to series of queries, commercial disputes,unjustified discrepancies leading to documentary rejections Indeed, under ICC’sestimate, there is up to a 70% documentary non-compliance rate in letter of credittransactions (ICC Thailand, 2002) The new 2007 Revision, therefore, should be made toimprove its certainty and clarity, reduce discrepancy problem and facilitate internationaltrade activities using L/C product

2 Aims of the study

This study, “An analysis of key changes in UCP 600 compared to UCP 500

and Recommendations for better application”, aims to consider the differences from

UCP 500 to UCP 600 The research questions posed in this study are: “Where the ruleshave been amended?” and “Which results in a potential changes in practice?” Basing onthe findings, this study will draw recommendations for parties involved in L/Ctransaction in applying the new revision UCP 600 before reaching the conclusion.

3 Research methodology

The thesis relies on relevant literature, associated rules, articles, availablestatistics and employs method of comparison, analysis, arguments and synthesis Data forthe study was collected from various sources including reference books, magazines,articles, reports, new letters and the Internet.

4 Object and scope of the study

Objects of the thesis are the two recent versions: UCP 500_1993 Revision andUCP 600 having commencement date of 1 July 2007 To have an in-depth understandingand appropriate application, associated rules that may have impact on these two revisionshave been used as reference documents.

5 Structure of the study

To achieve the above objectives, the study is divided into 3 chapters

Chapter I: “Literature review”, provides an in-depth background that covers all

theoretical issues relevant to UCP set of rules and documentary letter of credit.

Chapter II: “Key changes under UCP 600 in comparison to UCP 500”, points out

structural changes as well as key changes in UCP 600 in comparison with UCP 500 Anevaluation of improvements and remaining problems is also discussed in this chapter.

Chapter III: “Recommendations for better UCP 600 application”, based on the

findings, the chapter will put an end to the study with recommendations for main partiesinvolved in letter of credit transaction to suggest the best way in applying the new UCP600.

Chapter I

Literature review

1.1What is UCP?

The Uniform Customs and Practice for Documentary Credits (UCP) is a set of rules

on the issuance and use of letters of credit The UCP is utilised by bankers andcommercial parties in more than 175 countries About 11-15% of international tradeutilises letters of credit, totalling over a trillion dollars (US) each year (SITPRO Ltd,2003).

Historically, the commercial parties,particularly banks, have developed thetechniques and methods for handlingletters of credit in international tradefinance This practice has beenstandardized by the International Chamber of Commerce - ICC by publishing the UCP in1933 and subsequently updating it throughout the years Today, they have achievedalmost universal acceptance by practitioners in the countries worldwide.

It is important to note that The Uniforms and Practice for Documentary Credits(UCP) is not law It is private set of rules, which affects all the stakeholders involved inletter of credit transactions if they choose to apply it Stakeholders here refer to banks andother institutions that issue, confirm or otherwise process L/Cs; buyers who cause L/Csto be issued; seller who look to L/Cs for payment; and service providers such asforwarders, carriers, customs brokers who provide or use the documents that the creditsstipulate Therefore, UCP is not a legal regime automatically applicable to all letters of

credit It is just a voluntary self-regulatory rule system standardized by ICC when it isexpressly incorporated into the letter of credit

Beside UCP, ICC Banking Commission also provides some other supplementarypublications specifying in more details the relationship between the banks themselves, i.e.the rights and obligations of Advising, Confirming, Issuing and Nominated banks Thelatest up-to-date ones are ISBP 681 (International Standard banking Practice), eUCP 1.12007 (Supplementary to the Uniform Customs and Practices for Documentary Credits,for Electronic Presentation), “Commentary on UCP 600”, ICC Banking Opinions andmany guide books for Documentary Operation as well

1.1.1 The born of UCP 500

The considerable increase in litigation under documentary credits and the fact thatup to 50% of documents are rejected when firstpresented to Banks led to ICC’s authorization ofthe revision in November 1989 of UCPPublication No 400 published in 1983.International judicial decisions and technologicalinnovations were considered origins andfoundation for the content of new revision Thestated aim of this revision was to addressdevelopments in the banking, transport andinsurance industries It also sought to improvethe drafting of the UCP 400 in order to facilitateconsistent application and interpretation of UCPrules A Working Group (WG) including

international banking experts, legal professors and banking lawyers was formed to draftthe proposed revision After 4 years, with the tireless effort of WB, the final draft –UCP500, 1993 Revision – was reached and came into effect since January 1st 1994.

In comparison with the earlier revision UCP 400, UCP 500 is more concise andupdated with 49 articles It was divided into seven sections, which were lettered from Ato G and headed in turn: General Provisions and Definitions; Form and Notification ofCredits; Liabilities and Responsibilities; Documents; Miscellaneous Provisions,Transferable Credit and finally Assignment of Proceeds.

After ten year of usage, UCP 500 has revealed lots of weaknesses due to theadvance in fields of global logistics and technologies which needed to be incorporated inL/Cs In addition, there was a high proportion of documentary rejection under UCP 500.Seventy percent documentary discrepancy in letter of credit transaction is the statisticcollected by ICC Thailand in 2002 This fact together with the increasing demand ininternational trade transaction has forced ICC to start a new revision process.

1.1.2 The born of UCP 600

The latest revision process started in 2003 A drafting group comprising nine peopletogether with a consulting group with forty-one members from more than 25 countrieswere formed to develop proposed revisions for the ICC national committees worldwide.In fact, it cannot be denied that no draft will satisfy everyone, thus the drafting committeegave everyone an opportunity to express their own view by making comments

After all the suggestions hadbeen considered, no matter how theyare minor or small, decision on thenew draft is taken by a voting systemand the final text of UCP 600 wasreached The new revision replacingthe UCP 600 was approved by theBanking Commission of the ICC at itsmeeting in Paris on 25 October 2006and had a commencement date of 1July 2007 It is the fruit of more thanthree years of work by the ICC'sCommission on Banking Techniqueand Practice

The main objective of the revision was to reduce documentary rejection by ensuringtransparence and clarity, limit potential disputes, seek to eliminate poor presentation bybeneficiaries and provide a clearer understanding of principles in UCP

1.2What is Documentary Credit?

Documentary credit (D/C) or Letters of Credit (L/C) has been a milestone ofinternational trade since the early 1900s They continue to play a critical role in worldtrade today For any company entering the international market, letters of credit are apayment mechanism, which help eliminate certain risks.

A letter of credit is a document issued mostly by a financial institution whichusually provides an irrevocable payment undertaking (it can also be revocable,

confirmed, unconfirmed, transferable or others e.g back to back, revolving but is mostcommonly irrevocable/confirmed) to a beneficiary against complying documents asstated in the letter of credit Letter of credit is abbreviated as an LC or L/C, and often isreferred to as a documentary credit, abbreviated as DC or D/C, documentary letter ofcredit, or simply as credit (as in the UCP 500 and UCP 600) Once the beneficiary or apresenting bank acting on its behalf, makes a presentation to the issuing bank orconfirming bank, if any, within the expiry date of the LC, comprising documentscomplying with the terms and conditions of the LC, the applicable UCP and internationalstandard banking practice, the issuing bank or confirming bank, if any, is obliged tohonour irrespective of any instructions from the applicant to the contrary In other words,the obligation to honour (usually payment) is shifted from the applicant to the issuingbank or confirming bank, if any Non-banks can also issue letters of credit howeverparties must balance potential risks.

Source: the free encyclopedia Wikipedia

Letter of credit is also defined by TD bank financial group as “a written instrumentissued by a bank at the request of its customers, the Importer (Buyer), whereby the bankpromises to pay the Exporter (Beneficiary) for goods or services provided that theExporter presents all documents called for, exactly as stipulated in the letter of credit, andmeet all other terms and conditions set out in the letter of credit A letter of credit is alsocommonly referred to as a Documentary Credit or Commercial Credit.”

In principle, letters of credit are commonly used to reduce credit risk to sellers inboth domestic and international sales arrangements It is issued to substitute the bank'scredit worthiness for that of the customer Basically, if you are an importer, you don'twant to send the money before you get the goods On the contrary, the exporter does not

want to send the goods to you, unless they get their money Therefore, an LC is astatement of issuing bank, which tells that the buyer has the money, they gave the moneyto issuing bank, once the goods arrive safely at the destination, and is confirmed to bewhat it is supposed to be, this bank will give the money to the vendor Usually, banksplay the role of the 3rd party since they are institutions recognized to be trustworthy forthis sort of thing, and they sometimes also obliged to convert the currency as well – oneof bank’s main functions The bank will also charge a fee for the service and this is justone of the ways banks make money in the field of international business

However, traders should bear in mind that L/C is an independent agreementseparated from original sales contract All parties in letter of credit transaction deal withdocuments, not with goods which the documents refer Thus, the Seller gets paid, notafter the Buyer has inspected the goods and approved them, but when the Seller presentscertain documents (typically a bill of lading evidencing shipment of the goods, aninsurance policy for the goods, commercial invoice, etc.) to his bank The bank does notverify that the documents presented are true, but only whether they “on their face” appearto be consistent with each other and comply with the terms of the credit Afterexamination, the bank will pay the Seller.

1.2.1 Classification

There are three basic ways to classify letters of credit including classification bymethod of payment; by the manner in which the credit is issued and by other specificfeatures of the credit Each type of credit has advantages and disadvantages for the buyerand for the seller Charges for each type will also vary However, the more the banksassume risk by guaranteeing payment, the more they will charge for providing theservice.

Classification by reference to method of payment

Letter of credit may be by “sight” payment, by “deferred” payment, by“acceptance” or by “negotiation” All the credits must clearly state whether they availableby sight payment, deferred payment, by acceptance or by negotiation

A “sight” credit is one in which an issuing bank authorizes a seller of goods to

present documents for payment, without a bill of exchange or with a bill of exchangedrawn on it payable at sight, to the bank issuing the credit or its correspondent andundertakes to pay the seller, or reimburse its correspondent upon the correspondentpaying the seller, against the documents presented.

A “deferred payment” credit or ussance credit follows the normal form as to

payment against documents, except that the paying bank is not called upon to pay untilsome specific later date The paying bank is, however, required to pass the documents toits principal and may find itself under promise to pay in the future, having lost thesecurity of the documents Moreover a confirming bank that makes payment to thebeneficiary before the deferred payment date without obtaining the authority of theissuing bank does so as its peril If , before the date for payment, it is proved that thedocuments have been presented fraudulently the confirming bank cannot recover aindemnity from the issuing bank and must pursue a claim against the beneficiary oranother fraudulent party.

An “acceptance” credit is one which a bank authorizes a seller of goods to draw a

bill of exchange on it or its correspondent in the country of the seller, and undertakeseither to the seller or an intermediary bank to accept and pay at maturity a bill drawn o itor to pay a bill which has not been accepted by the bank on which it is drawn It ispossible to stipulate in a credit that the issuing bank will pay a bill of exchange drawn on

the buyer in the event of non-acceptance by the buyer, but this is discouraged by theUCP, which states that a credit should not be issued available by bills of exchange drawnon the applicant (buyer).

A “negotiation” credit is, strictly speaking, one that authorizes the beneficiary to

draw on the issuing bank and to negotiate the draft with the intermediary bank advisingthe credit or with his own or some other banks The issuing bank’s obligation is to paywithout recourse to the drawer The benefit of a negotiation credit is that the seller cadiscount the bills of exchange prior to the maturity date.

Classification by reference to the manner of which the credit is issued

Documentary letters of credit can be either Revocable or Irrevocable, although theformer is extremely rare Irrevocable letters of credit can be Confirmed or NotConfirmed.

Documentary Revocable credit may be modified or even canceled by the buyer

without the agreement of all the parties Therefore, they are generally unacceptable to theseller The issuing bank gives a binding undertaking t the beneficiary provided all termsand conditions are fulfilled Under UCP 600 all letter of credit are irrevocable.

Documentary Irrevocable letter of credit is the most common form of credit used

in international trade Irrevocable credits may not be modified or canceled by the buyer.The buyer's issuing bank must follow through with payment to the seller so long as theseller complies with the conditions listed in the letter of credit Changes in the credit mustbe approved by both the buyer and the seller If the documentary letter of credit does notmention whether it is revocable or irrevocable, it automatically defaults to irrevocable

There are two forms of irrevocable credits: Unconfirmed credit (theirrevocable credit not confirmed by the advising bank) and Confirmed credit (the

irrevocable confirmed credit)

In an unconfirmed credit, the buyer's bank issuing the credit is the onlyparty responsible for payment to the seller The seller's advising bank pays only afterreceiving payment from the issuing bank The seller's advising bank merely acts onbehalf of the issuing bank and, therefore, incurs no risk.

In a confirmed credit, the advising bank adds its guarantee to pay the sellerto that of the buyer's issuing bank Once the advising bank reviews and confirms that alldocumentary requirements are met, it will pay the seller The advising bank will thenlook to the issuing bank for payment Confirmed Irrevocable letters of credit are usedwhen trading in a high-risk area where war or social, political, or financial instability arereal threats Also common when the seller is unfamiliar with the bank issuing the letter ofcredit or when the seller needs to use the confirmed letter of credit to obtain financing itsbank to fill the order A confirmed credit is more expensive because the bank has addedliability.

Classification by reference to other specific features of credit

Standby letter of Credit

This credit is a payment or performance guarantee used primarily in the United

States They are often called non-performing letters of credit because they are only used

as a backup should the buyer fail to pay as agreed Thus, a stand-by letter of credit allowsthe customer to establish a link with the seller by showing that it can fulfill its paymentcommitments Standby letters of credit are commonly used to assure the refund ofadvance payments; support the obligation of a successful-bidder to accept a contract andto perform under the terms of the contract; back up bonds issued by insurance companies;and stand behind a monetary obligation under a promissory note or another likecommitment (rental payments, etc.) The beneficiary to a standby letter of credit can cashit on demand Stand-by letters of credit are generally less complicated and involve farless documentation requirements than irrevocable letters of credit If the seller performshis other obligation, there will be no need for the buyer to draw against the standby letterof credit, which supports the obligation.

Back-to-Back letter of Credit

Back-to-back L/C is a type of L/C issued in case of intermediary trade When one L/C is issued as security to obtain the issuance of the second L/C covering the sametransaction, and when all terms and conditions and terms of both credits are identical,excepts for amounts and dates in the second L/C which must be smaller and earlier, thearrangement is defined as a back-to-back L/C It is usually requested by middle personswho do not have sufficient credit available at their banks to open their own L/Cs to theultimate suppliers Under back-to-back L/C, the middleman will ask a bank to issue asecond L/C in favor of the ultimate suppliers, while using the L/C issued by the buyer ascollateral

Figure 1: Back-to-back letter of credit transaction

Many banks are reluctant to issue back-to-back letters of credit due to the level ofrisk to which they are exposed, whereas a transferable credit will not expose them to riskhigher than that under the original credit.

Green clause L/C

A clause in a letter of credit enabling the seller to receive pre-shipment advancesagainst a collateral represented by, for example, warehouse receipts/warrants It iscommonly used in the export of agricultural commodities, where the company may raisefunds to harvest new crops for export by pledging available stocks as collateral.

Red Clause letter of credit

Red Clause letters of Credit provide the seller with cash prior to shipment to financeproduction of the goods A red clause L/C using the term “red” is derived from thetraditional practice of writing the clause identifying this option in red ink Uponinstruction from the buyer, the issuing bank authorizes the confirming bank to make acash advance to the beneficiary against the beneficiary's written guarantee that the

documents evidencing shipment will be presented in compliance with the credit terms In

case the beneficiary fail to ship the goods or meet the credit requirements, the payingbank looks to the issuing bank to obtain reimbursement of the amount of the advance plusthe interest charges on the advance The issuing bank then charges the account of thebuyer who may or may not have received the goods.

Transferable letter of credit

“Transferable’, ‘transmissible” and “assignable” convey the same meaning referringto the same type of credit This kind of L/C allows the seller to transfer all or part of theproceeds of the original letter of credit to a second beneficiary, usually the ultimatesupplier of the goods The letter of credit must clearly state that it is transferable This is acommon financing tactic for middlemen and is common in East Asia.

Revolving letter of credit

With a Revolving letter of credit, the issuing bank restores the credit to its originalamount once it has been used or drawn down Usually, these arrangements limit thenumber of times the buyer may draw down its line over a predetermined period.Revolving letter of credit can revolve in relation to time or value If the credit is timerevolving, once utilized it is re-instated for further regular shipments until the credit is

fully drawn If the credit revolves in relation to value, once utilized and paid the valuecan be re-instated for further drawings.

Freely negotiable letter of credit

L/Cs which state “this credit is not restricted to any bank for payment” or suchsimilar words and do not indicate any particular bank who is authorized to pay, negotiateor accept are unrestricted or open credit.

Restricted negotiable letter of credit

When any specific bank is authorized to pay, negotiate or accept, the credit is calledrestricted or special credit.

1.2.2 The mechanics of letter of credit transaction

The mechanics of the letter of credit transaction can be quite complex and has beenstandardized by a set of rules published by the International Chamber of Commerce(ICC) under the Uniform Customs and Practice for Documentary Credits (UCP)

The basic letter of credit transaction has two sides: an import side (the buyer) and anexport side (the seller) Both sides ordinarily have a bank, which makes a total fourparties to the transaction The bank on the importer or the buyer’s bank normally issuesthe letter of credit, which obligates the bank to honour upon the receipt of the specifieddocuments Letter of credit rules typically describe the importer as the applicant and theapplicant’s bank as the issuing bank or the issuer of the letter of credit The fees differsignificantly from market to market and from customer to customer Indeed, bettercustomers paying much less Alternatively, the bank on the exporter or seller’s bankplays a different role The seller hopes to receive the funds offered by the letter of credit

as payment for shipment, and is thus identified as the “beneficiary” of the letter of credit.Because the beneficiary and applicant ordinarily are in different countries, the beneficiaryoften has its own bank oversea and then forwards the documents to seek payment fromthe issuer when the seller ships goods The beneficiary’s bank normally assumes one oftwo roles: if it only ‘advises’ the beneficiary of the issuance of letter of credit, it justprocesses the documents and has no direct liability on the letter of credit; besides, itmight “confirm” the letter of credit, in which case beneficiary’s bank directly obligatesitself on the letter of credit, pays the beneficiary directly, and then forwards thedocuments to the issuer for reimbursement.

The following is the basic set of steps used in a letter of credit transaction Specificletter of credit transactions follow somewhat different procedures.

Step 1 An Importer {Buyer) and Exporter (Seller) agree on a purchase and sale ofgoods where payments is made by letter of credit.

Step 2 The Importer completes an application requesting its bank (issuing bank) toissue a L/C in favor of the Exporter provided that the Importer must have a line of creditwith the issuing bank in order to request that a letter of credit be issued.

Step 3 The issuing Bank issues the letter of credit and sends it to the Advising bankby telecommunication or registered mail in accordance with the Importer’s instructions.A request may be included for the Advising bank to add its confirmation The AdvisingBank is typically located in the country where the Exporter carries on busiess and may bethe Exporter’s bank but does not have be.

Step 4: The Advising bank will verify the letter of credit for authenticity and send acopy to the Exporter Figure 2 illustrates the typical transaction

Figure 2: Issuance of letter of credit

Step 5 The Exporter examines the letter of credit to ensures that it corresponds thethe terms and conditions in the purchase and sale agreement, documents stipulated in theletter of credit can be produced and the terms and conditions of the letter of credit may befulfilled.

Step 6 If the Exporter is unable to comply with any terms and conditions of the L/Cor if the L/C differs from the purchase and sale agreement, the Exporter should notify theImporter and request an amendment to the L/C.

Step 7 When all the parties agree to the amendment, they are incorporated into theterms of the L/C and advised to the Exporter through the Advising bank It is notrecommended that the Exporter does not make any shipments against the L/C until therequired amendment have been received.

Step 8: The Exporter arranges for shipment of the goods, prepares and/or obtain thedocuments specified in the letter of credit and makes demand under the letter of credit bypresenting the documents within the stated period and before the expiry date to the‘available with” bank This may be the Advising/Confirming Bank That bank check thedocuments against the letter of credit and forwards them to the Issuing Bank Thedrawing is negotiated, paid or accepted as the case may be

Step 9 The Issuing Bank examines the documents to ensure they comply with theletter of credit terms and conditions The issuing bank obtains payment from the Importerfor payment already to make the “available with” or the Confirming bank

Step 10 Documents are delivered to the Importer to allow them to take possessionof the goods from the transport company The trade cycle is complete as the Importer hasreceived its goods and the Exporter has obtained payment Figure 3 will illustrate thepayment process

Figure 3: Payment under a letter of credit

1.2.3 Parties involved in a letter of credit transaction

In the process of a letter of credit transaction, there are essentially five partiesinvolved: importer, exporter, importer’s banks, exporter’s banks and service providers Ingeneral, except for importer, exporter and service provider, there are nine functionsconcerning letter of credit transaction, which banks can undertake It does not mean thateach documentary credit transaction requires all those actions It depends on requirementsof the sales agreement, relationship between importer and seller as well as relationshipbetween the two parties in commercial contract and their banks to choose or skip somecertain phases without affecting the principles of original sales arrangement.

Issuing bank (Opening Bank)

The bank issues the letter of credit on behalf of the applicant

Accepting bank

The bank named in a letter of credit on whom term drafts are drawn and whoindicates acceptance of the draft by dating and signing across its face, thereby incurring alegal obligation to pay the amount of the draft at maturity.

Paying bank

The bank authorized in the letter of credit by the issuing bank to honor sight ordeferred payments under the terms specified in the credit If this bank is the advisingbank, it has no obligation to honor documents; however, if this is a confirming bank, it isobligated to pay against complying documents.

Drawee bank

The bank on which the drafts specified in the credit are drawn and from whichpayment is expected

Chapter 2

Key Changes under UCP 600 compared to UCP 500

2.1 Changes in Structure of UCP 600 compared to UCP 500

The new rules UCP 600 is more concise than its predecessors with 39 articles asopposed to 49 articles in UCP 500 It is not divided into the same seven sections as theUCP 500, which were lettered from A to G and headed in turn: General Provisions andDefinitions, Form and Notification of Credits, Liabilities and Responsibilities,Documents, Miscellaneous Provisions, Transferable Credit and finally Assignment ofProceeds

Despite the fact that the UCP 600 does not expressly follow this allocation ofArticles by subject- master, it is still possible to divide those Articles up The frameworkof the UCP 600, which provides specific background on General Provisions andDefinitions, is stipulated in article 1-5 Article 6-13 specify the structure of adocumentary credit and obligations of parties under documentary credits includingissuance, advising, confirmation, amendments, availability and nomination The next sixarticles from Article 14 to 18 and article 28 look at two difference aspects including thecompliance of the documents and the definition of an original document Requirementsof the UCP 600 regarding transport documents, standard for checking documents as wellas insurance provisions are itemized in articles 19-27 From Article 29-37, these ninerules cover solutions for potential problems arisen during the process of the sales contractimplementation, which includes extension, tolerance, partial shipment, installments,

disclaimers, force majeure The two remaining articles regulate the transferable creditsand assignment of proceeds.

2.1.1 UCP 500 articles not included in UCP 600

There are 5 articles of UCP 500 that have not covered in UCP 600 Article 8 andpart of Article 6 refer to revocable letters of credit The limited usage of such instruments

in today’s letter of credit business led to the general viewpoint that there was no necessityto remain in UCP 600 If an applicant or bank desire to use a revocable credit in thefuture, they have two options: using the credit subject to UCP 600 and incorporate all theconditions applicable to the revocability; or using the revocable credit subject to UCP500 provided that all parties are in agreement to the usage of those rules.

Article 5 (Instruction to issue/ Amend Credits) This article is related to instructions

to issue and amend credits, which was seen as an article stated the obvious Instructionsfor the issuance of a credit and an amendment as well as the credit and the amendmentthemselves must be surely complete and precise in order to make payment, acceptance ornegotiation In addition, the absence of a specific rule in UCP 600 concerning theinstructions to issue and amend credits does not relieve Issuing banks from their duty ofcare for the proper creation, completeness and content of their credit or any amendment(if any)

Article 12 (Incomplete or Unclear Instructions) covered the issuance of preface

notification, by the Advising Bank, in the event a credit or an amendment was incompleteor unclear in its terms If a credit is received that is unworkable or incomplete, there is noneed for a rule to instruct Advising Bank that they should seek clarification or request acomplete message Therefore, it is not necessary to provide a rule that the Issuing Bank

must give the appropriate information “without delay” Similarly, the absence of aspecific rule in UCP 600 with regard to Incomplete and Unclear Instructions does notrelieve the Issuing Bank for their duty of care for the proper creation, completeness adcontent of their credit or any Amendment too

Finally, Article 38 under the heading “Other Documents” was removed at a very

early stage of the revision process The usage of this article’s content was consideredmarginal because the basic for the issuance of any credit is that it will specify the type ofdocument that is required for the presentation and its content If a condition such as averification of certification of weight is required, the the credit should specify the formand documents in which such information is to present

In addition, there are some content of 12 articles consisting of article 2, 6, 9, 10, 20,22, 30, 31, 35, 36, 46, 47 that were moved or merged with other articles in UCP 600 The

rationale behind those changes will be explained further more in the following chapterfocusing on analyzing the changes in one-by-one articles.

2.1.2 New articles for UCP 600

There are 6 articles that are not found in UCP 500 They are Article 2 (Definitions),Article 3 (Interpretations), Article 9 (Advising of Credits and Amendments), Article 12(Nomination), Article 15 (Complying Presentation) and Article 17 (original documentsand Copies) Each of these will be covered right after in the subsequent section.

2.2 key Changes under UCp 600 compared to UCP 500

2.2.1 Changes application method

The UCP 500 provided that it applied to all documentary credits where

“incorporated into the text of the credit” Courts, however, would generally found that

this provision was not forceful enough and these rules would apply when expressly stated

or by implication The UCP 600 more clearly states that it applies only “when the text ofthe credit expressly indicates that it is subject to these rules”

More significantly, with regard to modification and exclusion of its terms, UCP 500

only provided that its terms applied “unless otherwise expressly stipulated” In contract,the UCP 600 clearly stipulates that the rules applied “unless expressly modified orexcluded by the credit” It opens to exporters and importers to modify or exclude the

provisions of UCP 600 expressly and thus they can even continue with the provisions ofUCP 500 if they choose The application of UCP 600 give more contractual freedom andautonomy to parties because if there is an express exclusion of UCP 600 and partiesinclude their own provisions, any conflict between the express provisions and UCP 600will be resolved in favor of the former instead of UCP 600 rules

2.2.2 Changes in Definitions and interpretations

The big difference between UCP 500 and UCP 600 is the precision of the languagein the new rules makes them easier to read and understand, especially for people whose

daily life is not concerned with L/C world Article 2 (Definitions) and Article 3(Interpretations) provide general background on series of expressions which are

considered the international language of the L/C world

UCP 600 introduces in Article 2 the following new definitions: Advising Bank,Applicant, Banking day, Beneficiary, Complying Presentation, Confirming Bank,Honour, Issuing Bank, Negotiation, Nominated Bank, Presentation and Presenter which

are absent in UCP 500 Other definitions found in UCP 500 also moved to this Articlewith several modifications making them more clearly and precise such as “Credit” and

“Confirmation” UCP 600 defines credit in Article 2 as “any arrangement, howevernamed or described, that is irrevocable and thereby constitutes a definite undertaking ofthe issuing bank to honour a complying presentation” This simple definition is animprovement on the earlier definition and uses new term such as Honour and ComplyingPresentation which are also defined in this Article

“Honour” is considered a new word in the documentary credit banking languagethat is borrowed from the US law It is used to group together three types of payment

known to trade-finance namely “ to pay at sight if the credit is available by sightpayment”; or “ to incur a deferred payment undertaking and pay at maturity if the creditis available by deferred payment”; or “to accept a Bill of exchange (draft) drawn by theBeneficiary and paying at maturity if the credit is available by acceptance” All these

actions are merged under one concept –“Honour” Accordingly, instead of speaking ofpaying at sight or at maturity or incurring a deferred payment or negotiation, now underUCP 600 we would only speak of honour or negotiation The term “Honour’ covers threetypes of payment methods that are already in practice In addition, definition of honourhelps us to distinguish a payment under negotiation credit from an honour

The expression “Complying presentation’ is also a modification of what UCP 500

says “in compliance with the terms and conditions of the credit” This alternative concept

not only means a presentation that is in accordance with the terms and conditions of the

credit but also is considered the applicable provisions of the rules and internationalstandard banking practice

Among new definitions, the most remarkable one, which received lots of critical

attention, is “Negotiation” From the definition of UCP 500 identifying “negotiationmeans the giving of value for draft(s) and/or documents to the bank authorized tonegotiate”, different interpretations were given but overall consensus on the meaning of

“negotiation’ has not reached A number of banks failed to understand the meaning of theterm in connection with the L/C transaction because the phrase “giving of value” may beinterpreted as either making immediate payment or undertaking an obligation to make

payment The new UCP redefines “negotiations in Article 2 as “the purchase by thenominated bank of draft (drawn on a bank other than the nominated bank) and/ordocuments under a complying presentation, by advancing or agreeing to reimbursementfunds to the beneficiary on or before the banking day on which reimbursement is due tothe nominated bank” The language of this new definition is clearer and more specific

than the old one This is a kind of prepayment by the Nominated Bank if the credit isavailable by negotiation Once, the Nominated Bank has negotiated (prepaid) the creditagainst complying presentation, the Issuing Bank has obligation to reimburse thenominated bank under Article 7 of UCP 600 Negotiation credit may use time bills and ifthe nominated bank agrees to negotiate, the exporter can get paid before maturity date.

In Banking day definition, there are two points: a day that “bank is regularly open”

and “at the place at which an act subject to the rules is to be performed” A bank may

regularly open Mondays to Saturdays but its trade department is only open Mondays toFridays Thus, in this context, a banking day would be any day between Monday toFriday National holidays would be a day on which a bank regularly be open

UCP 600 has a new article named “Interpretations” which contains all sub-articlesin UCP 500 relating to interpretation They are Singed; Legalized; Branches; First-class;Prompt; On or About; To and Until; From and after; First half and second haft;Beginning, middle and end Besides, UCP 600 added two new interpretations on Singleor Plural and the default position of irrevocable letter of credit.

2.2.3 Changes in types of credit

As mentioned, there is a significant change in UCP 600 in terms of L/Cclassification UCP 500 provided that a L/C could be either irrevocable or revocable If itwas silent, it is would be assumed to be irrevocable UCP 600 also remains the samepreference for the irrevocable credit However, it goes in more details by making it

clearer that an irrevocable letter of credit is deemed as the default status: “A letter ofcredit is irrevocable even if there is no indication o that effect” Accordingly, it continues

to expressly provide that a credit cannot be cancelled without the agreement of the seller.In spite of the fact that the parties can still open a revocable letter of credit, they will needto ensure that those terms in the UCP 600 that are inconsistent with a revocable credit areexpressly deleted or amended.

In terms of availability of L/C, there are four types of credits in UCP 600 They aresight payment credit, deferred payment credit, acceptance credit and negotiation credit.The Article 6b identifies that a credit must state whether it is available by sight payment,deferred payment, acceptance or negotiation Once an L/C is issued in any one of theabove methods, it is an authorization to honour or negotiate However, Article 12(a)states clearly that an authorization to honour or negotiate does not impose anyimplication of the Nominated Bank to honour or negotiate, unless that Nominated Bankexpressly agrees to do so If it agrees to undertake any one of the two methods of

payment, payment should be at maturity Nevertheless, Article 12(b) enables theNominated Bank to prepay Previously, only Confirming Bank can make prepayment andNominated Bank is just allowed to incur a deferred payment undertaking Now,Nominated bank is authorized both to incur such an undertaking and to makeprepayment This would give banks more additional concern On the other hand, with thisstipulation, not only negotiation credits but also acceptance and deferred payment creditscan be negotiated or prepaid by Nominated Bank

2.2.4 Changes in time required for examination of documents

Under the UCP 500, the procedure set out under Article 13(b) is that a bank must

complete its examination of the documents in a “reasonable time not exceeding sevenbanking days” and “without delay” The question has arisen that how reasonable time is

for the banks to discover a discrepancy For example, the bank informed the seller ofdiscrepancies six days after the presentation of the documents, and the seller argued thatthis was not a “reasonable time” Although the bank is enabled to consult the applicantbefore it reaches decision, the time spent on the process does not reach the ultimate deadline of seven days Therefore, it was suggested that the reference to “a reasonable timenot exceeding seven banking days” should be replaced by a fixed time limit; and five orjust three days were thought to be adequate The UCP 600 now stipulates a fixed periodof five banking days for bankers’ examination process and refusal of documents Thisnew regulation, beside the advantage of reducing time for banks to process documents,has revealed its short-coming Indeed, the fixed period of “five banking days” will makebank use automatically five banking days even if they may pay earlier since there is nobreach if they choose to take advantage of the full five-day period.

2.2.5 Changes in addresses of of beneficiaries and applicants

The UCP 600 under Article 14(j) states when addresses of beneficiaries andapplicants must be the same as in the credit This article allows address of the seller andor buyer on the invoice need no longer be as mentioned in the documentary credit Itmust, however, in the same country Contact details such as phone, fax numbers may bedisregarded and if stated they need not as in the credit An exception to this is when theaddress and the contact details are used in the transport documents as part of theconsignee or notify party In that case, they must be as stated in the L/C This would givesome advantage to trading parties when Back-to-Back or transferable L/C is used intransactions having intermediary involved.

2.2.6 Changes in refusal notice

There are two points in UCP 600 that should be pay attention to regarding therefusal notice UCP 600 states that refusal notice must state that the bank is refusing tonegotiate or honuor (sub-Article 16(c) (i)) while UCP 500 implies such a requirement.Besides, UCP 600 allows refusal notice to state that “the issuing bank is holding thedocuments until it receives a waiver from the applicant and agrees to accept it, or receivesfurther instructions from the presenter prior to agreeing to accept a waiver” while underUCP 500, it is not allowed This article allows seller to provide instructions on how thediscrepant documents should be dealt with when Issuing Bank rejects them This, to someextents, would give the seller some control over the discrepancies especially whendealing with high value contract.

2.2.7 Changes in transport documents

The transport articles of UCP 600 are covered by articles 19-25 When UCP 500was born, the transport articles increased from two articles (one covering sea and the restcovering all other forms of transports) to individual transport articles covering the morepoplar means of shipment or despatch UCP 500 articles 23-29 sought to standardize theway in which the individual requirements would be expressed and to bring somecommonality to their structure With UCP 600, this process went even further to not onlylook at changes in transport industry practices but also at common standards for signingparties and authority, requirements for on board notations and transhipment provisions.

In general reference to “unless otherwise stipulated in the credit” no longerappears in the articles Transport documents, except Charter Party Bills of Lading andCourier Receipts, Post Receipts or Certificates of Posting, must indicate the name of thecarrier (in the same manner as was required under UCP 500) The transport articles nolonger make reference to “on its face” (except for one place in sub-article 14(a))

A consistent and standard style for signing transport documents should indicate thename of the carrier and be signed by the carrier or a named agent for or on behalf of thecarrier, or the master or a named agent for or on behalf of the master Any signature bythe carrier, master or agent must be identified as that of the carrier, master or agent Anysignature by an agent must indicate whether the agent has signed for or on behalf of thecarrier or the master Where an agent signs for or on behalf of the master under articles19- 22, there is no longer any need to add the name of the master These articles nolonger make reference to vessels propelled by sail, yet they add reference to “at the placestated in the credit” or “at the port of loading stated in the credit” to reflect that the bankneeds to be able to ascertain, from the transport document, that the goods have been takenin charge, dispatched or shipped on board at the place or port stated in the credit

Each transport article in UCP 500 contained reference to “in all other respects meetsthe stipulations of the credit” With UCP 600, this is not repeated in the transport articlesas the principle is captured in the definition of “Complying presentation” in article 2.

2.2.8 Changes in some other articles

Discount of deferred payment undertaking under Article 7c, 8c and 12

Nomination of a bank includes authorizing a bank to prepay or purchase This hasalso been included in Article 7 Issuing Bank Undertaking and Article 8 Confirming BankUndertaking

Sub-Article 7 (c) provides the reimbursement undertaking for the issuing Bank Itstipulates that when the nominated bank has acted and the issuing bank must reimbursewhen a complying presentation is made Next, it continues emphasizes thatreimbursement is due at maturity, under an acceptance or deferred payment credit,whether or not the nominated bank has prepaid or purchased Lastly, it focuses on theobligations of the issuing bank undertaking in relation to nominated bank (to reimbursewhere they act) and a beneficiary (where they may present documents directly ornominated bank does not act) Sub-article 8(c) showing reimbursement obligation ofconfirming bank to any nominated bank (if any) is exactly the same text as that whichappears in sub-article 7(c), except the word “confirming” replaces ‘issuing”.

Article 12 - Nomination adds a new concept specifying the ability of a nominatedbank to pre-pay or purchase under an acceptance or deferred payment credit It states ‘Bynominating a bank to accept a draft or incur a deferred payment undertaking, an issuingbank authorizes that nominated bank to prepay or purchase a draft accepted or a deferredpayment undertaking incurred by that nominated bank’ This represents a major changein scope of the UCP Previously, UCP has not involved in the area of financing.

However, due to recent court cases (including Banco Santander Vs Banque Paribas,Canada Bank Vs Credit Lyonnais), under sub-article (b), UCP 600 provides that when adocumentary credit is available with a nominated bank by acceptance or deferredpayment, such issuance includes an authority for nominated bank to prepay or purchase,providing that the nominated bank agrees to accept a draft or incur a deferred paymentundertaking Now, the courts will now recognize the issuance of such a documentarycredit conveys an explicit authority to discount This article provides an authority for thenominated bank prepay or purchase, not an obligation to do so.

Discrepant documents, Waiver and Notice under article 16

This article describes the requirements for banks when they determine that thepresentation does not comply An issuing bank may still approach an applicant for waiverof any discrepancies, prior to sending a refusal notice Sub-article (c) outlines thestructure of a required refusal notice Sub-article (c) (iii) provides four options regardingthe status of documents while under UCP 500, only two actions of banks are mentionedwhen sending notice, which are holding the documents pending further instructions fromthe presenter or returning documents The two added options for banks to dealing withdiscrepancies are holding the documents until receiving a waiver from the applicant, orreceiving further instructions from the presenter prior to agreeing to accept a waiver; andacting in accordance with instructions previously received from the presenter.

Original documents and copies under article 17

In this article, sub-article (b) and (c) have been taken from ICC Decision paperpublicized in 1999 Sub-article (b) describes how a document is an original and sub-article (c) defines how a document may be created as an original Sub-article (a)

emphasizes that when a credit requires a document in the singular then this documentmust be presented as an original Sub-article (d) provides that originals may be presentedwhen copies are requested This situation arises where a beneficiary may be required topresent a document in four copies To meet this requirement, the beneficiary may createone original invoice and then photocopy it three times or print four copies and sign eachone manually.

Insurance documents under article 28

Previously in UCP 500 Article 34 Insurance Documents; Article 35 Types ofInsurance Cover; Article 36 All Risks Insurance Cover In this article, insurancedocument must be issued and signed by an insurance company, an underwriter or theiragents or their proxies Cover notes will not be accepted (previously cover notes issuedby brokers) The Insurance document must indicate that risks are covered at least betweenthe place of taking in charge or shipment as stated in the credit and the place of dischargeor final destination as stated in the credit Amount of insurance coverage must be at least110% of the CIF or CIP value of the goods An insurance document may containreference to any exclusion clause.

Partial drawings or shipments under article 31

Partial shipments occur when the goods are loaded in more than one vessel, aircraft,truck, ect It should be noted that partial shipments could not be considered through thenumber of transport documents that are issued On the other hand, if it is only onetransport document is presented, it does not necessarily reflect that a partial shipment hasnot occurred When the goods are loaded in the same vessel for the same journey ordestination, it will not be regarded as a partial shipment, even when separate bills oflading are issued covering the loading of goods on different date For example, the credit

covers shipment of 50MT of rice and partial shipment is not allowed Bills of ladingcovering in the same vessel are issued as followed: 127 May-20MT, 28 May-20MT and28May-10MT Sub-article (b) indicates that the latest bills of lading (29 May) will beconsidered as the date of shipment Therefore, when a credit requires shipment by truckand does not allow partial shipment, the beneficiary must ensure that the goods arecapable of being loaded in the truck If more than one truck is needed, if will consideredas being a partial shipment even if they are leave on the same day for the samedestination.

Disclaimer on transmission under article 35

This article includes a new rule with regard to the loss of documents in transitbetween a nominated bank and the confirming bank or issuing bank The basis for thisrule is to avoid the situation when an issuing bank states that “we will reimburse thenominated bank upon receipt of documents” and if the documents are not received, theywill have no liability to reimburse

When a beneficiary presents documents that the nominated bank finds to complywith the terms and conditions of the credit, the confirming or issuing bank must honouror negotiate regardless of the nominated bank honours or negotiates, or the documents aresent to the confirming bank, issuing bank or lost in transit.

2.3 Improvements and remaining problems under UCP 600

2.3.1 UCP 600’s improvements

After ten year of usage, UCP 500 has revealed lots of weaknesses and led to a highproportion of documentary rejection Seventy percent documentary discrepancy in letterof credit transaction is the statistic collected by ICC Thailand in 2002 This fact along

with the increasing demand in international trade transaction have forced ICC to start therevision process in 2003 and UCP 600 was born three years later Right from the draftingtime, UCP 600 has received lost of comments, which are not merely from the LCcommunity That is to say, UCP 600 rules are the fruit of the tireless efforts and constantinnovation of ICC Commission on Banking Technique and Practice (BankingCommission) in general as well as the Drafting Group from twenty-six countries all overthe world in particular The most significant achievements of UCP 600 are concise andcomplete content, logic structure and easily understandable language in comparison withits predecessor UCP 500

In terms of content, UCP 600 has constituted by 39 articles as opposed to 49 articlesin UCP 500 The reduction in the number of articles does not means that UCP 600 rulesdo not cover full aspects in L/C transaction as stipulated in UCP 500 On the contrary, bybeing moved unnecessary articles and added essential provisions, 39 articles has provideda more comprehensive content to avoid discrepancies in documentary presentation due toinadequate stipulations.

Along with the conciseness, there are significant changes in the structure UnlikeUCP 500, UCP 600 is not divided into seven sections, which were lettered from A to Gand headed in turn: General Provisions and Definition, Form and Notification of Credits,Liabilities and Responsibilities, Documents, Miscellaneous Provisions, TransferableCredit and finally Assignment of Proceeds anymore Instead of allocating articles bysubject-master, UCP 600 just numbers articles from 1 to 39 Besides, order of certainarticles as well as sub-articles has been changed to meet the requirement that provisionsconcerning the same effect and the same content are placed together For example, under

UCP 500, provisions regarding “General Expression as to Dates for Shipment” and“Dates Terminologies for Periods of Shipment” stipulated in Article 46 and 47respectively are now moved to UCP 600 Article 3 stipulating Interpretations Next,

Article 14 named “Standard for Examination of Documents” in UCP 600 contains all

requirements for Documents issued and presented, which were previously allocated inseries of articles including Article 13 (Standard for Examination of Documents), Article21(Unspecified Issuers or Content of Documents), Article 22 (Issuance Date ofDocuments v Credits) and finally Article 43 (Limitation on the Expiry Date) In addition,there are many other sight modifications in terms of structure making the new draft moresystematically and logic.

With the regard to language, UCP 600 has achieved a considerable progress whenusing precise, explicable definitions as well as interpretations making the set of ruleseasier to understand and follow, even for people whose everyday life do not have a closerelation with the L/C world In addition, the clear language also helps to reducearguments and disputes relating to the way to interpret and apply these rules in practice.UCP 600 introduces in Article 2 a number of definitions, most of which are newly added(namely Advising Bank, Issuing Bank, Confirming Bank, Nominated Bank, Negotiation,Honour, Banking Day, Complying Presentation, ect); or modified in a more simply waysuch as “Credit” definition Interpretations on terms or words appearing frequently inletters of credit also explained more clearly and sufficiently in Article 3 under UCP 600.

2.3.2 Remaining problems in UCP 600

In fact, no rule can satisfy everyone, especially for internationally applied ones likeUCP, the draft UCP 600 is also not an exception Despite the Drafting Committee gaveeveryone opportunities to express their own point of view, the final draft is reachedsubject to a “yes” or “no” voting system, solely based on the content of that draft If themajority vote is positive, then the UCP will take effect As the result, there are severalshortcomings in the content of the new revision, which continue to cause concern forstakeholders involved in L/C transaction.

Instructions to documentary discrepancies under Transferable Credits

There is no article found in UCP 600 giving instructions to deal with documentarydiscrepancies as to Transferable Credits Or, at least, there should be a provision statingthat all the documentary discrepancies under Transferable Credit transaction would behandled as for non-transferable L/C, in particular, making a reference to Article 16 underUCP 600 The absence of such position may lead to the failure in achieving the uniformin dealing with this problem between banks, countries or between different cases that iscontrary to the spirit of UCP rules.

Description of goods

Next, there are some issues remain unresolved relating the description of goods onthe commercial invoice The problem with the description of the goods on thecommercial invoice is the level of accuracy demanded by the UCP rules, and this mainlyleads to documentary discrepancies in L/C transaction In fact, there is no change in thecontent of the provision on commercial invoice, except for the change in position fromArticle 37 in UCP 500 to article 18 in UCP 600 It states “The description of the goods,services or performance in the commercial invoice must correspond to that appearing inthe credit” From the exporter’s point of view, one of the most crucial steps is thepresentation of documents to receiving bank to get payment However, banks will decidewhether payment is made or not, mainly basing on checking documents presented by theexporter, not by specifying goods Among many required documents, commercial invoiceis the most vital one because there are a number of parties who rely on it to perform theirduties Banks do not expect the description of goods to be laid out exactly as shown in theL/C, but the data elements contained in the invoice must be match to the L/C In other