Letters of Credit (Doctrine of Strict Compliance)

Letter of credit means. A letter issued by a bank to another bank, especially one
in a different country, to serve as a guarantee for payment made to a specified
person under specified conditions.

Letters of Credit in Maritime Trade

Definition: A letter of credit (LC) is a financial instrument issued by a bank on

behalf of a buyer, guaranteeing payment to the seller for goods shipped,
provided the terms and conditions of the LC are met.
Role in International Trade: LCs are crucial in facilitating international trade
by reducing risks for both buyers and sellers. The buyer’s bank issues the LC to
assure the seller that payment will be made once the required shipping
documents (e.g., bill of lading, commercial invoice, insurance certificate) are
presented and verified as compliant with the LC terms.
Principles Governing LCs:
Independence Principle: The LC operates independently from the underlying
contract of sale. The bank’s obligation to pay is based solely on the proper
presentation of stipulated documents, not on disputes related to the goods or the
contract of sale.
Documentary Compliance: All documents presented must strictly adhere to
the terms of the LC. Banks are obligated to pay only if the documents exactly
match the LC requirements. Even minor discrepancies can lead to rejection and
non-payment.
Importance of Precision: The strict adherence to documentary terms highlights
the need for precision and accuracy in international trade. The details specified
in the LC must match the shipping documents to ensure payment.
Security Mechanism: LCs provide a secure mechanism for managing financial
risks associated with the shipment of goods by sea, offering assurance to the
seller of receiving payment.

Common discrepancies that often lead to the rejection of documents under

a letter of credit (LC) include:

 Inconsistent Information:
 Differences between the details on the documents and the terms specified
in the LC, such as mismatched names, addresses, or descriptions of
goods.
 Late Presentation:
 Documents presented after the deadline specified in the LC.
 Missing Documents:
  Required documents not included in the presentation, such as the bill of
lading, commercial invoice, or insurance certificate.
 Incorrect Document Format:
 Documents not formatted as required by the LC, such as missing
signatures or incorrect stamps.
 Discrepancies in Amounts:
 Differences in the amounts stated on the documents compared to the LC
terms.
 Non-compliance with Terms:
 Documents not complying with specific terms and conditions outlined in
the LC, such as shipment dates or port details.
 Typographical Errors:
 Spelling mistakes or typographical errors in critical information.
Improper Endorsements: Incorrect or missing endorsements on documents like
the bill of lading.
Incomplete Documents: Documents that are not fully completed or contain
blank fields.
Incorrect Shipping Details: Errors in shipping details, such as incorrect vessel
names or voyage numbers.

To avoid discrepancies in letter of credit (LC) documents, exporters can

follow these best practices:

 Understand LC Terms: Carefully review and understand all terms and

conditions of the LC. Ensure clarity on what documents are required and
the specific details they must contain.
 Accurate Documentation: Prepare all documents meticulously, ensuring
that all information matches the LC terms exactly. Double-check names,
addresses, descriptions of goods, amounts, and dates.
 Timely Presentation: Submit all required documents within the time
frame specified in the LC to avoid late presentation issues.
 Consistent Information: Ensure consistency across all documents. For
example, the description of goods on the invoice should match the
description on the bill of lading.
 Professional Assistance: Consider hiring a trade finance professional or
consultant who can help prepare and review documents to ensure
compliance with LC terms.
 Pre-shipment Review: Conduct a thorough review of all documents
before shipment. This can help identify and correct any discrepancies
early.
 Communication with Buyer: Maintain clear communication with the
buyer to ensure mutual understanding of the LC terms and requirements.
  Use Templates: Utilize standardized templates for documents like
invoices and packing lists to reduce the risk of errors.
 Training and Education: Invest in training for staff involved in preparing
LC documents to ensure they are knowledgeable about the requirements
and common pitfalls.
 Bank Assistance: Work closely with your bank to understand the LC
requirements and seek their guidance on document preparation.

There are different kinds of letter of credits. They are.

1. The clean letter of credit.
2. Conditional or documentary letter of credit.
3. Revocable letter of credit.
4. Irrevocable. Letter of credit.
5. Confirmed.Letter of credit.
6 unconfirmed letter of credit.
7. Fixed letter of credit.
8. Revolving.Letter of credit.
9. Circular letter of credit.
10 transferable letter of credit.
11. Letter of credit.

1. Clean letter of credit. If a letter of credit is without any conditions regarding

the attachment of documents of title to the goods, then it is called a clean letter
of credit.
2. Conditional or documentary letter of credit.
If if letter issuing bank requests the agent bank to pay customer on conditional
attachment of document of title to the goods. Then the letter of credit is known
as documentary letter of credit.
3. Revocable letter of credit.
Letter of credit The issuing bank reserves its right to cancel or modify the credit
without any notice to the customer.
4. Irrevocable letter of credit. Here, the bank cannot revoke the letter of credit
without consent and concurrence of the customer.
5. Confirmed a letter of credit. In confirmed letter of credit, the paying bank
abroad confirms by definite undertaking that it will fulfill all the provisions of
payment.
6. Unconfirmed letter of credit. In unconfirmed letter of credit, the paying bank
does not make any such confirmation.
7. Pixar Letter of Credit. If a letter of credit is issued for a fixed amount and for
a fxed period ., it is called fixed letter of credit.
8. Revolving letter of credit. If the amount of credit allowed under a letter of
credit automatically gets renewed after the bills negotiated under it are fully
honoured, it is called revolving letter of credit.
10. Circular letter of credit. Circular letter of credit are issued to tourists and
travellers who require money in different countries where they are likely to visit
a tourist. It may be travelers letters of credit or guarantee letter of credit.
A traveler's letter of credit is a request from the issuing bank to its foreign
agents to honor the beneficiary draft. In issuing guarantee letters of credit, the
banker obtains a guarantee, hence the name that reimbursement will be made on
demand at the agreed rate of interest, or he may require sufficient security for
the grant of the credit.

11. Transferable letter of credit In transferable letter of credit, the benefit under
it can be transferred to one or more parties.
12. Non transferable letter of credit. Here the letter of credit is not transferable.
Only the named beneficiary can avail the credit.

Letters of Credit and the Doctrine of Strict Compliance

Definition and Importance: A letter of credit is a crucial document in

international business transactions, issued by a bank to guarantee payment to a
seller. The seller presents the required documents to the advising bank, which
must strictly comply with the terms of the transaction.

Doctrine of Strict Compliance: According to the UCP 600 (Uniform Customs

and Practice for Documentary Credits), banks are only obligated to make
payments if the documents presented fully comply with the terms and
conditions of the credit. If there are discrepancies, banks are not required to pay.

Discrepancies in Documentation: A significant percentage of letters of credit are

rejected due to faulty or erratic documentation. For example, 48% of letters of
credit received by British exporters are rejected, with the global rejection rate
being around 70%. This is a major reason for payment failures in international
trade.

Challenges for Exporters: Exporters often face disappointment despite letters of

credit being considered secure and prompt payment methods. The
documentation process is typically handled by others, leading to errors that do
not meet the strict compliance standards. Banks sometimes apply the principle
narrowly to deny payments, and courts frequently uphold these decisions.

Conclusion
A letter of credit (LC) is a financial instrument issued by a bank on behalf of a
buyer, guaranteeing payment to the seller for goods shipped, provided the terms
and conditions outlined in the LC are met. In maritime trade, LCs play a crucial
role in facilitating international transactions by reducing risks for both buyers
and sellers. The principles governing LCs include the independence principle,
which ensures that the LC operates separately from the sales agreement, and the
principle of documentary compliance, which requires that all documents
presented must strictly adhere to the terms of the LC. This strict adherence
ensures that banks are obligated to pay only if the documents conform exactly
to the LC requirements, providing a secure mechanism for managing financial
risks associated with the shipment of goods by sea.