3 Letter of Credit Lessons That Will Help You Avoid an Export Disaster

One of the core tenets of an export transaction is that your documents must comply with the terms specified in the bank’s letter of credit. Even one small discrepancy can give the buyer license to delay or refuse payment—even if the goods meet specifications. These are the rules detailed in the Articles of the Uniform Customs and Practice (UCP).

Here’s a true story of how a buyer of pool cues gamed the system to delay payments to the manufacturer in Taiwan. But it was the factory that got the last laugh when it shipped the late-paying buyer a box of tree branches instead of cues!

Importer Tries to Game the System

A company was importing pool cues from a factory in Taiwan. The transaction consisted of multiple shipments with payments made on a letter of credit. Every presentation of documents had discrepancies that required the bank to obtain the importer’s waiver of the discrepancies before the bank could make payment (UCP Article 16).

The unscrupulous buyer sensed a chance to game the system and took one or two days before giving the waiver to the bank. In the meantime, the pool cue buyer contacted the seller in Taiwan and requested a discount on a future shipment before approving the pending payment—in effect, blackmailing the factory.

After some time, the Taiwan factory had had enough of their customer’s antics. On a subsequent shipment they prepared a set of documents which complied perfectly with the terms of the letter of credit. With no discrepancies, the bank did not have to obtain the buyer’s approval, so they made payment and released the documents to the buyer. After bringing the goods into his warehouse, the buyer opened the shipment and found several tree branches instead of his pool cues!

While the seller probably got fair revenge, the two companies likely did no further business with each other.

3 Important Letter of Credit Lessons

This story highlights three important lessons importers and exporters should heed when dealing with international letters of credit:

1. It's All about the Import-Export Documents

Banks take no responsibility for goods but deal in documents only. As stated in Article 5 of the Articles of Uniform Customs and Practice, “Banks deal with documents and not with goods, services or performance to which the documents may relate.” Banks don’t care about the location of the goods or even if they exist at all.

2. It's the Discrepancies That Can Do You In

Discrepancies in documents provide an opportunity for the buyer to refuse payment even though the goods meet specifications. A bank will make payment, on the other hand, against clean documents even if the goods are defective. The buyer does not have recourse to the bank if the documents are clean but the goods are defective. The buyer only has recourse against the seller, including possible litigation.

3. A Letter of Credit Does Not Police the Import-Export Transaction

The bank’s role constitutes that of a paymaster, not a police officer. Traders do well to follow an underlying rule: know your customer and know your contract.

This article was first published in August 2015 and has been updated to include current information, links and formatting.