Maritime sales, by their international nature and the distances involved, generate specific risks for the parties. The buyer is afraid of paying without receiving the goods; the seller is afraid of delivering without receiving payment. To resolve this complex equation, documentary credit has become the preferred financing instrument for international trade transactions. This mechanism, which is both legal and banking, offers unique security by linking payment to the presentation of compliant documents.
How documentary credits work
The documentary credit is a sophisticated payment instrument, specifically adapted to the needs of international trade.
The parties involved
Four main players are involved in the documentary credit mechanism:
- The principal (buyer): asks his bank to open a documentary credit in favour of the seller.
- The beneficiary (the seller): receives the payment against delivery of the stipulated documents.
- The issuing bank: opens credit at the buyer's request and undertakes to pay the seller.
- The notifying/confirming bank: generally located in the seller's country, this bank notifies the seller of the credit opening and may, if necessary, add its confirmation.
This quadripartite structure makes it possible to distribute the risks between professionals from different countries, while maintaining a balance between the divergent interests of the buyer and seller.
The essential stages of the operation
A documentary credit transaction generally follows the following stages:
- Conclusion of the underlying commercial contract, providing for payment by documentary credit
- Buyer applies to his bank for a credit facility
- Credit issued by the issuing bank and notified to the beneficiary
- Dispatch of goods by the seller
- Delivery of documents by the seller to the bank
- Verification of document conformity by the bank
- Payment to the seller if the documents are in order
- Delivery of documents to the buyer against reimbursement by the bank
This secure process allows each party to control its risks. The buyer pays only after verification of the documents attesting to the correct dispatch of the goods, while the seller can be sure of being paid as soon as he presents the required documents.
The place of documents in the mechanism
The documentary credit takes its name from the crucial importance of documents in its operation. Unlike other payment methods, the documentary credit is based on the appearance of conformity of the documents, and not on the actual condition of the goods.
Typical documents required include:
- Bill of lading: a document representing the goods, allowing possession to be taken of them.
- The commercial invoice: detailing the nature and price of the goods
- Insurance certificate: certifying cover for transport risks
- Certificates of origin, quality certificates or customs documents, where applicable
This emphasis on documents is both the strength and the limit of the documentary credit, as we shall see in our analysis of CIF saleswhere these documents play a particularly important role.
The obligations of the parties
Each party involved in the documentary credit transaction is subject to specific obligations, compliance with which determines the effectiveness of the mechanism.
Obligations of the principal (buyer)
The buyer, as the principal, must first obtain the opening of the documentary credit on the terms agreed in the commercial contract. This involves:
- Make a specific request to your bank, detailing the documents required
- Ensure that the credit terms and conditions are compatible with those of the sales contract
- Ensuring that the loan is opened within the contractual timeframe
In addition, the buyer undertakes to reimburse his bank for the sums paid to the seller, plus bank commission. This obligation applies even in the event of a subsequent dispute over the quality of the goods, unless fraud is proven.
Finally, for practical reasons, the buyer is advised not to demand documents that are impossible to provide or excessively strict conditions, which could block the transaction.
Obligations of the bank
The issuing bank assumes a fundamental obligation: to pay the beneficiary in return for the submission of compliant documents. This obligation varies according to the nature of the credit:
- In a revocable loan (which has become rare in practice), the bank can change or cancel its commitment at any time.
- In irrevocable credit, the bank's commitment is firm and definitive from the moment it is notified to the beneficiary.
The bank is also obliged to carefully examine the documents presented to it to verify their apparent compliance with the credit conditions. This examination must be carried out within a reasonable period of time, generally five working days according to the Uniform Customs and Practice for Documentary Credits (UCP 600).
It is important to note that the bank is not obliged to verify the reality of the facts attested by the documents, or the actual conformity of the goods. Its responsibility is limited to a formal check of the documents.
Obligations of the beneficiary (seller)
The seller, as beneficiary of the documentary credit, must first and foremost ship the goods in accordance with the stipulations of the commercial contract. This obligation arises from the underlying contract rather than from the documentary credit itself.
In the specific context of documentary credits, the seller must:
- Present documents that strictly comply with credit requirements
- Respect the deadlines stipulated for submitting these documents
- Ensure that documents are consistent with each other and contain no contradictions
Rigour is the order of the day, because the slightest irregularity can justify a refusal of payment. This requirement may sometimes seem excessive, but it is inherent in the nature of the documentary credit, designed to operate on the basis of objective and verifiable criteria.
Drawing up the documentary credit
The execution phase of the documentary credit is the critical point at which the parties' commitments take concrete form.
Presentation and control of documents
Once the goods have been dispatched, the seller must submit the documents stipulated in the credit agreement to the bank. This must be done before the expiry of the credit period.
The bank then carries out a detailed examination of the documents to check:
- Their apparent compliance with the credit terms
- Internal consistency (absence of contradictions between the various documents)
- Their formal regularity (signatures, dates, etc.)
This examination is strictly documentary and does not concern the goods themselves. The fundamental principle is that "banks deal with documents, not goods".
Checks must be particularly rigorous when it comes to the maritime bill of lading, the essential document that represents the goods and enables them to be taken into possession, as explained in our article on inbound maritime sales.
Dealing with irregularities
If the bank finds any irregularities in the documents submitted, it has several options:
- Refusing documents and payment
- Consult the customer to obtain a waiver of irregularities
- In some cases, documents may be accepted subject to
In the event of a refusal, the bank must notify the person submitting the documents of its decision within a reasonable period of time (five working days under UCP 600), specifying any irregularities found. Failure to do so may result in the bank losing the right to invoke these irregularities at a later date.
It is sometimes possible to regularise non-compliant documents, provided that this is done before the credit expires. However, this possibility depends on the nature of the irregularities and the time available.
Payment and transmission of documents
If the documents are in order, or if the principal waives the irregularities, the bank will make the payment in accordance with the credit terms and conditions:
- Payment on demand: immediate payment to the beneficiary
- Deferred payment: commitment to pay on a specific date
- Acceptance: acceptance of a bill of exchange payable on maturity
- Negotiation: purchase of documents by a designated bank
Once payment has been made, the bank forwards the documents to the buyer, who can then take possession of the goods. If the buyer refuses to reimburse the bank, citing defects in the goods, the bank can exercise its right of retention on the documents, or even sell the goods to recover its debt.
This implementation phase is a perfect illustration of the balance of interests that the documentary credit offers in the following situations outbound maritime sales such as FAS and FOB saleswith secure payment and delivery.
Points to watch and legal risks
Despite its undeniable advantages, the documentary credit presents certain risks and points for attention that deserve particular vigilance.
The principle of the autonomy of the documentary credit
One of the fundamental principles of the documentary credit is its independence from the underlying commercial contract. The issuing bank undertakes to pay against delivery of compliant documents, irrespective of the actual performance of the sales contract.
This autonomy, enshrined in Article 4 of UCP 600, has been confirmed by established case law. The Court of Cassation has ruled that "the obligation contracted by the bank does not depend on the sale financed" (Cass. com., 8 January 1991).
This principle offers major advantages in terms of legal certainty and the fluidity of transactions. However, it can sometimes lead to situations where the buyer has to pay even though the goods do not meet his expectations, and his recourse is then limited to a subsequent action against the seller.
Fraud as a limit to the principle of autonomy
The only significant exception to the principle of the documentary credit's autonomy is fraud. When the beneficiary knowingly presents falsified or misleading documents, the buyer can have the payment blocked.
However, case law has taken a restrictive view of this exception. According to the Court of Cassation, "the originator may only paralyse the realisation of the documentary credit, when it is irrevocable, by establishing a fraud relating to the implementation or execution of the documentary credit" (Cass. com., 18 December 2008).
In practice, it is often difficult to prove fraud within the time constraints of the documentary credit, which limits the effectiveness of this exception. Mere poor performance of a commercial contract, even if deliberate, does not constitute fraud within the meaning of this case law.
Frequent disputes and how to resolve them
The main disputes encountered in the area of documentary credit concern..:
- Contesting the conformity of documents submitted
- Disagreements over the interpretation of credit terms
- Disputes relating to deadlines (validity of credit, presentation of documents, etc.)
- The bank's liability in the event of negligent examination of documents
To prevent these difficulties, we recommend
- Draw up documentary credits with clear and realistic terms and conditions
- Precisely define the documents required and their content
- For the seller, to scrupulously check the conformity of the documents before presenting them
- For the buyer, to provide additional protection mechanisms (prior inspection, warranties, etc.)
In the event of an ongoing dispute, the parties may have recourse to various methods of resolving commercial disputes: mediation, arbitration or litigation. Arbitration often offers advantages in terms of speed and the expertise of the arbitrators, particularly in the specialised field of documentary credits.
The documentary credit is a sophisticated instrument that combines security and flexibility for financing international maritime sales. However, mastering it requires in-depth knowledge of its mechanisms and particular attention to its legal aspects. As the various maritime sales formulas showEach international commercial transaction has its own specific features, which may justify adjustments to the standard documentary credit scheme.
Specialist legal advice can play a decisive role in structuring these transactions effectively and preventing the legal risks inherent in them. Whether this involves drafting the payment clauses in the commercial contract, negotiating the terms of the documentary credit or defending your interests in the event of a dispute, our firm specialises in commercial maritime law provides you with the expertise you need to secure your international transactions.
If you are planning a maritime trade transaction or encountering difficulties in implementing a documentary credit, please do not hesitate to contact us for advice tailored to your situation.
Sources
- Uniform Customs and Practice for Documentary Credits (UCP 600) of the International Chamber of Commerce
- Monetary and Financial Code, articles L.330-1 et seq.
- United Nations Convention on Independent Guarantees and Stand-by Letters of Credit (1995)
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