The documentary credit: mechanism and fundamental principles

In international trade, payment is often the nerve centre of a transaction. The importer fears paying without receiving the goods ordered. The exporter fears delivery without payment. The documentary credit solves this equation by offering a mutual guarantee to both parties. This legal and financial instrument, a pillar of cross-border trade, deserves to be explored.

Definition and operation of the documentary credit

A documentary credit is a transaction whereby a bank undertakes, at the request of a buyer, to pay a seller in return for documents proving that the goods have been shipped. The resulting contractual package involves four parts :

• The buyer (principal)
• The seller (beneficiary)
• The issuing bank (buyer's bank)
• The notifying or confirming bank (the seller's bank)

The classic documentary credit process follows a number of chronological stages:

1. The buyer asks his bank to open a documentary credit
2. The issuing bank opens the credit and notifies the seller's bank.
3. The seller's bank notifies the seller of the credit opening
4. The seller dispatches the goods and gathers the required documents
5. The seller presents these documents to his bank
6. After verification, the seller's bank forwards the documents to the issuing bank.
7. The issuing bank in turn checks the documents and pays
8. The buyer reimburses his bank and recovers the documents

There are two main types of documentary credit:

• Credit revocable The issuing bank can change or cancel it without notice. Virtually obsolete due to the insecurity it generates.
• Credit irrevocable This is a firm commitment by the issuing bank, which cannot be cancelled without the agreement of all parties. This is the most common form.

Irrevocable credit can be confirmed by the seller's bank, adding an additional guarantee. Article 2 of UCP 600 defines it as " an irrevocable arrangement constituting a firm undertaking by the issuing bank [...] to pay [...] provided that the stipulated documents are presented and the terms and conditions of the credit are complied with" .

Uniform Customs and Practice (UCP)

Documentary credits operate according to internationally recognised rules: the Uniform Customs and Practice for Documentary Credits. Drawn up by the International Chamber of Commerce (ICC), these rules standardise documentary credit practices worldwide.

Historically, the first UCP date back to 1933. They have undergone several major revisions:

• RUU 222 (1962)
• RUU 290 (1974)
• RUU 400 (1983)
• RUU 500 (1993)
• UCP 600 (2007), currently in force

Version RUU 600, which came into force on 1 July 2007, comprises 39 articles. In particular, it includes clarifications on the control of documents (article 14) and the criteria for examining documents (article 15).

The legal scope of the UCP deserves attention. As Professor Jean Stoufflet points out in his booklet on documentary credit: ". the submission of a credit to the Rules and Practices does not preclude the parties from derogating on specific points from the provisions contained therein" . These rules are contractual in nature and only apply to documentary credits that expressly refer to them.

However, they have acquired such a degree of acceptance that they are often considered as usages of international trade. In a ruling dated 8 January 1976, the Paris Commercial Court described them as customary rules.

The principle of the autonomy of the documentary credit

The fundamental characteristic of the documentary credit is its independence from the underlying commercial contract. This principle of independence is explicitly stated in Article 4 of UCP 600: "The documentary credit is independent of the underlying commercial contract. By their very nature, loans are transactions distinct from sales or other contracts on which they may be based." .

This autonomy manifests itself on two levels:

1. Autonomy from the commercial contract between buyer and seller
2. Independence of the bank's commitment with respect to the originator's instructions

The Court of Cassation has consistently affirmed this principle. In a ruling dated 14 October 1981, it held that the buyer could not oppose payment of the documentary credit on the grounds that the seller had failed to fulfil its contractual obligations.

This autonomy is notable exception: outright fraud. In a ruling dated 24 June 1997, the Court of Cassation recognised that "the the fraud exception is enforceable against the beneficiary when the fraud is established and emanates from the beneficiary" . However, the fraud must be certain and must relate to the documentary credit itself, not to the performance of the commercial contract.

The documentary credit mechanism is also based on documentary formalism. The banks only examine documentswithout regard to the goods they represent. Article 14 of UCP 600 specifies that this examination must be carried out with ". reasonable care "to determine whether the documents present the appearance of conformity "with the credit terms.

Using a documentary credit to secure an international transaction requires advanced technical and legal expertise. Errors in the drafting of instructions, in the presentation of documents or in the interpretation of the applicable rules can have serious financial consequences.

For guarantee the success of your international sales operation and avoid any blockage in the payment process, the firm remains at your disposal to analyse your specific situation and help you set up your documentary credit. Do not hesitate to contact us for an initial meeting to assess your project.

Sources

• JurisClasseur Droit bancaire et financier, Fasc. 1080: Documentary credit, Jean Stoufflet, last updated: 27 September 2015
• International Chamber of Commerce, Uniform Customs and Practice for Documentary Credits, Publication No. 600, 2007
• Cass. com. 14th October 1981, Bull. civ. IV, n° 355
• Cass. com. 24 June 1997, Bull. civ. IV, no. 213
• T. com. Paris, 8 January 1976, RJ com. 1977, p. 72, note Le Guidec