The issuance of a documentary credit is not always a simple formality or an act that can be completed in a standard or repetitive manner. It often requires attention to detail and, more importantly, to contain wording that is not ambiguous or subject to more than one interpretation.
An applicant should ensure that the instructions it provides to its bank, for the issuance of any documentary credit, fully meets its needs in terms of specifying the appropriate documentary requirements, so as to enable the smooth importation of the goods, and provide a suitable level of assurance, as to the quality, standard and/or type of goods being purchased.
The basic building block of a trade transaction is often the sale contract. The majority of sale contracts that underlay documentary credits are international in nature. Exact definitions of a contract may differ depending on the country, region or territory, and even on the type of goods, services or performance that are provided or covered. In essence, a contract is a legally binding agreement between two or more persons or entities, obliging each to fulfil a promise against a consideration.
The content of a sale contract, proforma invoice or purchase order agreed with the exporter (seller) should, where appropriate, be reflected in these instructions.
A sale contract can be very simple or an extremely detailed document consisting of multiple pages. Where shipments of commodities are involved, some international organisations such as GAFTA (The Grain and Feed Trade Association) provide draft contract templates.
Two key components of a sale contract are the buyer's agreement to purchase the goods at an agreed price, under certain conditions, and the seller's agreement to sell the goods at that price and to ship appropriately. Most contracts will usually include detail such as a clear description of the goods, the mode of delivery, insurance coverage, method of settlement, and timeframes for delivery and settlement. For large value transactions, it is not uncommon for the signed contract to incorporate an agreed draft text of the documentary credit that is to be issued.
It is important to consider which law and jurisdiction would be applicable under the contract. Accordingly, it can be advantageous if the contract clearly defines the applicable legal jurisdiction. This is likely to be the country of either the buyer or the seller. In the absence of a governing law, the decision on the applicable law may well be determined by the terms of delivery that makes the choice of the relevant trade term (Incoterm) critical.
A global approach to introduce international law has been the UN Convention on Contracts for the International Sale of Goods (Vienna 1980) (CISG). The aim and purpose is to introduce enhanced certainty in commercial exchanges and to reduce transaction costs. UNCITRAL reports that there are currently 84 states that have adopted the CISG. Those that have ratified are referred to as ‘contracting states'.
The most common form of 'contract' referred to in a documentary credit is the proforma invoice. Issued by the beneficiary, and seen as a kind of 'short form' sale contract, it will provide details of the goods, the applicable trade term (Incoterm), the price to be paid, the payment terms and, where appropriate, that settlement is to be made by documentary credit. When a proforma invoice is issued, it is often left to the applicant to complete most of the documentary credit application form based upon its own preferences.
More information can be found in the training modules at www.tradefinance.training