Unpaid risks “Documentary credit guarantees the payment”

Luca Davini
Lawyer in Milan and Turin

One of the contractual objectives of the seller is to eliminate the risk of non-payment by requiring advance payment of the goods by bank transfer before delivery. But on the other hand, there is the opposite objective of the buyer who, fearing to pay and not receive the goods or to receive it late with respect to the agreed time, suggests to pay only after the delivery of the goods.

A possible solution for transactions of a certain amount could be to agree on a payment by means of documentary credit (in commercial jargon it is the letter of credit).

This does not mean that other measures can or should be taken. In fact, holding a too rigid position on an advance payment or on a request for payment by documentary credit could nullify the deal especially in the presence of solvent partners, who could then buy from stronger and prepared competitors. Since there is no “right” means of payment for each transaction, it will be necessary to make a decision by collecting a series of information that can help in choosing the best payment price in light of the specific situation.

It will be essential to have a clear picture of the legal and economic-patrimonial situation of the potential client and its country system, to take precaution against the political risk of that state (think of the risk connected to the blocking of funds/ or bank accounts at the credit institutions of a partner operating in Iran).

Insurance policy

This potential problem can be solved with an insurance policy on the protection against the risk of non-payment of the credit for events of a political nature, which can be concluded with Sace.

Such an insurance coverage can be accompanied by the stipulation, always with Sace, of a credit insurance policy that safeguards the seller from the commercial risk deriving from its exposure to the debtor (legal or de facto insolvency), but within the limits of the thresholds agreed in the policy (and established on the basis of the information collected periodically by the insurance companies). An ad hoc policy could also be used to cover risks related to any fluctuations in the foreign contractual currency. It must also be taken into account that, in the event of a claim by the debtor, the outcome of the judicial proceedings will have to be awaited in order to obtain compensation, unless otherwise agreed with the insurance company.

Actually, the contract, together with the preliminary collection of information, is the main working tool to prevent and manage the risk of non-payment. The clearer, more detailed and complete it is in establishing what is to be given, done or not done by one party and the related limits of liability assumed by the seller, the less the other party will be able to object complaints and exceptions to its payment.

International trade requires precautions to be taken upstream of the commercial transaction, which must be provided for in the contract in preventive terms, without, inter alia, whatever the means of payment to be agreed, an appropriate method of dispute resolution that takes into account the value and object of the deal, and, in any case, the possibility of recognizing and executing the judgment rendered by the judge or arbitrator and information on the efficiency of the judicial system of the country of the counterparty, the time and costs of litigation, as well as the possibility of obtaining emergency measures.

Documentary credit

Payment by documentary credit (or letter of credit) can be a balanced solution for the security needs of the transaction of the parties to the contract, thanks to the intervention of a bank. Especially in the context of international contracts with a partner based in extra-EU countries, where the country risk and insolvency factors of the buyer’s bank may become important.

The documentary credit is an irrevocable commitment that a credit institution (the issuing bank) assumes, on behalf of a buyer (ordering party), to make, within a determined deadline a certain performance in favor of a seller (beneficiary), subject to the presentation of the documents provided for in the text of the credit. Documents must comply with the terms and conditions stated in the credit (and according to the applicable rules).

Moreover, it can also be requested to issue it in the so-called “confirmed” form, which, unlike the “unconfirmed” form, also covers the country risk and the insolvency of the issuing bank; in this case, the payment of the first bank is guaranteed by a further bank, so-called “confirming” (obviously from another country).

Non-state source

The worldwide reference standards for documentary credits are published by the International Chamber of Commerce. They are therefore not state source standards. This means that the parties, in order to take advantage of these rules and operate in a certain legal environment, must expressly recall in the contract and in the text of the issuance of the documentary credit the reference to the “Uniform Customs and Practice of the International Chamber of Commerce relating to documentary credits” (the latest version is from 2007) every time they agree on the payment by letter of credit. Documentary credit is therefore a means of payment that, if well structured, offers a high level of security.

It can be used, for example, as a payment system for sales of goods and facilities, supplies of services and in the context of other international contracts.

It should be emphasized, however, that even in case of such a payment, the underlying international contract must be tailored to the economic operation and in such a way as to coordinate the payment clause by letter of credit with the other clauses connected to it (for example, with that on the modalities of return of the goods, preferably through the use of Intercoms Cci, to the extent that it will determine the availability of the related delivery and transport documents for the seller).

Nor should we fail to provide for a method of dispute resolution suitable for the specific case. This allows a last instance protection. For example, when the exporter made mistakes in the submission of documents provided for in the letter of credit.

Stand by letter of credit

Another option, which could simplify the relationship management in the event of repetitive but not regular deliveries, is the stand by letter of credit, that is an autonomous guarantee requested by the debtor/ buyer to his bank issued in favor of the seller (beneficiary), with which the bank guarantees payment to the beneficiary in the event of default by the buyer/ordering party.

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Marcello

Dear Aurelia, the information you have provided are not sufficient for an answer which is subject to a professional engagement. In any case, we should study the provisions of the contract and identify governing law of the contract.If it does not provide anything on governing law then conflict law shall apply (in the most part of the countries likely the governing law will be the law of the country where the agent is domiciled). best regards Marcello Mantelli

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Aurelia

I signed a contract with a fashion agency but there were no termination clauses in the contract and decided to withdraw it before one week after signature so sent them an email but after 14 days they sent me an email and asserted that because i didnt withdraw in legal deadlines i have to perform the contract and pay whole money.Noboday told me about any deadlines and nothing was in the contract!! Why did they claim such a thing?

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