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International trade transactions often involve buyers and sellers residing in countries with different legal systems, currencies, market practices, customs, trade, and exchange control regulations.
Buyers can face challenges in evaluating the credibility of foreign suppliers and have to bear the risks associated with the seller failing to fulfil its contractual obligations. This can include non-delivery or delayed delivery of the goods or goods that do not meet the quality standards agreed upon in the contract.
Given the challenge of remedying these issues in a foreign and unfamiliar legal system, buyers naturally prefer to commit to making payment only after receiving the goods to their satisfaction.
Likewise, sellers must bear the risk of non-payment and, if that occurs, would need to take legal action against the buyer in the buyer’s country. This means that sellers naturally prefer to receive payment before making a shipment.
This dynamic, where buyers only want to pay after delivery, but sellers want to receive payment before shipping, creates an imbalance in the system. Documentary credits provide a mechanism to address and help resolve these conflicting interests.
UCP 600 and International Standard Banking Practice (ISBP) publication 821 govern documentary credits and provide the rules and practice for the examination of documents. As such, when traders deal under the terms of a documentary credit, there is a reduced likelihood of misunderstanding or misinterpretation, which helps to minimise the risk of unforeseen disputes.
To avail upon the benefit of the documentary credit mechanism, it is vital for the beneficiary to clearly state the terms and conditions of the documentary credit, including which documents are needed and which party should issue them. Likewise, the beneficiary must submit the documents stipulated in the documentary credit’s terms and conditions.
The benefits of documentary credits differ depending on which side of the transaction a party finds themselves on.
For the buyer in an international transaction (i.e., the applicant), the primary benefits are assurance that:
For the seller in an international transaction (i.e., the beneficiary), the primary benefits of a documentary credit are that: