Part II — The Commercial Framework

Documentary Credits & Terms of Payment

How exporters get paid and importers get protected — open account, advance payment, collections, and the Letter of Credit that ties payment to documents.

---

International trade has a trust problem: the seller wants to be paid before releasing goods; the buyer wants the goods before paying. Thousands of kilometres and different legal systems sit between them. The mechanisms in this chapter exist to bridge that gap — and the freight forwarder’s documents (above all, the bill of lading) are what make them work.

The four ways to pay, from riskiest to safest for the seller

1. Open Account — goods shipped and delivered before payment is due (e.g. 30/60/90 days after). Cheapest and simplest; highest risk for the seller. Common between trusted, long-standing partners.
2. Documentary Collection — the seller ships, then routes documents through banks that release them to the buyer only against payment (D/P) or against the buyer’s acceptance of a time draft (D/A). Banks handle documents but do not guarantee payment.
3. Letter of Credit (Documentary Credit) — a bank guarantees payment provided the seller presents compliant documents (below). Balanced protection for both sides.
4. Advance Payment (Cash in Advance) — buyer pays before shipment. Safest for the seller, riskiest for the buyer.

The Letter of Credit (L/C)

The mechanism turns the trust problem into a documents problem: the buyer’s bank, not the buyer, is now obliged to pay — but only if the documents are exactly right.

The parties to an L/C

• Applicant — the buyer/importer who asks their bank to open the credit.
• Beneficiary — the seller/exporter who will be paid.
• Issuing bank — the buyer’s bank that issues and guarantees the credit.
• Advising / confirming bank — a bank in the seller’s country that advises the credit and (if it confirms) adds its own payment guarantee.

The documents typically required

The credit lists exactly what the seller must present — commonly:

• Bill of Lading (the document of title — see Chapter 8)
• Commercial Invoice
• Packing List
• Certificate of Origin
• Insurance certificate (if the Incoterm requires the seller to insure)
• Any inspection or specialised certificates the buyer demands

The three basic forms of documentary credit

NAFL distinguishes three forms, by how secure they are for the seller:

1. Irrevocable, Confirmed Credit — the strongest. Four parties: buyer, issuing bank (buyer’s), vendor/exporter, and the confirming bank (in the seller’s country). Both the issuing and confirming banks give a definite, independent undertaking to pay. The buyer cannot cancel or alter it without all parties’ agreement. Safest for the seller; the buyer bears the issuing cost.
2. Irrevocable, Unconfirmed Credit — three essential parties (the issuing bank may also be the remitting bank). The issuing bank’s undertaking is firm and cannot be cancelled or changed without the vendor’s agreement, but no second bank adds its guarantee — so the beneficiary should know where the credit is payable (local payment is more convenient than mailing documents abroad).
3. Revocable Credit — the weakest. The issuing bank can amend or cancel it at any time, acting on the buyer’s instructions. It demands full trust between partners who know each other well; its bank commissions are much lower. (Rare today.)

The L/C process, step by step

NAFL walks the flow through five steps — the sequence to picture:

1. The contract is concluded between buyer and seller. (The forwarder is not yet involved.)
2. The buyer applies to his bank to open the credit; the bank checks the buyer’s financial standing.
3. The issuing bank notifies the seller’s (advising/confirming) bank that the credit is opened (and confirmed, if applicable).
4. The advising bank notifies the seller, who then dispatches the goods per the credit’s terms and conditions.
5. The seller presents the documents to his bank and is paid; the documents pass to the issuing bank, which debits the buyer and releases the documents so the buyer can claim the goods.

Conditions stipulated on a credit — and the forwarder’s role

The credit spells out conditions the seller must meet: description, value, terms of sale, documents required, and critically date of validity / latest shipment date, transhipment allowed or not, part-shipment allowed or not, even the age/class/flag of the carrying vessel. This is precisely why the forwarder must see the L/C: only the forwarder can confirm whether a vessel can be secured in time, whether direct shipment or transhipment is possible, and whether a specified flag is available. If any condition cannot be met, the forwarder must alert the principal immediately so an amendment can be requested through the banks — before shipment. An amendment after shipment is too late, and a discrepant presentation will be refused.

Variants worth knowing

NAFL mentions, briefly, that credits can be:

• Transferable — to a second beneficiary (e.g. when the seller is a middleman).
• Red clause — allowing an advance to the seller before shipment.
• Back-to-back — a second credit opened on the strength of the first, used when there’s an intermediary between seller and final buyer.

Strict compliance — where shipments go wrong

Banks examine documents against the credit with no tolerance for error. A misspelt name, a description that doesn’t match the invoice, a presentation one day late, a weight that disagrees between documents — any of these is a discrepancy, and a discrepant presentation can be refused. Most L/C problems are not fraud; they are clerical mismatches between documents that should agree.

What to take from this chapter

1. Payment terms trade risk between buyer and seller: open account (seller-risk) → advance payment (buyer-risk), with collections and L/Cs in between.
2. An L/C makes a bank pay against strictly compliant documents — it deals in documents, not goods.
3. Most L/C failures are discrepancies — clerical mismatches between documents.
4. Under an L/C, the forwarder’s paperwork must match the credit exactly.