What to Do When the Bank Rejects Payment Due to Discrepancies in Letter of Credit Documents? A Practical Guide!

In the world of international trade, letters of credit (LCs) are a crucial financial instrument that provides security for both exporters and importers. However, one of the most common and frustrating issues exporters face is when a bank refuses to honor an LC due to discrepancies in the presented documents. This article aims to provide you with a practical guide on how to handle such situations, ensuring that you can take appropriate measures to protect your interests.

Understanding the Prevalence of Document Discrepancies

According to industry statistics, approximately 70% of all letters of credit presented for payment have some form of document discrepancy. This high percentage indicates that dealing with document discrepancies is almost inevitable in international trade. These discrepancies can range from minor clerical errors to more significant issues that may put the entire payment at risk. For example, a misspelled name, an incorrect date, or a missing signature can all be grounds for a bank to reject the documents and refuse payment.

Step 1: Reviewing the Validity of Discrepancies

The first step when faced with a bank's refusal to pay due to document discrepancies is to carefully review the stated discrepancies. You need to determine whether they are valid according to international banking practices, specifically the Uniform Customs and Practice for Documentary Credits (UCP 600). This set of rules, published by the International Chamber of Commerce (ICC), is widely recognized as the standard for handling letters of credit worldwide.

For instance, let's say a bank claims that a bill of lading does not show the port of discharge as required by the LC. You should check the UCP 600 rules regarding bills of lading and the specific terms of the LC. Sometimes, banks may misinterpret the rules or the LC terms, leading to unjustified rejections. In one case, an exporter received a notice of discrepancy stating that an insurance certificate did not cover the full value of the goods. After careful review, it was found that the LC allowed for a certain percentage of under - insurance, and the bank's claim was invalid.

It's also important to verify that the bank has met the prerequisites for raising discrepancies. According to UCP 600, the issuing bank must notify the presenter of the discrepancies within a reasonable time, usually five banking days after the receipt of the documents. The notice must clearly state all the discrepancies and whether the bank is holding the documents at the presenter's disposal or is returning them.

Step 2: Assessing the Possibility of Document Replacement

If the discrepancies are minor and can be corrected, you should consider whether it's possible to replace the documents within the validity period of the LC and the negotiation period. The validity period of an LC is the date by which all documents must be presented to the bank for payment, while the negotiation period is the time frame within which the documents can be negotiated (i.e., the bank can pay, accept, or negotiate the draft).

To prepare for potential document replacement, you should pay close attention to the place of expiry of the LC. If the LC expires at the issuing bank's counter, you need to ensure that the corrected documents reach the bank in time. In some cases, it may be necessary to expedite the shipping process or use express courier services to ensure timely delivery of the new documents. For example, if an exporter realizes that a commercial invoice has a wrong description of the goods, they can quickly prepare a new invoice and send it to the bank before the LC expires.

Step 3: Monitoring the Status of the Goods

While dealing with document discrepancies, it's crucial to keep a close eye on the status and location of the goods. In cases where the documents are rejected and the payment is on hold, the goods may be at risk. For example, if the goods are perishable, they may start to deteriorate if they are not released in a timely manner.

You can use various methods to track the goods, such as the bill of lading number, container number, or the shipping company's tracking system. If the goods have arrived at the port of destination, you may need to communicate with the shipping company or the freight forwarder to ensure that the goods are properly stored and protected. In some situations, you may even need to consider alternative arrangements, such as selling the goods to a local buyer at the port if the situation becomes too complicated.

Step 4: Negotiating with the Applicant

If the discrepancies are valid and it's not possible to replace the documents in time, you may need to engage in negotiations with the applicant (the importer) of the LC. The applicant has the power to waive the discrepancies and instruct the bank to make the payment. However, this negotiation process requires careful strategy and communication.

You should approach the applicant in a professional and diplomatic manner, explaining the situation and the reasons for the discrepancies. If the discrepancies are minor and do not affect the quality or quantity of the goods, you can emphasize that the overall value and purpose of the transaction remain intact. For example, if the only discrepancy is a slightly different description of the goods on the invoice, you can show the applicant that the actual goods shipped are exactly what was ordered.

On the other hand, if the applicant tries to use the discrepancies as a bargaining chip to demand a price reduction, you need to carefully evaluate the situation. You can counter - propose by offering some form of compensation, such as a small discount on future orders, rather than a significant reduction on the current shipment. In one case, an exporter was able to convince the applicant to waive the discrepancies by offering a 5% discount on the next order, which was a win - win solution for both parties.

Step 5: Considering Other Options

If the discrepancies are significant and the applicant refuses to waive them, and there is no possibility of replacing the documents, you may need to consider other options. One option is to accept a price reduction proposed by the applicant, especially if the cost of returning the goods or finding another buyer is too high. However, this should be your last resort, as it directly affects your profit margin.

Another option is to arrange for the return of the goods. Before making this decision, you need to consider several factors, such as the cost of transportation back to your country, storage fees at the port of destination, and potential damage to the goods during transit. You also need to ensure that you have the necessary insurance coverage for the return journey. In some cases, it may be more cost - effective to sell the goods at a discounted price to a local buyer at the port of destination rather than bear the cost of returning them.

Flowchart: Handling Document Discrepancies in LCs

Checklist for Dealing with Document Discrepancies

Frequently Asked Questions

Q: Can I appeal a bank's decision to reject documents?

A: While there is no formal "appeal" process, you can engage in discussions with the bank, providing evidence to show that the discrepancies are not valid according to the UCP 600. You can also involve your own bank to act as an intermediary in the communication.

Q: What if the applicant refuses to negotiate?

A: If the applicant is uncooperative, you may need to explore other options such as selling the goods locally or arranging for their return. You can also seek legal advice to understand your rights and potential courses of action.

Q: How can I prevent document discrepancies in the future?

A: To prevent document discrepancies, it's essential to carefully review the LC terms before preparing the documents. You can also use document management software or hire a professional document checker to ensure accuracy. Additionally, maintaining clear communication with your suppliers and freight forwarders can help avoid errors.

Conclusion

Dealing with a bank's refusal to pay due to document discrepancies in a letter of credit can be a complex and stressful process. However, by following the steps outlined in this guide, you can increase your chances of resolving the issue successfully. Remember to stay calm, review the discrepancies carefully, explore all possible solutions, and communicate effectively with all parties involved. By taking proactive measures, you can protect your interests in international trade transactions.

If you've faced similar issues in your industry, I'd love to hear about your specific situation. Click here to get three real - life solutions from other exporters who have overcome document discrepancy challenges.