Risks in the payment method by letter of credit, Risks in the payment method by LC, payment method by LC

Risks in the payment method by letter of credit

Currently, letter of credit (L/C) is an increasingly popular payment method in international commercial transactions because of the safety and prestige through the bank’s commitment to pay the seller. If the seller provides the full set of documents specified under the L/C and the buyer is also guaranteed by the bank that the goods will be delivered in accordance with the requirements specified in the L/C. However, this payment method also carries risks for both the seller and the buyer which are considered below.

1. Risks for the seller:

Firstly, in the contract sale of goods, the agreement is based on good faith and equality between the seller and the buyer to issue the terms of the contract. However, despite of coming from equality, the seller is still often the weaker party than the buyer in a contract from which to accept unfavorable agreements for the side of the seller. In fact, the seller must accept extremely complicated papers and documents that the buyer requires, and even there are many documents that the seller cannot conduct but they do not know about this. For example, the L/C requires that apart from the bill of lading (Bill of Lading-B/L), the seller must present an additional certificate signed and stamped by the shipping lines. However, after delivery, the shipping lines only issue to the seller a signed certificate without their stamp for the reason of being according to the provisions of international law applicable in the field of sea transport.

Due to this complicated document specified in the L/C, when the goods arrive to the port, it is not possible to provide this document to the Bank. Accordingly, the Bank will not accept to make the payment to the seller due to the lack of documents. For this reason, the goods must be left at the port and cannot be retrieved, which causes a lot of damage to the seller. It can be seen clearly that this is a case where the buyer has made some unfeasible terms to catch errors in the documents, thereby serving as a basis to refuse to receive the goods or force the seller to reduce the price of the goods if the buyer does not want to bear additional costs.

Secondly, the L/C payment method is a safe and reputable payment method through the bank, but it is for this reason that has made many people believe the role of L/C without clear understanding that the L/C payment method is a conditional payment method. This leads to that the seller failing to thoroughly check the terms and conditions of the L/C which resulted in meeting the difficult requirements of the L/C. Therefore, the seller will have to bear the costs that can be very large and take a lot of time and effort to fulfill the requirements of the L/C.

In addition, even though the L/C payment method has been made, the payment is still based on the goodwill of the buyer in the performance of the contract. As mentioned, the L/C payment method is based on the transaction of written documents and the bank must carefully check the accuracy of the documents and even will refuse the payment for smallest errors. Therefore, although the goods have been delivered in full with sufficient quantity and good quality, but due to these minor errors in the documents, the seller has not been accepted for payment. When the seller is not willing to perform the contract, they can rely on these small errors of the documents to request a discount or even refuse to pay. Therefore, although the Bank opening the L/C has committed to make the payment of documentary credit, an important factor to ensure the safety of international payment is trust and goodwill between the seller and the buyer.

2. Risks for the Buyer

Firstly, as stated above, although the payment method by L/C is very safe and reputable, it still depends on the goodwill and honesty of the seller and the buyer. Therefore, when the seller is not in good faith and intentionally performs fraudulent actions in the trade, this shall cause damages to the buyer. An example would be that the seller with intent to commit commercial fraud may present a set of forged documents that are ostensibly consistent with the L/C, to the Bank without the actually delivery of the goods. Thus, the buyer still have to pay to the bank even in the case of not receiving the goods or receiving the goods not in accordance with the contract from the seller because the bank has already paid the seller when they have provided all documents as required in the L/C. In fact, for resolving disputes for clients, we have also met cases where sellers have colluded with manufacturers to make fake documents as CO (Certificate of Origin) and CQ (Certificate) of Quality) to meet the requirements in the L/C and force the bank to pay. At that time, even though the buyer received the goods with poor quality as committed in the contract, they still lost the amount of money for goods to the seller.

Secondly, the next risk for the buyer is that the buyer accepts the documents prepared by the exporter to make the payment, even though these documents are not in accordance with the documents required in the L/C. Indeed, when the seller does not provide sufficient documents or the documents have many mistakes, the bank will refuse to pay the seller. However, sellers can entice  buyers to accept payment with promises of good products, promotions and accompanying benefits for buyers. And when the buyer receives the goods and accepts the payment, the goods have not met requirements in both of quality and quantity. This has affected business activities, especially discrediting the buyer’s business. export. Therefore, the buyer needs to pay attention to agreeing to accept payment if the seller does not provide sufficient documents or the documents are incomplete.

Thirdly, an additional risk for the buyer is that the sales contract and the LC may be considered as two separate contracts and are not affected by each other. In Vietnam, one of the letter of credit (L/C) disputes has become the 13th case law on the validity of the letter of credit, thereby recognizing that the L/C is an independent transaction with the sales contract referred to in Article 4 of UCP 600. And in fact, in another country, we attended a hearing regarding the breach of the L/C payment method, the receipt of goods and payment to the seller. Accordingly, the L/C payment method is specified as a payment term of the Sales Contract and the seller has repeatedly seriously violated this term in providing sufficient documents specified in the L/C which leads to Buyer’s refusal to accept the goods. However, in the trial, the decision was only emphasized on the delivery, receipt and payment obligations and the judger consider the L/C as an independent transaction. Accordingly, the buyer must compensate the seller for damage caused by the failure to receive the goods and pay the seller.

3. Solutions to avoid disputes

Firstly, before making the LC as their payment method, the parties need to consult with individuals and organizations with expertise in the L/C payment method to avoid unnecessary or impossible documents for the seller and provide necessary documents to protect the interests of the buyer.

Secondly, there is a strict agreement on the validity between the sales contract and the L/C, and it is possible to clearly agree that if a breach of the payment terms through the L/C method will lead to a breach of the contract and contract may be terminated in this serious contract breach.

Thirdly, businesses should equip themselves with knowledge about payment methods by L/C and avoid relying on banks in finding international laws and practices on this payment method. This is an extremely necessary way to limit the risks when using this payment method.

ASL LAW is the top-tier Vietnam law firm for doing business in Vietnam. If you need any advice, please contact us for further information or collaboration.


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