What is it?
The UCP 600 is the revised version of the Uniform Customs and Practice for Documentary Credits (UCP), the internationally recognised contractual rules governing letters of credit which aim to establish uniformity of practice for documentary credits. The UCP rules were first promulgated by the International Chamber of Commerce (ICC) in 1933 and today they have attained almost universal acceptance by practitioners in countries worldwide.
Who undertook the revision?
In May 2003, the ICC authorised its Banking Commission to begin a revision of the UCP 500. To undertake this substantial task, the Banking Commission established two working groups: a Drafting Group and a Consulting Group.
The Drafting Group considered more than 5,000 individual comments before it agreed the new text for the UCP 600. It drew heavily on the advice of the Consulting Group which comprised members from over 25 countries whose task it was to react to, advise on and propose changes to the drafts.
When does it come into effect?
By a unanimous vote, the Banking Commission formally adopted the UCP 600 on 25 October 2006. The new rules come into effect and can be incorporated into letters of credit from 1 July 2007, replacing the existing rules as of that date.
Who does it affect?
Significant changes to the rules are relevant to anyone involved in letter of credit transactions. Thus the UCP 600 will affect anyone in the banking, commodity trading and shipping world.
Objectives of the revision
Under the prevailing edition of the rules – UCP 500 – approximately 70 per cent of documents presented under letters of credit are rejected on first presentation. Despite the obvious benefit of credits as international payment mechanisms, this is a clear indication that there are difficulties in usage. The underlying problem is that the UCP procedure is too open to ambiguity and error. The Banking Commission’s intention was to bring the procedure in line with the times and to alleviate inconsistent application and interpretation of the rules. A further primary aim was to add clarity to the rules and cut down the frequency documentary rejections.
Highlights of the changes
Structure and procedure
The UCP 600 is set out in a new, simplified structure. The number of articles has been reduced from 49 to 39 and position papers, previously used to clarify rules, are no longer used.
- This restructuring condenses the provisions and streamlines the procedure.
- Banks will need to take a different approach when deciding whether to accept or reject a presentation of documents.
- UCP 600 – as with previous versions of the UCP – is not automatically applicable to all letters of credit but rather provides a set of terms governing letters of credit which may be voluntarily applied should the parties so agree to those terms in the underlying contract.
- Consequently, consistent with the principle of freedom of contract, the individual rules themselves may be derogated from or amended by express agreement between the parties.
- The default credit anticipated under UCP 600 is an irrevocable credit. Under an irrevocable credit the issuing bank’s undertaking to pay the sum of the credit cannot be revoked, thereby ensuring greater assurance of payment. Even if the credit does not specify that it is irrevocable, under UCP 600 it is.
- Moreover, an additional term under UCP 600 expressly provides that a credit cannot be cancelled without the agreement of the beneficiary.
- A revocable credit may be opened under the new rules. The parties would simply agree to the application of UCP 600 to that credit subject to the deletion or amendment of specific terms inconsistent with a revocable credit.
- New provisions containing definitions and interpretations have been added to clarify the meaning of terms which previously caused ambiguity.
- For instance, the phrases “without delay” and “reasonable time”, being the period in which banks previously had to accept or refuse documents, has been replaced with a defined period of five banking days.
- Another clarification is what constitutes an “original” document, which has now been defined in the rules.
Under the new rules, the issuing bank will be liable if fraud comes to light after a deferred letter of credit is assigned. This overturns the previous position under Banco Santander case which placed the risk of fraud on the discounting bank. This creates a new exposure for the beneficiary in such circumstances.
The changes aim to reduce the number of rejections of documents tendered under letter of credit applications. It remains to be seen how successful they will be in practice but the outlook is favourable.
Some examples of changes are set out below:
- Documents no longer need to be “consistent” which, in practice, waters down the requirement under the previous rules. Now, documents need only to be “not conflicting”.
- In practice, this means that data in one document need not be identical to or a mirror image of that in another document provided it does not conflict with other data in the documents.
- Purely typographical errors in otherwise compliant documents may be disregarded in certain circumstances. Similarly, incorrect addresses in documents are not problematic provided the country is correct and the documents are not transport documents.
- If a credit contains a condition without stipulating the document to indicate compliance with that condition, the bank will deem the condition as not stated and will disregard it.
- For instance, if a credit requires that the goods be shipped on a first class vessel but does not at the same time call for tender of a first class classification certificate for the vessel, the condition can be ignored. The change is intended to alleviate the number of rejections made on the basis of non-documentary conditions such as this.
- The new rules emphasise that banks deal with documents, not with goods, services or performance to which they may relate; and, moreover, that banks are in no way concerned with the underlying contract.
No default acceptance of amendments
Importantly, a credit cannot now be amended or cancelled without the agreement of the issuing bank, confirming bank (if any) and the beneficiary. This is to avoid parties from unintentionally accepting amendments made to credits by default. This change in the rules directly addresses the practice of some banks to impose a time limit for the acceptance or rejection of amendments to the credit, in default of which acceptance is assumed.
Focus on commodity traders
A significant advantage for traders of incorporating UCP 600 is certainty. That is, the seller will know in advance the criteria against which the banks will examine documents and thus pay out under the credit. Similarly, the buyer will know in advance what the requirements are for payment under the credit for the contract goods.
Whether a seller is paid promptly will depend upon whether conforming documents are tendered under the credit. Thus the criteria and approach which banks must adopt in deciding whether a presentation of documents is conforming is naturally a key issue for traders.
The relevant requirements of a complying documentary presentation will be set out in the sales contract and subsequently reflected in the credit terms. Equally, for the UCP 600 to apply to a given letter of credit, the parties to a sales contract must agree this in advance in their contract. The rules do not apply automatically.
One new article has been added to the UCP 600 which provides that “Data in a document, when read in context with the credit, the document itself and international standard practice, need not be identical to, but must not conflict with, data in that document, any other stipulated document or the credit”. This term affects what has become known as “linkage” in documents which is, in effect, “the degree to which inconsistencies between documents presented to a bank constitute a discrepancy which prevents payment from being made. The effect of this term and how it will be construed is rather unclear and, for the sake of clarity, sellers would be well advised to exclude it when incorporating UCP 600, at least initially until application becomes clear.
Focus on banks
Under the new rules, banks now have a maximum of five banking days in which to determine whether a presentation of documents complies with the credit terms, as already noted above.
The bank is not required to wait five banking days. Rather it is entitled to those five days but must act sooner if it comes to a decision earlier on.
Thus the bank is fully entitled to pay early on, say, the second or third day without risk of any liability.
Importantly, the bank must pay the sum due under the credit immediately upon deciding that the presentation is compliant. The consequence of not doing so would be a breach of the bank’s duty to pay the beneficiary. Should the beneficiary be able to prove this had happened, the bank would be liable for damages including, for instance, interest on the sum due.
The UCP 600 does provide an improvement to the previous version of the rules, but a new set of rules means that there is room for uncertainty. A revision of the rules was undoubtedly needed to modernise the provisions and in doing so reassess, clarify, consolidate and improve the UCP and international practice regarding documentary credits.
The actual effect of the changes under UCP 600 remains to be seen in practice from 1 July 2007 going forward. When that time comes, commodity traders need to be aware of the changes most likely to affect them and to have these in mind when they conclude their sales contract, receive the letter of credit from the bank and subsequently tender their shipping documents for payment under the credit.
Banks similarly need to appreciate the nature of the changes and, particularly, the impact of such changes on their approach to examination of documents presented to them.
The new rules should address a real fear that the commercial value of letters of credit might in practice be undermined by too frequent rejections of documents presented under these instruments. Undoubtedly, there is a fine balance to attain here since discrepancies may affect the integrity of the credit. To this end, strict compliance in relation to conforming documents remains essential. It is hoped that UCP 600, whilst still upholding the need for strict compliance in relation to genuine inconsistencies in documents, will impact on the approach to be taken and enable a distinction to be drawn between unnecessary rejections on entirely technical grounds on the one hand and true non-compliant presentations on the other hand.