A documentary credit is a written undertaking given by a bank (Issuing Bank) to the seller (Beneficiary) on the instruction of the buyer (Applicant) to pay at sight or at a determinable future date up to a stated amount of money.
This undertaking is conditional upon a beneficiary's compliance with the terms and conditions of the documentary credit issued in its favour and is satisfied by a ‘complying presentation'.
Key considerations
A sales contract may be the basis from which a documentary credit is generated, but it is entirely separate and should never form part of the documentary credit.
A documentary credit has its own terms and conditions which do not rely upon the terms or performance of the sales contract. This is the principle of autonomy and relates to a documentary credit being treated as an independent transaction. The autonomy of a documentary credit has been re-confirmed in law many times over the years.
In effect, this leads to a documentary credit being considered as a primary means of payment (as opposed to a demand guarantee or standby letter of credit which is a secondary means of payment).
This principle is highlighted in both UCP and ISBP.
UCP 600 article 4 - Credits v. Contracts: The autonomy of a documentary credit is paramount to any transaction. The separateness of the credit and the contract is a key feature of a documentary credit process, and it is the terms and conditions of a documentary credit that will prevail in the determination of compliance of a presentation. Article 4 and its content are reinforced in ISBP 745 Preliminary Considerations (iii).
UCP 82 and UCP 151 both stated in article 1 that: "Commercial Documentary Credits are essentially distinct transactions from sales contracts, on which they may be based, with which Banks are not concerned."
The wording in UCP 222 General Provisions & Definitions (c) is almost identical to that which appears today: "Credits, by their nature, are separate transactions from the sales or other contracts on which they may be based and banks are in no way concerned with or bound by such contracts."
UCP 82, General Provision (c), also stated: "The beneficiary of a credit can in no case avail himself of the legal relations existing between Banks, or between the Bank of the principal (purchaser) and the latter." This wording was further developed in UCP 222, General Provisions & Definitions (f), to read almost as it does today, "A beneficiary can in no case avail himself of the contractual relationships existing between banks or between the applicant for the credit and the issuing bank."
The principle of autonomy underlines the whole concept of a documentary credit. Without such autonomy, the aims of a documentary credit would not be achievable. The autonomy of a documentary credit reflects the principle that a documentary credit is to be treated as a separate transaction.
In effect, the performance or non-performance of the contract agreed between the buyer (applicant) and the seller (beneficiary) is irrelevant to the performance under a documentary credit.
A beneficiary is not entitled to rely on any arrangements that it may understand to exist between the issuing bank and the applicant. It can only rely on the documentary credit as issued or as subsequently amended, and the undertaking that issuing a documentary credit imposes on an issuing bank as defined in UCP 600.
UCP 600 article 5 - Documents v. Goods, Services or Performance: The basis for the examination of documents is asserted here i.e., banks deal with documents and have no dealings or involvement with the goods, services or performance to which the documents may relate.
It was not until UCP 151, article 10, that this concept first appeared: "In documentary credit operations, all parties concerned deal in documents and not in goods."
UCP 400, article 4, widened the scope by stating: "In credit operations all parties concerned deal in documents, and not in goods, services and/or other performances to which the documents may relate."
UCP 500 made the change to reflect that banks deal with documents (and not in documents) and not with goods, services or performance (and not in goods, services or performance).
UCP 600 article 5 makes the correct distinction that the rule should refer specifically to the actions of banks and not ‘all parties concerned'.
Previously, this article referred to all parties dealing with documents. This was not an accurate reflection of the actual situation, so the change was made to refer to banks only. For example, a beneficiary does deal with the goods, services or performance.
This article underpins the autonomy principle stated in article 4.