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Home > Operations Management Best Practice > Understanding the UCP600

Operations Management Best Practice

Understanding the UCP600

by Buddy Baker

Executive Summary

  • The UCP600 provides a global standard set of practices for letters of credit.

  • Anyone engaged in international trade, whether selling goods, buying goods, or providing financing, needs to be familiar with the UCP600.

  • While the UCP is designed for use with commercial letters of credit, it is often used for standby letters of credit, a reliable type of bank guarantee.

  • The most important principles of letters of credit set down in the UCP are the independence principle, and the principle that banks deal in documents, not goods.

  • The UCP defines the responsibilities of banks involved in handling letters of credit and provides rules for examining documents they call for; documents must strictly comply in order to trigger the issuing and confirming banks’ payment obligation, but if documents do not strictly comply, the banks must themselves follow strict rules for refusing payment.

  • Parties who have used the UCP to govern their standby letters of credit and bank guarantees in the past should seriously consider using the International Standby Practices instead.

Introduction

In May 2003, the Banking Commission of the International Chamber of Commerce (ICC) began revising the international rules for letters of credit, known as the Uniform Customs and Practice for Documentary Credits. The process took three and a half years. The ICC published the new rules in their publication number 600, commonly referred to as the “UCP600,” and set the effective date as July 1, 2007. This article describes the UCP rules and their revisions, some of the limitations of the UCP, what was not revised, and what managers need to know in order to avoid being tripped up by the UCP600.

What the UCP Is

Firstly, it is important to establish what the UCP is, what it does, and whom it affects, and also what the UCP is not. The UCP is often thought to be a law, but it is not. On the other hand, to say it is simply a publication does not do it justice. The UCP can be characterized as a rulebook that reflects practice. Because the UCP is not a law, its use is voluntary. The power of the UCP lies in its universal adoption by banks all over the world and incorporation into their letters of credit. Every player agrees to play by the same rules.

The UCP is concerned with documentary credits, commonly referred to as “letters of credit.” The UCP is focused on “commercial” letters of credit, the traditional letters of credit that are used as a vehicle for payment in international trade, but the UCP is also used in the realm of standby letters of credit and bank guarantees. Anyone engaged in international trade, whether selling goods, buying goods, or providing financing, should become familiar with the UCP.

As it is not a law, the UCP only applies to letters of credit that actually state that they are subject to it. Furthermore, individual rules provided by the UCP may be excluded or altered by the terms of a letter of credit. For example, it is not uncommon for a letter of credit to state that it is subject to the UCP600 except for the provisions in article 35 regarding lost documents.

The most important principles set down in the UCP are the independence principle and the principle that banks deal only in documents. These principles have existed in every UCP over the years, and are fundamental to the nature of letters of credit. A letter of credit involves three parties: the applicant for the letter of credit (the bank’s customer—typically the buyer of goods described in the letter of credit); the beneficiary of the letter of credit (the party to be paid—typically the seller of the goods); and the issuing bank. The independence principle is found in article 4 of the UCP600, which states, “A credit by its nature is a separate transaction from the sale or any other contract on which it may be based.” Simply put, this means that a bank that has issued a letter of credit is not, and cannot, be concerned with whether or not the beneficiary has met its obligations under the underlying contract between the beneficiary and the applicant, for example, whether the seller has actually shipped the goods the buyer ordered. All the bank cares about is whether the documents comply, which is stated in article 5: “Banks deal with documents and not with goods, services or performance to which the documents may relate.”

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Further reading

Books:

  • Baker, Walter (Buddy), and John Dolan. Users’ Handbook for Documentary Credits under UCP600. Publication number 694. Paris: International Chamber of Commerce, 2008.
  • Byrne, James E. The Comparison of UCP600 & UCP500. Montgomery Village, MD: Institute of International Banking Law & Practice, 2007.
  • Katz, Ron (ed). Insights into UCP600-Collected Articles from DCI 2003 to 2008. Publication number 682. Paris: International Chamber of Commerce, 2008.

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