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University of Michigan Study: 73% of L/Cs Have Discrepancies - But Most Are Quickly Waived
 

IOMA

From the June 2001 edition of Managing Exports

Even export pros jaded by a steady diet of reports detailing the high discrepancy rate for Letters of Credit (L/Cs) will likely sit up and take notice of a recent survey of the problem.

Ronald J. Mann, professor of law at the University of Michigan Law School at Ann Arbor, recently surveyed 500 L/C transactions, half export and half import, taken from five banks. The banks include large and midsize, regional and domestic U.S. institutions in different parts of the country and a major foreign bank with U.S. locations█all with substantial worldwide L/C operations.

Bad News: 23% Conformation Rate

The presentations Mann reviewed conformed to the L/Cs in only 27% (135) of the 500 transactions. More important, the discrepancies were serious ones (see graph below), including failure to contain required documents (22%), late shipment (18%), late presentation (14%), and expired L/C (11%). Most of the presentations contained multiple discrepancies.

Good News: Discrepancies Waived Quickly

The surprise, which defies conventional wisdom, is that in the majority of cases applicants waived the discrepancies and authorized full payment to the issuer. This was the case in fully 364 out of 365 transactions involving defective documents. Furthermore, the defects were waived speedily. Within just one week after the issuer contacted the applicant, applicants had waived discrepancies in 84% of the cases Mann reviewed. At the four-week point, a tiny 3% of the presentations remained unaccepted.

Why are presentations that fail in crucial ways to conform to L/Cs paid quickly in most cases? Mann cites the following reasons:

  • Issuers have a strong ¤reputational interestË in their L/C business and can potentially lose business if their L/Cs frequently go unpaid. Also, there are relatively few foreign L/C issuing banks and their reliability is easily checked.
  • A bank that issues a L/C is implicitly ¤vouchingË for its customer, even though the bank makes no direct promise to actively discourage rejection of the L/C. The bank has leverage, in that it can cease doing business with customers that reject L/Cs the bank believes should be paid.

For more details or the complete survey, published in 98 Michigan Law Review (2000), contact Ronald Mann at rmann@umich.edu.

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