L/C Transactions and Incoterms

What L/C Transactions and Incoterms Are

L/C transactions and Incoterms involve the practical process of organizing the relationship between the document examination conditions set by banks in letter of credit transactions and the terms regarding cost allocation, transfer of risk, transportation arrangements, and insurance arrangements between sellers and buyers.

In L/C (Letter of Credit) transactions, banks generally decide whether to make payment solely based on the documents presented. They do not primarily focus on whether the cargo is actually damaged, at what point under the sales contract the delivery was completed, or when the risk transfer occurred under Incoterms.

As a result, discrepancies can arise in L/C transactions, such as “no issues on the documents but practical cargo issues,” “cargo shipped as planned but documents do not meet L/C requirements,” or “documents requested by the L/C that are not an obligation of the seller under Incoterms.”

Particularly, the Bill of Lading (B/L), insurance policy, shipment deadline, On board date, Clean B/L, freight indication, consignee details, notification party, transshipment permissions, and partial shipment permissions are important points closely linked to payment decisions.

Scope Covered in This Article

This article focuses on the relationship between Incoterms conditions, B/L conditions, insurance policies, shipment deadlines, and discrepancies in L/C transactions.

Theme	Content Covered in This Article	Content That Should Be Addressed as Separate Themes
L/C Transactions	Bank's payment decision based on documents, consistency between L/C terms and submitted documents	L/C issuance procedures, bank operations, credit assessments, trade finance details
Incoterms	Cost allocation, risk transfer, insurance and transportation arrangements between seller and buyer, and discrepancies with L/C terms	Individual explanations of EXW, FCA, FOB, CFR, CIF, CIP, etc.
B/L	Verification of Clean B/L, On board B/L, consignee details, freight indication, shipment date, transshipment permissions	Types of B/L, endorsements, Waybills, Surrendered B/L, details of Switch B/L
Insurance Policy	Insurance policies under CIF and CIP terms, inconsistencies when insurance policies are required under FOB and FCA terms	Coverage conditions of marine cargo insurance, insurance claims, details of P&I Club cargo clauses
UCP600	Basic concept that banks deal with documents, not cargo itself	Detailed interpretation of UCP600 articles, bank-specific examination practices
Freight Forwarder Practices	Whether transport documents conform to L/C terms, items to check before shipment	Bank negotiations, legal judgments on L/C amendments, sales contract negotiations

Why Incoterms Confirmation Is Needed in L/C Transactions

Incoterms are trade terms to organize cost allocation, transportation arrangements, insurance arrangements, and the timing of risk transfer between the seller and buyer.

Meanwhile, an L/C is a payment method where the bank examines documents and makes payment if the documents comply with the L/C terms.

Since their roles differ, Incoterms organize the sales contract and logistics practice, while the L/C covers document conditions for bank settlement.

Therefore, in terms such as CIF or CIP where the seller arranges insurance, it is necessary to check whether the insurance policy required by the L/C matches what is practically needed.

Also, even under conditions like FOB or FCA where the buyer usually arranges insurance, if the L/C requires insurance documents, the exporter may need to prepare those documents to receive payment.

Ignoring such inconsistencies can cause discrepancies, payment refusals, waiting for buyer approval, document returns, and settlement delays.

UCP600 and the Principles of Document Examination

In L/C transactions, the UCP600 (Uniform Customs and Practice for Documentary Credits) is commonly referred to internationally.

The basic concept of UCP600 is that banks handle documents, not the cargo itself. In other words, banks are not institutions that verify cargo quality, quantity, damage, or actual delivery conditions on site.

The bank checks whether the terms set in the L/C and the submitted documents such as invoice, B/L, insurance policy, and packing list are outwardly consistent.

If the documents comply with the terms, payment at the bank may proceed even if there are actual cargo issues.

Conversely, even if there are no problems with the cargo itself, if details such as B/L notation, shipment date, consignee, notification party, insurance amount, insurance policy date, or transaction terms on the invoice conflict with the L/C terms, this is treated as a discrepancy and may result in refusal of payment or waiting for buyer approval.

Common Misunderstandings

Misconception	Correct Understanding	Practical Notes
If documents are accepted under L/C, the cargo is also fine	Banks primarily examine the documents. They do not verify the actual damage or quality of the cargo.	Document examination and cargo incident handling should be considered separately.
As long as the cargo is shipped correctly, L/C payment will also be fine	Even if the cargo is shipped as planned, discrepancies arise if the documents do not meet L/C terms.	Check B/L, invoice, insurance policy, shipment date, and consignee fields in advance.
Incoterms and L/C terms automatically match	Incoterms govern sales terms; L/C specifies documentary conditions. They do not automatically align.	Cross-check sales contract, L/C, B/L, and insurance policy.
Under FOB, insurance policy is not required in an L/C	Even if Incoterms don’t obligate the seller to arrange insurance, the L/C may require an insurance policy.	Confirm whether insurance policy is required upon L/C issuance; request corrections if inconsistent.
On FCA, On board B/L can always be easily obtained	Under FCA, the seller delivers before loading on vessel, so On board B/L requests may be incompatible.	Verify shipment proof method, B/L issuance conditions, and whether L/C amendment is needed.
Clean B/L is always issued	If there is damage to packing, leakage, broken bags, wetness, or quantity discrepancies, B/L may have remarks.	If Clean B/L is required under L/C, inspect cargo condition before shipment.

Typical Examples of Misalignment between Incoterms and L/C Conditions

Misalignments between Incoterms and L/C conditions are common in actual logistics practice. Particular frequent issues involve whether insurance policies are required, B/L terms, shipment deadlines, freight charge notation, and consignee names.

Situation	Common Issues	Practical Checks
CIF Terms	The seller arranges insurance, but the actual insurance does not conform to the L/C’s insurance requirements	Verify insurance amount, currency, coverage period, insured risks, and insurance policy date.
CIP Terms	Despite multimodal transport, documentation conditions focus mainly on sea transport	Confirm types of transport documents, insurance period, and origin/destination descriptions.
FOB Terms	Although insurance is usually buyer’s responsibility, submitting insurance policies is demanded under L/C	Confirm sales contract, L/C conditions, and responsible party for insurance arrangement in advance.
FCA Terms	L/C requests On board B/L even though FCA fits container cargo better	Check delivery location, B/L issuance conditions, and shipment proof method.
Shipment Deadline	Even if cargo is shipped, the On board date on B/L may exceed the L/C deadline	Confirm the latest shipment date in L/C and B/L date.
Clean B/L	Abnormal cargo or packing conditions prevent obtaining a Clean B/L	Confirm cargo condition, presence of remarks, and issuance conditions with the carrier or forwarder.
Freight notation	L/C requires Freight prepaid but quoted price or freight arrangement is Freight collect	Confirm that Incoterms, freight responsibility, and B/L freight terms are consistent.
Consignee field	Consignee or “to order” specified by L/C differs from what is stated on B/L	Verify bank instructions, endorsement conditions, notification party, and B/L issuance method.

Common Issues Regarding B/L Conditions

In L/C transactions, the B/L is not merely a transport document but a crucial document to satisfy payment terms.

Particularly, entries such as On board notation, Clean B/L status, consignee field, notification party, freight payment, shipment date, transshipment allowed or not, and partial shipment allowed or not are cross-checked against the L/C conditions.

For instance, if an L/C requires a “Full set of clean on board ocean bills of lading,” the B/L must be clean and include an On board notation.

If the cargo’s packaging is damaged and remarks are added on the B/L, it ceases to be a Clean B/L, potentially resulting in discrepancies.

Additionally, if the L/C prohibits transshipment but it occurs in the transport route, there may be issues depending on how the B/L records it.

Freight forwarders must confirm early on whether it is possible to issue a B/L that complies with L/C conditions, rather than only arranging transport.

CIF and CIP Terms and Insurance Policies

Under CIF and CIP terms, it is assumed that the seller arranges a certain level of insurance.

However, the minimum insurance required by Incoterms, the buyer’s expected coverage, and the insurance documents required by an L/C do not necessarily align.

L/Cs may specify conditions for insurance policies or certificates such as sum insured, currency, insured perils, insurance start date, signatures, or need for blank endorsement.

Banks check if these documentary conditions are met but do not assess whether the insurance coverage adequately corresponds to the cargo nature and transport risks.

For example, if the minimum insurance is arranged under CIF terms and insurance policies are submitted under the L/C, the banking settlement process may proceed smoothly.

Nevertheless, if a cargo incident occurs, and the insurance does not sufficiently cover water damage, breakage, temperature change, theft, transshipment accidents, or incidents during final delivery, the buyer or other stakeholders may incur actual losses.

When Insurance Policies Are Required under FOB and FCA Terms

Under FOB and FCA terms, typically the seller is not obliged to arrange cargo insurance for the buyer.

However, if the submission of an insurance certificate is stipulated as a condition in the L/C, the exporter must meet this condition to receive payment.

In this case, there is a discrepancy between the Incoterms obligations and the document requirements under the L/C.

It is important to confirm, either before or immediately after the L/C is issued, whether the seller will arrange the insurance, whether the buyer will amend the L/C terms, or whether another document can substitute for the insurance certificate.

Especially under FCA terms, the practical handling of container cargo and the L/C requirement for an On board B/L may not align.

Since under FCA the seller may not directly manage the shipment, failure to confirm in advance whether an On board B/L can be obtained may cause issues at the document preparation stage.

Step-by-step Flow from L/C Receipt to Payment Collection

Stage	What to Confirm	Relationship with Incoterms	Actions if Issues Arise
Before L/C Issuance	Sales contract, Incoterms conditions, required documents, insurance arranger	Align contract terms with document conditions in the L/C.	Avoid contradictions such as demanding insurance certificates under FOB or FCA beforehand.
Upon L/C Receipt	L/C terms, latest shipment date, document submission deadline, required documents	Confirm whether the seller’s obligations match the document requirements under the L/C.	If any conditions are impractical, request an L/C amendment before shipment.
At Booking	Vessel name, scheduled shipment date, transshipment existence, B/L issuance format	Check whether the B/L conditions required by the L/C can be met.	Confirm ability to comply with transshipment prohibition, On board B/L, or Ocean B/L requirements.
At Insurance Arrangement	Insurance amount, currency, coverage conditions, insurance period, signatures, endorsements	For CIF and CIP, seller-arranged insurance must match L/C requirements.	If insurance conditions differ from those specified in the L/C, make corrections before issuing the policy.
Before Shipment	Cargo condition, packing condition, shipment deadline, required documents	Whether a Clean B/L can be obtained and shipment date relate to payment conditions.	If packing damage or deadline overruns are expected, consider L/C amendments or shipment postponement.
At B/L Issuance	On board date, Clean notation, consignee, notify party, freight terms	Confirm whether freight payment responsibility under Incoterms matches the B/L notation under the L/C.	If discrepancies appear, check correction possibilities before issuance.
At Shipment Document Submission	Invoice, B/L, insurance certificate, packing list, certificate of origin, etc.	Review sales terms, L/C terms, transport documents, and insurance documents as a whole.	If inconsistencies arise, correct them or confirm buyer approval before submitting to the bank.
Bank Review and Payment Collection	Discrepancies, buyer approval, payment timing	Payment proceeds if documents comply with L/C terms.	If discrepancies arise, consider obtaining approvals, re-submitting documents, or negotiating terms.

Matters Freight Forwarders Should Check

Even if the freight forwarder is not a direct party to the L/C transaction, they play an important practical role as they are involved in B/L issuance, shipment date, transportation routes, transshipment, insurance documents, and shipment certification.

Confirmation Occasion	Person to Confirm With	Points to Confirm	Actions if Issues Arise
After L/C Receipt	Exporter / shipper	Type of transport documents required by the L/C	Confirm whether Ocean B/L, Combined Transport B/L, or House B/L is acceptable.
Before B/L Issuance	Shipping company / NVOCC	Whether a Clean on board B/L is required	If cargo condition or packing condition is problematic, notify in advance the possibility of remarks.
At Booking	Exporter / shipping company	Whether the latest shipment date can be met	If shipment deadline cannot be met, consider an L/C amendment or vessel change.
At Transport Route Confirmation	Shipping company / NVOCC	Whether transshipment or split shipment is permitted	If prohibited under the L/C, confirm availability of direct sailing or possibility of changing conditions.
At B/L Entry Confirmation	Exporter / shipping company / bank	Whether freight prepaid or freight collect notation agrees with L/C terms	If there are discrepancies in declared value, freight responsibility, or L/C terms, consider corrections.
At Consignee Entry Confirmation	Exporter / bank / shipping company	Whether consignee, notify party, to order, and endorsement conditions match L/C terms	Check draft before B/L issuance to prevent errors.
At Insurance Document Confirmation	Exporter / insurer / insurance agent	For CIF or CIP, whether insurance certificate conditions match the L/C	Verify amount, currency, coverage conditions, date, signature, and endorsements.
For FOB / FCA Transactions	Exporter / buyer / bank	Whether submission of insurance certificate is required	If there is a mismatch between Incoterms obligations and L/C document conditions, recommend amending the L/C.

Practical Confirmation Checklist

Checkpoint	Party to Confirm With	Items to Confirm	Actions if Problems Arise
Before L/C issuance	Seller / Buyer	Sales contract, Incoterms conditions, required documents	Ensure document requirements included in the L/C do not conflict with the sales terms.
Upon receiving L/C	Exporter / Bank	Document requirements, shipment deadline, document submission deadline, need for insurance policy	If any conditions cannot be met, request L/C amendment before shipment.
At Booking	Freight forwarder / Shipping line	Vessel, shipment date, transshipment, B/L issuance conditions	Confirm that shipment and B/L issuance can comply with L/C conditions.
Before shipment	Exporter / Warehouse / Freight forwarder	Cargo condition, packaging condition, feasibility of obtaining Clean B/L	If there is a possibility remarks will be added, confirm in advance with the bank and buyer.
At insurance policy issuance	Insurer / Insurance agent / Exporter	Insurance amount, currency, coverage conditions, insurance period, date, signature, endorsement	If inconsistent with L/C conditions, make corrections before issuance.
At B/L issuance	Shipping line / NVOCC / Freight forwarder	On board date, Clean notation, consignee, notify party, freight indication	Check draft and verify no discrepancies with L/C conditions.
Before submission to bank	Exporter / Bank / Freight forwarder	Consistency among invoice, B/L, insurance policy, packing list	Check consistency of descriptions, dates, amounts, and conditions among documents before submission.
When discrepancy occurs	Exporter / Bank / Buyer	Details of discrepancy, buyer approval, possibility of resubmission	Consider obtaining approval, L/C amendment, document reissuance, or changing payment conditions.

Cases Commonly Problematic in Practical Logistics

Case Where Insurance Policy Was Required in L/C Despite FOB Terms

Under FOB terms, the seller usually does not have the obligation to arrange cargo insurance on behalf of the buyer.

However, if the L/C requires submission of an insurance policy, the seller may fail to meet L/C conditions, causing issues during document submission.

In such cases, the requirement for an insurance policy should be checked immediately after receiving the L/C, and if necessary, the buyer should be requested to amend the L/C.

Case Where On Board B/L Was Requested Despite FCA Terms

FCA terms can fit actual logistics with container cargo, but sometimes the L/C requests an On board B/L.

Under FCA, the seller’s obligation can be fulfilled by delivering the cargo at CFS or CY, and the seller may not manage direct loading onto the vessel.

In this case, it should be confirmed before shipment whether an On board B/L can be obtained or how shipment proof will be provided, and if the L/C conditions should be amended.

Case Where Clean B/L Could Not Be Obtained

When an L/C requires a Clean on board B/L, adding remarks that indicate cargo or packaging defects may cause a discrepancy.

For example, if packaging is damaged, there is leakage, wet marks on the exterior, or quantity inconsistencies, the shipping line or freight forwarder may not issue a Clean B/L.

In this case, cargo conditions should be checked before shipment, and if issues are found, consider repacking, L/C amendment, or obtaining buyer approval.

Case Where Shipment Deadline Was Missed Based on B/L Date

Even if the cargo physically arrives at the port as scheduled, delays in the vessel or rollovers could make the On board date on the B/L exceed the L/C’s latest shipment date.

The bank compares the shipment deadline in the L/C with the B/L date, so exceeding the deadline often leads to a discrepancy.

In such cases, an L/C amendment or vessel change should be considered once shipment delays are anticipated.

Case Where Freight Prepaid/Collect Indications Did Not Match

Even when the L/C specifies Freight prepaid, the B/L may show Freight collect.

This occurs when the freight responsibility under the Incoterms, the actual transportation contract, and the document conditions in the L/C do not align.

In this case, freight indications should be checked at the B/L draft stage and aligned with pricing and L/C conditions.

Case Where CIF Insurance Policy Did Not Match L/C Conditions

Under CIF terms, the seller arranges insurance, but insurance amount, currency, coverage conditions, dates, or endorsement conditions in the policy may not align with those specified in the L/C.

The bank checks whether the insurance policy matches L/C requirements, and discrepancies cause document discrepancies.

In this case, L/C conditions should be accurately shared with the insurer or insurance agent before issuing the policy.

Case Where Transshipment Was Prohibited but Actual Route Included Transshipment

Though the L/C states Transshipment prohibited, the actual shipment route might include transshipment.

In container transport, transshipment at hub ports is common in practice, so the transportation route may not match the L/C conditions.

In this case, transshipment should be confirmed before booking, and the L/C conditions amended as necessary.

Examples

Example 1: Insurance Policy Requested Under FOB Terms

The exporter sold cargo under FOB terms, and the sales contract assumed the buyer would arrange marine cargo insurance.

However, the buyer’s opened L/C required the exporter to submit an insurance policy.

The exporter proceeded with shipment preparations but discovered at document review that the insurance policy could not be provided.

In this example, FOB terms themselves were correct, but the L/C conditions did not match the sales contract. The content should have been checked immediately after receiving the L/C, and an L/C amendment requested from the buyer.

Specific Example 2: On board B/L Issues with FCA Container Cargo

The exporter sold container cargo under FCA Yokohama CFS terms. The seller assumed delivery of the cargo at the CFS.

However, the L/C required the presentation of a full set of clean on board ocean bills of lading.

Under FCA terms, the seller does not directly manage the cargo loading on board the vessel, so obtaining an on board B/L as planned became an issue.

In this example, there was a practical disconnect between the FCA terms and the on board B/L requirement under the L/C. Before shipment, it was necessary to check the B/L issuance conditions, shipment certification, and whether amendments to the L/C terms were required.

Specific Example 3: Insufficient Insurance Policy Terms under CIF

The exporter sold the cargo under CIF terms and arranged marine cargo insurance.

However, the L/C specified that the insurance amount had to be at least a certain percentage of the invoice value, the currency had to be US dollars, the coverage had to meet specific conditions, and the insurance policy had to be endorsed to order.

The insurance policy actually issued did not match the L/C requirements in terms of the amount insured or endorsement conditions.

In this case, even if insurance was arranged under CIF, failure to comply with the L/C terms could cause issues with bank settlement. Before issuing the insurance policy, the L/C terms needed to be shared with the insurance company or insurance broker.

Practical Points to Note

In L/C transactions, the question of whether the cargo has been properly shipped is separate from whether the bank will make payment.

Even if the cargo is shipped safely, payment can be stopped if the documents do not meet the L/C conditions. Conversely, payment may proceed despite cargo damage if the documents are in order.

Also, although Incoterms form the basis of the sales contract, banks do not examine the sales contract itself. Banks primarily review the L/C and the presented documents.

Therefore, the sales contract, Incoterms, L/C, B/L, and insurance policy details need to be cross-checked against each other.

Exporters should verify upon receipt of the L/C that there are no document requirements inconsistent with the Incoterms.

Importers should confirm that necessary insurance and transport terms are correctly reflected in the L/C.

Freight forwarders must check whether the specified B/L terms are practically achievable in the actual transport arrangements.

In particular, under CIF, CIP, FOB, and FCA terms, gaps often arise between insurance arrangements and B/L conditions, so pre-shipment confirmation is crucial.

Summary

Both L/C transactions and Incoterms are important in international trade, but they serve different purposes.

Incoterms organize the responsibilities for costs, risk transfer, transport arrangements, and insurance between seller and buyer. Meanwhile, an L/C is a payment mechanism where the bank decides whether to pay based on the documents.

If these differences are not well understood, circumstances can arise where payment is stopped due to document discrepancies despite no issues in cargo handling, or actual losses remain due to cargo damage or insufficient insurance even though the documents are compliant.

In L/C transactions, it is essential to check the Incoterms in the sales contract, L/C terms, B/L conditions, and insurance policy as an integrated whole.

Especially under CIF, CIP, FOB, and FCA, misalignment between insurance arrangements and B/L conditions is common, so confirming these points before L/C issuance, upon L/C receipt, at booking, and before submitting shipping documents is key to avoiding trouble.