Fraud in Documentary Credits

International trade fraud is not a new phenomenon. Ever since trade began, merchants have been victims of fraud and other criminal activity. As early as the 1st century BC, there were pirate states along the Anatolian coast, threatening the commerce of the Roman Empire in the eastern Mediterranean. Roman ships were attacked by pirates who seized their cargoes of grain and olive oil. The Vikings (which means “sea-raider”) were renowned for attacking shipping and coastal settlements.

There are different types of trade fraud, ranging from piracy and theft to marine insur­ance fraud. This section focuses on documentary (letter of credit) fraud.

1. Common Features of Documentary

1.1. Fraud Fraud by Seller

• Fraudulent seller ships worthless goods or goods of lower quality: Seller ships worthless goods or goods of lower quality, pays for freight costs, and obtains a genuine bill of lading that enables it to receive payment from the advising or issuing bank for the shipment.
• Fraudulent seller does not ship any merchandise: Seller forges an entire set of documents required under the letter of credit and presents them to the bank for payment. Such sell­ers even furnish the buyer with a performance bond (for 10 percent of the value of the cargo) and obtain full value of the purchase price without sending any merchandise to buyer.

1.2. Fraud by Buyer

• Fraudulent buyer forges original documents for payment: Seller sends cargo (under docu­ments against payment arrangement) to buyer and submits the original documents to the collecting bank in the buyer’s country for presentation against payment. Mean­while, a copy of the original documents is sent directly to the buyer. The buyer forges the original documents and presents them to the carrier to clear the cargo. The authen­tic documents are still with the collecting bank.
• Fraudulent buyer receives merchandise from carrier on the strength of letter of indemnity: Indemnities are issued to enable the discharge of cargo (or to induce the carrier to discharge at a different destination if sold to another party while on transit) without presentation of the bill of lading. The letter of indemnity substitutes for the bill of lad­ing, allowing the buyer to receive the goods. This occurs when the cargo arrives before the bill of lading. The buyer obtains delivery of the goods and sells the bill of lading to an innocent buyer.

1.3. Fraud by Buyer, Seller, and Other Parties

• Buyer and seller conspire to defraud paying bank: Seller and buyer conspire to defraud paying bank by using forged documentary credits. Seller may also induce buyer into sending goods on a fraudulent letter of credit.
• Seller and carrier falsify the actual order and condition of the goods: Seller and carrier falsify to the buyer the order and condition of the goods by issuing a clean bill of lading. A letter of indemnity taken out by the seller covers the carrier against any liability in connection with the release of the goods. It is fraud on the buyer, who receives a clean bill of lading and assumes the cargo to be in good condition.

2. Protective Measures Against Documentary Fraud

2.1. Proactive Measures by Sellers

• Verify the background and credibility of your partner through your government agency, bank, or professional associations
• Stipulate the required documents and other pertinent conditions in the sales contract
• Check the validity of the letter of credit as well as the credibility of the issuing bank. It is also important to verify that the terms in the letter of credit comply with the sales contract.

2.2. Proactive Measures by Buyers

• Verify the background and credibility of your partner through your government agency, bank, or professional associations
• Choose FOB trade term rather the CIF in a sales contract so that you have more control over the shipment. It is also important to verify the availability of the ship, its capacity to carry the agreed merchandise, and its physical location
• Use independent inspectors to verify the quality and quantity of goods and whether they have been loaded on the vessel
• Choose time drafts (instead of sight drafts) to allow you to make payment some days after acceptance of the draft. This allows the buyer to discover fraud after the goods arrive but before the date of payment. It is also possible to condition the passage of title upon buyer’s inspection and approval of the goods.
• Verify the authenticity of the documents, especially the bill of lading, before they are presented to the bank for payment. To reduce possible forgery, the buyer can require that original bills of lading be sent directly to banks and not to the seller (shipper) in CIF contracts.
• Sellers can provide performance guarantee to buyer to carry out its obligations. In the event of fraud by seller, issuing bank will be obligated to compensate buyer solely upon demand by buyer. Buyers can also take out export credit insurance.

2.3. Proactive Measures by Banks

• Paying bank should offer an additional service for a fee. Banks can undertake an inves­tigation into the validity, genuineness, or accuracy of the documents before payment. The Bank of China, for example, provides a commercial credibility investigation service for its customers. The service includes a report on the foreign partner’s background, credit status, and solvency; the name of the loading ship and port; and condition of the goods as well as information on the carrier.
• Make further investigations in cases where fraud is suspected to avoid future occurrences.

Source: Seyoum Belay (2014), Export-import theory, practices, and procedures, Routledge; 3rd edition.