Letters of credit provide great capacity for fraud because they are used in transactions where goods are not sighted directly by the buyer, and are often paid for after shipment, not upon receipt, thus trading globally provides great capacity for profit, but also great capacity for deception.
Letters of credit have proved to be one of the safer financial instruments, and have a long history indeed, however they are vulnerable to fraud due to the fact that they are entirely dependent on documentation. If documentation presented along with a letter of credit appears valid, then a bank will pay the amount stipulated on the letter of credit. If the transaction is later revealed to be fraudulent, the bank takes no responsibility for the buyer’s loss. In fact clauses in the Letter of Credit itself specifically absolve the bank of any responsibility for paying out
These clauses are outlined in the UCP 600, a document issued by the ICC (International Chamber of Commerce) which covers the Uniform Customs and Practice for letters of credit. This document is made up of several Articles which comprise the guidelines under which letters of credit are issued, used, verified and otherwise handled. Article 34 is a specific disclaimer which absolves banks of any responsibility in the event of document fraud.

  • UCP 600 Article 34: Disclaimer on Effectiveness of Documents
    A bank assumes no liability or responsibility for the form, sufficiency, accuracy, genuineness, falsification or legal effect of any document, or for the general or particular conditions stipulated in a document or superimposed thereon; nor does it assume any liability or responsibility for the description, quantity, weight, quality, condition, packing, delivery, value or existence of the goods, services or other performance represented by any document, or for the good faith or acts or omissions, solvency, performance or standing of the consignor, the carrier, the forwarder, the consignee or the insurer of the goods or any other person.
  • Buyers should therefore be wary when it comes to issuing letters of credit, being aware that whilst there is a certain level of protection inbuilt into the letter of credit, an unscrupulous scam artist with well forged documentation can quite easily claim the full value of the letter of credit, leaving the buyer with no goods, and no legal recourse.
    In many cases those perpetrating fraud into the millions are never caught. The money is sent to offshore sheltered accounts, and the scam sellers disappear underground. For this reason it is imperative that traders seeking to deal with sellers verify the authenticity and background of the seller. Scammers normally do not spend years building solid reputations simply to destroy them with one dirty deal, which means that a buyer can protect him or herself simply by researching a seller’s background, or a broker’s background if one is going through a trade intermediary. If there is little to no background, steer clear, at best this means that the trader or seller is inexperienced, at worst, they are a scammer.
    A clear sign that a proposed transaction may be fraudulent is when a commodity is offered far below market value. Whilst it might be tempting to try and pick up a cheap deal often advertised as stock which has gone unsold after another buyer pulled out, or which was found to be surplus after a bumper crop, one must keep one’s head. Scammers often trap buyers by their greed, enticing them into deals that are quite simply too good to be true, and making off with their money whilst the buyer gets nothing.
    This makes for a rather intimidating trading climate for some buyers. Realizing that they have little to no protection in the event of fraud, one might wonder how it is that more fraudulent activities are not reported. Indeed, the playing field seems skewed towards fraudsters, and banks, whilst happy to keep one’s money, are disinclined to safeguard funds when a letter of credit is presented.
    However, doing a little research is an excellent way to protect oneself. Fraudulent documentation can be detected by doing a little research. Does the carrier exist? Can the reports be independently verified? Accepting things at face value without checking the veracity of claims is a surefire way to eventually become the victim of a scam, which brings us to our next section, preventing fraud.