Letter of credit

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After a contract is concluded between buyer and seller, buyer's bank supplies a letter of credit to seller.

Seller consigns the goods to a carrier in exchange for a bill of lading.

Seller provides bill of lading to bank in exchange for payment. Seller's bank exchanges bill of lading for payment from buyer's bank. Buyer's bank exchanges bill of lading for payment from the buyer.

Buyer provides bill of lading to carrier and takes delivery of goods. A standard, commercial letter of credit is a document issued mostly by a financial institution, used primarily in trade finance, which usually provides an irrevocable payment undertaking. The LC can also be source of payment for a transaction, meaning that redeeming the letter of credit will pay an exporter. Letters of credit are used primarily in international trade transactions of significant value, for deals between a supplier in one country and a customer in another. They are also used in the land development process to ensure that approved public facilities (streets, sidewalks, stormwater ponds, etc.) will be built. The parties to a letter of credit are usually a beneficiary who is to receive the money, the issuing bank of whom the applicant is a client, and the advising bank of whom the beneficiary is a client. Almost all letters of credit are irrevocable, i.e., cannot be amended or cancelled without prior agreement of the beneficiary, the issuing bank and the confirming bank, if any. In executing a transaction, letters of credit incorporate functions common to giros and Traveler's cheques. Typically, the documents a beneficiary has to present in order to receive payment include a commercial invoice, bill of lading, and documents proving the shipment was insured against loss or damage in transit. However, the list and form of documents is open to imagination and negotiation and might contain requirements to present documents issued by a neutral third party evidencing the quality of the goods shipped, or their place of origin.

Contents
[hide]

1 Terminology 2 How it works 3 Availability 4 Some of the Documents Called for under a LC 5 Legal principles governing documentary credits 6 The price of LCs 7 Legal Basis for Letters of Credit 8 International Trade Payment methods 9 Risks in International Trade

10 See also 11 References

[edit] Terminology
The English name letter of credit derives from the French word accreditation, a power to do something, which in turn is derivative of the Latin word accreditivus, meaning trust. S.The Application any defence relating to the underlying contract of sale. This is as long as the seller performs their duties to an extent that meets the requirements contained in the LC.

[edit] How it works

A business called the InCosmetika from time to time imports goods from a business called BLISS, which banks with the ABC Bank. InCosmetika holds an account at the Commonwealth Bank. InCosmetika wants to buy $500,000 worth of merchandise from BLISS, who agrees to sell the goods and give InCosmetika 60 days to pay for them, on the condition that they are provided with a 90-day letter of credit for the full amount. The steps to get the letter of credit would be as follows:

InCosmetika goes to The Commonwealth Bank and requests a $500,000 letter of credit, with BLISS as the beneficiary. The Commonwealth Bank can issue an LC either on approval of a standard loan underwriting process or by InCosmetika funding it directly with a deposit of $500,000 plus fees which are typically between 1% and 8% of the face value of the LC. The Commonwealth Bank sends a copy of the LC to the ABC Bank, which notifies BLISS that payment is available and they can ship the merchandise InCosmetika has ordered with the full assurance of payment to them. On presentation of the stipulated documents in the letter of credit and compliance with the terms and conditions of the letter of credit, the Commonwealth Bank transfers the $500,000 to the ABC Bank, which then credits the account of BLISS for that amount. Note that banks deal only with documents required in the letter of credit and not the underlying transaction. Many exporters have mistakenly assumed that the payment is guaranteed after receiving the LC. The issuing bank is obligated to pay under the letter of credit only when the stipulated documents are presented and the terms and conditions of the letter of credit have been met.

[edit] Availability
LC being an irrevocable undertaking of the issuing bank makes available the Proceeds, to the Beneficiary of the Credit provided, stipulated documents strictly complying with the 3

provisions of the LC, UCP 600 and other international standard banking practices, are presented to the issuing bank, then:

i.if the Credit provides for sight payment by payment at sight against compliant presentation ii.if the Credit provides for deferred payment by payment on the maturity date(s) determinable in accordance with the stipulations of the Credit; and of course undertaking to pay on due date and confirming maturity date at the time of compliant presentation iii.a.if the Credit provides for acceptance by the Issuing Bank by acceptance of Draft(s) drawn by the Beneficiary on the Issuing Bank and payment at maturity of such tenor draft, or iii.b. if the Credit provides for acceptance by another drawee bank by acceptance and payment at maturity Draft(s)drawn by the Beneficiary on the Issuing Bank in the event the drawee bank stipulated in the Credit does not accept Draft(s) drawn on it,

or by payment of Draft(s) accepted but not paid by such drawee bank at maturity;

iv. if the Credit provides for negotiation by another bank by payment without recourse to drawers and/or bona fide holders, Draft(s) drawn by the Beneficiary and/or document(s) presented under the Credit, (and so negotiated by the nominated bank ) Negotiation means the giving of value for Draft(s) and/or document(s) by the bank authorized to negotiate, viz the nominated bank. Mere examination of the documents and forwarding the same to LC issuing bank for reimbursement, without giving of value / agreed to give, does not constitute a negotiation.

[edit] Some of the Documents Called for under a LC

Financial Documents Bill of Exchange, Co-accepted Draft Commercial Documents Invoice, Packing list Shipping Documents Transport Document, Insurance Certificate, Commercial, Official or Legal Documents Official Documents License, Embassy legalization, Origin Certificate, Inspection Cert , Phyto-sanitary Certificate Transport Documents 4

Bill of Lading (ocean or multi-modal or Charter party), Airway bill, Lorry/truck receipt, railway receipt, CMC Other than Mate Receipt, Forwarder Cargo Receipt, Deliver Challan...etc Insurance documents Insurance policy, or Certificate but not a cover note.

pre shipment packing list

[edit] Legal principles governing documentary credits

One of the primary peculiarities of the documentary credit is that the payment obligation is abstract and independent from the underlying contract of sale or any other contract in the transaction. Thus the banks obligation is defined by the terms of the credit alone, and the sale contract is irrelevant. The defences of the buyer arising out of the sale contract do not concern the bank and in no way affect its liability.[1] Article 4(a) UCP states this principle clearly. Article 5 the UCP further states that banks deal with documents only, they are not concerned with the goods (facts). Accordingly, if the documents tendered by the beneficiary, or his or her agent, appear to be in order, then in general the bank is obliged to pay without further qualifications. The policies behind adopting the abstraction principle are purely commercial and reflect a partys expectations: firstly, if the responsibility for the validity of documents was thrown onto banks, they would be burdened with investigating the underlying facts of each transaction and would thus be less inclined to issue documentary credits as the transaction would involve great risk and inconvenience. Secondly, documents required under the credit could in certain circumstances be different from those required under the sale transaction; banks would then be placed in a dilemma in deciding which terms to follow if required to look behind the credit agreement. Thirdly, the fact that the basic function of the credit is to provide the seller with the certainty of receiving payment, as long as he performs his documentary duties, suggests that banks should honour their obligation notwithstanding allegations of misfeasance by the buyer. [2] Finally, courts have emphasised that buyers always have a remedy for an action upon the contract of sale, and that it would be a calamity for the business world if, for every breach of contract between the seller and buyer, a bank were required to investigate said breach. The principle of strict compliance also aims to make the banks duty of effecting payment against documents easy, efficient and quick. Hence, if the documents tendered under the credit deviate from the language of the credit the bank is entitled to withhold payment even if the deviation is purely terminological.[3] The general legal maxim de minimis non curat lex has no place in the field of documentary credits.

[edit] The price of LCs

All the charges for issuance of Letter of Credit, negotiation of documents, reimbursements and other charges like courier are to the account of applicant or as per the terms and conditions of the Letter of credit. If the LC is silent on charges, then they are to the account of the Applicant. The description of charges and who would be bearing them would be indicated in the field 71B in the Letter of Credit.

[edit] Legal Basis for Letters of Credit

Although documentary credits are enforceable once communicated to the beneficiary, it is difficult to show any consideration given by the beneficiary to the banker prior to the tender of documents. In such transactions the undertaking by the beneficiary to deliver the goods to the applicant is not sufficient consideration for the banks promise because the contract of sale is made before the issuance of the credit, thus consideration in these circumstances is past. In addition, the performance of an existing duty under a contract cannot be a valid consideration for a new promise made by the bank: the delivery of the goods is consideration for enforcing the underlying contract of sale and cannot be used, as it were, a second time to establish the enforceability of the bank-beneficiary relation. Legal writers have analyzed every possible theory from every legal angle and failed to satisfactorily reconcile the banks undertaking with any contractual analysis. The theories include: the implied promise, assignment theory, the novation theory, reliance theory, agency theories, estoppels and trust theories, anticipatory theory, and the guarantee theory. [4] Davis, Treitel, Goode, Finkelstein and Ellinger have all accepted the view that documentary credits should be analyzed outside the legal framework of contractual principles, which require the presence of consideration. Accordingly, whether the documentary credit is referred to as a promise, an undertaking, a chose in action, an engagement or a contract, it is acceptable in English jurisprudence to treat it as contractual in nature, despite the fact that it possesses distinctive features, which make it sui generis. A few countries including the US (see Article 5 of the Uniform Commercial Code) have created statutes in relation to the operation of LCs. These statutes are designed to work with the rules of practice including the UCP and the ISP98. These rules are practice are incorporated into the LC transaction by agreement of the parties. The latest version of the UCP is the UCP600 effective July 1, 2007[5]. The previous revision was the UCP500 and became effective on 1 January 1994. Since the UCP are not laws, parties have to include them into their arrangements as normal contractual provisions.

[edit] International Trade Payment methods

Advance payment (most secure for seller)

Where the buyer parts with money first and waits for the seller to forward the goods

Documentary Credit (more secure for seller as well as buyer)

subject to ICC's UCP 600, where the bank gives an undertaking (on behalf of buyer and at the request of applicant ) to pay the shipper ( beneficiary ) the value of the goods shipped if certain documents are submitted and if the stipulated terms and conditions are strictly complied. Here the buyer can be confident that the goods he is expecting only will be received since it will be evidenced in the form of certain documents called for meeting the specified terms and conditions while the supplier can be confident that if he meets the stipulations his payment for the shipment is guaranteed by bank, who is independent of the parties to the contract.

Documentary collection (more secure for buyer and to a certain extent to seller)

subject to ICC's URC 525, sight and usance, for delivery of shipping documents against payment or acceptances of draft, where shipment happens first, then the title documents are sent to the [collecting bank] buyer's bank by seller's bank [remitting bank], for delivering documents against collection of payment/acceptance

Direct payment (most secure for buyer)

Where the supplier ships the goods and waits for the buyer to remit the bill proceeds, on open account terms. Risk situations in LC transaction Fraud Risks

The payment will be obtained for nonexistent or worthless merchandise against presentation by the beneficiary of forged or falsified documents. Credit itself may be forged.

Sovereign and Regulatory Risks

Performance of the Documentary Credit may be prevented by government action outside the control of the parties.

Legal Risks

Possibility that performance of a Documentary Credit may be disturbed by legal action relating directly to the parties and their rights and obligations under the Documentary Credit

Force Majeure and Frustration of Contract

Performance of a contract including an obligation under a Documentary Credit relationship is prevented by external factors such as natural disasters or armed conflicts

Risks to the Applicant

Non-delivery of Goods Short Shipment Inferior Quality Early /Late Shipment Damaged in transit Foreign exchange Failure of Bank viz Issuing bank / Collecting Bank

Risks to the Issuing Bank

Insolvency of the Applicant Fraud Risk, Sovereign and Regulatory Risk and Legal Risks

Risks to the Reimbursing Bank

no obligation to reimburse the Claiming Bank unless it has issued a reimbursement undertaking.

Risks to the Beneficiary

Failure to Comply with Credit Conditions Failure of, or Delays in Payment from, the Issuing Bank Credit Issued by Party other than Bank

Risks to the Advising Bank

The Advising Banks only obligation if it accepts the Issuing Banks instructions is to check the apparent authenticity of the Credit and advising it to the Beneficiary

Risks to the Nominated Bank

Nominated Bank has made a payment to the Beneficiary against documents that comply with the terms and conditions of the Credit and is unable to obtain reimbursement from the Issuing Bank

Risks to the Confirming Bank

If Confirming Banks main risk is that, once having paid the Beneficiary, it may not be able to obtain reimbursement from the Issuing Bank because of insolvency 8

of the Issuing Bank or refusal of the Issuing Bank to reimburse because of a dispute as to whether or not payment should have been made under the Credit

[edit] Risks in International Trade

A Credit risk risk from change in the credit of an opposing business. An Exchange risk is a risk from a change in the foreign exchange rate. A Force majeure risk is 1. a risk in trade incapability caused by a change in a country's policy, and 2. a risk caused by a natural disaster. Other risks are mainly risks caused by a difference in law, language or culture. In these cases, the cargo might be found late because of a dispute in import and export dealings.

[edit] See also

Uniform Customs and Practice for Documentary Credits Buyer's Credit

[edit] References
1. ^ See Ficom S.A. v. Sociedad Cadex [1980] 2 Lloyds Rep. 118. 2. ^ United City Merchants (Investments) Ltd v Royal Bank of Canada (The American Accord) [1983] 1.A.C.168 at 183 3. ^ J. H. Rayner & Co., Ltd., and the Oilseeds Trading Company, Ltd. v.Hambros Bank Limited [1942] 73 Ll. L. Rep. 32 4. ^ For extensive analysis See Finkelstein, H. Legal Aspects of Commercial Letters of Credit, pp. 275-295 5. ^ Dominique Doise,The 2007 Revision of the Uniform Customs and Practice for Documentary Credits (UCP 600)[1] Retrieved from "http://en.wikipedia.org/wiki/Letter_of_credit" Categories: Contract law | Basic financial concepts | Legal documents | Letters (message) | International trade
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Letter Of Credit
What Does Letter Of Credit Mean? A letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase.

Investopedia explains Letter Of Credit Letters of credit are often used in international transactions to ensure that payment will be received. Due to the nature of international dealings including factors such as distance, differing laws in each country and difficulty in knowing each party personally, the use of letters of credit has become a very important aspect of international trade. The bank also acts on behalf of the buyer (holder of letter of credit) by ensuring that the supplier will not be paid until the bank receives a confirmation that the goods have been shipped.

Letter Of Credit Types

There are several types of letters of credit. o The differences are found in the wording. Revocable versus Irrevocable o You should always insist and carefully check that a letter of credit is irrevocable. Once an irrevocable letter of credit is open it cannot be changed without the written consent of all parties including the beneficiary. A revocable letter of credit can be change or withdrawn without notifying the beneficiary. Confirmed versus Advised o Confirmed is preferred, as the Confirming Bank promises to pay. o Advised does not guarantee the creditworthiness of the Opening Bank. Straight versus Negotiation o A negotiation letter of credit can be presented to any bank. o A straight letter of credit can only be paid in the country of the Paying Bank.

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Sight versus Usance o At sight means the Beneficiary is paid as soon as the Paying Bank has determined that all necessary documents are in order. o Usance time can be between 30 and 180 days after the bill of lading date. This is a form of delayed payment, and should be avoided.

It can be: Revocable Credit Irrevocable Credit Confirmed Credit Payment Credit Negotiation Credit Deferred Payment Credit Acceptance Credit Back-to-Back Credit Transferable Credit Red Clause Credit Green Clause Credit Packing Credit Standby Credit Revolving CreditCredit Letters are used to ensure payments that have been issued from creditors. It is a document that guarantees a buyer's payment to a seller that will be received on time with the correct amount.

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3:58 How to Calculate your Stimulus Payment By 5min Life Videopedia 1. Remember to be courteous when writing a credit letter whatever be the situation or circumstances may be. Keep a professional tone while explaining the reasons for making the letter.Don't let personal differences or issues affect the letter as it will be very unprofessional. Business is business, it doesn't have to be personal. 2. If you are to deny a request for credit, don't close the door. Allow it to be open for future credit applications from that same person or business entity. If you denied the first time, don't let it end there. Encourage them to try the next time they decided to ask for credit. 3. If the payment is late for more than a month, tell the debtor to contact you and discuss issues with you about the lapse in payment. In this way, the debtor may feel more obliged to pay you on time because of creating a good working relationship with them. 4. If it has been sixty days and the payment is still not settled, and the customer don't show any signs of paying or settling the credit or to even discuss terms with you, inform him or her throught the letter the consequences and penalties that will be incurred. Do not threat your customers about not paying on time. Remember to stil pursue with the letters to let them know that it is important for them to pay even if it has been overdue. 5. Write all the information needed and write them clearly. In this way, you are sending your message to your customer very well and you convey the message you want them to receive. Again, keep a professional tone. 6. Make sure that your letter is tailored to your customer. Know your customer. If they are in the restaurant industry, then tailor the letter to them. If it is for personal use, then tailor it and make it more specific. 7. Don't write letters that are too long. It should go directly to the point and it should be straightforward. Still, keep it professional and business-like. 8. Be persuasive when writing a letter. It should be confident about what you are saying in the letter and it should be but not overbearing.

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9. Tell your reader that all pertinent information that he or she will give you should and will remain confidential. In this way, you are securing your reader about the relationship you are to build with him or her. Remember that making a credit letter should be brief and should be professional. These are just tips on how to make a credit letter.

Types of Letters of Credit [edit]

Revocable [edit]
A revocable letter of credit is one which can be amended or cancelled by the applicant or the issuing bank at any time, without prior notice, discussion or agreement with the beneficiary. A revocable letter of credit offers no protection to the beneficiary and is seldom if ever used.that is in the relation with transferable lc.

Irrevocable [edit]
An irrevocable letter of credit can not be amended or revoked without the agreement of ALL the parties to the letter of credit, so it provides the assurance that providing the beneficiary complies with the terms, he/she will be paid for the goods or services. Under UCP 500, a letter of credit is deemed irrevocable unless otherwise stated.

Unconfirmed [edit]
An unconfirmed irrevocable letter of credit provides a commitment by the issuing bank to pay, accept, or negotiate a letter of credit. An advising bank forwards the letter of credit to the beneficiary without responsibility or undertaking on its part except that it must use reasonable care to check the authenticity of the credit which it advised. It does not provide a commitment from the advising bank to pay, so the beneficiary is reliant upon the undertaking of the overseas bank. The beneficiary is not protected from the credit risk of the issuing bank nor the country risk.

Confirmed [edit]
A confirmed irrevocable letter of credit is one to which the advising bank adds its confirmation, makes its own independent undertaking to effect payment, negotiation or acceptance, providing documents are presented which comply with the terms of the letter of credit. The advising bank, which may also be the confirming bank, assumes the 13

country (political and economic) risk of the applicants country as well as the credit risk, failure and default of the issuing bank and effects payment to the beneficiary without recourse. In order for a letter of credit to be confirmed, a bank accepting this risk would have a correspondent relationship with the issuing bank. If the advising bank does not have such a relationship, the letter of credit can be confirmed by an independent bank. The negative aspect here is the cost of adding another bank to the scenario. A seller should consider requesting a confirmed credit when

the credit standing of the issuing bank is unknown to the seller or viewed by the seller as questionable. exchange controls in the buyers country may prevent local banks from honoring certain external payments. the importing country is suffering economic difficulties: large external debt and/or high debt service ratios, a persistent negative balance of payments, or a record of being late or having defaulted on its international payments.

Transferable Credit [edit]

Under a transferable letter of credit a beneficiary (the first beneficiary) can ask the issuing/advising/confirming bank to transfer the letter of credit in whole or in part to another party/ies such as supplier/s (second beneficiary/ies). A transferable letter of credit is usually used when the beneficiary is not the manufacturer/original supplier of some/all of the goods/services. This process enables the beneficiary to pay the manufacturer/original supplier by letter of credit. If the bank agrees, this bank, referred to as the transferring bank, advises the letter of credit to the second beneficiary/ies in the terms and conditions of the original letter of credit with certain constraints defined in Article 48 of UCP 500. In general, unless the letter of credit states that it is transferable, it is considered nontransferable.

Assignment of Proceeds [edit]

The right to the proceeds of a letter of credit can sometimes be assigned where the beneficiary of a letter of credit is not the actual supplier of all or part of the letter of credit and wants the bank to pay the supplier out of funds received from the letter of credit. The beneficiary may choose this option if he or she

does not want to request a transferable letter of credit from a buyer in order to keep the buyer from knowing who is the actual supplier of the goods. does not have the necessary credit with the bank to issue a new letter of credit to a supplier.

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An assignment of proceeds takes the form of an irrevocable instruction from the beneficiary to the bank requesting that it pay the supplier out of the proceeds of the letter of credit which becomes due when documents are presented in compliance with the terms of the letter of credit.

Revolving [edit]
Although infrequently used today, revolving letters of credit were a tool created to allow companies conducting regular business to issue a letter of credit that could roll-over without the company having to reapply, thus enabling business flow to continue without interruption as long as the terms and conditions, quantities, and other transaction details did not change. In addition, if a letter of credit were a revolving one, there were few ways to stop it from rolling over; so, should a conflict arise between the parties while the letter of credit was in place or should the products change, there was little recourse for either party. In the business world today, the fact is that, unless required by law or because of high risk, on-going business is usually conducted without of letters of credit

Standby [edit]
As is the case with the revolving letter of credit, standby letters of credit are infrequently used today. A standby letter of credit is one which is issued as a back-up or form of insurance for the seller should the buyer default on the agreed-upon payment terms. A standby letter of credit is issued in the same way a documentary credit is in that the collateral needed for issuance is required by the issuing bank and the beneficiary must comply with every detail as outlined in the letter of credit. The problem with this instrument is that the applicant has no guarantee, other than the sellers word, that the standby will not be drawn against even if payment is made as agreed. This situation is challenging, especially if the letter of credit is confirmed and the advising bank sees only documents pertaining to the shipment as outlined in the letter of credit and has no knowledge of other payments being made.

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