Letter of Credit
This query is : Resolved
26 May 2010
what is letter of credit?
26 May 2010
Letter of credit(L/C) is the non-fund based working capital limit.
L/C. A binding document that a buyer can request from his bank in order to guarantee that the payment for goods will be tranferred to the seller. Basically, a letter of credit gives the seller reassurance that he will receive the payment for the goods. In order for the payment to occur, the seller has to present the bank with the necessary shipping documents confirming the shipment of goods within a given time frame. It is often used in international trade to eliminate risks such as unfamiliarity with the foreign country, customs, or political instability.
L/C. A binding document that a buyer can request from his bank in order to guarantee that the payment for goods will be tranferred to the seller. Basically, a letter of credit gives the seller reassurance that he will receive the payment for the goods. In order for the payment to occur, the seller has to present the bank with the necessary shipping documents confirming the shipment of goods within a given time frame. It is often used in international trade to eliminate risks such as unfamiliarity with the foreign country, customs, or political instability.
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26 May 2010
Letter of credit is the Non fund based credit facility given by the bank to the customers. While you are purachsing the materials against that payment you can open a letter of credit with bank in the name of the supplier with the number of credit days like 30,60 90 days with in the period based on the LC condition the supplier supply the goods and raise the Bill of exchage for negotitation and got the payment from Bank and the buyer can pay to Bank on the due date of the BOE
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26 May 2010
Letters of Credit The privilege of buying goods, services or borrowing money in return for a promise of future payment.
When a buyer wishes to acquire goods or services from a seller, the buyer can request his or her bank to issue a letter of credit A financing instrument issued by a bank in favor of an exporter that substitutes the bank's creditworthiness for that of the importer. (also called a documentary credit). A letter of credit is a written document issued by the buyer's (or importer's) bank and addressed to a seller (or exporter The person or company that sells or arranges to transport goods out of a country. ). It specifies the terms and conditions under which the seller, or "beneficiary The person or company due payment in the letter of credit. Usually the exporter (seller). ," will be paid for merchandise or services.
The letter of credit guarantees payment to the seller through the seller's bank when the seller, through his or her bank, presents certain documents to the buyer's bank. The letter of credit specifies where and what documents the seller must present, the amount of money A medium of exchange; coined or stamped currency. available, and the latest date for presenting the documents. The documents may vary, but their purpose is to assure that the goods have been "sold" and are on their way to the buyer.
They usually include the following:
Invoice Document which shows the terms of a sale. Includes a full description of the goods, sale price, charges, and discounts.
Bill of Lading (from the shipper Indemnity given by the beneficiary of a letter of credit to the negotiating bank to induce payment despite any discrepancies that may exist in the documents. Compensation paid for damage or loss sustained or anticipated. given by the beneficiary of a letter of credit to the negotiating bank to induce payment despite any discrepancies that may exist in the documents. )
Certificate of Origin
Insurance documents
Export Certificate
Transfer of Ownership
The letter of credit agrees to make payment in a specified manner if the seller complies with its terms and conditions in accordance with the International Chamber of Commerce rules governing letters of credit. These rules are known officially as The Uniform Customs National government authorities that control imports, inspect imports, and collect duties levied on both imports and exports and Practice for Documentary Credits (ICC The International Chamber of Commerce. Publishes rules governing the preparation and usage of letters of credit. (See also UCP 500.) Publication 500). The current version is referred to as "UCP 500 Uniform Customs and Practices for Documentary Credit of the International Chamber of Commerce, Publication 500. These are rules for managing letters of credit. " and went into effect January 1, 1994.
The letter of credit procedure The actual working steps that should be followed in the appropriate order to accomplish the desired credit result or decision. substitutes the creditworthiness of a bank for that of the buyer. It assures a seller that if he or she complies with the letter of credit, the bank will pay regardless of the wishes or financial ability of the buyer. In this manner, the seller is assured payment by an assumed reputable third-party financial institution.
Format
The format for a letter of credit has been specified within the Federal Register of the United States by the Department of the Treasury. It is related under the Comptroller of the Currency Interpretive Rulings, May 5, 1977, Section 7.7016, Letters of Credit as follows:
"A national bank may issue letters of credit permissible under the Uniform Commercial Code or the Uniform Customs and Practice for Documentary Credits to or on behalf of its customers. As a matter of sound banking practice, letters of credit should be issued in conformity with the following: (a) Each letter of credit should conspicuously entitled as such; (b) the bank's undertaking should contain a specified expiration date The last date upon which the presentation of documents may occur under a letter of credit under UCP rules. or be for a definite term; (c) the bank's undertaking should be limited in amount; (d) the bank's obligation to pay should arise only upon the presentation The beneficiary delivers the documents to the advising bank to negotiate on the seller's behalf. of a draft A negotiable instrument that calls for payment of money. The drawer (or seller) orders in writing for the drawee (or buyer) to pay a specific amount of money to the drawer on a certain date. Also called a bill of exchange. bill of exchange (See Draft.) . bill of exchang (See Draft.) e. or other documents as specified in the letter of credit, and the bank must not be called upon to determine questions of fact or law at issue between the account party Party for whom a letter of credit is opened. "Account party" and "applicant" are generally synonymous, but sometimes one party will agree with the issuing bank to make all payments under a letter of credit showing the name of another party (often two affiliated companies). Banks may refer to one of these parties as the applicant and the other as the account party, but there is no consistency among banks regarding which is which. and the beneficiary; (e) the bank's customer should have an unqualified obligation to reimburse the bank for payments made under the letter of credit."
The format stated above for United States Banks is generally followed throughout the world.
Types of Letters of Credit:
Merchandise/Commercial
The majority of letters of credit issued today are in payment for goods in shipment or current services performed. Payment is normally made against a set of documents consisting of commercial invoices, packing, weight, and shipping documents for goods shipped. Payment for services may be against invoices, vouchers, paid bills, or other records of work performed. Letters of credit of this nature are usually referred to as commercial or trade letters of credit.
Standby
Standby letters of credit function like a guarantee To assume liability for the debts or obligations of another in the event of a default. or a bond A promise under seal to pay money; an IOU or promissory not A legal and binding promise by a debtor (the promisor) to pay a certain sum of money to a creditor (the promisee) at a future date, usually with interest at a fixed rate. e issued as evidence of long-term indebtedness. . They are issued to support the payment of obligations based on money loaned or advanced, or upon the occurrence of nonoccurrence of another contingency. They are generally not to be drawn upon by the beneficiary unless a delinquency of some form takes place in a business transaction.
Standby letters of credit issued by United States Banks are subject to Federal Law specifically Regulation H (12 CFR 203). Under Section 208.8 (d) a standby letter of credit is defined as follows:
"Standby letters of credit include every letter of credit (or similar arrangement, however, named or designated) which represents an obligation to the beneficiary on the part of the issuer (1) to repay money borrowed by or advance to or for the account of the account party, (2) to make payment on account of any evidence Testimony of witnesses and facts presented to the court and jury by way of writings and exhibits, which impress the minds of the court and jury, to the extent that an allegation has been proven. of indebtedness undertaken by the account party, or (3) to make payment on account of any default by the account party in the performance of an obligation."
The International Standby Practices 1998 (ISP98) provides separate rules for standby letters of credit.
Irrevocable
An irrevocable letter of credit may not be repealed, annulled, revoked, recalled, canceled, amended, altered, or changed without the express approval of the beneficiary. It constitutes a definite undertaking of the issuing and confirming bank The seller can instruct the buyer to make provisions for a letter of credit to be confirmed. A confirming bank adds its own irrevocable undertaking to that of the issuing bank. , provided the beneficiary absolutely complies with the terms and conditions.
Revocable
A revocable letter of credit is the opposite of an irrevocable credit. It may be repealed, annulled, revoked, recalled, canceled, amended, altered, or changed without prior notice to or approval by the beneficiary. Consequently, the revocable letter of credit is seldom employed as security for business. All letters of credit are deemed irrevocable unless specifically designated otherwise in the credit.
Unconfirmed
An unconfirmed letter of credit means that it bears the undertaking of the issuing bank Also known as the opening bank. It issues its commitment to the seller in the form of a letter of credit. opening bank The account party's bank that issues or opens the credit. . It issues its commitment to the seller in the form of a letter of credit. opening ban The account party's bank that issues or opens the credit. k. It issues its commitment to the seller in the form of a letter of credit. alone. When the beneficiary meets the credit's terms and conditions, then the issuing bank is assuring payment of funds by itself to a beneficiary directly or through a collecting, drawee The person, company, or bank upon which a draft is drawn. , or negotiating bank. The beneficiary should therefore look to the creditworthiness of only the issuing bank and not an intermediary's bank.
Confirmed
A confirmed letter of credit is a credit where a second undertaking is added to the letter of credit by another bank. Therefore, the beneficiary may look additionally to the creditworthiness of the confirming bank for payment assurance. The issuing bank is primarily guaranteeing payment; however, if payment complications arise from the issuing bank, then the second guaranteeing bank (confirming bank) is responsible for making payment if the terms and conditions have been met.
The beneficiary who has requested a confirmed letter of credit should note who is doing the confirming, and whether it is actually a second financial institution. For example, if the issuing bank states: "We confirm this letter of credit," it is meaningless, as you cannot confirm your own instrument A right to the payment of money such as agency notes, commercial pape The unsecured promissory notes of large, financially sound corporations. r, T-Bills, certificates of deposit (CD's), banker's acceptances and repurchase agreements. . As such, there is only one guarantee for the credit. For all intents and purposes, beneficiaries usually present their documents to the confirming bank, and regard them as the primary source of payment.
Straight
Straight letters of credit are those credits where a beneficiary must present documents to a named drawee bank. Payment will only be made at that bank and the letter will expire for presentation of documents at their counters. Documents may not be negotiated by an intermediary bank or purchased for value. An interposing bank may not be a holder in due course One who has acquired possession of a negotiable instrument through proper negotiation for value, in good fait Honesty in fact in the conduct or transaction concerned. h, and without notice of any defenses to it. . The engagement to pay is made only (or straight) to the beneficiary of the letter of credit and does not extend to any other party.
Negotiable Quality belonging to a document to transfer ownership of money, goods, or other items of value specified in the document by endorsement and/or delivery of the document. endorsement Writing one's name upon paper for the purpose of transferring the title. and/or delivery of the document.
For a negotiable letter of credit, an intermediary bank may be employed between the beneficiary and the drawee or issuing bank for the purpose of taking documents in charge (negotiating them) within the expiration date of the letter of credit. Under a straight letter of credit, the letter of credit expires at the counters of the drawee or issuing bank. Under a negotiable type, the letter of credit may expire at the counters of a negotiating bank. In addition, the letter of credit engagement extends not only to the beneficiary (drawer The person, company, or bank that creates the draft and receives payment. ) but also to bona fide ("bone-a-fide") In good faith. holders. Consequently, a negotiating bank has the protection of a holder in due course.
Sight
Letters of credit may be payable at sight A term used in the body of drafts/bills of exchange indicating that payment is due upon presentation or demand. , which means that if the drafts and documents are in order, they are honored by making payment without delay. The only delays may result from collecting funds through a reimbursing bank In a letter of credit transaction, the bank with which the issuing bank maintains an account and which is authorized by the issuing bank to charge that account to pay claims received from the negotiating bank for documents that have been presented. .
Usance
If a letter of credit calls for usance (time) draft payments, then the draft is honored by accepting it for payment in the future. Thus, payment would be delayed until the maturity of the draft plus any delay in the transmittal of funds. However, special attention should be given to special instructions that might grant A term used in deeds for the transfer of the title to real propert Land with all its buildings and legal interests. y payment before maturity, such as discount charges for buyer's account.
Deferred Payment
A deferred payment letter of credit is one in which the beneficiary will present documents to a paying bank The bank named in the letter of credit to make payment to the seller or the negotiating bank upon presentation of the proper documentation. . If the paying bank finds the documents in order, the bank will acknowledge receipt and undertake to remit payment at a future date. This undertaking has the full commitment of the paying bank, similar to the acceptance When a drawee acknowledges in writing on the face of the draft that the buyer will pay the draft at maturity. (See also Draft, Drawee.) When a drawee acknowledges in writing on the face of the draft that the buyer will pay the draft at maturity. of a time draft. The only difference is that the advantage of a negotiable instrument is not present, and therefore the beneficiary cannot obtain payment prior to the future date (discounting is not possible). The buyer actually does not save any costs for a deferred payment Payment scheduled for a set period of time after shipment or presentation of shipping documents, as opposed to immediately or "at sight." credit. He or she is charged a deferred payment commission as opposed to an acceptance commission.
Deferred Documents
A deferred document is different from a deferred payment credit in two ways. First, deferred payment documents are presented right away for examination and approval, but under a deferred document credit, document presentation is delayed by the beneficiary for a specified period of time. Second, an undertaking to pay certification is transmitted to the beneficiary for his or her security under deferred payment. However, this does not take place with deferred documents. Thus, the beneficiary has only the contingent liability Potential obligation that will materialize only if certain events occur in the future (e.g., a parent guaranteeing the debts of a subsidiar A company, usually a corporation, that is controlled by a parent company. y). of payment if documents are in order. This is fine if documents are in order, but control of merchandise complications could arise if documents are rejected. Under deferred payment, if documents were rejected, the beneficiary could possibly have kept cargo from the buyer due to the current shipment. Conversely, under deferred documents, documents were presented after shipment and the cargo is lodged with the buyer.
Transferable
A transferable credit is a credit wherein the beneficiary may request the bank entitled to make negotiation The transfer of a negotiable instrument in such form that the transferee becomes a holder. , acceptance, or payment to convey his or her rights under the credit to another company. This may be a complete conveyance called a "transfer in the whole," or a conveyance within limitations called a "partial transfer." Transferable credits are used for a variety of reasons, such as: transferring control from a purchasing or selling agent to a third party vendor The seller of property or goods. , dividing up a letter of credit from a contractor to several suppliers, and providing the first beneficiary with the ability to offer letter of credit protection to a vendor without having to ask their bank to issue a brand new letter of credit.
The credit can be transferred only on the terms and conditions of the original credit with the exception of:
The amount of the credit
Any unit price stated therein
The expiry date (may be shortened but not extended)
The last date for presentation of documents in accordance with UCP 500, article 43
The period for shipment
Any of the above may be reduced or curtailed
The percentage for which insurance cover must be given may be increased in such a way as to provide the amount of cover stipulated in the original credit. For example, if the original credit were for $100,000 and it called for insurance for 110% of CIF Cost, insurance and freight. Shipping terms under which the seller pays all expenses involved in placing merchandise on board the carrier and prepays the freight and insures the goods to an agreed-upon destination. Shipping terms That part of a contract of sale that specifies who, between the buyer and the seller, is responsible for each aspect of shipping the goods. under which the seller pays all expenses involved in placing merchandise on board the carrier and prepays the freight and insures the goods to an agreed-upon destination. Shipping term That part of a contract of sale that specifies who, between the buyer and the seller, is responsible for each aspect of shipping the goods. s under which the seller pays all expenses involved in placing merchandise on board the carrier and prepays the freight and insures the goods to an agreed-upon destination. value, then the policy would have to be for $110,000. When the transfer was made (assume a transfer of $90,000) the transferring bank would stipulate that insurance should be in the amount of $110,000 and not 110% of the (reduced amount) invoice value. To do otherwise would run the risk Conditions in which the decision maker has to estimate the likelihood of certain outcomes. of the transferee The party to which the rights under a transferable letter of credit are transferred. submitting an insurance policy for $99,000 (110% of $90,000) which would thus cause the goods to be under-insured.
In addition, the name of the first beneficiary must be substituted for that of the applicant The party (generally buyer/importer) for whose account a letter of credit is established. . However if the name of the applicant is specifically required by the original credit to appear in any document other than the invoice, then such requirement must be fulfilled.
The major concern of first beneficiaries when using transferable letters of credit is that the transferee will learn the identity of the applicant (or vice-versa), and the next time the applicant will deal directly with the transferee, thus cutting out the middleman. While there are ways in which the documentation Financial and commercial documents such as drafts, commercial invoices, packing lists, bills of lading, insurance certificates, etc. In Letter of Credit transactions, banks deal with documents alone and are not involved in underlying sales agreements. commercial documents Documents, such as commercial invoices, certificates of origin, packing lists, bills of lading, etc., usually covering a merchandise transaction. such as drafts, commercial invoices, packing lists, bills of lading, insurance certificates, etc. In Letter of Credit transactions, banks deal with documents alone and are not involved in underlying sales agreements. commercial document Documents, such as commercial invoices, certificates of origin, packing lists, bills of lading, etc., usually covering a merchandise transaction. s such as drafts, commercial invoices, packing lists, bills of lading, insurance certificates, etc. In Letter of Credit transactions, banks deal with documents alone and are not involved in underlying sales agreements. may hide the identity of the transferee from the applicant, there is no guarantee that this information will not become apparent from other sources such as markings on packages. For these reasons, it is advisable for "middleman" beneficiaries to consider having an attorney draw up a document that requires the applicant to buy through them.
Combination Types
Letters of credit are made up of a combination of types. For example: (1) Unconfirmed, sight, irrevocable, negotiable letter of credit; (2) Confirmed, irrevocable, straight, sight letter of credit; (3) Irrevocable, straight, usance draft, unconfirmed letter of credit. Therefore, it is important for a buyer and seller to agree on the appropriate combination of types for the transaction, including any special clauses that are necessary.
Parties Individuals involved in a sales transaction. In domestic sales: seller and buyer. In international sales: exporter and importer. In shipping: shipper and consignee. In letters of credit: beneficiary (seller) and applicant (buyer). consignee An individual or company to whom cargo is shipped or consigned. . In letters of credit: beneficiary (seller) and applicant (buyer). consigne An individual or company to whom cargo is shipped or consigned. e. In letters of credit: beneficiary (seller) and applicant (buyer). to Letters of Credit:
The parties to a letter of credit are defined as follows:
Beneficiary - The seller of goods or services to whom the letter of credit is addressed. The party entitled to its benefits.
Applicant or Account Party - The buyer of goods or services who requested the letter of credit to be issued.
Issuing Bank - The primary fmancial institution that initiated and wrote the letter of credit extending their guarantee and liability to pay if the terms and conditions are fulfilled.
Advising Bank - The bank, usually in the beneficiary's country, whose primary job is to pass on the letter of credit to the beneficiary. The advising bank The bank that receives a letter of credit issued by the applicant's bank (the issuing bank) and forwards it to the beneficiary without assuming any responsibility or liability other than to verify the authenticity of the letter of credit. is principally a correspondent bank of the issuing bank which means that the two parties have exchanged authenticating procedures, and may have also established accounts with each other. An important part of passing on a letter of credit to a beneficiary is verifying its authenticity. When the advising bank The bank that receives a letter of credit issued by the applicant's bank (the issuing bank) and forwards it to the beneficiary without assuming any responsibility or liability other than to verify the authenticity of the letter of credit. authenticates the credit, they are saying it is a genuine instrument from the named issuing bank. They are not commenting on the creditworthiness of the bank or its country. This procedure gives the seller some protection against fraudulent instruments. That is why it is common practice to have letters of credit advised to a seller through a correspondent bank. The advising bank may receive the letter of credit by mail, telex, cable, or S.W.I.F.T.
Drawee Bank - The bank named in the credit as duly authorized to make payment. Drafts are drawn or documents are presented to this bank, unless otherwise specified.
Confirming Bank - A separate financial institution requested by the issuing bank to add their guarantee of payment or acceptance to the credit instrument. It is necessary for this bank to establish a credit line Credit that will be or has been granted up to a specific amount usually for a given period of time, as in the case of a bank line of credit. or facility for the issuing bank in order to agree with this request. The confirming bank is usually but not necessarily the advising or drawee bank. The beneficiary cannot request on its own for a bank to confirm a letter of credit. The request must come through the issuing bank. Therefore, a seller should ask the buyer to authorize the issuing bank to request confirmation The court order which makes the Plan of Reorganization binding in a Chapter 11, 12 or 13 bankruptcy case. Chapter 11 A process set forth by the Bankruptcy Code that allows a debtor to operate the business as a 'debtor in possession" with the protection of the "automatic stay." , 12 or 13 bankruptcy (See Insolvency.) case. bankruptc (See Insolvency Under the Balance Sheet definition of insolvent in the U.S. Bankruptcy Code, a debtor is insolvent when the value of a debtor's assets is exceeded by the debtor's liabilities. Balance Shee A financial statement listing the assets, liabilities and owner's equity of a business entity as of a specific date. t definition of insolvent in the U.S. Bankruptcy Code, a debto or business entity that owes money. r is insolvent when the value of a debtor or business entity that owes money. 's assets is exceeded by the debtor's liabilities. .) y case. .
Reimbursing Bank - Sometimes the issuing bank names a bank where it keeps funds in the currency of the letter of credit to pay drawee or negotiating banks on its behalf. This bank is known as a reimbursing bank, and is usually named under the special instructions portion of the letter of credit.
Negotiating Bank - A bank either nominated by the beneficiary under a freely negotiable letter of credit or designated as a restricted negotiating bank by the issuing bank. Allows more flexibility in making payment, and enables beneficiaries to present documents for payment to their local international bank.
When a buyer wishes to acquire goods or services from a seller, the buyer can request his or her bank to issue a letter of credit A financing instrument issued by a bank in favor of an exporter that substitutes the bank's creditworthiness for that of the importer. (also called a documentary credit). A letter of credit is a written document issued by the buyer's (or importer's) bank and addressed to a seller (or exporter The person or company that sells or arranges to transport goods out of a country. ). It specifies the terms and conditions under which the seller, or "beneficiary The person or company due payment in the letter of credit. Usually the exporter (seller). ," will be paid for merchandise or services.
The letter of credit guarantees payment to the seller through the seller's bank when the seller, through his or her bank, presents certain documents to the buyer's bank. The letter of credit specifies where and what documents the seller must present, the amount of money A medium of exchange; coined or stamped currency. available, and the latest date for presenting the documents. The documents may vary, but their purpose is to assure that the goods have been "sold" and are on their way to the buyer.
They usually include the following:
Invoice Document which shows the terms of a sale. Includes a full description of the goods, sale price, charges, and discounts.
Bill of Lading (from the shipper Indemnity given by the beneficiary of a letter of credit to the negotiating bank to induce payment despite any discrepancies that may exist in the documents. Compensation paid for damage or loss sustained or anticipated. given by the beneficiary of a letter of credit to the negotiating bank to induce payment despite any discrepancies that may exist in the documents. )
Certificate of Origin
Insurance documents
Export Certificate
Transfer of Ownership
The letter of credit agrees to make payment in a specified manner if the seller complies with its terms and conditions in accordance with the International Chamber of Commerce rules governing letters of credit. These rules are known officially as The Uniform Customs National government authorities that control imports, inspect imports, and collect duties levied on both imports and exports and Practice for Documentary Credits (ICC The International Chamber of Commerce. Publishes rules governing the preparation and usage of letters of credit. (See also UCP 500.) Publication 500). The current version is referred to as "UCP 500 Uniform Customs and Practices for Documentary Credit of the International Chamber of Commerce, Publication 500. These are rules for managing letters of credit. " and went into effect January 1, 1994.
The letter of credit procedure The actual working steps that should be followed in the appropriate order to accomplish the desired credit result or decision. substitutes the creditworthiness of a bank for that of the buyer. It assures a seller that if he or she complies with the letter of credit, the bank will pay regardless of the wishes or financial ability of the buyer. In this manner, the seller is assured payment by an assumed reputable third-party financial institution.
Format
The format for a letter of credit has been specified within the Federal Register of the United States by the Department of the Treasury. It is related under the Comptroller of the Currency Interpretive Rulings, May 5, 1977, Section 7.7016, Letters of Credit as follows:
"A national bank may issue letters of credit permissible under the Uniform Commercial Code or the Uniform Customs and Practice for Documentary Credits to or on behalf of its customers. As a matter of sound banking practice, letters of credit should be issued in conformity with the following: (a) Each letter of credit should conspicuously entitled as such; (b) the bank's undertaking should contain a specified expiration date The last date upon which the presentation of documents may occur under a letter of credit under UCP rules. or be for a definite term; (c) the bank's undertaking should be limited in amount; (d) the bank's obligation to pay should arise only upon the presentation The beneficiary delivers the documents to the advising bank to negotiate on the seller's behalf. of a draft A negotiable instrument that calls for payment of money. The drawer (or seller) orders in writing for the drawee (or buyer) to pay a specific amount of money to the drawer on a certain date. Also called a bill of exchange. bill of exchange (See Draft.) . bill of exchang (See Draft.) e. or other documents as specified in the letter of credit, and the bank must not be called upon to determine questions of fact or law at issue between the account party Party for whom a letter of credit is opened. "Account party" and "applicant" are generally synonymous, but sometimes one party will agree with the issuing bank to make all payments under a letter of credit showing the name of another party (often two affiliated companies). Banks may refer to one of these parties as the applicant and the other as the account party, but there is no consistency among banks regarding which is which. and the beneficiary; (e) the bank's customer should have an unqualified obligation to reimburse the bank for payments made under the letter of credit."
The format stated above for United States Banks is generally followed throughout the world.
Types of Letters of Credit:
Merchandise/Commercial
The majority of letters of credit issued today are in payment for goods in shipment or current services performed. Payment is normally made against a set of documents consisting of commercial invoices, packing, weight, and shipping documents for goods shipped. Payment for services may be against invoices, vouchers, paid bills, or other records of work performed. Letters of credit of this nature are usually referred to as commercial or trade letters of credit.
Standby
Standby letters of credit function like a guarantee To assume liability for the debts or obligations of another in the event of a default. or a bond A promise under seal to pay money; an IOU or promissory not A legal and binding promise by a debtor (the promisor) to pay a certain sum of money to a creditor (the promisee) at a future date, usually with interest at a fixed rate. e issued as evidence of long-term indebtedness. . They are issued to support the payment of obligations based on money loaned or advanced, or upon the occurrence of nonoccurrence of another contingency. They are generally not to be drawn upon by the beneficiary unless a delinquency of some form takes place in a business transaction.
Standby letters of credit issued by United States Banks are subject to Federal Law specifically Regulation H (12 CFR 203). Under Section 208.8 (d) a standby letter of credit is defined as follows:
"Standby letters of credit include every letter of credit (or similar arrangement, however, named or designated) which represents an obligation to the beneficiary on the part of the issuer (1) to repay money borrowed by or advance to or for the account of the account party, (2) to make payment on account of any evidence Testimony of witnesses and facts presented to the court and jury by way of writings and exhibits, which impress the minds of the court and jury, to the extent that an allegation has been proven. of indebtedness undertaken by the account party, or (3) to make payment on account of any default by the account party in the performance of an obligation."
The International Standby Practices 1998 (ISP98) provides separate rules for standby letters of credit.
Irrevocable
An irrevocable letter of credit may not be repealed, annulled, revoked, recalled, canceled, amended, altered, or changed without the express approval of the beneficiary. It constitutes a definite undertaking of the issuing and confirming bank The seller can instruct the buyer to make provisions for a letter of credit to be confirmed. A confirming bank adds its own irrevocable undertaking to that of the issuing bank. , provided the beneficiary absolutely complies with the terms and conditions.
Revocable
A revocable letter of credit is the opposite of an irrevocable credit. It may be repealed, annulled, revoked, recalled, canceled, amended, altered, or changed without prior notice to or approval by the beneficiary. Consequently, the revocable letter of credit is seldom employed as security for business. All letters of credit are deemed irrevocable unless specifically designated otherwise in the credit.
Unconfirmed
An unconfirmed letter of credit means that it bears the undertaking of the issuing bank Also known as the opening bank. It issues its commitment to the seller in the form of a letter of credit. opening bank The account party's bank that issues or opens the credit. . It issues its commitment to the seller in the form of a letter of credit. opening ban The account party's bank that issues or opens the credit. k. It issues its commitment to the seller in the form of a letter of credit. alone. When the beneficiary meets the credit's terms and conditions, then the issuing bank is assuring payment of funds by itself to a beneficiary directly or through a collecting, drawee The person, company, or bank upon which a draft is drawn. , or negotiating bank. The beneficiary should therefore look to the creditworthiness of only the issuing bank and not an intermediary's bank.
Confirmed
A confirmed letter of credit is a credit where a second undertaking is added to the letter of credit by another bank. Therefore, the beneficiary may look additionally to the creditworthiness of the confirming bank for payment assurance. The issuing bank is primarily guaranteeing payment; however, if payment complications arise from the issuing bank, then the second guaranteeing bank (confirming bank) is responsible for making payment if the terms and conditions have been met.
The beneficiary who has requested a confirmed letter of credit should note who is doing the confirming, and whether it is actually a second financial institution. For example, if the issuing bank states: "We confirm this letter of credit," it is meaningless, as you cannot confirm your own instrument A right to the payment of money such as agency notes, commercial pape The unsecured promissory notes of large, financially sound corporations. r, T-Bills, certificates of deposit (CD's), banker's acceptances and repurchase agreements. . As such, there is only one guarantee for the credit. For all intents and purposes, beneficiaries usually present their documents to the confirming bank, and regard them as the primary source of payment.
Straight
Straight letters of credit are those credits where a beneficiary must present documents to a named drawee bank. Payment will only be made at that bank and the letter will expire for presentation of documents at their counters. Documents may not be negotiated by an intermediary bank or purchased for value. An interposing bank may not be a holder in due course One who has acquired possession of a negotiable instrument through proper negotiation for value, in good fait Honesty in fact in the conduct or transaction concerned. h, and without notice of any defenses to it. . The engagement to pay is made only (or straight) to the beneficiary of the letter of credit and does not extend to any other party.
Negotiable Quality belonging to a document to transfer ownership of money, goods, or other items of value specified in the document by endorsement and/or delivery of the document. endorsement Writing one's name upon paper for the purpose of transferring the title. and/or delivery of the document.
For a negotiable letter of credit, an intermediary bank may be employed between the beneficiary and the drawee or issuing bank for the purpose of taking documents in charge (negotiating them) within the expiration date of the letter of credit. Under a straight letter of credit, the letter of credit expires at the counters of the drawee or issuing bank. Under a negotiable type, the letter of credit may expire at the counters of a negotiating bank. In addition, the letter of credit engagement extends not only to the beneficiary (drawer The person, company, or bank that creates the draft and receives payment. ) but also to bona fide ("bone-a-fide") In good faith. holders. Consequently, a negotiating bank has the protection of a holder in due course.
Sight
Letters of credit may be payable at sight A term used in the body of drafts/bills of exchange indicating that payment is due upon presentation or demand. , which means that if the drafts and documents are in order, they are honored by making payment without delay. The only delays may result from collecting funds through a reimbursing bank In a letter of credit transaction, the bank with which the issuing bank maintains an account and which is authorized by the issuing bank to charge that account to pay claims received from the negotiating bank for documents that have been presented. .
Usance
If a letter of credit calls for usance (time) draft payments, then the draft is honored by accepting it for payment in the future. Thus, payment would be delayed until the maturity of the draft plus any delay in the transmittal of funds. However, special attention should be given to special instructions that might grant A term used in deeds for the transfer of the title to real propert Land with all its buildings and legal interests. y payment before maturity, such as discount charges for buyer's account.
Deferred Payment
A deferred payment letter of credit is one in which the beneficiary will present documents to a paying bank The bank named in the letter of credit to make payment to the seller or the negotiating bank upon presentation of the proper documentation. . If the paying bank finds the documents in order, the bank will acknowledge receipt and undertake to remit payment at a future date. This undertaking has the full commitment of the paying bank, similar to the acceptance When a drawee acknowledges in writing on the face of the draft that the buyer will pay the draft at maturity. (See also Draft, Drawee.) When a drawee acknowledges in writing on the face of the draft that the buyer will pay the draft at maturity. of a time draft. The only difference is that the advantage of a negotiable instrument is not present, and therefore the beneficiary cannot obtain payment prior to the future date (discounting is not possible). The buyer actually does not save any costs for a deferred payment Payment scheduled for a set period of time after shipment or presentation of shipping documents, as opposed to immediately or "at sight." credit. He or she is charged a deferred payment commission as opposed to an acceptance commission.
Deferred Documents
A deferred document is different from a deferred payment credit in two ways. First, deferred payment documents are presented right away for examination and approval, but under a deferred document credit, document presentation is delayed by the beneficiary for a specified period of time. Second, an undertaking to pay certification is transmitted to the beneficiary for his or her security under deferred payment. However, this does not take place with deferred documents. Thus, the beneficiary has only the contingent liability Potential obligation that will materialize only if certain events occur in the future (e.g., a parent guaranteeing the debts of a subsidiar A company, usually a corporation, that is controlled by a parent company. y). of payment if documents are in order. This is fine if documents are in order, but control of merchandise complications could arise if documents are rejected. Under deferred payment, if documents were rejected, the beneficiary could possibly have kept cargo from the buyer due to the current shipment. Conversely, under deferred documents, documents were presented after shipment and the cargo is lodged with the buyer.
Transferable
A transferable credit is a credit wherein the beneficiary may request the bank entitled to make negotiation The transfer of a negotiable instrument in such form that the transferee becomes a holder. , acceptance, or payment to convey his or her rights under the credit to another company. This may be a complete conveyance called a "transfer in the whole," or a conveyance within limitations called a "partial transfer." Transferable credits are used for a variety of reasons, such as: transferring control from a purchasing or selling agent to a third party vendor The seller of property or goods. , dividing up a letter of credit from a contractor to several suppliers, and providing the first beneficiary with the ability to offer letter of credit protection to a vendor without having to ask their bank to issue a brand new letter of credit.
The credit can be transferred only on the terms and conditions of the original credit with the exception of:
The amount of the credit
Any unit price stated therein
The expiry date (may be shortened but not extended)
The last date for presentation of documents in accordance with UCP 500, article 43
The period for shipment
Any of the above may be reduced or curtailed
The percentage for which insurance cover must be given may be increased in such a way as to provide the amount of cover stipulated in the original credit. For example, if the original credit were for $100,000 and it called for insurance for 110% of CIF Cost, insurance and freight. Shipping terms under which the seller pays all expenses involved in placing merchandise on board the carrier and prepays the freight and insures the goods to an agreed-upon destination. Shipping terms That part of a contract of sale that specifies who, between the buyer and the seller, is responsible for each aspect of shipping the goods. under which the seller pays all expenses involved in placing merchandise on board the carrier and prepays the freight and insures the goods to an agreed-upon destination. Shipping term That part of a contract of sale that specifies who, between the buyer and the seller, is responsible for each aspect of shipping the goods. s under which the seller pays all expenses involved in placing merchandise on board the carrier and prepays the freight and insures the goods to an agreed-upon destination. value, then the policy would have to be for $110,000. When the transfer was made (assume a transfer of $90,000) the transferring bank would stipulate that insurance should be in the amount of $110,000 and not 110% of the (reduced amount) invoice value. To do otherwise would run the risk Conditions in which the decision maker has to estimate the likelihood of certain outcomes. of the transferee The party to which the rights under a transferable letter of credit are transferred. submitting an insurance policy for $99,000 (110% of $90,000) which would thus cause the goods to be under-insured.
In addition, the name of the first beneficiary must be substituted for that of the applicant The party (generally buyer/importer) for whose account a letter of credit is established. . However if the name of the applicant is specifically required by the original credit to appear in any document other than the invoice, then such requirement must be fulfilled.
The major concern of first beneficiaries when using transferable letters of credit is that the transferee will learn the identity of the applicant (or vice-versa), and the next time the applicant will deal directly with the transferee, thus cutting out the middleman. While there are ways in which the documentation Financial and commercial documents such as drafts, commercial invoices, packing lists, bills of lading, insurance certificates, etc. In Letter of Credit transactions, banks deal with documents alone and are not involved in underlying sales agreements. commercial documents Documents, such as commercial invoices, certificates of origin, packing lists, bills of lading, etc., usually covering a merchandise transaction. such as drafts, commercial invoices, packing lists, bills of lading, insurance certificates, etc. In Letter of Credit transactions, banks deal with documents alone and are not involved in underlying sales agreements. commercial document Documents, such as commercial invoices, certificates of origin, packing lists, bills of lading, etc., usually covering a merchandise transaction. s such as drafts, commercial invoices, packing lists, bills of lading, insurance certificates, etc. In Letter of Credit transactions, banks deal with documents alone and are not involved in underlying sales agreements. may hide the identity of the transferee from the applicant, there is no guarantee that this information will not become apparent from other sources such as markings on packages. For these reasons, it is advisable for "middleman" beneficiaries to consider having an attorney draw up a document that requires the applicant to buy through them.
Combination Types
Letters of credit are made up of a combination of types. For example: (1) Unconfirmed, sight, irrevocable, negotiable letter of credit; (2) Confirmed, irrevocable, straight, sight letter of credit; (3) Irrevocable, straight, usance draft, unconfirmed letter of credit. Therefore, it is important for a buyer and seller to agree on the appropriate combination of types for the transaction, including any special clauses that are necessary.
Parties Individuals involved in a sales transaction. In domestic sales: seller and buyer. In international sales: exporter and importer. In shipping: shipper and consignee. In letters of credit: beneficiary (seller) and applicant (buyer). consignee An individual or company to whom cargo is shipped or consigned. . In letters of credit: beneficiary (seller) and applicant (buyer). consigne An individual or company to whom cargo is shipped or consigned. e. In letters of credit: beneficiary (seller) and applicant (buyer). to Letters of Credit:
The parties to a letter of credit are defined as follows:
Beneficiary - The seller of goods or services to whom the letter of credit is addressed. The party entitled to its benefits.
Applicant or Account Party - The buyer of goods or services who requested the letter of credit to be issued.
Issuing Bank - The primary fmancial institution that initiated and wrote the letter of credit extending their guarantee and liability to pay if the terms and conditions are fulfilled.
Advising Bank - The bank, usually in the beneficiary's country, whose primary job is to pass on the letter of credit to the beneficiary. The advising bank The bank that receives a letter of credit issued by the applicant's bank (the issuing bank) and forwards it to the beneficiary without assuming any responsibility or liability other than to verify the authenticity of the letter of credit. is principally a correspondent bank of the issuing bank which means that the two parties have exchanged authenticating procedures, and may have also established accounts with each other. An important part of passing on a letter of credit to a beneficiary is verifying its authenticity. When the advising bank The bank that receives a letter of credit issued by the applicant's bank (the issuing bank) and forwards it to the beneficiary without assuming any responsibility or liability other than to verify the authenticity of the letter of credit. authenticates the credit, they are saying it is a genuine instrument from the named issuing bank. They are not commenting on the creditworthiness of the bank or its country. This procedure gives the seller some protection against fraudulent instruments. That is why it is common practice to have letters of credit advised to a seller through a correspondent bank. The advising bank may receive the letter of credit by mail, telex, cable, or S.W.I.F.T.
Drawee Bank - The bank named in the credit as duly authorized to make payment. Drafts are drawn or documents are presented to this bank, unless otherwise specified.
Confirming Bank - A separate financial institution requested by the issuing bank to add their guarantee of payment or acceptance to the credit instrument. It is necessary for this bank to establish a credit line Credit that will be or has been granted up to a specific amount usually for a given period of time, as in the case of a bank line of credit. or facility for the issuing bank in order to agree with this request. The confirming bank is usually but not necessarily the advising or drawee bank. The beneficiary cannot request on its own for a bank to confirm a letter of credit. The request must come through the issuing bank. Therefore, a seller should ask the buyer to authorize the issuing bank to request confirmation The court order which makes the Plan of Reorganization binding in a Chapter 11, 12 or 13 bankruptcy case. Chapter 11 A process set forth by the Bankruptcy Code that allows a debtor to operate the business as a 'debtor in possession" with the protection of the "automatic stay." , 12 or 13 bankruptcy (See Insolvency.) case. bankruptc (See Insolvency Under the Balance Sheet definition of insolvent in the U.S. Bankruptcy Code, a debtor is insolvent when the value of a debtor's assets is exceeded by the debtor's liabilities. Balance Shee A financial statement listing the assets, liabilities and owner's equity of a business entity as of a specific date. t definition of insolvent in the U.S. Bankruptcy Code, a debto or business entity that owes money. r is insolvent when the value of a debtor or business entity that owes money. 's assets is exceeded by the debtor's liabilities. .) y case. .
Reimbursing Bank - Sometimes the issuing bank names a bank where it keeps funds in the currency of the letter of credit to pay drawee or negotiating banks on its behalf. This bank is known as a reimbursing bank, and is usually named under the special instructions portion of the letter of credit.
Negotiating Bank - A bank either nominated by the beneficiary under a freely negotiable letter of credit or designated as a restricted negotiating bank by the issuing bank. Allows more flexibility in making payment, and enables beneficiaries to present documents for payment to their local international bank.
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