Help file: types of Letter of credits

8/14/2019 Help file: types of Letter of credits

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CONTENTS OF LETTER OF CREDIT

1. Name and Complete address of opening bank, with other contacts etc.

2. Test Code.

3. Number of Letter of Credit.

4. Date of issue of Letter of Credit.

5. Sequence of Total (Number of L/Cs being transmitted)

6. Form of documentary credit. Revocable or

Irrevocable.

7. Applicable rules. Latest UCP

8. Date and place of expiry.

9. Applicants Name and Complete address.

10.Beneficiarys Name and Complete Address.

11.Currency Code and amount. EUR 50000

12.Bill of Exchange. Sight or Usance.13.Drawee of Bill of Exchange. Habib Bank Ltd.

14.Partial Shipment. Allowed/Not

Allowed.

15.Transshipment. Allowed/Not

Allowed

16.Port of loading/ dispatch. London

17.Port of destination. Karachi.

18.Latest Date of Shipment. Not after that date.

19.Complete Description of Goods.20.Documents Required.

a) Signed Commercial Invoice in Octuplicate, not exceeding the

amount of credit made out in the name of opener and certifying

merchandise of German origin.

b) Insurance Covered by opener, all shipment under this credit

must be advised by you immediately after shipment direct to

M/s Adamjee Insurance Company, 49-Hadi Road, Lahore,

Pakistan and applicant, referring to their Cover Note #

ADM/HBL/GM/2523/07 giving full detail of shipment. A copy

of this advice must accompany with full set of documents.c) Full set of Clean Shipped on Board Bill of Lading, drawn or

endorsed in the favour of Habib Bank Ltd, Showing Freight

Pre-Paid.

d) Weight and packing list required in duplicate.

e) Certificate of origin in duplicate, certifying goods to be of

German Origin.


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Additional Conditions.

1. Shipping documents must evidence shipment according

to the terms of L/C

2. Stale, Claused, Blank Back Bill of Lading not

acceptable. Bill of Lading prior to the date of this L/C

not accepted. Shipment/Transshipment on Israeli Flag,

Vessel not allowed.

3. Goods are imported under L/C Number

GM/0299/1355/07 H.S. Code Number 0801.1990

which should appear on Bill of Lading, Invoices,

Packing List and Certificate of Origin.

WE HEREBY ENGAGE WITH THE DRAWER AND / ORBONAFIDE HOLDER THAT DRAFT DRAWN AND

NEGOTIATED IN CONFORMITY WITH TERMS OF THIS

CREDIT WILL BE DULY HONOURED.

CHARGES. All charges outside Pakistan i.e. Advising, Negotiating

are on account of beneficiary.

REIMBURSEMENT INSTRUCTIONS. We authorize you to debit

our Nostro Account being maintained with you, if all the terms and

conditions of this letter of credit have been complied, and you would

certify it on the covering schedule of documents to be sent by you.

DOCUMENTS IN INTERNATIONAL TRADE

financial documents

Transport documents.

Commercial documents.

FINANCIAL DOCUMENTS Bill of exchange.

Both sight and usance.


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TRANSPORT DOCUMENTS Bill of lading.

Airway bill / air consignment note.

Railway receipt. Truck receipt.

Post parcel receipt

COMMERCIAL DOCUMENTS Commercial invoice.

Weight / packing list.

Inspection certificate.

insurance policy

Insurance cover note. Certificate of origin.

TYPES OF L/C Revocable.

Irrevocable.

irrevocable confirmed

TYPES OF L/C

Red claused.

Green claused.

REVOCABLE It can be cancelled any time by any party just by information or not

implementing on expiry.

this letter of credit is practically not operative

IRREVOCABLE It cannot be cancelled unless all the parties involved in letter of credit

agree to it.

All parties means: - opener, opening bank, advising bank, negotiating

bank and beneficiary.

IRREVOCABLE CONFIRMED


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This letter of credit must be confirmed by any bank at the choice of

beneficiary, it should be a negotiation bank.

This confirmation further provides guarantee to seller about getting

the value of goods

RED CLAUSED Through this letter of credit, opening bank requests the

advising/negotiation bank to provide funds to the beneficiary in

advance.

This amount is adjusted at the time of negotiation.

GREEN CLAUSED Through this letter of credit, opening bank requests the

advising/negotiation bank not only to provide funds in advance, butalso storage and transportation facility.

DOCUMENTS IN INTERNATIONAL TRADE Financial documents

Transport documents.

Commercial documents.

FINANCIAL DOCUMENTS

Bill of exchange. Both sight and usance.

BILL OF EXCHANGE It is an instrument in writing, signed by a maker, containing an un

conditional order, directing a certain person to pay a certain sum of

money to or to the order of certain person on demand or future

determinable period.

It must be in writing.

It must signed by its maker.

It must be addressed to a certain person.

The instructions must be to pay certain sum of money only.

Money must be payable to a certain person.

Money could be paid on demand or at future fixed or determinable

period.


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There are three parties in it.

The person who draws it is drawer.

The person to whom it is being addressed is drawee.

The person whom payment is to be made is payee.

It could be sight/on demand or on usance basis. On sight or demand money is paid or refused on demand.

On usance basis money is payable at future period.

On usance basis, bill must be accepted first, before it is presented for

payment on maturity.

BILL OF EXCHANGE

Specimen (sight)March 10, 2007. Rs. 100,000.

Please pay on demand rs.100, 000/- (Rs. one hundred thousand) to MR.DAWOOD or order

To.

MR. ZAHID.

42-THE MALL, MANSOOR

Lahore. (Signature)

SPECIMEN (USANCE)MARCH 10, 2007. Rs. 100,000.

Please pay after 90 days rs.100, 000/- (Rs. one hundred thousand) to MR.DAWOOD OR ORDER

TO.

MR. ZAHID. MANSOOR

42-THE MALL, 33-HALL ROAD

LAHORE LAHORE

(SIGNATURE)

Cheque is bill of exchange drawn on a specified banker, and is always

payable on demand. Account holder who writes cheque is drawer, bank is drawee and

person receiving money is payee.

CHEQUEUNITED BANK LTD

DATE : 10. 03.2007.


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PAY MR. SAEED AHMED_____________ OR BEARER

RUPEES TEN THOUSAND ONLY

(SIGNATURE)

TRANSPORT DOCUMENTS Bill of lading.

Airway bill / air consignment note.

Railway receipt.

Truck receipt.

Post parcel receipt.

BILL OF LADING When goods are dispatched by ship, the captain of the ship /or the

agent of shipping company issues an instrument under seal and

signature against the goods received. It is bill of lading.

Its CONTENTS ARE Name of shipping company.

Date.

Name of vessel.

Port of shipment.

Port of destination.

Name of merchandise.

Number of packages.

Wight of merchandize.

Amount of freight paid or payable. If terms are F.O.B. then fright to pay

If terms are C&F, the freight pre-paid

Number of sets set of 3, set of 4 or set of 5

REPORTED TO CONTAIN

Rs. 10,000


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COMMERCIAL DOCUMENTS Commercial invoice.

Weight / packing list.

Inspection certificate.

Insurance policy Insurance cover note.

Certificate of origin.

USANCE BILL OF EXCHANGE

Bill of exchange if drawn on usance basis, its payment is made not on demand

but on FUTURE FIXED or FUTURE DETERMINABLE PERIOD

The Bill is drawn in two manners.

Payable after 90 days/03 months from the date of bill of exchange.

Payable after 90 days/03 months after the date of bill of exchange.

These two instances are relating to FUTURE FIXED its date of maturity has

been fixed by the drawer, and is known to all the three parties. Reason being

that the maturity is based on the date of Bill, and the drawer knows it and

drawee will come to know on presentation of Bill, and its maturity date wouldnever be changed, since the date of bill cannot be changed, so it is FUTURE

FIXED

Payable after 90 days/03 months sight/acceptance.

This instance pertains to FUTURE DETERMINABLE PERIOD as it

requires that first Bill will be presented to the drawee and he would accepts it

by writing ACCEPTED and putting his signature and date on it. Its maturity

would be calculated from the date of acceptance of bill and not from the date of

bill. Hence it could be any date depending upon the date of acceptance. Thisbill is termed as based on FUTURE DETERMINABLE PERIOD

In all the above stated cases, where Negotiable Instrument Act is applicable 03

days grace period is allowed while calculating date of maturity, and it is not

necessary that it should be mentioned on the Bill.


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Exercise.

Calculate the dates of maturity of the following Bills Of Exchange.

1. Date of Bill is January 29, 2007, and is payable 120 days from the date

of Bill.

2. Date of Bill is February 28, 2007, and is payable 120 days after the date

of Bill.

3. Date of Bill is March 01, 2007, and is payable 90 days from the date of

Bill.

4. Date of Bill is March 30 29, 2007, and is payable 60 days from the date

of Bill.

(2)

5. Date of Bill is January 15, 2007, and is payable 180 days after the date

of Bill.

6. Date of Bill is January 01, 2007, and is payable 120 days from the date

of Bill.

7. Date of Bill is January 29, 2007, and is payable 03 months from the date

of Bill.

8. Date of Bill is January 29, 2007, and is payable 01 month from the date

of Bill.

9. Date of Bill is November 30 2006, and is payable 04 months from the

date of Bill.

10.Date of Bill is December 31, 2007, and is payable 03 from the date ofBill.

11.Date of Bill is February 28, 2007, it was accepted on March 08, 2007,

and is payable 04 months from the date of acceptance.


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12.Date of Bill is November 30, 2006, it was accepted on December 05,

2007, and is payable 04 months from the date Bill.

13.Date of Bill is February 28, 2007, it was accepted on March 08, 2007,


14.Date of Bill is January 01, 2007, it was accepted on February 10, 2007,


15.Date of Bill is December 31, 2006, it was accepted on January 05, 2007,

and is payable 05 months from the date Bill

TRANSPORT DOCUMENTS

BILL OF LADING.

AIRWAY BILL / AIR CONSIGNMENT NOTE.

RAILWAY RECEIPT.

TRUCK RECEIPT.

POST PARCEL RECEIPT.

BILL OF LADING

WHEN GOODS ARE DISPATCHED BY SHIP, THE CAPTAIN OF THE

SHIP /OR THE AGENT OF SHIPPING COMPANY ISSUES ANINSTRUMENT UNDER SEAL AND SIGNATURE AGAINST THE GOODS

RECEIVED. IT IS BILL OF LADING.

ITS CONTENTS ARE

NAME OF SHIPPING COMPANY.

DATE.

NAME OF VESSEL.PORT OF SHIPMENT.

PORT OF DESTINATION.

NAME OF MERCHANDISE.NUMBER OF PACKAGES.

ITS CONTENTS AREWIGHT OF MERCHANDIZE.AMOUNT OF FREIGHT PAID OR PAYABLE.

IF TERMS ARE F.O.B. THEN FRIGHT TO PAY

IF TERMS ARE C&F, THE FREIGHT PRE-PAIDNUMBER OF SETS SET OF 3, SET OF 4 OR SET OF 5

REPORTED TO CONTAIN


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TYPES OF BILL OF LADING

RECEIVED FOR SHIPMENT.

SHIPPED ON BOARD.

STALE BILL OF LADING.

CONTAINER BILL OF LADING. TRANSHIPMENT B/L.

THROUGH B/L.

DIRTY,FOUL,CLAUSED B/L.

CHARTER PARTY B/L

CLEAN SHIPPED ON BOARD B/L.

RECEIVED FOR SHIPMENT

THIS B/L IS ISSUED BY THE AGENT OF CARRIER, AND SREVES THEPURPOSE OF RECEIPT OF GOODS ONLY. LATER ON WHEN GOODS

ARE SHIPPED ON BOARD IT IS SUBSTITUTED WITH ORIGINAL B/L.

ITS NEED ARISES WHEN SELLER IS AWAY FROM THE CITY OF SEAPORT.

SHIPPED ON BOARD

IT IS ISSUED AFTER THE GOODS HAVE BEEN PYSICALLY LOADED ON

THE BOARD OF SHIP. THE IS THE SAFEST ONE AND BEARS THE DATE

OF LOADING. IT IS THE MOST DESIRED FOR THE BUYERS POINT OFVIEW.

TRANSHIPMENT B/L

WHEN MORE THAN ONE VESSEL IS INVOLVED FROM PORT OF

SHIPMENT TO THE PORT OF DESTINATION, THEN THIS TYPE OF B/L ISISSUED. THERE CAN BE NORE THAN ONE BILLS OF LADING. IT CAN

BE ISSUED IF L/C PERMITS FOR ACCEPTANCE OF SUCH BILL.

THROUGH BILL OF LADING

WHEN MORE THAN ONE MODE OF TRANSPORTATION IS INVOLVED, LIKE:-

VESSEL, TRAIN AIRCRAFT, THEN THIS TYPE OF BILL OF LADING IS ISSUED.

DIRTY, FOUL, CLAUSED B/L

IN CASE A BILL OF LADING SHOWS THE DEFECTIVE CONDITION OF

GOODS OR LOOSE AND NOT SEA WORTHY PACKING, THEN THE

CARRIER SPECIFICALLY STATE THIS CONDITION ON BILL OFLADING. IT IS NOT ACCEPTED BY NEGOTIATION BANK.


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IF PERISHABLES ARE NOT PROPERLY PROTECTED FOR BEING

PERISHED, IN CASE OF LIQUID ITEM, DRUMS/CONTAINERS ARELEAKING OR FRAGILE ITEMS ARE NOT SUITABLY PACKED.THEN

THIS CONDITION IS STATED IN A SEPARATE CLAUSE.

CHARTER PARTY B/L

WHEN SHIPPER NEEDS THE ENTIRE VESSEL FOR THE DISPATCHED

OF MERCHANDISE OR THE ENTIRE CAPACITY OF SHIP IS MADEAVAILABLE TO THE SHIPPER, THIS FORM OF BILL OF LADING IS

ISSUED.

CLEAN SHIPPED ON BOARD B/L

THIS ONE IS THE COMMON AND MOSTLY DESIRED BY THE BUYER, AS IT IS

SAFE FROM ANY OUTSIDE ACCIDENTS, AND IS FREE FROM ANY DEFECT OFGOODS OR PACKAGING

COMMERCIAL DOCUMENTS

COMMERCIAL INVOICE.

WEIGHT / PACKING LIST.

INSPECTION CERTIFICATE.

INSURANCE POLICY

INSURANCE COVER NOTE.

CERTIFICATE OF ORIGIN

CERTIFICATE OF ORIGIN

IT SHOWS THE NAME OF THE COUNTRY, WHERE THE GOODS AREORIGINALLY MANUFACTURED OR PRODUCED. THIS CERTIFICATE IS

REQUIRED FOR THE PUPOSE OF QUOTA OR TO AVOID IMPORTS

FROM BLACK LISTED PRODUCERS/COUNTRIES. (CONTD)

SOME COUNTRIES ARE SUBJECT TO SANCTIONS FROM UNO, ANDSOME ARAB/MUSLIM COUNTRIES HAVE BANNED ANY TRADE FROM

ISRAEL, SO TO AVOID TRADE FROM SUCH COUNTRIES THIS

CERTIFICATE PROVIDES EVIDENCE.

SIMPLE CERTIFICATE

IT SHOWS THE NAME OF PARTICULAR COUNTRY ONLY. (IT IS NOT AT ALL

NECESSARY THAT THE GOODS MUST BE OF THE COUNTRYOF ORIGIN FROM WHERE THOSE ARE SHIPPED)

NEGATIVE CERTIFICATE


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IN THIS CERTIFICATE, IT INDICATES THAT GOODS ARE NOT OF SO AND SO

COUNTRYS ORIGIN, WHERE AS IN SIMPLE CERTIFICATE IS IS WRITTEN

THAT THE GOODS ARE OF SO AND SOCOUNTRY ORIGIN

THIS IS CERTIFY THAT THE GOODS ARE OF PAKISTAN ORIGIN.(SIMPLE CERTIFICATE)

THIS IS CERTIFY THAT GOODS ARE NOT OF ISRAEL ORIGIN.(NEGATIVE CERTIFICATE)

AMENDMENTS IN LETTER OF CREDIT

After establishment of L/C if both seller and buyer agree plus the concerned

banks have no objection, moreover local laws are not violated then there can be

change in the contents of letter of credit or there can be change in the terms of

letter of letter of credit.

This change in the contents and terms of letter of credit is done through a

process known as Amendment in Letter of Credit.

Silent features of amendment are: -

It must be done at written request of Opener/Importer/Buyer and not atthe option of sellers, but it would be considered as amended if Seller

accepts it. Any amendment initiated by the buyer, if not accepted by the

seller would not be considered as void.

It must be done after establishment of L/C and before expiry of L/C

There can be many changes in the contents and terms of letter of credit

through one amendment.

There is no limit of number of amendments in one L/C. It means thatthere can be numerous amendments in one letter of credit.

COMMON TYPES OF AMENDMENTS.

Change of beneficiary.


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Change in the value of letter of credit.

Change in mode of transportation.

Change in the nature and quantity of merchandise.

Extension in the date last date of shipment.

Extension in validity of letter of credit.

From Part Shipment not allowed to allowed and vice versa.

From Transshipment not allowed to allowed and vice versa.

HANDLING OF DISCREPANT DOCUMENTS

If shipment is done against terms of letter of credit, or documents are submitted

not accordance with the terms of letter of credit, then there could be three

options available with the negotiating bank.

1. Negotiation under Indemnity.2. Negotiation under Reserve.

3. Documents to be sent on collection.

MODES OF IMPORTS:-

advance payment

Collection-sight.

Collection-usance.

letter of credit


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ADVANCE PAYMENT : -buyer (exporter) sends payment inadvance by way of swift/instrument, and later on seller (importer)

sends goods. bank has to submit advance payment voucher to SBP

COLLECTION-SIGHT : - merchandize are imported in a waythat after arrival of documents related to imports, importer first makes payment to local banker, gets documents and arranges release of

goods.

COLLECTION-USANCE: - merchandize are imported in a waythat documents related to imported goods are delivered to the

importer, without any payment. Importer gets the goods and makes

payment on future date.

LETTER OF CREDIT : -

This is the most secured and common method of imports. Other than

buyer and seller bankers of both parties act as intermediaries and

undertake to protect interest of both parties.

Letter of credit too can be issued on sight and usance basis. It differs

from imports on collection basis that, under simple collection there is

no protection to seller, in case the importers refuse to pay in future.

On usance basis under letter of credit, the importers bank is bound to

make payment to the banker of exporter on arrival of documents or at

future fixed date, whether even if importer fails to pay.

Payment on arrival of documents.

Payment on future fixed date.

Additional

Letter of Credit

What is a Letter of Credit?


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A Letter of Credit is a payment term generally used for international salestransactions. It is basically a mechanism, which allows importers/buyers to offer

secure terms of payment to exporters/sellers in which a bank (or more than onebank) gets involved. The technical term for Letter of credit is 'Documentary Credit'.

At the very outset one must understand is that Letters of credit deal in documents,not goods. The idea in an international trade transaction is to shift the risk from the

actual buyer to a bank. Thus a LC (as it is commonly referred to) is a paymentundertaking given by a bank to the seller and is issued on behalf of the applicant i.e.the buyer. The Buyer is the Applicant and the Seller is the Beneficiary. The

Bank that issues the LC is referred to as the Issuing Bank which is generally in the

country of the Buyer. The Bank that Advises the LC to the Seller is called theAdvising Bank which is generally in the country of the Seller.

The specified bank makes the payment upon the successful presentation of therequired documents by the seller within the specified time frame. Note that the Bank

scrutinizes the 'documents' and not the 'goods' for making payment. Thus theprocess works both in favor of both the buyer and the seller. The Seller gets assured

that if documents are presented on time and in the way that they have beenrequested on the LC the payment will be made and Buyer on the other hand is

assured that the bank will thoroughly examine these presented documents andensure that they meet the terms and conditions stipulated in the LC.

Typically the documents requested in a Letter of Credit are the following:

Commercial invoice

Transport document such as a Bill of lading or Airway bill,


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Insurance document;

Inspection Certificate

Certificate of Origin

But there could be others too.

Letters of credit (LC) deal in documents, not goods. The LC could be 'irrevocable' or'revocable'. An irrevocable LC cannot be changed unless both the buyer and seller

agree. Whereas in a revocable LC changes to the LC can be made without theconsent of the beneficiary. A 'sight' LC means that payment is made immediately to

the beneficiary/seller/exporter upon presentation of the correct documents in therequired time frame. A 'time' or 'date' LC will specify when payment will be made at

a future date and upon presentation of the required documents.

Essential Principles Governing Law Within the United States, Article 5 of the

Uniform Commercial Code (UCC) governs L/Cs. Article 5 is foundedon two principles: (1) the L/C,s independence from the underlying

business transaction, and (2) strict compliance with documentary

requirements.

1) Strict Compliance

How strict compliance? Some courts insist upon literal compliance, so that a

misspelled name or typographical error voids the exporter's/beneficiary's/seller'sdemand for payment. Other courts require payment upon substantial compliance

with documentary requirements. The bank may insist upon strict compliance with therequirements of the L/C. In the absence of conformity with the L/C, the Seller cannot

force payment and the bank pays at its own risk. Sellers should be careful andremember that the bank may insist upon strict compliance with all documentary

requirements in the LC. If the documents do not conform, the bank should give theseller prompt, detailed notice, specifying all discrepancies and shortfalls.

2) The Independence Doctrine

Letters of credit deal in documents, not goods. L/Cs are purely documentarytransactions, separate and independent from the underlying contract between the

Buyer and the Seller. The bank honoring the L/C is concerned only to see that the

documents conform with the requirements in the L/C. If the documents conform, thebank will pay, and obtain reimbursement from the Buyer/Applicant. The bank need

not look past the documents to examine the underlying sale of merchandise or the

product itself. The letter of credit is independent from the underlying transactionand, except in rare cases of fraud or forgery, the issuing bank must honor

conforming documents. Thus, Sellers are given protections that the issuing bankmust honor its demand for payment (which complies with the terms of the L/C)

regardless of whether the goods conform with the underlying sale contract.

3 Most Common Reasons why Letters of Credit Fail

1) Time Lines:


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The letter of credit should have an expiration date that gives sufficient time to the

seller to get all the tasks specified and the documents required in the LC. If the letterof credit expires, the seller is left with no protection. Most LC s fail because

Sellers/Exporters/Beneficiaries were unable to perform within the specified timeframe in the LC. Three dates are of importance in an LC:

a) The date by when shipment should have occurred. The date on the Bill of Lading.b) The date by when documents have to be presented to the Bankc) The expiry date of the LC itself.

A good source to give you an idea of the timelines would be your freight forwarding

agent. As a seller check with your freight forwarding agent to see if you would be ina position to comply.

2) Discrepancy within the Letter of Credit:

Letters of credit could also have discrepancies. Even a discrepancy as small as a

missing period or comma can render the document invalid. Thus, the earlier in the

process the letter of credit is examined, the more time is available to identify and fixthe problem. This is another common reason why LCs fail.

3) Compliance with the Documents and Conditions within the Letter of

Credit.

Letters of credit are about documents and not facts; the inability to produce a given

document at the right time will nullify the letter of credit. As aSeller/Exporter/Beneficiary you should try and run the compliance issues with the

various department or individuals involved within your organization to see ifcompliance would be a problem. And if so, have the LC amended before shipping the

goods.

Learning the Terminology of Exporting

INCOTERMS (TRANSPORTATION)

Shipping terms set the parameters for international shipments, specify points of

origin and destination, outline conditions under which title is transferred from seller

to buyer, and determine which party is responsible for shipping costs. They alsoindicate which party assumes the cost if merchandise is lost or damaged during

transit. To provide a common terminology for international shipping, INCOTERMS

(International Commercial Terms) have been developed under the auspices of theInternational Chamber of Commerce. See their website at www.iccwbo.org for the

latest Incoterms2000.

For resources on this subject please visit our 'Links' page

Understanding and Using Letters of Credit, Part I

Letters of credit accomplish their purpose by substituting the credit of the bank for that of

the customer, for the purpose of facilitating trade. There are basically two types:
http://www.iccwbo.org/http://www.creditguru.com/cgi-bin/Clinks/main.cgihttp://www.iccwbo.org/http://www.creditguru.com/cgi-bin/Clinks/main.cgi


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commercial and standby. The commercial letter of credit is the primary payment

mechanism for a transaction, whereas the standby letter of credit is a secondary payment

mechanism.

Commercial Letter of Credit

Commercial letters of credit have been used for centuries to facilitate payment ininternational trade. Their use will continue to increase as the global economy evolves.

Letters of credit used in international transactions are governed by the International

Chamber of Commerce Uniform Customs and Practice for Documentary Credits. Thegeneral provisions and definitions of the International Chamber of Commerce are binding

on all parties. Domestic collections in the United States are governed by the Uniform

Commercial Code.

A commercial letter of credit is a contractual agreement between a bank, known as theissuing bank, on behalf of one of its customers, authorizing another bank, known as the

advising or confirming bank, to make payment to the beneficiary. The issuing bank, onthe request of its customer, opens the letter of credit. The issuing bank makes acommitment to honor drawings made under the credit. The beneficiary is normally the

provider of goods and/or services. Essentially, the issuing bank replaces the bank's

customer as the payee.

Elements of a Letter of Credit

A payment undertaking given by a bank (issuing bank)

On behalf of a buyer (applicant)

To pay a seller (beneficiary) for a given amount of money

On presentation of specified documents representing the supply of goods Within specified time limits

Documents must conform to terms and conditions set out in the letter of credit Documents to be presented at a specified place

BeneficiaryThe beneficiary is entitled to payment as long as he can provide the documentary

evidence required by the letter of credit. The letter of credit is a distinct and separatetransaction from the contract on which it is based. All parties deal in documents and not

in goods. The issuing bank is not liable for performance of the underlying contract

between the customer and beneficiary. The issuing bank's obligation to the buyer, is to

examine all documents to insure that they meet all the terms and conditions of the credit.Upon requesting demand for payment the beneficiary warrants that all conditions of the

agreement have been complied with. If the beneficiary (seller) conforms to the letter of

credit, the seller must be paid by the bank.

Issuing BankThe issuing bank's liability to pay and to be reimbursed from its customer becomesabsolute upon the completion of the terms and conditions of the letter of credit. Under the


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provisions of the Uniform Customs and Practice for Documentary Credits, the bank is

given a reasonable amount of time after receipt of the documents to honor the draft.

The issuing banks' role is to provide a guarantee to the seller that if compliant documentsare presented, the bank will pay the seller the amount due and to examine the documents,

and only pay if these documents comply with the terms and conditions set out in the letterof credit.

Typically the documents requested will include a commercial invoice, a transportdocument such as a bill of lading or airway bill and an insurance document; but there are

many others. Letters of credit deal in documents, not goods.

Advising BankAn advising bank, usually a foreign correspondent bank of the issuing bank will advise

the beneficiary. Generally, the beneficiary would want to use a local bank to insure thatthe letter of credit is valid. In addition, the advising bank would be responsible for

sending the documents to the issuing bank. The advising bank has no other obligationunder the letter of credit. If the issuing bank does not pay the beneficiary, the advisingbank is not obligated to pay.

Confirming BankThe correspondent bank may confirm the letter of credit for the beneficiary. At therequest of the issuing bank, the correspondent obligates itself to insure payment under the

letter of credit. The confirming bank would not confirm the credit until it evaluated the

country and bank where the letter of credit originates. The confirming bank is usually theadvising bank.

Letter of Credit Characteristics

NegotiabilityLetters of credit are usually negotiable. The issuing bank is obligated to pay not only thebeneficiary, but also any bank nominated by the beneficiary. Negotiable instruments are

passed freely from one party to another almost in the same way as money. To be

negotiable, the letter of credit must include an unconditional promise to pay, on demandor at a definite time. The nominated bank becomes a holder in due course. As a holder in

due course, the holder takes the letter of credit for value, in good faith, without notice of

any claims against it. A holder in due course is treated favorably under the UCC.

The transaction is considered a straight negotiation if the issuing bank's paymentobligation extends only to the beneficiary of the credit. If a letter of credit is a straight

negotiation it is referenced on its face by "we engage with you" or "available with

ourselves". Under these conditions the promise does not pass to a purchaser of the draftas a holder in due course.

RevocabilityLetters of credit may be either revocable or irrevocable. A revocable letter of credit may


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be revoked or modified for any reason, at any time by the issuing bank without

notification. A revocable letter of credit cannot be confirmed. If a correspondent bank is

engaged in a transaction that involves a revocable letter of credit, it serves as the advisingbank.

Once the documents have been presented and meet the terms and conditions in the letterof credit, and the draft is honored, the letter of credit cannot be revoked. The revocable

letter of credit is not a commonly used instrument. It is generally used to provideguidelines for shipment. If a letter of credit is revocable it would be referenced on its

face.

The irrevocable letter of credit may not be revoked or amended without the agreement of

the issuing bank, the confirming bank, and the beneficiary. An irrevocable letter of creditfrom the issuing bank insures the beneficiary that if the required documents are presented

and the terms and conditions are complied with, payment will be made. If a letter of

credit is irrevocable it is referenced on its face.

Transfer and AssignmentThe beneficiary has the right to transfer or assign the right to draw, under a credit only

when the credit states that it is transferable or assignable. Credits governed by the

Uniform Commercial Code (Domestic) maybe transferred an unlimited number of times.

Under the Uniform Customs Practice for Documentary Credits (International) the creditmay be transferred only once. However, even if the credit specifies that it is

nontransferable or nonassignable, the beneficiary may transfer their rights prior to

performance of conditions of the credit.

Sight and Time Drafts

All letters of credit require the beneficiary to present a draft and specified documents inorder to receive payment. A draft is a written order by which the party creating it, orders

another party to pay money to a third party. A draft is also called a bill of exchange.

There are two types of drafts: sight and time. A sight draft is payable as soon as it is

presented for payment. The bank is allowed a reasonable time to review the documentsbefore making payment.

A time draft is not payable until the lapse of a particular time period stated on the draft.

The bank is required to accept the draft as soon as the documents comply with credit

terms. The issuing bank has a reasonable time to examine those documents. The issuing

bank is obligated to accept drafts and pay them at maturity.

Standby Letter of CreditThe standby letter of credit serves a different function than the commercial letter of

credit. The commercial letter of credit is the primary payment mechanism for a

transaction. The standby letter of credit serves as a secondary payment mechanism. Abank will issue a standby letter of credit on behalf of a customer to provide assurances of

his ability to perform under the terms of a contract between the beneficiary. The parties


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involved with the transaction do not expect that the letter of credit will ever be drawn

upon.

The standby letter of credit assures the beneficiary of the performance of the customer'sobligation. The beneficiary is able to draw under the credit by presenting a draft, copies

of invoices, with evidence that the customer has not performed its obligation. The bank isobligated to make payment if the documents presented comply with the terms of the letter

of credit.

Standby letters of credit are issued by banks to stand behind monetary obligations, to

insure the refund of advance payment, to support performance and bid obligations, and to

insure the completion of a sales contract. The credit has an expiration date.

The standby letter of credit is often used to guarantee performance or to strengthen thecredit worthiness of a customer. In the above example, the letter of credit is issued by the

bank and held by the supplier. The customer is provided open account terms. If payments

are made in accordance with the suppliers' terms, the letter of credit would not be drawnon. The seller pursues the customer for payment directly. If the customer is unable to pay,

the seller presents a draft and copies of invoices to the bank for payment.

The domestic standby letter of credit is governed by the Uniform Commercial Code.

Under these provisions, the bank is given until the close of the third banking day afterreceipt of the documents to honor the draft.

Procedures for Using the ToolThe following procedures include a flow of events that follow the decision to use a

Commercial Letter of Credit. Procedures required to execute a Standby Letter of Credit

are less rigorous. The standby credit is a domestic transaction. It does not require acorrespondent bank (advising or confirming). The documentation requirements are also

less tedious.

Step-by-step process:

Buyer and seller agree to conduct business. The seller wants a letter of credit to

guarantee payment.

Buyer applies to his bank for a letter of credit in favor of the seller.

Buyer's bank approves the credit risk of the buyer, issues and forwards the credit

to its correspondent bank (advising or confirming). The correspondent bank is

usually located in the same geographical location as the seller (beneficiary). Advising bank will authenticate the credit and forward the original credit to the

seller (beneficiary).

Seller (beneficiary) ships the goods, then verifies and develops the documentary

requirements to support the letter of credit. Documentary requirements may varygreatly depending on the perceived risk involved in dealing with a particular

company.


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Seller presents the required documents to the advising or confirming bank to be

processed for payment.

Advising or confirming bank examines the documents for compliance with theterms and conditions of the letter of credit.

If the documents are correct, the advising or confirming bank will claim the funds

by:o Debiting the account of the issuing bank.

o Waiting until the issuing bank remits, after receiving the documents.

o Reimburse on another bank as required in the credit.

Advising or confirming bank will forward the documents to the issuing bank.

Issuing bank will examine the documents for compliance. If they are in order, the

issuing bank will debit the buyer's account.

Issuing bank then forwards the documents to the buyer.

Standard Forms of DocumentationWhen making payment for product on behalf of its customer, the issuing bank must

verify that all documents and drafts conform precisely to the terms and conditions of theletter of credit. Although the credit can require an array of documents, the most commondocuments that must accompany the draft include:

Commercial InvoiceThe billing for the goods and services. It includes a description of merchandise, price,

FOB origin, and name and address of buyer and seller. The buyer and seller information

must correspond exactly to the description in the letter of credit. Unless the letter of credit

specifically states otherwise, a generic description of the merchandise is usuallyacceptable in the other accompanying documents.

Bill of LadingA document evidencing the receipt of goods for shipment and issued by a freight carrier

engaged in the business of forwarding or transporting goods. The documents evidencecontrol of goods. They also serve as a receipt for the merchandise shipped and as

evidence of the carrier's obligation to transport the goods to their proper destination.

Warranty of TitleA warranty given by a seller to a buyer of goods that states that the title being conveyed

is good and that the transfer is rightful. This is a method of certifying clear title to product

transfer. It is generally issued to the purchaser and issuing bank expressing an agreementto indemnify and hold both parties harmless.

Letter of IndemnitySpecifically indemnifies the purchaser against a certain stated circumstance.

Indemnification is generally used to guaranty that shipping documents will be provided in

good order when available.

Common Defects in DocumentationAbout half of all drawings presented contain discrepancies. A discrepancy is an


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irregularity in the documents that causes them to be in non-compliance to the letter of

credit. Requirements set forth in the letter of credit cannot be waived or altered by the

issuing bank without the express consent of the customer. The beneficiary should prepareand examine all documents carefully before presentation to the paying bank to avoid any

delay in receipt of payment. Commonly found discrepancies between the letter of credit

and supporting documents include:

Letter of Credit has expired prior to presentation of draft. Bill of Lading evidences delivery prior to or after the date range stated in the

credit.

Stale dated documents.

Changes included in the invoice not authorized in the credit.

Inconsistent description of goods.

Insurance document errors.

Invoice amount not equal to draft amount.

Ports of loading and destination not as specified in the credit.

Description of merchandise is not as stated in credit. A document required by the credit is not presented. Documents are inconsistent as to general information such as volume, quality, etc.

Names of documents not exact as described in the credit. Beneficiary information

must be exact.

Invoice or statement is not signed as stipulated in the letter of credit.

When a discrepancy is detected by the negotiating bank, a correction to the document

may be allowed if it can be done quickly while remaining in the control of the bank. If

time is not a factor, the exporter should request that the negotiating bank return thedocuments for corrections.

If there is not enough time to make corrections, the exporter should request that the

negotiating bank send the documents to the issuing bank on an approval basis or notify

the issuing bank by wire, outline the discrepancies, and request authority to pay. Paymentcannot be made until all parties have agreed to jointly waive the discrepancy.

Tips for Exporters

Communicate with your customers in detail before they apply for letters of credit.

Consider whether a confirmed letter of credit is needed.

Ask for a copy of the application to be fax to you, so you can check for terms or

conditions that may cause you problems in compliance. Upon first advice of the letter of credit, check that all its terms and conditions can

be complied with within the prescribed time limits.

Many presentations of documents run into problems with time-limits. You must

be aware of at least three time constraints - the expiration date of the credit, the

latest shipping date and the maximum time allowed between dispatch andpresentation.


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If the letter of credit calls for documents supplied by third parties, make

reasonable allowance for the time this may take to complete.

After dispatch of the goods, check all the documents both against the terms of thecredit and against each other for internal consistency.

SummaryThe use of the letters of credit as a tool to reduce risk has grown substantially over the

past decade. Letters of credit accomplish their purpose by substituting the credit of the

bank for that of the customer, for the purpose of facilitating trade.

The credit professional should be familiar with two types of letters of credit: commercial

and standby. Commercial letters of credit are used primarily to facilitate foreign trade.

The commercial letter of credit is the primary payment mechanism for a transaction.

The standby letter of credit serves a different function. The standby letter of credit servesas a secondary payment mechanism. The bank will issue the credit on behalf of a

customer to provide assurances of his ability to perform under the terms of a contract.

Upon receipt of the letter of credit, the credit professional should review all items

carefully to insure that what is expected of the seller is fully understood and that he cancomply with all the terms and conditions. When compliance is in question, the buyer

should be requested to amend the credit.


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Help file: types of Letter of credits

Documents

Transcript of Help file: types of Letter of credits