Letter of creditFrom Wikipedia, the free encyclopedia Jump to: navigation, search After a contract is concluded between buyer and seller, buyer's bank supplies a letter of credit to seller. Seller consigns the goods to a carrier in exchange for a bill of lading. Seller provides bill of lading to bank in exchange for payment. Seller's bank exchanges bill of lading for payment from buyer's bank. Buyer's bank exchanges bill of lading for payment from the buyer. 1 which usually provides an irrevocable payment undertaking. Letters of credit are used primarily in international trade transactions of significant value. the issuing bank of whom the applicant is a client. the issuing bank and the confirming bank.) will be built. meaning that redeeming the letter of credit will pay an exporter. In executing a transaction. They are also used in the land development process to ensure that approved public facilities (streets. cannot be amended or cancelled without prior agreement of the beneficiary. and documents proving the shipment was insured against loss or damage in transit. However. sidewalks. or their place of origin. i. letters of credit incorporate functions common to giros and Traveler's cheques. the documents a beneficiary has to present in order to receive payment include a commercial invoice. The LC can also be source of payment for a transaction. A standard. stormwater ponds. commercial letter of credit is a document issued mostly by a financial institution. Contents [hide] • • • • • • • • • 1 Terminology 2 How it works 3 Availability 4 Some of the Documents Called for under a LC 5 Legal principles governing documentary credits 6 The price of LCs 7 Legal Basis for Letters of Credit 8 International Trade Payment methods 9 Risks in International Trade 2 .. and the advising bank of whom the beneficiary is a client. the list and form of documents is open to imagination and negotiation and might contain requirements to present documents issued by a neutral third party evidencing the quality of the goods shipped. for deals between a supplier in one country and a customer in another. bill of lading. etc.Buyer provides bill of lading to carrier and takes delivery of goods. used primarily in trade finance.e. Typically. if any. The parties to a letter of credit are usually a beneficiary who is to receive the money. Almost all letters of credit are irrevocable. [edit] How it works A business called the InCosmetika from time to time imports goods from a business called BLISS.000 letter of credit. which in turn is derivative of the Latin word “accreditivus”. The issuing bank is obligated to pay under the letter of credit only when the stipulated documents are presented and the terms and conditions of the letter of credit have been met. The Commonwealth Bank can issue an LC either on approval of a standard loan underwriting process or by InCosmetika funding it directly with a deposit of $500. which then credits the account of BLISS for that amount. stipulated documents strictly complying with the 3 .‘The Application any defence relating to the underlying contract of sale. Many exporters have mistakenly assumed that the payment is guaranteed after receiving the LC. a power to do something. with BLISS as the beneficiary.000 to the ABC Bank. [edit] Availability LC being an irrevocable undertaking of the issuing bank makes available the Proceeds. InCosmetika wants to buy $500. which banks with the ABC Bank. InCosmetika holds an account at the Commonwealth Bank. Note that banks deal only with documents required in the letter of credit and not the underlying transaction. which notifies BLISS that payment is available and they can ship the merchandise InCosmetika has ordered with the full assurance of payment to them. to the Beneficiary of the Credit provided. on the condition that they are provided with a 90-day letter of credit for the full amount.• • 10 See also 11 References [edit] Terminology The English name “letter of credit” derives from the French word “accreditation”. The steps to get the letter of credit would be as follows: • • • • • • InCosmetika goes to The Commonwealth Bank and requests a $500. The Commonwealth Bank sends a copy of the LC to the ABC Bank. This is as long as the seller performs their duties to an extent that meets the requirements contained in the LC.000 plus fees which are typically between 1% and 8% of the face value of the LC. On presentation of the stipulated documents in the letter of credit and compliance with the terms and conditions of the letter of credit. meaning trust. S. who agrees to sell the goods and give InCosmetika 60 days to pay for them.000 worth of merchandise from BLISS. the Commonwealth Bank transfers the $500. if the Credit provides for acceptance by another drawee bank – by acceptance and payment at maturity Draft(s)drawn by the Beneficiary on the Issuing Bank in the event the drawee bank stipulated in the Credit does not accept Draft(s) drawn on it.provisions of the LC.a. Phyto-sanitary Certificate Transport Documents 4 • • • • . does not constitute a negotiation. Origin Certificate. Embassy legalization.b. Commercial. Insurance Certificate. Mere examination of the documents and forwarding the same to LC issuing bank for reimbursement.if the Credit provides for deferred payment – by payment on the maturity date(s) determinable in accordance with the stipulations of the Credit. or by payment of Draft(s) accepted but not paid by such drawee bank at maturity. or iii. Packing list Shipping Documents Transport Document. • [edit] Some of the Documents Called for under a LC • Financial Documents Bill of Exchange. Official or Legal Documents Official Documents License.if the Credit provides for sight payment – by payment at sight against compliant presentation ii. viz the nominated bank. (and so negotiated by the nominated bank ) Negotiation means the giving of value for Draft(s) and/or document(s) by the bank authorized to negotiate. UCP 600 and other international standard banking practices. are presented to the issuing bank. Draft(s) drawn by the Beneficiary and/or document(s) presented under the Credit. Inspection Cert . and of course undertaking to pay on due date and confirming maturity date at the time of compliant presentation iii. without giving of value / agreed to give. if the Credit provides for negotiation by another bank – by payment without recourse to drawers and/or bona fide holders. Co-accepted Draft Commercial Documents Invoice. • iv. then: • • • • i.if the Credit provides for acceptance by the Issuing Bank – by acceptance of Draft(s) drawn by the Beneficiary on the Issuing Bank and payment at maturity of such tenor draft. they would be burdened with investigating the underlying facts of each transaction and would thus be less inclined to issue documentary credits as the transaction would involve great risk and inconvenience. Forwarder Cargo Receipt. pre shipment packing list [edit] Legal principles governing documentary credits One of the primary peculiarities of the documentary credit is that the payment obligation is abstract and independent from the underlying contract of sale or any other contract in the transaction. Secondly. [edit] The price of LCs 5 . Thus the bank’s obligation is defined by the terms of the credit alone. railway receipt. efficient and quick. Thirdly. The policies behind adopting the abstraction principle are purely commercial and reflect a party’s expectations: firstly. for every breach of contract between the seller and buyer. Hence. if the documents tendered under the credit deviate from the language of the credit the bank is entitled to withhold payment even if the deviation is purely terminological. Lorry/truck receipt.[3] The general legal maxim de minimis non curat lex has no place in the field of documentary credits.. Article 5 the UCP further states that banks deal with documents only. or his or her agent. Accordingly. if the documents tendered by the beneficiary. appear to be in order.. suggests that banks should honour their obligation notwithstanding allegations of misfeasance by the buyer.• Bill of Lading (ocean or multi-modal or Charter party). the fact that the basic function of the credit is to provide the seller with the certainty of receiving payment. as long as he performs his documentary duties. The defences of the buyer arising out of the sale contract do not concern the bank and in no way affect its liability. Deliver Challan. Airway bill.[1] Article 4(a) UCP states this principle clearly. banks would then be placed in a dilemma in deciding which terms to follow if required to look behind the credit agreement. they are not concerned with the goods (facts).etc Insurance documents Insurance policy. or Certificate but not a cover note. a bank were required to investigate said breach. if the responsibility for the validity of documents was thrown onto banks. CMC Other than Mate Receipt. and the sale contract is irrelevant. The “principle of strict compliance” also aims to make the bank’s duty of effecting payment against documents easy. and that it would be a calamity for the business world if. then in general the bank is obliged to pay without further qualifications. courts have emphasised that buyers always have a remedy for an action upon the contract of sale. [2] Finally. documents required under the credit could in certain circumstances be different from those required under the sale transaction. The latest version of the UCP is the UCP600 effective July 1. In such transactions the undertaking by the beneficiary to deliver the goods to the applicant is not sufficient consideration for the bank’s promise because the contract of sale is made before the issuance of the credit. then they are to the account of the Applicant. it is difficult to show any consideration given by the beneficiary to the banker prior to the tender of documents. 2007[5]. thus consideration in these circumstances is past. negotiation of documents. an undertaking. The theories include: the implied promise. parties have to include them into their arrangements as normal contractual provisions.All the charges for issuance of Letter of Credit. Accordingly. the performance of an existing duty under a contract cannot be a valid consideration for a new promise made by the bank: the delivery of the goods is consideration for enforcing the underlying contract of sale and cannot be used. a second time to establish the enforceability of the bank-beneficiary relation. Goode. These statutes are designed to work with the rules of practice including the UCP and the ISP98. In addition. despite the fact that it possesses distinctive features. which make it sui generis. Treitel. The description of charges and who would be bearing them would be indicated in the field 71B in the Letter of Credit. assignment theory. These rules are practice are incorporated into the LC transaction by agreement of the parties. [edit] International Trade Payment methods • Advance payment (most secure for seller) Where the buyer parts with money first and waits for the seller to forward the goods • Documentary Credit (more secure for seller as well as buyer) 6 . [edit] Legal Basis for Letters of Credit Although documentary credits are enforceable once communicated to the beneficiary. If the LC is silent on charges. and the guarantee theory. The previous revision was the UCP500 and became effective on 1 January 1994. as it were. the novation theory. A few countries including the US (see Article 5 of the Uniform Commercial Code) have created statutes in relation to the operation of LCs. a chose in action. it is acceptable in English jurisprudence to treat it as contractual in nature. Finkelstein and Ellinger have all accepted the view that documentary credits should be analyzed outside the legal framework of contractual principles. reimbursements and other charges like courier are to the account of applicant or as per the terms and conditions of the Letter of credit. reliance theory. an engagement or a contract. whether the documentary credit is referred to as a promise. estoppels and trust theories. [4] Davis. Legal writers have analyzed every possible theory from every legal angle and failed to satisfactorily reconcile the bank’s undertaking with any contractual analysis. anticipatory theory. Since the UCP are not laws. which require the presence of consideration. agency theories. on open account terms. Credit itself may be forged. sight and usance. Risk situations in LC transaction Fraud Risks • • The payment will be obtained for nonexistent or worthless merchandise against presentation by the beneficiary of forged or falsified documents.subject to ICC's UCP 600. • Documentary collection (more secure for buyer and to a certain extent to seller) subject to ICC's URC 525. where shipment happens first. Legal Risks • Possibility that performance of a Documentary Credit may be disturbed by legal action relating directly to the parties and their rights and obligations under the Documentary Credit Force Majeure and Frustration of Contract 7 . who is independent of the parties to the contract. for delivery of shipping documents against payment or acceptances of draft. where the bank gives an undertaking (on behalf of buyer and at the request of applicant ) to pay the shipper ( beneficiary ) the value of the goods shipped if certain documents are submitted and if the stipulated terms and conditions are strictly complied. Here the buyer can be confident that the goods he is expecting only will be received since it will be evidenced in the form of certain documents called for meeting the specified terms and conditions while the supplier can be confident that if he meets the stipulations his payment for the shipment is guaranteed by bank. then the title documents are sent to the [collecting bank] buyer's bank by seller's bank [remitting bank]. for delivering documents against collection of payment/acceptance • Direct payment (most secure for buyer) Where the supplier ships the goods and waits for the buyer to remit the bill proceeds. Sovereign and Regulatory Risks • Performance of the Documentary Credit may be prevented by government action outside the control of the parties. it may not be able to obtain reimbursement from the Issuing Bank because of insolvency 8 . or Delays in Payment from. Risks to the Beneficiary • • • Failure to Comply with Credit Conditions Failure of. Sovereign and Regulatory Risk and Legal Risks Risks to the Reimbursing Bank • no obligation to reimburse the Claiming Bank unless it has issued a reimbursement undertaking. once having paid the Beneficiary. the Issuing Bank Credit Issued by Party other than Bank Risks to the Advising Bank • The Advising Bank’s only obligation – if it accepts the Issuing Bank’s instructions – is to check the apparent authenticity of the Credit and advising it to the Beneficiary Risks to the Nominated Bank • Nominated Bank has made a payment to the Beneficiary against documents that comply with the terms and conditions of the Credit and is unable to obtain reimbursement from the Issuing Bank Risks to the Confirming Bank • If Confirming Bank’s main risk is that.• Performance of a contract – including an obligation under a Documentary Credit relationship – is prevented by external factors such as natural disasters or armed conflicts Risks to the Applicant • • • • • • • Non-delivery of Goods Short Shipment Inferior Quality Early /Late Shipment Damaged in transit Foreign exchange Failure of Bank viz Issuing bank / Collecting Bank Risks to the Issuing Bank • • Insolvency of the Applicant Fraud Risk. H. ^ United City Merchants (Investments) Ltd v Royal Bank of Canada (The American Accord) [1983] 1. [edit] See also • • Uniform Customs and Practice for Documentary Credits Buyer's Credit [edit] References 1.168 at 183 3.A. Sociedad Cadex [1980] 2 Lloyd’s Rep. v.wikipedia.org/wiki/Letter_of_credit" Categories: Contract law | Basic financial concepts | Legal documents | Letters (message) | International trade Views • • • • Article Discussion Edit this page History Personal tools • • Try Beta Log in / create account 9 . pp. and the Oilseeds Trading Company. Rayner & Co. ^ For extensive analysis See Finkelstein. A Force majeure risk is 1. v. ^ See Ficom S.“The 2007 Revision of the Uniform Customs and Practice for Documentary Credits (UCP 600)”[1] Retrieved from "http://en. a risk in trade incapability caused by a change in a country's policy. the cargo might be found late because of a dispute in import and export dealings. L. H. Other risks are mainly risks caused by a difference in law. 275-295 5.C. 2. and 2.A. In these cases. a risk caused by a natural disaster. Ltd.. language or culture. 118. 32 4..of the Issuing Bank or refusal of the Issuing Bank to reimburse because of a dispute as to whether or not payment should have been made under the Credit [edit] Risks in International Trade • • • • A Credit risk risk from change in the credit of an opposing business. ^ J. Ltd. Rep. ^ Dominique Doise. An Exchange risk is a risk from a change in the foreign exchange rate. Legal Aspects of Commercial Letters of Credit.Hambros Bank Limited [1942] 73 Ll. the use of letters of credit has become a very important aspect of international trade. as the Confirming Bank promises to pay.Letter Of Credit What Does Letter Of Credit Mean? A letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. differing laws in each country and difficulty in knowing each party personally. o A straight letter of credit can only be paid in the country of the Paying Bank. • • • 10 . Once an irrevocable letter of credit is open it cannot be changed without the written consent of all parties including the beneficiary. The bank also acts on behalf of the buyer (holder of letter of credit) by ensuring that the supplier will not be paid until the bank receives a confirmation that the goods have been shipped. In the event that the buyer is unable to make payment on the purchase. the bank will be required to cover the full or remaining amount of the purchase. o The differences are found in the wording. Letter Of Credit Types • There are several types of letters of credit. Straight versus Negotiation o A negotiation letter of credit can be presented to any bank. o Advised does not guarantee the creditworthiness of the Opening Bank. Revocable versus Irrevocable o You should always insist and carefully check that a letter of credit is irrevocable. Due to the nature of international dealings including factors such as distance. A revocable letter of credit can be change or withdrawn without notifying the beneficiary. Investopedia explains Letter Of Credit Letters of credit are often used in international transactions to ensure that payment will be received. Confirmed versus Advised o Confirmed is preferred. This is a form of delayed payment. It is a document that guarantees a buyer's payment to a seller that will be received on time with the correct amount.• Sight versus Usance o At sight means the Beneficiary is paid as soon as the Paying Bank has determined that all necessary documents are in order. It can be: Revocable Credit Irrevocable Credit Confirmed Credit Payment Credit Negotiation Credit Deferred Payment Credit Acceptance Credit Back-to-Back Credit Transferable Credit Red Clause Credit Green Clause Credit Packing Credit Standby Credit Revolving CreditCredit Letters are used to ensure payments that have been issued from creditors. 11 . o Usance time can be between 30 and 180 days after the bill of lading date. and should be avoided. In this way. 2. If you are to deny a request for credit. it doesn't have to be personal. 3. If it has been sixty days and the payment is still not settled. In this way. 4. 12 . you are sending your message to your customer very well and you convey the message you want them to receive. 8. Allow it to be open for future credit applications from that same person or business entity. Remember to stil pursue with the letters to let them know that it is important for them to pay even if it has been overdue. Encourage them to try the next time they decided to ask for credit. Make sure that your letter is tailored to your customer. Still. Keep a professional tone while explaining the reasons for making the letter. If it is for personal use. 7. If they are in the restaurant industry. Be persuasive when writing a letter. Remember to be courteous when writing a credit letter whatever be the situation or circumstances may be. and the customer don't show any signs of paying or settling the credit or to even discuss terms with you. Business is business.• 3:58 How to Calculate your Stimulus Payment By 5min Life Videopedia 1.Don't let personal differences or issues affect the letter as it will be very unprofessional. then tailor it and make it more specific. tell the debtor to contact you and discuss issues with you about the lapse in payment. 6. don't let it end there. inform him or her throught the letter the consequences and penalties that will be incurred. the debtor may feel more obliged to pay you on time because of creating a good working relationship with them. Know your customer. then tailor the letter to them. Don't write letters that are too long. It should be confident about what you are saying in the letter and it should be but not overbearing. 5. Do not threat your customers about not paying on time. keep a professional tone. Again. keep it professional and business-like. If the payment is late for more than a month. don't close the door. It should go directly to the point and it should be straightforward. Write all the information needed and write them clearly. If you denied the first time. negotiation or acceptance. so it provides the assurance that providing the beneficiary complies with the terms. providing documents are presented which comply with the terms of the letter of credit. The beneficiary is not protected from the credit risk of the issuing bank nor the country risk. Irrevocable [edit] An irrevocable letter of credit can not be amended or revoked without the agreement of ALL the parties to the letter of credit.that is in the relation with transferable lc. An advising bank forwards the letter of credit to the beneficiary without responsibility or undertaking on its part except that it must use reasonable care to check the authenticity of the credit which it advised. so the beneficiary is reliant upon the undertaking of the overseas bank. The advising bank. It does not provide a commitment from the advising bank to pay. Under UCP 500. These are just tips on how to make a credit letter. Unconfirmed [edit] An unconfirmed irrevocable letter of credit provides a commitment by the issuing bank to pay. Types of Letters of Credit [edit] Revocable [edit] A revocable letter of credit is one which can be amended or cancelled by the applicant or the issuing bank at any time. A revocable letter of credit offers no protection to the beneficiary and is seldom if ever used. you are securing your reader about the relationship you are to build with him or her. accept. In this way. discussion or agreement with the beneficiary. a letter of credit is deemed irrevocable unless otherwise stated. or negotiate a letter of credit.9. Confirmed [edit] A confirmed irrevocable letter of credit is one to which the advising bank adds its confirmation. makes its own independent undertaking to effect payment. Remember that making a credit letter should be brief and should be professional. Tell your reader that all pertinent information that he or she will give you should and will remain confidential. without prior notice. he/she will be paid for the goods or services. assumes the 13 . which may also be the confirming bank. Transferable Credit [edit] Under a transferable letter of credit a beneficiary (the first beneficiary) can ask the issuing/advising/confirming bank to transfer the letter of credit in whole or in part to another party/ies such as supplier/s (second beneficiary/ies). This process enables the beneficiary to pay the manufacturer/original supplier by letter of credit. a persistent negative balance of payments. it is considered nontransferable. In order for a letter of credit to be confirmed. referred to as the transferring bank. A transferable letter of credit is usually used when the beneficiary is not the manufacturer/original supplier of some/all of the goods/services. In general. The beneficiary may choose this option if he or she • • does not want to request a transferable letter of credit from a buyer in order to keep the buyer from knowing who is the actual supplier of the goods. exchange controls in the buyer’s country may prevent local banks from honoring certain external payments. the letter of credit can be confirmed by an independent bank. If the advising bank does not have such a relationship. 14 . a bank accepting this risk would have a correspondent relationship with the issuing bank. or a record of being late or having defaulted on its international payments. Assignment of Proceeds [edit] The right to the proceeds of a letter of credit can sometimes be assigned where the beneficiary of a letter of credit is not the actual supplier of all or part of the letter of credit and wants the bank to pay the supplier out of funds received from the letter of credit.country (political and economic) risk of the applicant’s country as well as the credit risk. If the bank agrees. unless the letter of credit states that it is transferable. A seller should consider requesting a confirmed credit when • • • the credit standing of the issuing bank is unknown to the seller or viewed by the seller as questionable. The negative aspect here is the cost of adding another bank to the scenario. does not have the necessary credit with the bank to issue a new letter of credit to a supplier. this bank. the importing country is suffering economic difficulties: large external debt and/or high debt service ratios. advises the letter of credit to the second beneficiary/ies in the terms and conditions of the original letter of credit with certain constraints defined in Article 48 of UCP 500. failure and default of the issuing bank and effects payment to the beneficiary without recourse. quantities. there were few ways to stop it from rolling over. the fact is that. This situation is challenging. other than the seller’s word. unless required by law or because of high risk. A standby letter of credit is one which is issued as a back-up or form of insurance for the seller should the buyer default on the agreed-upon payment terms. and other transaction details did not change. standby letters of credit are infrequently used today. In the business world today. that the standby will not be drawn against even if payment is made as agreed. The problem with this instrument is that the applicant has no guarantee. In addition. should a conflict arise between the parties while the letter of credit was in place or should the products change. revolving letters of credit were a tool created to allow companies conducting regular business to issue a letter of credit that could “roll-over” without the company having to reapply. Revolving [edit] Although infrequently used today. there was little recourse for either party.An assignment of proceeds takes the form of an irrevocable instruction from the beneficiary to the bank requesting that it pay the supplier out of the proceeds of the letter of credit which becomes due when documents are presented in compliance with the terms of the letter of credit. especially if the letter of credit is confirmed and the advising bank sees only documents pertaining to the shipment as outlined in the letter of credit and has no knowledge of other payments being made. on-going business is usually conducted without of letters of credit Standby [edit] As is the case with the revolving letter of credit. so. thus enabling business flow to continue without interruption as long as the terms and conditions. if a letter of credit were a revolving one. A standby letter of credit is issued in the same way a documentary credit is in that the collateral needed for issuance is required by the issuing bank and the beneficiary must comply with every detail as outlined in the letter of credit. 15 .