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Letter of credit

From Wikipedia, the free encyclopedia

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 p bill of lading for payment from buyer's bank. Buyer's bank exchanges bill of lading for payment from the buyer.

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Buyer provides bill of lading to carrier and takes delivery of goods.

A standard, commercial letter of credit (LC[1]

) is a document issued mostly by afinancial institution, used primarily

intrade finance, which usually provides an irrevocable payment undertaking.

The letter of credit can also be source of payment for a transaction, meaning that redeeming the letter of credit will pay an

exporter. Letters of credit are used primarily ininternational tradetransactions of significant value, for deals between a

supplier in one country and a customer in another. In such cases the International Chamber of CommerceUniform

Customs and Practice for Documentary Creditsapplies (UCP 600 being the latest version).[2]

They are also used in the

land development process to ensure that approved public facilities (streets, sidewalks, storm water ponds, etc.) will be

built. The parties to a letter of credit are usually a beneficiary who is to receive the money, the issuing bank of whom the

applicant is a client, and theadvising bankof whom the beneficiary is a client. Almost all letters of credit are irrevocable,

i.e., cannot be amended or canceled without prior agreement of the beneficiary, the issuing bank and the confirming bank,

if any. In executing a transaction, letters of credit incorporate functions common togirosandTraveler's cheques.

Typically, the documents a beneficiary has to present in order to receive payment include acommercial invoice,bill of

lading, and documents proving the shipment was insured against loss or damage in transit.

Contents

[hide]

1 Terminology

o 1.1 Origin of the termo 1.2 Types and related terms

2 Documents that can be presented for payment

3 Legal principles governing documentary credits

4 The price of letters of credit

5 Legal basis

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6 International Trade Payment methods7 Risk situations in letter-of-credit transactions

8 See also

9 References10 External links

[edit]Terminology

[edit]Origin of the term

The English name letter of credit derives from the French word accreditation, a power to do something, which in turn

is derivative of the Latin word accreditivus, meaning trust. This applies to any defense relating to the underlying

contract of sale. This is as long as the seller performs their duties to an extent that meets the requirements contained in the

letter of credit.[citation needed]

[edit]Types and related terms

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 the

consent of the beneficiary. A sightLC means that payment is made immediately to the beneficiary/seller/exporter upon

presentation of the correct documents in the required 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.[citation needed]

Negotiation means the giving of value for draft(s) and/or document(s) by the bank authorized to negotiate, viz the

nominated bank. Mere examination of the documents and forwarding the same to the letter of credit issuing bank for

reimbursement, without giving of value / agreed to give, does not constitute a negotiation.[clarification needed][citation needed]

[edit]Documents that can be presented for payment

To receive payment, an exporter or shipper must present the documents required by the letter of credit. Typically instead

of presenting goods themselves, a document proving the goods were sent is presented instead. However, the list and form

of documents is open to imagination and negotiation and might contain requirements to present documents issued by a

neutral third party evidencing the quality of the goods shipped, or their place of origin or place. Typical types of

documents in such contracts might include:[citation needed]

Financial DocumentsBill of Exchange, Co-accepted Draft

Commercial DocumentsInvoice,Packing list

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Shipping DocumentsTransport Document, Insurance Certificate, Commercial, Official or Legal Documents

Official DocumentsLicense, Embassy legalization, Origin Certificate, Inspection Certificate,Phytosanitary certificate

Transport DocumentsBill of Lading(ocean or multi-modal or Charter party), Airway bill, Lorry/truck receipt, railway receipt, CMC

Other than Mate Receipt, Forwarder Cargo Receipt, Deliver Challan...etc

Insurance documentsInsurance policy, or Certificate but not a cover note.

[edit]Legal principles governing documentary credits

One of the primary peculiarities of the documentary credit is that the payment

obligation is abstract and independent from the underlying contract of sale or any

other contract in the transaction. Thus the banks obligation is defined by the terms

of the credit alone, and the sale contract is irrelevant. The defences of the buyer

arising out of the sale contract do not concern the bank and in no way affect its

liability.[3]

Article 4(a) UCP states this principle clearly. Article 5 the UCP further

states that banks deal with documents only, they are not concerned with the goods

(facts). Accordingly, if the documents tendered by the beneficiary, or his or her

agent, appear to be in order, then in general the bank is obliged to pay without

further qualifications.

The policies behind adopting the abstraction principle are purely commercial and

reflect a partys expectations: firstly, if the responsibility for the validity of

documents was thrown onto banks, they would be burdened with investigating the

underlying facts of each transaction and would thus be less inclined to issue

documentary credits as the transaction would involve great risk and inconvenience.

Secondly, documents required under the credit could in certain circumstances be

different from those required under the sale transaction; banks would then be placed

in a dilemma in deciding which terms to follow if required to look behind the credit

agreement. Thirdly, the fact that the basic function of the credit is to provide the

seller with the certainty of receiving payment, as long as he performs his

documentary duties, suggests that banks should honour their obligation

notwithstanding allegations of misfeasance by the buyer.[4]

Finally, courts have

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emphasised that buyers always have a remedy for an action upon the contract of sale,

and that it would be a calamity for the business world if, for every breach of contract

between the seller and buyer, a bank were required to investigate said breach.

The principle of strict compliance also aims to make the banks duty of effecting

payment against documents easy, efficient and quick. Hence, if the documents

tendered under the credit deviate from the language of the credit the bank is entitled

to withhold payment even if the deviation is purely terminological.[5]

The general

legal maximde minimis non curat lexhas no place in the field of documentary

credits.

[edit]The price of letters of credit

All the charges for issuance of Letter of Credit, negotiation of documents,

reimbursements and other charges like courier are to the account of applicant or as

per the terms and conditions of the Letter of credit. If the letter of credit is silent on

charges, then they are to the account of the Applicant. The description of charges

and who would be bearing them would be indicated in the field 71B in the Letter of

Credit.[citation needed]

[edit]Legal basis

Although documentary credits are enforceable once communicated to the

beneficiary, it is difficult to show anyconsiderationgiven by the beneficiary to the

banker prior to the tender of documents. In such transactions the undertaking by the

beneficiary to deliver the goods to the applicant is not sufficient consideration for the

banks promise because the contract of sale is made before the issuance of the credit,

thus consideration in these circumstances is past. In addition, the performance of an

existing duty under a contract cannot be a valid consideration for a new promise

made by the bank: the delivery of the goods is consideration for enforcing the

underlying contract of sale and cannot be used, as it were, a second time to establish

the enforceability of the bank-beneficiary relation.[citation needed]

Legal writers have failed to satisfactorily reconcile the banks undertaking with any

contractual analysis. The theories include: the implied promise,assignmenttheory,

thenovationtheory, reliance theory,agencytheories,estoppelsandtrusttheories,

anticipatory theory, and the guarantee theory.[6]

Davis, Treitel, Goode, Finkelstein

and Ellinger have all accepted the view that documentary credits should be analyzed

outside the legal framework of contractual principles, which require the presence of

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consideration. Accordingly, whether the documentary credit is referred to as a

promise, an undertaking, a chose in action, an engagement or a contract, it is

acceptable in English jurisprudence to treat it as contractual in nature, despite the

fact that it possesses distinctive features, which make itsui generis.

A few countries including the United States (see Article 5 of theUniform

Commercial Code) have created statutes in relation to the operation of letters of

credit. These statutes are designed to work with the rules of practice including the

UCP and the ISP98. These rules of practice are incorporated into the transaction by

agreement of the parties. The latest version of the UCP is the UCP600 effective July

1, 2007.[7]

The previous revision was the UCP500 and became effective on 1 January

1994. Since the UCP are not laws, parties have to include them into their

arrangements as normal contractual provisions.

[edit]International Trade Payment methods

This article is in a list format that may be better

presented usingprose. You can help by converting this

article to prose, ifappropriate.Editing helpisavailable. (January 2011)

Advance payment (most secure for seller)Where the buyer parts with money first and waits for the seller to forward the goods

Documentary Credit (more secure for seller as well as buyer)Subject to ICC's UCP 600, where the bank gives an undertaking (on behalf of buyer

and at the request of applicant) to pay the shipper (beneficiary) the value of the

goods shipped if certain documents are submitted and if the stipulated terms and

conditions are strictly complied with.

Here the buyer can be confident that the goods he is expecting only will be received

since it will be evidenced in the form of certain documents called for meeting the

specified terms and conditions while the supplier can be confident that if he meets

the stipulations his payment for the shipment is guaranteed by bank, who is

independent of the parties to the contract.

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

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Also called "Cash Against Documents". Subject to ICC's URC 525, sight and

usance, for delivery of shippingdocuments against paymentor acceptances of draft,

where shipment happens first, then the title documents are sent to the [collecting

bank] buyer's bank by seller's bank [remitting bank], for delivering documents

against collection of payment/acceptance

Direct payment (most secure for buyer)Where the supplier ships the goods and waits for the buyer to remit the bill proceeds,

on open account terms.

[edit]Risk situations in letter-of-credit transactions

This article is in a list format that may be better

presented usingprose. You can help by converting this

article to prose, ifappropriate.Editing helpisavailable. (January 2011)

Fraud Risks

The payment will be obtained for nonexistent or worthless merchandise againstpresentation by the beneficiary of forged or falsified documents.

Credit itself may be forged.Sovereign and Regulatory Risks

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

Legal Risks

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

Documentary Credit

Force Majeureand Frustration of Contract

Performance of a contractincluding an obligation under a DocumentaryCredit relationshipis prevented by external factors such as natural disasters or

armed conflicts

Risks to the Applicant

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

Insolvency of the Applicant Fraud Risk, Sovereign and Regulatory Risk and Legal RisksRisks to the Reimbursing Bank

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

Risks to the Beneficiary

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

The Advising Banks only obligationif it accepts the Issuing Banksinstructionsis 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 thatcomply with the terms and conditions of the Credit and is unable to obtain

reimbursement from the Issuing Bank

Risks to the Confirming Bank

If Confirming Banks main risk is that, once having paid the Beneficiary, it maynot be able to obtain reimbursement from the Issuing Bank because of

insolvency of the Issuing Bank or refusal of the Issuing Bank to reimburse

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because of a dispute as to whether or not payment should have been made under

the Credit

Other Risks in International Trade

ACredit riskrisk from change in the credit of an opposing business. AnExchange riskis a risk from a change in the foreign exchange rate. AForce majeurerisk is 1. a risk in trade incapability caused by a change in a

country's policy, and 2. a risk caused by a natural disaster.

Other risksare mainly risks caused by a difference in law, language or culture.In these cases, the cargo might be found late because of a dispute in import and

export dealings.

[edit]See also

Uniform Customs and Practice for Documentary Credits Buyer's Credit[edit]References

1. ^Letter of Credit explained What is a letter of credit?. LoanUniverse.com.2. ^Understanding and Using Letters of Credit, Part I. Credit Research Foundation.3. ^See Ficom S.A. v. Sociedad Cadex [1980] 2 Lloyds Rep. 118.4.

^United City Merchants (Investments) Ltd v Royal Bank of Canada (The

American Accord) [1983] 1.A.C.168 at 183

5. ^J. H. Rayner & Co., Ltd., and the Oilseeds Trading Company, Ltd. v.HambrosBank Limited [1942] 73 Ll. L. Rep. 32

6. ^For extensive analysis See Finkelstein, H. Legal Aspects of Commercial Lettersof Credit, pp. 275-295

7. ^Dominique Doise,The 2007 Revision of the Uniform Customs and Practice forDocumentary Credits (UCP 600)[1]

[edit]External links

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Letter of Credit, LC

What is a Letter of Credit?A Letter of Credit is a payment term generally used for international sales transactions. It is basically a mechanism,

which allows importers/buyers to offer secure terms of payment to exporters/sellers in which a bank (or more thanone bank) 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. Thus a LC (as it is commonly referred to) is a payment undertaking 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 the

Advising Bank which is generally in the country of the Seller.The specified bank makes the payment upon the successful presentation of the required documents by the seller

within the specified time frame. Note that the Bank scrutinizes the 'documents' and not the 'goods' for making

payment. The process works in favor of both the buyer and the seller.

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Introduction

Letter of Credit L/c also known as Documentary Credit is a widely used term to make payment securein domestic and international trade. The document is issued by a financial organization at the buyerrequest. Buyer also provide the necessary instructions in preparing the document.

The International Chamber of Commerce (ICC) in the Uniform Custom and Practice for DocumentaryCredit (UCPDC) defines L/C as:

"An arrangement, however named or described, whereby a bank (the Issuing bank) acting at therequest and on the instructions of a customer (the Applicant) or on its own behalf :

1. Is to make a payment to or to the order third party ( the beneficiary ) or is to accept bills ofexchange (drafts) drawn by the beneficiary.

2. Authorised another bank to effect such payments or to accept and pay such bills of exchange(draft).

3. Authorised another bank to negotiate against stipulated documents provided that the terms arecomplied with.

A key principle underlying letter of credit (L/C) is that banks deal only in documents and not in goods.The decision to pay under a letter of credit will be based entirely on whether the documents presentedto the bank appear on their face to be in accordance with the terms and conditions of the letter ofcredit.

Parties to Letters of Credit

Applicant (Opener): Applicant which is also referred to as account party is normally a buyer orcustomer of the goods, who has to make payment to beneficiary. LC is initiated and issued athis request and on the basis of his instructions.

Issuing Bank (Opening Bank) : The issuing bank is the one which create a letter of credit andtakes the responsibility to make the payments on receipt of the documents from thebeneficiary or through their banker. The payments has to be made to the beneficiary withinseven working days from the date of receipt of documents at their end, provided thedocuments are in accordance with the terms and conditions of the letter of credit. If thedocuments are discrepant one, the rejection thereof to be communicated within seven workingdays from the date of of receipt of documents at their end.

Beneficiary : Beneficiary is normally stands for a seller of the goods, who has to receivepayment from the applicant. A credit is issued in his favour to enable him or his agent to obtainpayment on surrender of stipulated document and comply with the term and conditions of theL/c.If L/c is a transferable one and he transfers the credit to another party, then he is referred toas the first or original beneficiary.

Advising Bank : An Advising Bank provides advice to the beneficiary and takes theresponsibility for sending the documents to the issuing bank and is normally located in thecountry of the beneficiary.

Confirming Bank : Confirming bank adds its guarantee to the credit opened by another bank,thereby undertaking the responsibility of payment/negotiation acceptance under the credit, inadditional to that of the issuing bank. Confirming bank play an important role where theexporter is not satisfied with the undertaking of only the issuing bank.

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Negotiating Bank: The Negotiating Bank is the bank who negotiates the documents submittedto them by the beneficiary under the credit either advised through them or restricted to themfor negotiation. On negotiation of the documents they will claim the reimbursement under thecredit and makes the payment to the beneficiary provided the documents submitted are inaccordance with the terms and conditions of the letters of credit.

Reimbursing Bank : Reimbursing Bank is the bank authorized to honor the reimbursementclaim in settlement of negotiation/acceptance/payment lodged with it by the negotiatingbank. It is normally the bank with which issuing bank has an account from which payment hasto be made.

Second Beneficiary : Second Beneficiary is the person who represent the first or originalBeneficiary of credit in his absence. In this case, the credits belonging to the originalbeneficiary is transferable. The rights of the transferee are subject to terms of transfer.

Types of Letter of Credit

1. Revocable Letter of Credit L/c

A revocable letter of credit may be revoked or modified for any reason, at any time by the issuing bankwithout notification. It is rarely used in international trade and not considered satisfactory for theexporters but has an advantage over that of the importers and the issuing bank.

There is no provision for confirming revocable credits as per terms of UCPDC, Hence they cannot beconfirmed. It should be indicated in LC that the credit is revocable. if there is no such indication thecredit will be deemed as irrevocable.

2. Irrevocable Letter of CreditL/c

In this case it is not possible to revoked or amended a credit without the agreement of the issuingbank, the confirming bank, and the beneficiary. Form an exporters point of view it is believed to be

more beneficial. An irrevocable letter of credit from the issuing bank insures the beneficiary that if therequired documents are presented and the terms and conditions are complied with, payment will bemade.

3. Confirmed Letter of Credit L/c

Confirmed Letter of Credit is a special type of L/c in which another bank apart from the issuing bankhas added its guarantee. Although, the cost of confirming by two banks makes it costlier, this type ofL/c is more beneficial for the beneficiary as it doubles the guarantee.

4. Sight Credit and Usance Credit L/c

Sight credit states that the payments would be made by the issuing bank at sight, on demand or onpresentation. In case of usance credit, draft are drawn on the issuing bank or the correspondent bankat specified usance period. The credit will indicate whether the usance draft are to be drawn on theissuing bank or in the case of confirmed credit on the confirming bank.

5. Back to Back Letter of Credit L/c

Back to Back Letter of Credit is also termed as Countervailing Credit. A credit is known as backtobackcredit when a L/c is opened with security of another L/c.

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A backtoback credit which can also be referred as credit and countercredit is actually a method offinancing both sides of a transaction in which a middleman buys goods from one customer and sellsthem to another.

The parties to a BacktoBack Letter of Credit are:1. The buyer and his bank as the issuer of the original Letter of Credit.

2. The seller/manufacturer and his bank,3. The manufacturer's subcontractor and his bank.

The practical use of this Credit is seen when L/c is opened by the ultimate buyer in favour of aparticular beneficiary, who may not be the actual supplier/ manufacturer offering the main credit withnear identical terms in favour as security and will be able to obtain reimbursement by presenting thedocuments received under back to back credit under the main L/c.

The need for such credits arise mainly when :

1. The ultimate buyer not ready for a transferable credit2. The Beneficiary do not want to disclose the source of supply to the openers.3. The manufacturer demands on payment against documents for goods but the beneficiary of

credit is short of the funds

6. Transferable Letter of Credit L/c

A transferable documentary credit is a type of credit under which the first beneficiary which is usuallya middleman may request the nominated bank to transfer credit in whole or in part to the secondbeneficiary.

The L/c does state clearly mentions the margins of the first beneficiary and unless it is specified theL/c cannot be treated as transferable. It can only be used when the company is selling the product of athird party and the proper care has to be taken about the exit policy for the money transactions thattake place.

This type of L/c is used in the companies that act as a middle man during the transaction but donthave large limit. In the transferable L/c there is a right to substitute the invoice and the whole valuecan be transferred to a second beneficiary.

The first beneficiary or middleman has rights to change the following terms and conditions of the letterof credit:

1. Reduce the amount of the credit.2. Reduce unit price if it is stated3. Make shorter the expiry date of the letter of credit.4. Make shorter the last date for presentation of documents.5. Make shorter the period for shipment of goods.6. Increase the amount of the cover or percentage for which insurance cover must be effected.7. Substitute the name of the applicant (the middleman) for that of the first beneficiary (the

buyer).

Standby Letter of Credit L/c

Initially used by the banks in the United States, the standby letter of credit is very much similar innature to a bank guarantee. The main objective of issuing such a credit is to secure bank loans.

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Standby credits are usually issued by the applicants bank in the applicants country and advised to thebeneficiary by a bank in the beneficiarys country.

Unlike a traditional letter of credit where the beneficiary obtains payment against documentsevidencing performance, the standby letter of credit allow a beneficiary to obtains payment from abank even when the applicant for the credit has failed to perform as per bond.

A standby letter of credit is subject to "Uniform Customs and Practice for Documentary Credit" (UCP),International Chamber of Commerce Publication No 500, 1993 Revision, or "International StandbyPractices" (ISP), International Chamber of Commerce Publication No 590, 1998.

Import Operations Under L/c

The Import Letter of Credit guarantees an exporter payment for goods or services, provided the termsof the letter of credit have been met.

A bank issue an import letter of credit on the behalf of an importer or buyer under the followingCircumstances

When a importer is importing goods within its own country. When a trader is buying good from his own country and sell it to the another country for the

purpose of merchandizing trade. When an Indian exporter who is executing a contract outside his own country requires

importing goods from a third country to the country where he is executing the contract.

The first category of the most common in the day to day banking

Fees And Reimbursements

The different charges/fees payable under import L/c is briefly as follows

1. The issuing bank charges the applicant fees for opening the letter of credit. The fee chargeddepends on the credit of the applicant, and primarily comprises of :

(a) Opening Charges This would comprise commitment charges and usance charged to be chargedupfront for the period of the L/c.

The fee charged by the L/c opening bank during the commitment period is referred to as commitmentfees. Commitment period is the period from the opening of the letter of credit until the last date ofnegotiation of documents under the L/c or the expiry of the L/c, whichever is later.

Usance is the credit period agreed between the buyer and the seller under the letter of credit. Thismay vary from 7 days usance (sight) to 90/180 days. The fee charged by bank for the usance period is

referred to as usance charges

(b)Retirement Charges

1. This would be payable at the time of retirement of LCs. LC opening bank scrutinizes the bills underthe LCs according to UCPDC guidelines , and levies charges based on value of goods.

2. The advising bank charges an advising fee to the beneficiary unless stated otherwise The fees couldvary depending on the country of the beneficiary. The advising bank charges may be eventually borne

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by the issuing bank or reimbursed from the applicant.

3. The applicant is bounded and liable to indemnify banks against all obligations and responsibilitiesimposed by foreign laws and usage.

4. The confirming bank's fee depends on the credit of the issuing bank and would be borne by thebeneficiary or the issuing bank (applicant eventually) depending on the terms of contract.

5. The reimbursing bank charges are to the account of the issuing bank.

Risk Associated with Opening Imports L/cs

The basic risk associated with an issuing bank while opening an import L/c are :

1. The financial standing of the importerAs the bank is responsible to pay the money on the behalf of the importer, thereby the bankshould make sure that it has the proper funds to pay.

2. The goodsBankers need to do a detail analysis against the risks associated with perishability of the goods,

possible obsolescence, import regulations packing and storage, etc. Price risk is the anothercrucial factor associated with all modes of international trade.

3. Exporter RiskThere is always the risk of exporting inferior quality goods. Banks need to be protective byfinding out as much possible about the exporter using status report and other confidentialinformation.

4. Country RiskThese types of risks are mainly associated with the political and economic scenario of acountry. To solve this issue, most banks have specialized unit which control the level ofexposure that that the bank will assumes for each country.

5. Foreign exchange riskForeign exchange risk is another most sensitive risk associated with the banks. As thetransaction is done in foreign currency, the traders depend a lot on exchange rate fluctuations.

Export Operations Under L/c

Export Letter of Credit is issued in for a trader for his native country for the purchase of goods andservices. Such letters of credit may be received for following purpose:

1. For physical export of goods and services from India to a Foreign Country.2. For execution of projects outside India by Indian exporters by supply of goods and services from

Indian or partly from India and partly from outside India.3. Towards deemed exports where there is no physical movements of goods from outside India But

the supplies are being made to a project financed in foreign exchange by multilateral agencies,organization or project being executed in India with the aid of external agencies.

4.

For sale of goods by Indian exporters with total procurement and supply from outside India. Inall the above cases there would be earning of Foreign Exchange or conservation of ForeignExchange.

Banks in India associated themselves with the export letters of credit in various capacities such asadvising bank, confirming bank, transferring bank and reimbursing bank.

In every cases the bank will be rendering services not only to the Issuing Bank as its agentcorrespondent bank but also to the exporter in advising and financing his export activity.

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1. Advising an Export L/cThe basic responsibility of an advising bank is to advise the credit received from its overseasbranch after checking the apparent genuineness of the credit recognized by the issuing bank.

It is also necessary for the advising bank to go through the letter of credit, try to understandthe underlying transaction, terms and conditions of the credit and advice the beneficiary in thematter.

The main features of advising export LCs are:

1. There are no credit risks as the bank receives a onetime commission for the advisingservice.2. There are no capital adequacy needs for the advising function.

2. Advising of Amendments to L/CsAmendment of LCs is done for various reasons and it is necessary to fallow all the necessary theprocedures outlined for advising. In the process of advising the amendments the Issuing bankserializes the amendment number and also ensures that no previous amendment is missing fromthe list. Only on receipt of satisfactory information/ clarification the amendment may beadvised.

3. Confirmation of Export Letters of CreditIt constitutes a definite undertaking of the confirming bank, in addition to that of the issuingbank, which undertakes the sight payment, deferred payment, acceptance or negotiation.

Banks in India have the facility of covering the credit confirmation risks with ECGC under theirTransfer Guarantee scheme and include both the commercial and political risk involved.

4. Discounting/Negotiation of Export LCsWhen the exporter requires funds before due date then he can discount or negotiate the LCswith the negotiating bank. Once the issuing bank nominates the negotiating bank, it can takethe credit risk on the issuing bank or confirming bank.

However, in such a situation, the negotiating bank bears the risk associated with the document

that sometimes arises when the issuing bank discover discrepancies in the documents andrefuses to honor its commitment on the due date.

5. Reimbursement of Export LCsSometimes reimbursing bank, on the recommendation of issuing bank allows the negotiatingbank to collect the money from the reimbursing bank once the goods have been shipped. It isquite similar to a cheque facility provided by a bank.

In return, the reimbursement bank earns a commission per transaction and enjoys float incomewithout getting involve in the checking the transaction documents.

reimbursement bank play an important role in payment on the due date ( for usance LCs) orthe days on which the negotiating bank demands the same (for sight LCs)

Regulatory Requirements

Opening of imports LCs in India involve compliance of the following main regulation:

Trade Control Requirements

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The movement of good in India is guided by a predefined se of rules and regulation. So, the bankerneeds to assure that make certain is whether the goods concerned can be physically brought into India or not as per the current EXIM policy.

Exchange Control Requirements

The main objective of a bank to open an Import LC is to effect settlement of payment due by theIndian importer to the overseas supplier, so opening of LC automatically comes under the policies ofexchange control regulations.

UCPDC Guidelines

Uniform Customs and Practice for Documentary Credit (UCPDC) is a set of predefined rules establishedby the International Chamber of Commerce (ICC) on Letters of Credit. The UCPDC is used by bankersand commercial parties in more than 200 countries including India to facilitate trade and paymentthrough LC.

UCPDC was first published in 1933 and subsequently updating it throughout the years. In 1994, UCPDC500 was released with only 7 chapters containing in all 49 articles .

The latest revision was approved by the Banking Commission of the ICC at its meeting in Paris on 25October 2006. This latest version, called the UCPDC600, formally commenced on 1 July 2007. It containa total of about 39 articles covering the following areas, which can be classified as 8 sections accordingto their functions and operational procedures.

Serial No. Article Area Consisting

1. 1 to 3 GeneralApplication, Definition and

Interpretations

2. 4 to 12 Obligations Credit vs. Contracts, Documentsvs. Goods

3. 13 to 16Liabilities and

responsibilities.

Reimbursement, Examination of

Documents, Complying,

Presentation, Handling

Discrepant Documents

4. 17 to 28 Documents

Bill of Lading, Chapter Party Bill of

Lading, Air Documents, Road Rail

etc. Documents, Courier , Postal etc.Receipt. On board, Shippers' count,

Clean Documents, Insurance documents

5. 29 to 33Miscellaneous

Provisions

Extension of dates, Tolerance in

Credits, Partial Shipment and

Drawings. House of Presentation

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6 34 to 37 Disclaimer

Effectiveness of Document

Transmission and Translation

Force Majeure

Acts of an Instructed Party

7 38 & 39 Others Transferable CreditsAssignment of Proceeds

ISBP 2002

The widely acclaimed International Standard Banking Practice(ISBP) for the Examination of Documentsunder Documentary Credits was selected in 2007 by the ICCs Banking Commission.

First introduced in 2002, the ISBP contains a list of guidelines that an examiner needs to check thedocuments presented under the Letter of Credit. Its main objective is to reduce the number ofdocumentary credits rejected by banks.

FEDAI Guidelines

Foreign Exchange Dealer's Association of India (FEDAI) was established in 1958 under the Section 25 ofthe Companies Act (1956). It is an association of banks that deals in Indian foreign exchange and workin coordination with the Reserve Bank of India, other organizations like FIMMDA, the Forex Associationof India and various market participants.FEDAI has issued rules for import LCs which is one of the important area of foreign currency exchanges.It has an advantage over that of the authorized dealers who are now allowed by the RBI to issue standby letter of credits towards import of goods.

As the issuance of stand by of letter of Credit including imports of goods is susceptible to some risk inthe absence of evidence of shipment, therefore the importer should be advised that documentary

credit under UCP 500/600 should be the preferred route for importers of goods.

Below mention are some of the necessary precaution that should be taken by authorised dealers Whileissuing a stands by letter of credits:

1. The facility of issuing Commercial Standby shall be extended on a selective basis and to thefollowing category of importers

i. Where such standby are required by applicant who are independent powerproducers/importers of crude oil and petroleum products

ii. Special category of importers namely export houses, trading houses, star tradinghouses, super star trading houses or 100% Export Oriented Units.

2. Satisfactory credit report on the overseas supplier should be obtained by the issuing banksbefore issuing Stands by Letter of Credit.

3. Invocation of the Commercial standby by the beneficiary is to be supported by properevidence. The beneficiary of the Credit should furnish a declaration to the effect that theclaim is made on account of failure of the importers to abide by his contractual obligationalong with the following documents.

i. A copy of invoice.ii. Nonnegotiable set of documents including a copy of non negotiable bill of

lading/transport document.iii. A copy of Lloyds /SGS inspection certificate wherever provided for as per the

underlying contract.

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4. Incorporation of a suitable clauses to the effect that in the event of such invoice /shippingdocuments has been paid by the authorised dealers earlier, Provisions to dishonor the claimquoting the date / manner of earlier payments of such documents may be considered.

5. The applicant of a commercial stand by letter of credit shall undertake to provide evidence ofimports in respect of all payments made under standby. (Bill of Entry)

Fixing limits for Commercial Stand by Letter of Credit L/c

1. Banks must assess the credit risk in relation to stand by letter of credit and explain to theimporter about the inherent risk in stand by covering import of goods.

2. Discretionary powers for sanctioning standby letter of credit for import of goods should bedelegated to controlling office or zonal office only.

3. A separate limit for establishing stand by letter of credit is desirable rather than permitting itunder the regular documentary limit.

4. Due diligence of the importer as well as on the beneficiary is essential .5. Unlike documentary credit, banks do not hold original negotiable documents of titles to gods.

Hence while assessing and fixing credit limits for standby letter of credits banks shall treat suchlimits as clean for the purpose of discretionary lending powers and compliance with variousReserve Bank of India's regulations.

6. Application cum guarantee for stand by letter of credit should be obtained from the applicant.7. Banks can consider obtaining a suitable indemnity/undertaking from the importer that allremittances towards their import of goods as per the underlying contracts for which stand byletter of credit is issued will be made only through the same branch which has issued thecredit.

8. The importer should give an undertaking that he shall not raise any dispute regarding thepayments made by the bank in standby letter of credit at any point of time howsoever, and willbe liable to the bank for all the amount paid therein. He importer should also indemnify thebank from any loss, claim, counter claims, damages, etc. which the bank may incur on accountof making payment under the stand by letter of credit.

9. Presently, when the documentary letter of credit is established through swift, it is assumedthat the documentary letter of credit is subject to the provisions of UCPDC 500/600Accordingly whenever standby letter of credit under ISP 98 is established through SWIFT, a

specific clause must appear that standby letter of credit is subject to the provision of ISP 98.10. It should be ensured that the issuing bank, advising bank, nominated bank. etc, have allsubscribed to SP 98 in case stand by letter of credit is issued under ISP 98.

11.When payment under a stand by letter of credit is effected, the issuing bank to report suchinvocation / payment to Reserve Bank of India.

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Understanding and Using Letters of Credit, Part I

Letters of credit accomplish their purpose by substituting the credit of the bank for that of thecustomer, for the purpose of facilitating trade. There are basically two types: 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 CreditCommercial letters of credit have been used for centuries to facilitate payment in international

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. The general provisions anddefinitions 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 the issuingbank, 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, on the request of itscustomer, opens the letter of credit. The issuing bank makes a commitment 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 separate transaction from the

contract on which it is based. All parties deal in documents and not in goods. The issuing bank isnot 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 warrantsthat 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 becomes absolute

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upon the completion of the terms and conditions of the letter of credit. Under the provisions of

the Uniform Customs and Practice for Documentary Credits, the bank is given a reasonableamount 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 documents are

presented, the bank will pay the seller the amount due and to examine the documents, and onlypay if these documents comply with the terms and conditions set out in the letter of credit.

Typically the documents requested will include a commercial invoice, a transport document 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 that the letter ofcredit is valid. In addition, the advising bank would be responsible for sending the documents to

the issuing bank. The advising bank has no other obligation under the letter of credit. If theissuing bank does not pay the beneficiary, the advising bank is not obligated to pay.

Confirming BankThe correspondent bank may confirm the letter of credit for the beneficiary. At the request of the

issuing bank, the correspondent obligates itself to insure payment under the letter of credit. Theconfirming bank would not confirm the credit until it evaluated the country and bank where the

letter of credit originates. The confirming bank is usually the advising bank.

Letter of Credit Characteristics

NegotiabilityLetters of credit are usually negotiable. The issuing bank is obligated to pay not only the

beneficiary, but also any bank nominated by the beneficiary. Negotiable instruments are passedfreely 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 demand or 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 duecourse is treated favorably under the UCC.

The transaction is considered a straight negotiation if the issuing bank's payment obligationextends 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 theseconditions the promise does not pass to a purchaser of the draft as a holder in due course.

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

revoked or modified for any reason, at any time by the issuing bank without notification. Arevocable 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 advising bank.

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Once the documents have been presented and meet the terms and conditions in the letter of

credit, and the draft is honored, the letter of credit cannot be revoked. The revocable letter ofcredit is not a commonly used instrument. It is generally used to provide guidelines 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 theissuing bank, the confirming bank, and the beneficiary. An irrevocable letter of credit from the

issuing bank insures the beneficiary that if the required documents are presented and the termsand 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 credit may be transferred only once.

However, even if the credit specifies that it is nontransferable or nonassignable, the beneficiarymay transfer their rights prior to performance of conditions of the credit.

Sight and Time DraftsAll letters of credit require the beneficiary to present a draft and specified documents in order 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 documents before makingpayment.

A time draft is not payable until the lapse of a particular time period stated on the draft. The bankis 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 standbyletter of credit serves as a secondary payment mechanism. A bank 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 involved with the transaction do not expect that theletter of credit will ever be drawn upon.

The standby letter of credit assures the beneficiary of the performance of the customer's

obligation. The beneficiary is able to draw under the credit by presenting a draft, copies ofinvoices, with evidence that the customer has not performed its obligation. The bank is obligated

to make payment if the documents presented comply with the terms of the letter of credit.

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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 thecompletion of a sales contract. The credit has an expiration date.

The standby letter of credit is often used to guarantee performance or to strengthen the credit

worthiness of a customer. In the above example, the letter of credit is issued by the bank and heldby 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 drawn on. The sellerpursues 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 after receipt of the

documents to honor the draft.

Procedures for Using the Tool

The following procedures include a flow of events that follow the decision to use a CommercialLetter 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 a correspondent bank (advising orconfirming). 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 guaranteepayment.

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 locatedin 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 documentaryrequirements to support the letter of credit. Documentary requirements may vary greatly

depending on the perceived risk involved in dealing with a particular company.

Seller presents the required documents to the advising or confirming bank to beprocessed for payment.

Advising or confirming bank examines the documents for compliance with the terms andconditions 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.

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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 the letter of credit.Although the credit can require an array of documents, the most common documents 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 specificallystates otherwise, a generic description of the merchandise is usually acceptable in the other

accompanying documents.

Bill of LadingA document evidencing the receipt of goods for shipment and issued by a freight carrier engagedin the business of forwarding or transporting goods. The documents evidence control of goods.

They also serve as a receipt for the merchandise shipped and as evidence of the carrier'sobligation 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 isgenerally issued to the purchaser and issuing bank expressing an agreement to 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 whenavailable.

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

the documents that causes them to be in non-compliance to the letter of credit. Requirements setforth in the letter of credit cannot be waived or altered by the issuing bank without the express

consent of the customer. The beneficiary should prepare and 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.

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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 beallowed 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 the documents 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. Payment cannot 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 becomplied with within the prescribed time limits.

Many presentations of documents run into problems with time-limits. You must be awareof at least three time constraints - the expiration date of the credit, the latest shipping date

and the maximum time allowed between dispatch and presentation.

If the letter of credit calls for documents supplied by third parties, make reasonableallowance for the time this may take to complete.

After dispatch of the goods, check all the documents both against the terms of the creditand 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 thatof 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. Thecommercial 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 serves as 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.

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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 can comply with all theterms and conditions. When compliance is in question, the buyer should be requested to amend

the credit.