LESSON 16 Letter of Credit

A letter of credit is a document from a bank guaranteeing that a seller will receive payment in full as long as certain delivery conditions have been met. In the event that the buyer is unable to make payment on the purchase, the bank will cover the outstanding amount.bankpayment

They are often used in international transactions to ensure that payment will be received where the buyer and seller may not know each other and are operating in different countries. In this case the seller is exposed to a number of risks such as credit risk, and legal risk caused by the distance, differing laws and difficulty in knowing each party personally. A letter of credit provides the seller with a guarantee that they will get paid as long as certain delivery conditions have been met. For this reason the use of letters of credit has become a very important aspect of international trade.credit risklegal riskinternational trade

The bank that writes the letter of credit will act on behalf of the buyer and make sure that all delivery conditions have been met before making the payment to the seller. Most letters of credit are governed by rules promulgated by the International Chamber of Commerce known as Uniform Customs and Practice for Documentary Credits. Letters of credit are typically used by importing and exporting companies particularly for large purchases and will often negate the need by the buyer to pay a deposit before delivery is made.International Chamber of CommerceUniform Customs and Practice for Documentary Credits

They are also used in land development to ensure that approved public facilities (streets, sidewalks, storm water ponds, etc.) will be built. The parties to a letter of credit are the supplier, usually called the "beneficiary", "the issuing bank", of whom the buyer is a client, and sometimes an advising bank, of whom the beneficiary is a client. Almost all letters of credit are irrevocable, i.e., cannot be amended or canceled without mutual consent of all parties.advising bank

A sight LC causes payment to be made immediately to the beneficiary/seller/exporter upon presentation of the correct documents. A time or date LC specifies when payment is to be made at a future date and upon presentation of the required documents Negotiation means the giving of value for draft(s) or document(s) by the bank authorized to negotiate, with the nominated bank. Mere examination of the documents and forwarding the same to the LC issuing bank for reimbursement, without giving of value / agreed to give, does not constitute a negotiation.

Advising Bank — advises the beneficiary at the request of the issuing bank. Applicant — the party on whose request the issuing bank issues a credit. Banking day—The day on which a bank is regularly open at the place at which an act to be performed. Beneficiary — the party who is to receive the benefit (payment) of the LC. The consignee of an LC and the beneficiary may not be the same. The credit is issued in the beneficiary's favor.

One of the primary peculiarities of the documentary credit is that the payment obligation is independent from the underlying contract of sale or any other contract in the transaction. Thus the bank’s obligation is defined by the terms of the LC alone, and the sale contract is irrelevant. The defenses available to the buyer arising out of the sale contract do not concern the bank and in no way affect its liability. Article 4(a) of the UCP states this principle clearly. Article 5 of 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, are in order, then in general the bank is obliged to pay without further qualifications.

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

Documentary collection (more secure for buyer and to a certain extent to seller) — Also called "Cash Against Documents". Subject to ICC's URC 525, sight and usance, for delivery of shipping documents against payment or acceptances of draft, where shipment happens first, then the title documents are sent to the buyer's bank by seller's bank, for delivering documents against collection of payment/acceptanceusance Direct payment (most secure for buyer) — The supplier ships the goods and waits for the buyer to remit the bill, on open account terms.