LETTER OF CREDIT (DOCUMENTARY CREDIT)

The D/P and the D/A modes of payment suggest that there is a certain degree of lack of confidence of the parties in each other. The exporter is not willing to send the goods on D/P or D/A basis because he is not sure as to whether the importer would make the payment and if the importer doesn’t pay, then he runs the risk of non-payment. Similarly, importer may also have the feeling that if he makes advance payment to the exporter and he does not supply the goods of the quality desired by him on the due date, then he would also suffer loss. Both the parties would be able to conduct their part of the transaction smoothly if there is an assurance to them as regards protection of their interests. The exporter requires an assurance for payment of the goods if he has sent the shipment as per export order. The importer on the other hand, requires an assurance that the payment would be released to the exporter only when he has supplied the goods as per the terms and conditions stipulated in the export contract. This assurance in the form of undertaking to pay is provided by the importer’s bank and is known as Letter of Credit or the Documentary Credit. Letter of Credit refers to a written undertaking given by the importer’s bank, at the request and instruction of importer (i.e., applicant), to the exporter (i.e., beneficiary) that the payment shall be made to him against stipulated documents provided that the same appear on their face to be in accordance with the terms and conditions of the credit, the applicable provision of UCP 600 and international standard banking practice. These terms and conditions are indicated by the importer to the bank issuing the letter of credit. An essential characteristic of the Letter of Credit is that it relies on the doctrine of strict compliance for making payment to the exporter against the documents stipulated in the Credit. The banks do not deal in goods; they deal in documents. As such, the importer has to specify to the bank the documents which it should examine to conclude that the exporter has sent the shipment in strict compliance with the terms and conditions of the Credit.

Features of letter of credit

A Letter of credit is characterized by the following features:

1. Parties to a Letter of CreditThe parties to a letter of credit transaction are as follows:

a. Issuing bank I.E., The bank that issues the letter of credit. It is the bank acting the request… of a customer.

b. Applicant i.e, the customer on whose behalf the letter of credit is issued. In relation to export – import transaction, the customer is the importer.

c. Beneficiary i.e., the third party to whom the payment shall be made. In relation to export- import transaction, the beneficiary is the exporter.

d. Negotiating bank i.e., the bank authorized to negotiate the documents stipulated in the letter of credit.

2 This arrangement, called letter of credit, is an undertaking of the Issuing Bank, that is, the Issuing Bank shall:

a. make payment to the beneficiary or to a party as per the order of the

beneficiary, of b. accept and pay the bills of exchange i.e., draft (s) drawn by the

beneficiary, or c. authorize another bank to effect such payment ( in this case the other bank

shall be called the paying bank) or accept and pay such bills of exchange (in this case the bank accepting the bill of exchange would be called the accepting bank)or

d. Authorize another bank to negotiate the stipulated documents (In this case ‘another bank’ is called the negotiating bank).

3 It needs to be clearly understood that this undertaking of the issuing bank is a conditional undertaking and is subject to the following conditions that the:

a. beneficiary presents the documents as stipulated in the letter of credit andb. Documents on their face appear to constitute a complying presentation,

that is, presentation of documents is in accordance with terms and conditions of the credit, the applicable provisions of UCP600 and international standard banking practice.

Procedure for the issue of Letter of Credit

The procedure for the issue of letter of credit as explained in figure 10.3 is as follows:

1. The exporter and the importer enter into an export contract which provides for payment by means of a letter of credit

2. The importer approaches his bank to open the letter of credit in favors of the exporter

3. The importer’s bank sends the letter of credit to the exporter through one of its corresponding banks in the exporter’s country, known as advising bank.

4. Advising bank authenticates the letter of credit and sends it to the exporter.

Contents of letter of credit

A letter of credit generally contains the following information:

1. Complete and correct name and address of the beneficiary i.e., the exporter.

2. Complete and correct name and address of her applicant i.e., importer. 3. They of the letter of Credit / Documentary Credit.4. Amount of credit5. How the credit shall be available e.g., by sight payment, deferred payment

acceptance or negotiation 6. Name of the nominated bank,(That is , the bank which shall make

payment to the beneficiary.)7. The name of the drawee of the draft and the tenor of the draft.8. List of documents required to be submitted by the beneficiary.9. Description of goods, quantity of the items and the unit price.10. Port of discharge and the place of final destination.11. Terms of delivery i.e., FOB, CFR, CIF etc.12. Status of transshipment i.e. whether allowed or not.13. status of partial shipment i.e., whether allowed or not 14. The last date of sending shipment.15. Time period for the presentation of documents for negotiation by the

beneficiary after the dispatch of the shipment.16. The date and lace of expiry of the letter of credit.17. Transfer of the letter of credit allowed or not.18. Mode of advice of the letter of credit i.e., by mail or teletransmission.

Precautions to be taken by the Beneficiary on the Receipt of letter of Credit

An exporter should scrutinise the letter of credit carefully before proceeding to execute the export order. He should examine the following points to ensure that:

1. The letter of credit appears to be a valid letter of credit. He can consult his banker for this purpose.

2. The type of letter of credit and its terms and conditions are as per the agreed terms and conditions of the export contract.

3. All the terms and conditions are acceptable and can be complied with. It should be ensured that the letter of credit does not include any condition that is unacceptable or cannot be complied with.

4. The documents required under the letter of credit can be obtained and presented.

5. The description of the goods, quantity and the unit prices are as per the export contract.

6. there is no clause in the letter of credit that requires payment of costs or charges not agreed to with importer.

7. The last date for sending shipment and the time allowed for presentation of the documents are acceptable.

8. The port of loading and the port of discharge are as per the export contract.

9. The responsibility for the insurance of the goods has been clearly stated.

FORM OF DOCUMENTARY CREDIT

The form of documentary credit is the irrevocable documentary credit or the letter of credit even if there is no indication that effect. An irrevocable letter of credit implies that its terms and conditions can be cancelled/ modified only the express consent of the beneficiary, the issuing bank and the confirming bank (if any). Thus, an importer cannot get the term and conditions of the letter of credit modified/ cancelled without the express consent of the exporter. An irrevocable letter of credit implies an undertaking to the beneficiary that the issuing bank commits itself to honour the draft/s drawn by the exporter under the credit provided that all the stipulated documents are presented and these are in strict compliance with the terms and conditions of the letter of credit, the applicable provisions of UCP600 and international standard banking practice. This means that the irrevocable letter of credit is an insurance against commercial risk to payment. Such risks arise due to the bankruptcy of importer, dishonest intentions of the importer to make the payment or the liquidity problems faced by him. These risks would not affect payment to the exporter.

On the other hand, a letter of credit is known as revocable if its terms and conditions can be amended, revoked or cancelled without the consent of the beneficiary and even without giving prior notice to the beneficiary regarding the likely change in the letter of credit. Such a letter of credit involves lot of risk to the beneficiary as its terms and conditions can be modified/ cancelled while the goods are in transit or though the documents have been presented but before payment could be made. In such a situation, the exporter will face the problem of realizing payment directly from the importer.

KINDS OF LETTER OF CREDIT

There are various kinds of letter of credit depending upon the features added to it as desired by the applicant. The various kinds of the letter of credit are as follows:

1. Sight or Usance letter of credit 2. Confirmed or Unconfirmed letter of credit3. Negotiable letter of credit4. Revolving letter of credit 5. Red clause letter of credit 6. Green clause letter of credit7. Transferable letter of credit

8. Bank to back letter of credit9. With recourse or without recourse letter of credit 10. Standby letter of credit

Sight or Usance letter of credit

A Letter of credit is known as sight letter of credit or the letter of credit at sight if it involves payment to the exporter against sight draft. On the other hand, if the payment is to be made against usance draft, then the letter of credit is known as Usance letter of credit.