8/14/2019 Notes - Letter of Credit.doc

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An LC is a letter written by the buyers bank to the seller advising him that he may draw a bill of exchange upto aparticular amount for the shipment of certain goods and assuring him of payment on his submitting certainspecified documents. It is in short an undertaking or a guarantee by a bank of payment should certain conditionsbe met.

Any arrangement, however named or described, whereby a bank (the Issuing ank! acting at the re"uest and onthe instructions of a customer (the Applicant! or on its own behalf#i! Is to make a payment to or to the order of a third party (the beneficiary! or is to accept bills of exchange (drafts!

drawn by the eneficiary.orii! Authori$es another bank to effect such payment or to accept and pay such bills of exchange (draft(s!!.oriii! Authori$es another bank to negotiate against stipulated document(s! provided that the terms are complied with.ranches of bank in different countries are considered another bank. (Article % &C' ))!.

It is to be noted that as banks deal only in documents and payment is made on the submission of documents.(Article *, &C' ))!.

+he parties to a letter of credit are#. +he uyer or Importer +he buyer is the person at whose instance the letter of credit is opened. -e is

therefore called or known as the Opener. &ntil the letter of credit is opened he is the applicant.

%. +he uyers ank +he buyers bank is the one that, at the buyers re"uest, opens the letter of credit. It istherefore known as the Opening or Issuing Bank. +he /eller +he seller is called the beneficiaryof the credit as he is the one who will receive the payment

on the letter of credit.*. Intermediary Bank:+he opening bank does not usually correspond directly with the beneficiary but

through another bank. +he intermediary bank is often located in the same country as the seller. +heintermediary bank advises the beneficiary of the letter of credit having been opened and the conditionsstated therein. +hese intermediaries are known as advising or notifying banks.

. Correspondent Bank:A correspondent bank is one with which a bank has a business relationship. +hecorrespondent bank may have an account with the bank or may advise and confirm letters of credit ormay issue guarantees on behalf of the bank. A bank will normally have, as a conse"uence, a list of theauthori$ed signatories of the bank in order for it to verify that the instructions received are in order. +heusefulness of a correspondent bank is evident in situations where a letter of credit or a guarantee has tobe advised or issued in a country in which the bank does not have a branch. In such a situation the bankutili$es the services of its correspondent bank to advise0confirm a letter of credit or issue a guarantee.

1. Advising Bank:An advising bank advises the beneficiary (seller! that a letter of credit has been issued inhis favor. Implicit in the advise is that it is genuine as the bank would advise a letter of credit issued onlyby one of its own branches or one of its correspondents. 'rior to advising the letter of credit, the advisingbank will check that it is properly signed by those authori$ed to issue it. +his is extremely important tosellers. -e needs an assurance that the letter of credit that he receives be it from the &/A or 2aire isgenuine. +he advising bank is invariably a bank in the sellers (beneficiary3s! country 4 a bank that heknows and trusts. +his gives him the assurance that the document is genuine. It is important to reali$ethough that an advising bank advises the beneficiary with no responsibility for payment. It performs thefunction of a courier or an informer informing the beneficiary that a letter of credit has been issued in hisfavor. +he only assurance implied, as mentioned earlier, is that the letter of credit is genuine. +his is whyletters of credit are never sent to a beneficiary directly by the issuing bank but through another bank.

5. Confirming Bank: +he beneficiary in another country is often concerned about payment. -e may have

received a genuine letter of credit but he may be worried whether he would be paid. +here was aninstance of a company in India that entered into an agreement to sell certain articles to a company in6igeria. +he 6igerian company had its bank in 6igeria open a letter of credit and actually deposited theentire value of the letter of credit with the bank. +he goods were exported but the seller was not paid asthe 6igerian government, on account of a lack of foreign exchange, did not permit the bank in 6igeria topay the seller. +his worry is negated by a confirmed letter of credit. A bank in the sellers country confirmsthe letter of credit and by doing this that bank takes the position and liabilities of the issuing bank. +hatbank would then, should the documents be in order, pay the seller.

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7. Negotiating Bank:+he negotiating bank is one with whom the documents may be negotiated. Letters ofcredit may specify through which bank0banks the letter of credit may be negotiated or they may be freelynegotiable through any bank.

8. Paying Bank:+he paying bank is that bank at whose counters the seller would be paid. +his can be abank other than the issuing bank and this is often the case in instances such as#

a. 9hen payment had to be made in a currency that is alien to both the opener and the beneficiary.b. 9hen there are exchange controls regarding remittance in the country in which the opener

resides.