Letters of Credit (L/C)

What Letters Of Credit (L/C) Is

Letters of Credit (L/C) is in general a conditional document extended by the bank in connection with presentation of export value. L/C plays a very dominant role in this matter. On receipt of this document from the buyer, the exporters become sure that they would obtain foreign currency after the peaceful shipment of the consignment directed by the buyer in the L/C. And for monetary transactions in this connection the negotiating banks stand as a symbol of surety for the exporters. Negotiating bank act on behalf of the exporter and is held liable or responsible for realization of exporter’s money from the L/C opening bank.

A credit may be advised to a beneficiary through another bank (the advising bank) without engagement on the part of the advising bank, but that bank shall take reasonable care to check the apparent authenticity of the credit which it advises.

All credits will always clearly indicate whether they are available by sight payment, by deferred payment, by acceptance or by negotiation. Moreover every credit must nominate the bank (nominated bank) which is authorized to pay (paying bank) or to accept drafts (accepting bank) or to negotiate (negotiating bank), unless the credit allows negotiation by any bank (negotiating bank). The nominated bank unless is the issuing bank or the confirming bank, its nomination by the issuing bank does not constitute any undertaking by the nominated bank to pay, accept, or to negotiate. When an L/C issuing bank instructs a bank (advising bank) by any tale transmission to advise a credit or a amendment to a credit, and intends the mail Confirmation to be the operative credit instrument, or the operative amendment, the tale transmission must state “full details to follow” (or words of similar effect) or that the mail confirmation will be the in that case, operative credit instrument or the operative amendment. The issuing bank must forward the operative credit instrument or the operative amendment to such advising bank without delay.

In spite of production of all related documents with the banks, the exporters however, became victims to some unpleasant situations which push them towards the uncertainty of realization of money. This results from the absurdity or ambiguity of L/C. An in most cases from faulty presentation of documents to be required in export connection. So unless exporters have a clear conception and apprehension about export business and be aware beforehand about all these documents, they would certainly face some major troubles. In per export and post export process, exporters will after all, have first hand knowledge about UC. They must be in the climax of knowledge. It is L/C which act a medium of money during the time of execution of export order and this gives surety to the exporter that their dues would be obtained in due time.

In fact, in the whole export and import process four sides are connected. In absence of any one of them the process can not take full shape. These four sides are, exporter, Importer, exporter’s bank and importers’ bank. Principally, the success of import and export business lies in the exchange of proper and accurate correspondence. Any fault in these may cause in total disaster in whole import and export business. So in order to avoid the ambiguous, absurd and understandable correspondences, both the sides are to exercise special and particular attention. They should remember that the success of export and Import business depends mainly upon the careful execution of these things.

It is seen that inadequate knowledge in this business create some trouble that in the long run, both the sides are put to difficulty for their business i.e. exporters fail to realize their money and importers to get their goods from the exporters’ country. In addition to the exporter become harassed to have this just value from the bank. So both the sides should be particular as far as possible about it.

In export business, the first thing to do is to make a sale contract with the buyer. And this may be made in the presence of both of the importer and exporter. In most cases this may not be done formally. Yet, it plays a very significant role in the preliminary stage of export business. If this is not done formally, then exchange of letters, fax and email between them from time to time is taken for granted as the contract of the business. This may be styled as verbal contract. This also leaves importance in the business. These exchange documents are important for this reason that many times these are required by the negotiating bank of the exporters. Any loss of these may bring in fault in the business.

In case of verbal contact, verbal contact here refers to the contact which is formed through correspondences, exporters are to send pro-forma invoice along with all other details, including Specifications of goods, definite price and the date of shipment and payment terms. In addition this all other conditions, if the exporter thinks necessary, may be placed in this from.

There are some methods of payment of export value. These are as follows

•             Letters of Credit

•             Advance T.T Remittances.

•             Deferred payment

•             C. A. D. basis etc.

Of all the methods referred to above, letter of credit method is most popular and it is in fashion.

Kinds of Letters of Credit (L/C)

•             Revocable Letter Of Credit.

•             Irrevocable Letter Of Credit

•             Confirmed Letter Of Credit.

•             Confirmed And Irrevocable Letter Of Credit

•             Transferable Or Divisible Letter Of Credit

•             Back To Back Letter Of Credit

•             Red Clause Letter Of Credit

•             Sight Letter Of Credit

•             Usance Letter Of Credit

•             Revolving Letter Of Credit

•             Stand-By Letter Of Credit

All letters of credit therefore, should clearly indicate whether they are revocable or irrevocable. In the absence of such indication the credit shall be deemed to be revocable.

Revocable L/C

A revocable L/C may be amended or canceled by the issuing bank at any moment and without prior notice to the beneficiary. In case of revocable credit, however, the L/C issuing bank is bound to:

(i) Reimburse a branch or bank with which a revocable credit has been made available for deferred payment, if such branch or bank has, prior to receipt by it for notice of amendment or cancellation, taken up documents which appear on their face to be in accordance with the terms and conditions of the credit.

(ii) Reimburse a branch of bank with which a revocable credit has been made available for sight payment, acceptance or negotiation, for any payment, acceptance or negotiation made by such branch or bank prior to receipt by it for notice of amendment or cancellation, against documents which appear on their face to be in accordance with the terms and conditions of the credit.

Irrevocable L/C

An irrevocable L/C constitutes a definite undertaking of the issuing bank, provided that the stipulated documents are presented; the terms and conditions of the credit are complied with. The full name of “L/C” is Irrevocable Letter Of Credit which means once it is issued by the bank for the buyer and received and accepted by the beneficiary (the seller), it cannot be canceled or withdrawn by the buyer or the opening bank, unless with the consent of the beneficiary. In short, once the buyer opens the L/C from his bank to cover the goods he has purchased, he will have to pay for the goods when the seller ships the goods exactly as per the terms stipulated in the L/C. Therefore, as far as the seller is concerned, the sooner he has the L/C on hand, the safer he is.

L/Cs can be opened in many ways, but in essence, it is a promise the buyer’s bank makes to the supplier, to pay him when he does certain things with evidence to prove. The things the L/C opening bank wants the supplier to do are called “terms”. Therefore, when the supplier receives an L/C, he must read the terms carefully to make sure he is capable of fulfilling them all exactly as they are written. If some terms are beyond his ability to fulfill, he must point them out to the buyer and explain why he cannot comply with those terms, and request the buyer to amend them by means of an official amendment through the bank.

Confirmed L/C

This is such a credit for which exporter’s bank gives all sorts of surety for the advance of payment.

Confirmed and Irrevocable L/C

Confirmed and Irrevocable L/C Which combines the quality of Confirmed L/C and Irrevocable L/C clause.

Transferable or Divisible  L/C

A Transferable credit is a credit under which the beneficiary has the right to request the bank called upon to effect payment or acceptance or any bank entitled to effect negotiation to make the credit available in whole or in part to one or more other parties (second beneficiaries.)

A credit can be transferred only if it is expressly designated as “transferable” by the issuing bank. Terms such as ” divisible”, “fraction able”, “assignable” and “transmissible” add nothing to the meeting of the term “transferable” and shall not be used, In that case the bank requested to effect the transfer (transferring bank), Whether it has confirmed the credit or not shall be under no obligation to effect such transfer except to the extent and in the manner Expressly consented to by such bank. Bank charges in respect of transfers are payable by the first beneficiary unless, otherwise specified.

A transferable credit can be transferred once only. Fractions of transferable credit (not exceeding in the aggregate the amount of credit) can be transferred separately, provided partial shipment are not prohibited, and the aggregate of such transfers will be considered as constituting only one transfer of the credit. The credit can be transferred only one the terms and conditions specified in the original credit, with the exception of the amount of the credit.

Back to Back L/C

A back to back letter of credit is a new credit. It is different from the original credit based on which the bank undertakes the risk under the back to back credit. In this case the bank’s main surety / security are the original credit. The original credit (selling credit) and the back the back credit although they both from the part of the same business operation. The supplier (beneficiary of the back to back credit) ships goods to the importer or supplies goods to the exporter and presents the document to the bank as is specified in the credit. It is intended that the exporter would substitute his own documents and ships the goods to the importer, if necessary, and present documents for negotiation under the original credit, his liability under the back to back credit would be adjusted out of these proceeds.

Types of Back To Back Letter Of Credit

There are two types of back to back credits:

•             Congruent: The back to back credit calls for such documents (with the exception of the invoice and possibly the draft) as can be used without any amendment for the original credit.

•             Incongruent: After exchange of the invoice (and draft, if any) none or only a part of the documents to be submitted for the back to back credit can be used for the original credit (for example the letter requires a certificate of origin to be legalized in the country of the middleman)

Only the transferable credit is mentioned in the UCP, the back to back be omitted. Therefore, no specific rule for the back to back credit exists. A bank will treat such an operation as two separate transactions, each legally independent of the other.

A bank is prepared to open a back to back credit if the middleman (Applicant) is considered sufficiently reliable and capable of a faultless execution of this part of the operation.

Red-Clause L/C

In this credit, the exporter’s bank is directed to advance his dues even before they produce all export documents to the bank.

Sight L/C

It means when the shipper ships the goods covered by the L/C, and presents the documents to the bank for negotiation, the bank (the negotiating bank) will credit the proceeds to the shipper’s account immediately after checking and finding the, documents in order. When the documents are sent by the negotiating bank to the L/C opening bank, the VC opening bank will effect payment to the negotiating bank immediately. Such L/Cs usually says “AT SIGHT” which means “pay when the bank sees the documents”.

Usance L/C

It means L/C with time allowed for the opening bank to make payment of a foreign bill of exchange. Or, put it in another way, payment from the L/C opening bank to the negotiating bank will only be made after a period of time as stipulated in the L/C. The length can be worked out between the buyer and the supplier, sometimes 60 days, sometimes 90 days or 120 days.

Sometimes when the exporter receives a usance L/C of, for instance, 90 days sight, he may think he has to wait 90 days after shipping goods to receive payment, or if he wishes to receive payment at once, he will have to pay interest to his bank. However, this is not always the case. Sometimes, the L/C may say-  “90 days sight with interest to be borne by the L/C opener”. If it does say this, he virtually can use it like a sight L/C. After he has presented the documents to his bank, his bank should pay him in full (not discounted) at once after checking them and finding them in order. However, his bank, the negotiating bank would have to wait 90 days for the L/C opening bank to pay. Therefore, as far as he is concerned, he can receive payment as if is a sight L/C.

If the usance L/C does not say “Interest is to be borne by the L/C opener”, then either he will have to wait till the maturity of the 90 days or whatever the time spent is as specified in the L/C to receive payment, or he may request his bank to pay him at once and charge him for the interest. His bank usually should accept his request.

Revolving L/C

It means that the beneficiary can draw money from such L/C up to the amount specified by means of documents, and after drawing, the amount drawn will automatically be replenished and is available for another drawing and another drawing, and so on.

However, in order to limit the size of loss which might be caused by fraudulent activities by the beneficiary, it is advisable for the opening bank to specify a time interval between each drawing based on the actual need of the beneficiary.

Revolving L/Cs are good for the buyer and the supplier to cover purchases made regularly as one L/C can be used many times saving a lot of paper work as well as L/C opening charges and receiving charges at both ends.

However, the L/C opening bank usually would not open a revolving L/C for the buyer unless he has much bigger credit line than the size of the L/C he would like the bank to open for him. The following will explain why:

•             If the buyer wants to open an UC of $ 10,000.00 the credit line he has to have with the bank is $10,000.00 because the maximum risk the bank is exposed to is $ 10,000.00

•             If the buyer wants to open a revolving L/C of $ 10,000.00 for 4 months with a time interval of one month between each drawing, the bank may need a credit line or cash or collateral of $ 40,000.00 from your buyer because the risk the bank is exposed to is truly $ 40,000.00 not $ 10,000.00.

Stand by L/C

This is normally used by the opener, party (a) to assist the beneficiary, party (b), or for party (a) to guarantee party (b) for certain reason. The following example will illustrate the function more clearly:

Example:

Party (a) is a rich company with a big credit line from a bank and party (b) is a small company with insufficient financial strength to handle certain business activities. (a) And (b) have a close business relationship. Now (a) Has decided to assist (b) but would not like to give a cash loan to (b).

In order to give (b) the assistance, (a) now opens an UC to (b) for say $10,000.00 with simple term that if (b) presents an invoice or a receipt written a certain way for any amount up to $10,000.00 (a)’s bank will pay accordingly. The UC may also say negotiation must not be made before a certain date, and not after a certain date so as to give a time limit for this matter to end.

When such UC is received by (b), will surrender it to his bank with the invoice or receipt prepared as required by the UC for a loan of $ 10,000.00 or any amount less than $ 10,000.00 against it, or will get a credit line from the bank for his business activities. He should be able to achieve this by means of this stand by L/C. In short, the spirit of a stand by UC is to transfer some financial strength from one company to another.

Defective Clauses Appeared in the L/Cs

•             Issuing bank is not reputed

•             Advising credit by the advising bank without authentication

•             Port of destination Absent;

•             Inspection clause;

•             Nomination of specific sipping / Air line or nomination of specified vessel by subsequent amendment.

•             B/L to blank Endorse, to endorse to 3rd bank, to be endorsed to buyer or 3rd parry.

•             No specific reimbursement clause;

•             U.C.P clause not mentioned;

•             Shipment/ presentation period is not sufficient

•             Original documents to be sent to buyer or nominated agent;

•             FCR or HAWB consigned to applicant or buyer;

•             “Shipper’s load and count is not acceptable” clause;

•             L/C shall expire in the country of the issuing bank’

•             Negotiation is restricted.

Documentation for Opening L/C

Before preparing necessary documents importer must collect Indent / Pro-forma Invoice. Otherwise, importer will not be able to fill up the L/C application form. So, obtain an indent / pro-forma invoice as per the category of your L/C prior to filling up the forms.

Documents Provided by the Bank for Opening L/C

•             L/C Application Form

•             LCA Form (Letter of Credit Authorization Application Form)

•             IMP Form (Import Permission Form)

•             TM Form

•             Agreement Form

•             Charges of Documents

•             Guarantee Form

Importer has to fill up the forms mentioned above, and after verifying and signing, the following documents should be submitted to the bank.

•             Trade License (valid)

•             Import Registration certificate (IRC)

•             Income tax declaration or a TIN

•             Membership Certificate

•             Memorandum of Association

•             Registered deed (in case of partnership firm)

•             Resolution (in case of partnership firm)

•             Photographs.

•             Insurance cover Note and receipt of premium payment.

•             A copy of indent/pro-forma invoice etc.

Documents Required for Opening a Cash L/C

•             A prayer for opening L/C.

•             L/C Application form

•             Indent / pro-forma invoice

•             L/C A Form

•             IMP

•             Charge of Documents

•             Insurance cover note

Documents required for Opening Back To Back L/C

•             Master L/C.

•             Valid Import Registration Certificate (I R C) & Export Registration certificate (ERC).

•             L/C application & LCA form duly filled in & signed.

•             Pro-forma Invoice or Indent.

•             Insurance Cover Note with Money Receipt.

•             IMP Form duly signed.

In addition to the above the following papers/ documents are also required for export oriented garment industries while requesting for opening of back to back L/C:

•             Textile permission.

•             Valid Bonded ware house License.

In case the Factory premises is a rented one, letter of Disclaimer duly executed by the owner of the house / premises to be submitted.