LETTER OF CREDIT

INTRODUCTION: A letter of credit(L/C or LC) is a document issued by a financial institution which provides an irrevocable payment undertaking to a beneficiary against complying documents as stated in the credit. It is often referred to as a documentary credit, abbreviated as DC or D/C, documentary letter of credit, or simply as credit. Once the beneficiary or a presenting bank acting on its behalf, makes a presentation to the issuing bank or confirming bank, if any, within the expiry date of the LC, comprising documents complying with the terms and conditions of the LC, the applicable UCP and international standard banking practice, the issuing bank or confirming bank, if any, is obliged to honour irrespective of any instructions from the applicant to the contrary. In other words, the obligation to honour (payment) is shifted from the applicant to the issuing bank or confirming bank. Non-banks can also issue letters of credit however parties must balance potential risks.

BENEFITS OF A LETTER OF CREDIT: To The Exporter/Seller Letters of credit open doors to international trade by providing a secure mechanism for payment upon Fulfillmentof contractual obligations. A bank is substituted for the buyer as the source of payment for goods or services exported. The issuing bank undertakes to make payment, provided all the terms and conditions stipulated in the letter of credit are complied with. Financing opportunities, such as pre-shipment finance secured by a letter of credit and/or discounting of accepted drafts drawn under letters of credit, are available in many countries. Bank expertise is made available to help complete trade transactions successfully. Payment for the goods shipped can be remitted to your own bank or a bank of your choice.

To the Importer/Buyer Payment will only be made to the seller when the terms and conditions of the letter of credit are compliedwith. The importer can control the shipping dates for the goods being purchased. Cash resources are not tied up. 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

Types: There are two basic forms of letters of credit: Standby and Documentary. Documentary letters of credit can be either Revocable or Irrevocable, although the first is extremely rare. Irrevocable letters of credit can be Confirmed or Not Confirmed. Each type of credit has advantages and disadvantages for the buyer and for the seller, which this information will review below. Charges for each type will also vary. However, the more the banks assume risk by guaranteeing payment, the more they will charge for providing the service.

Documentary Revocable Letter of Credit Revocable credits may be modified or even canceled by the buyer without notice to the seller. Therefore, they are generally unacceptable to the seller.

Documentary Irrevocable Letter of Credit This is the most common form of credit used in international trade. Irrevocable credits may not be modified or canceled by the buyer. The buyer's issuing bank must follow through with payment to the seller so long as the seller complies with the conditions listed in the letter of credit. Changes in the credit must be approved by both the buyer and the seller. If the documentary letter of credit does not mention whether it is revocable or irrevocable, it automatically defaults to irrevocable. See Credit Administration, Sample Procedure for Administration of a Documentary Irrevocable Letters of Credit for a systematic procedure for establishing an irrevocable letter of credit.

There are two forms of irrevocable credits: Unconfirmed credit (the irrevocable credit not confirmed by the advising bank)In an unconfirmed credit, the buyer's bank issuing the credit is the only party responsible for payment to the seller. The seller's advising bank pays only after receiving payment from the issuing bank. The seller's advising bank merely acts on behalf of the issuing bank and, therefore, incurs no risk. Confirmed credit (the irrevocable confirmed credit) In a confirmed credit, the advising bank adds its guarantee to pay the seller to that of the buyer's issuing bank. Once the advising bank reviews and confirms that all documentary requirements are met, it will pay the seller. The advising bank will then look to the issuing bank for payment. Confirmed Irrevocable letters of credit are used when trading in a high-risk area where war or social, political, or financial instability are real threats. Also common when the seller is unfamiliar with the bank issuing the letter of credit or when the seller needs to use the confirmed letter of credit to obtain financing its bank to fill the order. A confirmed credit is more expensive because the bank has added liability.

Standby Letter of Credit This credit is a payment or performance guarantee used primarily in the United States. They are often called non-performing letters of credit because they are only used as a backup should the buyer fail to pay as agreed. Thus, a stand-by letter of credit allows the customer to establish a rapport with the seller by showing that it can fulfill its payment commitments. Standby letters of credit are used, for example, to guarantee repayment of loans, to ensure fulfillment of a contract, and to secure payment for goods delivered by third parties. The beneficiary to a standby letter of credit can cash it on demand. Stand-by letters of credit are generally less complicated and involve far less documentation requirements than irrevocable letters of credit. See Credit Administration, Sample Procedure for Administration of a Standby Letter of Credit for a systematic procedure for establishing a standby letter of credit. Special Letters of Credit: The following is a brief description of some special letters of credit.

Back-to-Back Letter of Credit This is a new letter of credit opened based on an already existing, nontransferable credit used as collateral. Traders often use back-to-back arrangements to pay the ultimate supplier. A trader receives a letter of credit from the buyer and then opens another letter of credit in favor of the supplier. The first letter of credit serves as collateral for the second credit.

Deferred Payment (Usance) Letter of Credit In Deferred Payment Letters of Credit, the buyer accepts the documents related to the letter of credit and agrees to pay the issuing bank after a fixed period. This credit gives the buyer a grace period for payment.

Red Clause Letter of Credit Red Clause Letters of Credit provide the seller with cash prior to shipment to finance production of the goods. The buyer's issuing bank may advance some or all of the funds. The buyer, in essence, extends financing to the seller and incurs the risk for all advanced credits.

Revolving Letter of Credit With a Revolving Letter of Credit, the issuing bank restores the credit to its original amount once it has been used or drawn down. Usually, these arrangements limit the number of times the buyer may draw down its line over a predetermined period.

Transferable Letter of Credit This type of credit allows the seller to transfer all or part of the proceeds of the original letter of credit to a second beneficiary, usually the ultimate supplier of the goods. The letter of credit must clearly state that it is transferable for its to be considered as such. This is a common financing tactic for middlemen and is common in East Asia.

Assignment of Proceeds The beneficiary of a letter of credit may assign all or part of the proceeds under a credit to a third party (the assignee). However, unlike a transferred credit, the beneficiary maintains sole rights to the credit and is solely responsible for complying with its terms and conditions. For the assignee, an assignment only means that the paying bank, once it receives notice of the assignment, undertakes to follow the assignment instructions, if and when payment is made. The assignee is dependent upon the beneficiary for compliance, and thus this arrangement is riskier than a transferred credit. Before agreeing to an assignment of proceeds arrangement, the assignee should carefully review the original letter of credit.

Commercial Letter of Credit Commercial 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 and definitions 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 issuing bank, 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 its customer, 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 payor.

The Letter of Credit Application: The following information should be addressed when establishing a letter of credit. 1. Beneficiary The seller should provide to the buyer its full corporate name and correct address. A simple mistake here may translate to inconsistent or improper documentation at the other end. 2. Amount The seller should state the actual amount of the letter of credit. One can request a maximum amount when there is doubt as to the actual count or quantity of the goods. Another option is to use words like "approximate", "circa", or "about" to indicate an acceptable 10 % plus or minus from the stated amount. For consistency, if you use this wording you will need to use it also in connection with the quantity.

3. Validity The seller will need time to ship and to prepare all the necessary documents. Therefore, the seller should ensure that the validity and period for document presentation after the shipment of the goods is long enough. 4. Seller's Bank The seller should list its advising bank as well as a reimbursing bank if applicable. The reimbursing bank is the local bank appointed by the issuing bank as the disbursing bank. 5. Type of Payment Availability The buyer and seller may agree to use sight drafts, time drafts, or some sort of deferred payment mechanism. 6. Desired Documents The buyer specifies the necessary documents. Buyers can list, for example, a bill of lading, a commercial invoice, a certificate of origin, certificates of analysis, etc. The seller must agree to all documentary requirements or suggest an amendment to the letter of credit. 7. Notify Address This is the address to notify upon the imminent arrival of goods at the port or airport of destination. A notification listing damaged goods is also sent to this address, if applicable. 8. Description of Goods The seller should provide a short and precise description of the goods as well as the quantity involved. Note the comments in step #2 above concerning approximate amounts. 9. Confirmation Order With international arrangements, the seller may wish to confirm the letter of credit with a bank in its country.

Documentary Collection: Documentary Collection is a process, in which the seller's instructs his bank to forwards documents related to the export of goods to the buyer's bank with a request to present these documents to the buyer for payment, indicating when and on what conditions these documents can be released to the buyer. The buyer may obtain possession of goods and clear them through customs, if the buyer has the shipping documents (original bill of lading, certificate of origin, etc.). The documents, however, are only released to the buyer after payment has been made ("Documents against Payment") or payment undertaking has been given - the buyer has accepted a bill of exchange issued by the seller and payable at a certain date in the future (maturity date) ("Documents against Acceptance"). Documentary Collections facilitate import/export operations. However, they do not provide the same level of security as Letters of Credit, but, as a result, the costs are lower. Unlike the Letters of Credit, for a Documentary Collection the bank acts as a channel for the documents but does not issue any payment covenants (does not guarantee payment). The bank that has received a documentary collection may debit the buyer's account and make payment only if authorised by the buyer. Possibilities and advantages:

Make international trade operations more flexible, Use Documentary Collection in cases when the seller does not want to deliver goods to the buyer on "open account" basis, but due to a long-term stable business relationship between the parties there is no need for security provided by a Letter of Credit or payment guarantee,

Documentary collection is suitable to the seller:

o o o

if the seller has no doubts about the buyer's ability to meet its payment obligations, if the political and economic situation in the buyer's country is stable, if there are no foreign exchange restrictions in the seller's country;

Documentary collection is convenient for the buyer because:

o

there is no need for an advance payment; payment for goods can be made when shipping documents have been received,

in cases of documents released against acceptance the buyer has the possibility to sell the goods first and afterwards make payment to the seller.

Standard Forms of Documentation: When 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 Invoice: The 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 specifically states otherwise, a generic description of the merchandise is usually acceptable in the other accompanying documents. Bill of Lading A document evidencing the receipt of goods for shipment and issued by a freight carrier engaged in 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's obligation to transport the goods to their proper destination. Warranty of Title A 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 is generally issued to the purchaser and issuing bank expressing an agreement to indemnify and hold both parties harmless. Letter of Indemnity Specifically indemnifies the purchaser against a certain stated circumstance. Indemnification is generally used to guaranty that shipping documents will be provided in good order when available.

DOCUMENTS USUALLY REQUIRED UNDER A LETTER OF CREDIT:

There is no limit to the number and variety of documents which letters of credit may stipulate. The followingis a list of documents most commonly seen in a letter of credit transaction. Each document is described in briefwith a check-list for preparing the document. As already stated, the beneficiary should, on first being advised of the letter of credit, examine it carefully andbe satisfied that all the documentary requirements can be complied with. Unless the

documentaryrequirements can be strictly complied with, the beneficiary may not receive payment from the issuing bank. If there are any requirements that cannot be complied with, the beneficiary should immediately request the applicant to arrange for an appropriate amendment to the letter of credit. Draft: A draft is a bill of exchange and a legally enforceable instrument which may be regarded as the formalevidence of debt under a letter of credit. Drafts drawn at sight are payable by the drawee on presentation. Term (usance) drafts, after acceptance by the drawee, are payable on their indicated due date. Checklist: Drafts must show the name of the issuing bank and the number and date of the letter of credit underwhich they are drawn. Drafts must be drawn and signed by the beneficiary of the letter of credit. The terms of the draft must be expressed in accordance with the tenor shown in the letter of credit; e.g., at sight or at a stated number of days after bill of lading/shipment date. The amount in words and figures must agree and be within the available balance of the letter of credit and in the same currency as the letter of credit. The amount must agree with the total amount of the invoices unless the letter of credit stipulates that drafts are to be drawn for a given percentage of the invoice amount.

Commercial Invoice The commercial invoice is an itemized account issued by the beneficiary and addressed to the applicant, and must be supplied in the number of copies specified in the letter of credit. Checklist The invoice description of the goods must be identical to that stipulated in the letter of credit. Unit prices and shipping terms, ie., CIF, FOB, etc., must be as stipulated in the letter of credit. Extensions and totals should be checked for arithmetical correctness. For definitions of CIF, FOB etc. Consular or Customs Invoice A consular or customs invoice is prepared by the beneficiary on forms either supplied by the buyer or local consulate offices. Checklist Consular invoices must be visaed (officially stamped) and signed by a consular officer of the importing country and be supplied in the official form and number of copies as stipulated in the letter of credit. All headings of the forms must be completed. The value of goods required must agree with that shown on the commercial invoice. Bill of Lading A bill of lading is a receipt issued by a carrier for goods to be transported to a named destination, which details the terms and conditions of transit. In the case of goods shipped by sea, it is the document of title which controls the physical custody of the goods. There are two different types of bill of lading: A STRAIGHT BILL OF LADING is one that names a specific consignee to whom goods are to be delivered. It is a non-negotiable document. An ORDER BILL OF LADING is one that is written to order or to order of a named party making the instrument negotiable by endorsement. Letters of credit usually call for an order bill of lading blank endorsed, meaning the holder of the bill of lading has title to the goods.Given that each bill of lading must be either straight or order, the following is a list of more common.

Types of bill of lading: An OCEAN BILL OF LADING is one issued by an ocean carrier in sets, usually three signed originals comprising a complete set, any one of which gives title to the goods. Ocean bills of lading may be issued in straight or order form. A SHORT FORM BILL OF LADING is one issued by a carrier which does not indicate all the conditions of the contract of carriage. This is acceptable unless otherwise specified in the letter of credit. A CHARTER PARTY BILL OF LADING, is one which shippers may, when large or bulk cargoes are concerned, lease the carrying vessel for a stated time or specific voyage under a charter party contract with the owner. Goods carried are then covered under a form of bill of lading issued by the charterer and indicate as being shipped, subject to the term and conditions of the charter party. Charter party bills of lading are not acceptable unless specifically authorized by the letter of credit. A MULTIMODAL TRANSPORT DOCUMENT is one covering shipments by at least two different modes of transport. Checklist: Ensure that the port of loading and port of discharge are as stipulated in the letter of credit. The shipment must be consigned in the manner stipulated in the letter of credit. A general description of the goods is acceptable if consistent with but not necessarily identical with the description specified in the letter of credit and other documents. If the letter of credit calls for an on board bill of lading, it must be evidenced by a shipped on board bill of lading, or by marked or stamped on board notation indicating the date the goods were loaded on board. If the letter of credit stipulates that freight is to be prepaid; or if the invoice is priced CIF or CFR; or if the ocean freight has been added to the FOB or FAS value: the bill of lading must be marked freight paid or freight prepaid. Expressions such as freight to be paid or freight payable are not acceptable. The bill of lading must be clean. Any superimposed marking indicating a defect in the packaging or condition of the goods renders the bill of lading unclean and unacceptable. Bills of lading indicating goods shipped on deck are not acceptable unless specifically allowed in the letter of credit.

 The total number of packages comprising the shipment, shipping marks and numbers, and any gross weight must agree with those on the commercial invoice and other documents. Letters of credit should stipulate a period of time after date of issue of the bill of lading or other shipping document for presentation of drawings. If no such period is specified, banks will refuse documents and consider them to be stale dated if presented later than 21 days after the date of on board endorsement, or, in the case of a shipped bill of lading or other shipping document, 21 days after the date of issue. The bill of lading is to cover only goods described in the invoice and specified in the letter of credit. Any correction or alteration must be initialled by the party signing the bill of lading. The name of the carrier must appear on the front of the bill of lading where the particulars of the shipment are shown. If the bill of lading is signed by an agent, the name of the agent as well as the name of the carrier must be shown. Air Waybill An air waybill is a receipt issued by an air carrier indicating receipt of goods to be transported by air and showing goods consigned to a named party. Being a non-negotiable receipt it is not a document of title. Checklist: Only the goods invoiced and specified in the letter of credit may be covered by the air waybill. If the letter of credit stipulates that freight is to be prepaid; or if the invoice is priced CIF or CFR; or if freight is otherwise included in the invoice: the air waybill must indicate that freight has been paid. The airport of departure and airport of destination must be as stipulated in the letter of credit. The number of packages and gross weight shown on the air waybill must be consistent with the other documents. An air waybill issued by a forwarder is not acceptable.

Insurance Policy or Certificate Under the terms of a CIF contract, the beneficiary is obliged to arrange insurance and furnish the buyer with the appropriate insurance policy or certificate. The extent of coverage and risks should be agreed upon between the buyer and seller in their initial negotiations and be set out in the sales contract. Since the topic of marine insurance is extremely specialized and with conditions varying from country to country, the services of a competent marine insurance broker are useful and well-advised.Checklist If the letter of credit calls for an insurance policy, an insurance certificate is not acceptable and the policy must be provided. Brokers cover notes are not acceptable unless specifically allowed in the letter of credit. If the insurance policy or certificate indicates that it is issued in duplicate, both copies must be presented. Unless the amount to be insured is stipulated in the letter of credit, the amount should cover at least the CIF value plus 10 percent if invoiced in those terms. Otherwise, the amount should be for the greater of the draft amount or the total invoice value plus 10%. The amount insured must be expressed in the same currency as the letter of credit. The description of the goods insured must be consistent with that in the other documents although not necessarily identical. The number of packages comprising the shipment and shipping marks and numbers must agree with those shown on the invoice and bill of lading. The name of the carrying vessel, port of loading and port of discharge must agree with those shown on the bill of lading. The insurance document must cover transshipment if transshipment is indicated on the bill of lading. The insurance document must cover specifically those risks stipulated in the letter of credit. The all risks clause in the insurance document does not cover risks of war, which must be separately shown as covered, if required by the letter of credit. Unless the letter of credit specifies to whom loss is to be payable, the insurance document must be endorsed by the party to whose order it is made so as to be in negotiable form.

The date of the insurance document should not be later than the date of shipment as shown by the bill of lading or other transport document. However, the insurance document may be dated after the date of

shipment provided it evidences that cover is effective from date of dispatch ie., by way of warehouse to warehouse clause. Any alterations or corrections to the insurance document must be initialed by the party signing the document. The insurance document must be signed by an authorized person. The foregoing are the most common documents usually called for in an export letter of credit. The following may also be asked for to satisfy government requirements or for the convenience of the buyer. Certificate of Origin As the name suggests, a certificate of origin certifies as to the country of origin of the goods described and should comply with any stipulations in the letter of credit as to originating country and by whom the certificate is to be issued. The certificate should be consistent with and identified with the other shipping documents by shipping marks and numbers, and must be signed.

Inspection Certificate When a letter of credit calls for an inspection certificate it will usually specify by whom the certificate is to be issued; otherwise, the same general comments as in the case of the certificate of origin apply.As a preventative measure against fraud or as a means of protecting the buyer against the possibility of receiving substandard or unwanted goods, survey or inspection certificates issued by a reputable third party may be deemed prudent. Such certificates indicate that the goods have been examined and found to be as ordered.

Packing List A packing list is usually requested by the buyer to assist in identifying the contents of each package or container. It must show the shipping marks and number of each package. It is not usually required to be signed.

STEPS IN AN IMPORT LETTER OF CREDIT TRANSACTION: The Sales Contract The sales contract is the formal agreement between the buyer and seller specifying the terms of sale that both parties have agreed upon. The contract should include: a description of the goods; the amount; the unit price; the terms of delivery; the time allowed for shipment and presentation of documents; the currency; and the method of payment.

Application & Agreement The banks letter of credit application and agreement forms, when executed, constitute a payment and reimbursement contract between the issuing bank and its customer. It is also the customers instruction to the issuing bank. The letter of credit must be issued exactly in accordance with the customers instructions; therefore, it is important that the application be completed fully and accurately, so as to avoid the inconvenience of having to have the letter of credit amended. The agreement constitutes an undertaking by the customer to reimburse the issuing bank for drawings paid in accordance with the terms of the letter of credit, and normally takes the form of an authorization to debit the customers account.

Issuance of the Letter of Credit The issuing bank prepares the letter of credit as specified in the application and forwards it by tele transmission or airmail to the advising bank, (a branch or correspondent of the issuing bank). The issuing bank instructs the advising bank as to whether or not to add its confirmation, as per their customers instructions.

Advising The advising bank forwards the letter of credit to the beneficiary (seller) stating that no commitment isconveyed on its part. However, if the advising bank has been asked to confirm the letter of credit and agrees to do so, it will incorporate a clause undertaking to honour the beneficiarys drafts, provided the documents evidence that all terms and conditions of the letter of credit have been complied with.

STEPS IN AN EXPORT LETTER OF CREDIT TRANSACTION: Shipment of Goods Upon receiving the letter of credit, the beneficiary should examine it carefully and be satisfied that all the terms and conditions can be complied with. If this is not possible, the beneficiary should request the applicant to arrange an amendment to the letter of credit. Once completely satisfied, the beneficiary will then be in a position to assemble and ship the goods.

Presentation of Documents by Beneficiary The beneficiary prepares an invoice in the number of copies required, with the description of goods shown exactly as stipulated in the letter of credit. The beneficiary obtains the bill of lading and/or other transport documents from the carrier and prepares and/or obtains all other documents required by the letter of credit. These are attached to the draft, drawn on the bank indicated and at the term stipulated in the letter of credit, and are presented to the advising/confirming/negotiating bank.

Sending Documents to the Issuing Bank The advising/confirming/negotiating bank checks the documents presented by the seller against the letter of credit. If the documents meet the requirements of the letter of credit, that bank will send them to the issuing bank, claiming reimbursement and paying the seller.

Delivering Documents to the Applicant The issuing bank will also check the documents for compliance and then deliver them to the applicant either against payment or as an undertaking to pay on maturity of the drawing under the letter of credit.

Letter of Credit Characteristics Negotiability Letters 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 passed freely 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 due course is treated favorably under the UCC. The transaction is considered a straight negotiation if the issuing bank's payment obligation extends 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 these conditions the promise does not pass to a purchaser of the draft as a holder in due course. Revocability Letters 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. A revocable 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. 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 of credit 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 the issuing 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 terms and conditions are complied with, payment will be made. If a letter of credit is irrevocable it is referenced on its face. Transfer and Assignment The 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 non-assignable, the beneficiary may transfer their rights prior to performance of conditions of the credit.

Sight and Time Drafts All 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 making payment. A time draft is not payable until the lapse of a particular time period stated on the draft. The bank is 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. PAYMENT PROCEDURE: Payment On presentation of the documents called for under the letter of credit, provided they are in compliance with its terms, the advising/negotiating bank, in the case of an unconfirmed letter of credit, may pay/negotiate the draft. In the case of a confirmed letter of credit, the confirming bank is obliged to honour the drawing without recourse to the beneficiary.

Reimbursement The advising/confirming/negotiating bank will claim reimbursement from the issuing bank.

Settlement On receipt of conforming documents, the issuing bank will also be responsible for checking documents and will charge the applicants account under the terms of the letter of credit application and agreement forms, effecting reimbursement to the negotiating bank.

PAYMENT METHODS: LETTER OF CREDIT Letters of Credit:Letters of credit (LCs) are one of the most secure instruments available to international traders. An LC is a commitment by a bank on behalf of the buyer that payment will be made to the exporter, provided that the terms and conditions stated in the LC have been met, as verified through the presentation of all required documents. LC can be of different types depending on the basis for categorization. However, there are basically two broad classification of LC and these include: Unconfirmed LC and Confirmed LC. Unconfirmed LC involves only one bank giving undertaking to pay under certain documentary terms and conditions while Confirmed LC involves an additional undertaking by a second Bank called the Confirming Bank. This is use to protect the seller against political and economic risk in the destination country.

TERMS FOR BILL OF COLLECTION:

UNCONFIRMED LETTER OF CREDIT: 1. Exporter and Importer sign the purchase contract 2. Importer requests for Letter of credit (LC) and release funds to its Bank 3. Importers Bank Issue LC and sends it to the Exporters Bank 4. Exporters Bank advises the LC the Exporter 5. Exporter ships the goods to the Importer 6. Exporter forwards shipping documents to its Bank 7. Exporters Bank forwards shipping

CONFIRMED LETTER OF CREDIT: 1. Exporter and Importer sign the purchase contract 2. Importer requests for Letter of credit (LC) and release funds to its Bank 3. Importers Bank Issue LC and sends it to the Confirming Bank 4. Confirming Bank adds its confirmation to the LC and forwards it to the Exporters Bank 5. Exporters Bank advises the LC the Exporter 6. Exporter ships the goods to the Importer 7. Exporter forwards shipping documents to its Bank 8. Exporters Bank forwards shipping

documents to the Importers Bank 8. Importers Bank transfers the funds to the Exporters Bank 9. Exporters Bank pays the Exporter 10. Importers Bank release the shipping

documents to the Confirming Bank 9. Confirming Bank transfers the funds to the Exporters Bank 10. Exporters Bank pays the Exporter 11. Confirming Bank forwards shipping

documents to the Importer 11. Importer clears its goods using the shipping documents

documents to the Importers Bank 12. Importers Bank release the shipping

documents to the Importer 13. Importer clears its goods using the shipping document

PAYMENT METHOD: BILL FOR COLLECTION Documentary Collections: A documentary collection (D/C) is a transaction whereby the exporter entrusts the collection of a payment to the remitting bank (exporters bank), which sends documents to a collecting bank (importers bank), along with instructions for payment. Funds are received from the importer and remitted to the exporter through the banks involved in the collection in exchange for those documents. Document can either be delivered to the importer against payment at the sight (D/P) or against the acceptance of a Bill of Exchange (D/A) tenured for 30 to 180days.

BILL OF CREDIT (SIGHT D/P): 1. Exporter and Importer sign the purchase contract 2. Exporter ships the goods to the Importer 3. Exporter forwards shipping documents to its Bank 4. Exporters Bank forwards shipping

BILL OF COLLECTION (TENDOR, D/A): 1. Exporter and Importer sign the purchase contract 2. Exporter ships the goods to the Importer 3. Exporter forwards shipping documents to its Bank 4. Exporters Bank forwards shipping

documents to the Importers Bank 5. Importers Bank release the shipping

documents to the Importers Bank 5. Importers Bank release the shipping

documents to the Importer 6. Importer pays its Bank for the goods in exchange for documents received 7. Importers Bank transfers the funds to the Exporters Bank 8. Exporters Bank pays the Exporter 9. Importer clears its goods using the shipping documents

documents to the Importer 6. Importer clears its goods using the shipping documents 7. Importer pay its Bank for the goods already cleared 8. Importers Bank transfers the funds to the Exporters Bank 9. Exporters Bank pays the Exporter

PAYMENT METHOD: OPEN ACCOUNT (CASH AGAINST DOCUMENTS) Open Account: An open account transaction is a sale where the goods are shipped and delivered before payment is due, which is usually in 10 to 90 days. Obviously, this option is the most advantageous option to the importer in terms of cash flow and cost, but it is consequently the highest risk option for an exporter. Because of intense competition in export markets, foreign buyers often press exporters for open account terms since the extension of credit by the seller to the buyer is more common abroad.

1. Exporter and Importer sign the purchase contract. 2. Exporter ships the goods to the Importer. 3. Exporter forwards shipping documents to the Importer. 4. Importer transfers funds to pay Exporter.

International Trade Payment methods: International Trade Payment method can be done in the following ways.

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 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 [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. Risk situations in letter-of-credit transactions Fraud Risks

The payment will be obtained for nonexistent or worthless merchandise against presentation 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 government action outside the control of the parties.

Legal Risks

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

Force Majeure and Frustration of Contract

Performance of a contract including an obligation under a Documentary Credit relationship is prevented by external factors such as natural disasters or armed conflicts

Risks to the Applicant

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

Risks to the Issuing Bank

Insolvency of the Applicant Fraud Risk, Sovereign and Regulatory Risk and Legal Risks

Risks to the Reimbursing Bank

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

Risks to the Beneficiary

Failure to Comply with Credit Conditions Failure of, or Delays in Payment from, the Issuing Bank

Uniform Customs and Practice for Documentary Credits The Uniform Customs and Practice for Documentary Credits (UCP) is a set of rules on the issuance and use of letters of credit. The UCP is utilized by bankers and commercial parties in more than 175 countries in trade finance. Some 11-15% of international trade utilizes letters of credit, totaling over a trillion dollars (US) each year. Historically, the commercial parties, particularly banks, have developed the techniques and methods for handling letters of credit in international trade finance. This practice has been standardized by the ICC (International Chamber of Commerce) by publishing the UCP in 1933 and subsequently updating it throughout the years. The ICC has developed and moulded the UCP by regular revisions, the current version being the UCP600. The result is the most successful international attempt at unifying rules ever, as the UCP has substantially universal effect. The latest revision was approved by the Banking Commission of the ICC at its meeting in Paris on 25 October 2006. This latest version, called the UCP600, formally commenced on 1 July 2007.

CASE STUDY The letter of credit was one of the key factors why Vulcan, a small company, could conduct international business with the reasonable expectation of getting paid. Vulcan required virtually all of its customers outside of the US (even ones with a long-term relationship) to pay via the letter of credit. This was insurance of performance both for Vulcan and its customer. This page is a step-by-step case history of how the letter of credit works. On 12 April 1988, Vulcan received a telex from Lu Xiaozhuan of the Equipment Import Division, Bohai Oil Company, as follows: it has passed 5 years since we met you in tanggu. up to this time i get the opportunity to send you my greeting. at present we want to buy some spare parts of 560 hammer as follows:... yr prompt confirmation to the above will be much appreciated. The body of the telex contained an extensive list of spare parts. Things then proceeded as follows:

We furnished them with the quotation they requested on 12 April via telex. After the usual back and forth re the composition of the parts list, request for discount and confirmation of the terms and conditions, they agree to our revised proposal on 16 April. (Unlike the 1981 and 1983 negotiations, this was done long distance.)

The same day, they prepared and signed the contract for us and mailed it to us. We recieved it, signed it and returned it on 25 April.

As we prepared the parts for shipment, the next step was for Bohai Oil to have a letter of credit opened in Vulcan's favour. This involved then contacting the Bank of China and committing funds to the bank, either in cash or via a credit facility. The Bank of China issued this letter of credit (shown below) on 6 May 1988:

Note the detailed documentary requirements. The key with a letter of credit (L/C) is that, upon presentation of the proper documents, payment can be effected. Note also the deadline for shipment: in cases where the deadline could not be met, the L/C would have to be amended. Amendment was also necessary if the shipment went past the expiration of the L/C. The Bank of China's New York branch sent us an advice of the letter of credit on 17 May 1988. While preparing the parts, Vulcan also booked the ocean freight. On 20 May 1988 the shipping company (Transoceanic in New Orleans) advised that the ship was booked. Vulcan then had the parts transported via truck to New Orleans to beat the container terminal's deadline of 26 May 1988. The parts were then loaded on the ship, the ship sailed, and Vulcan could collect the necessary documents to request payment under the L/C. Those documents were as follows:

(1) Commercial Invoic

(2) Clean Ocean Bill of Lading. The "clean" business doesn't refer to the fact that the freight forwarder hasn't wiped his or her feet on it, but that the freight was without defect when the carrier received it. The box list is omitted here.

e, Signed

(3) Packing List. For brevity, only the first two pages are included.

(5) Insurance Policy for the shipment. Keep in mind that (4) Certificate of Quality this shipment was C.I.F. (cost/insurance/freight,) thus all of these had to be verified in the L/C's paperwork.

It's interesting to note that the contract--a very important document, especially with the Chinese--was not necessary for the L/C. Having assembled all of this, on 9 June Vulcan submitted its sight draft (with required documents) to receive payment under the L/C:

Sometimes some inspiration for the bank to expedite payment is necessary, as evidenced by this:

Although not always the quickest or simplest method of receiving payment, the letter of credit spared Vulcan many of the pitfalls of non-payment that others had experienced in international business.

CONCLUSION: The condition of trade finance International trade amounts to about $14 trillion and, according to the World Trade Organization (WTO), 90 percent of these transactions involve trade financing. Trade-related credit is issued primarily by banks via letters of credit, the purpose of which is to secure payment for the exporter. Letters of credit prove that a business is able to pay and allow exporters to load cargo for shipments with the assurance of being paid. Though routine in normal times, the letter of credit of process is yet another example of how transactions between multiple financial intermediaries introduce counterparty risk and the potential for trouble when confidence flags.

The 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 that of 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. The commercial 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.

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 the terms and conditions. When compliance is in question, the buyer should be requested to amend the credit.