SPECIAL COMMERCIAL LAWS

LETTER OF CREDITS
LETTER OF CREDIT

• A letter of credit is basically an open letter of request whereby one

person requests another to advance money or give credit to a third
person for a certain amount and promises to repay the person advancing
the money.

• They are intended generally to facilitate the purchase and sale of goods
by providing assurance to the seller of prompt payment upon compliance
with specified conditions or presentation of stipulated documents without
the seller having to rely upon the solvency and good faith of the buyer.
 rule of strict compliance

means that the documents tendered by the seller or beneficiary must

strictly conform to the terms of the letter of credit, i.e., they must include
all documents required by the letter of credit such as:

(a) a draft which is also called a bill of exchange, is an order written by an

exporter/seller instructing an importer/buyer or its agent to pay a
specified amount of money at a specified time
(b) a bill of lading, which is a document issued to the exporter by a common
carrier transporting the merchandise, and
(c) invoices.
independence principle in a letter of credit
transaction.

• The issuing bank in determining compliance with the terms of

the letter of credit is required to examine only the shipping
documents presented by the seller and is precluded from
determining whether the main contract is actually
accomplished or not.

• This arrangement assures the seller of prompt payment,

independent of any breach of the main sales contract.
•The primary purpose of a letter of credit is to
substitute for, and therefore support, the agreement
of the buyer-importer to pay money under a contract
or other arrangement.

•This instrument is basically a credit security through

availment of credit facilities of the participating
banks.
 The parties to a letter of credit are:

(a) The Buyer- he is the one who procures the letter of credit and obliges
himself to reimburse the issuing bank upon receipt of the documents of
title
(b) The Issuing Bank- is the bank from whom the letter of credit is procured
and which undertakes to pay the seller upon receipt of the draft and
proper documents of titles and to surrender the documents to the buyer
upon reimbursement, and
(c) The seller- who in compliance with the contract of sale ships the goods to
the buyer and deliver the documents of title and draft to the issuing bank
to recover payment.
 In an international credit transaction carried
through a letter of credit, the parties are:

(a) The Customer- who is the party who applies to a bank in one country for
the opening of a letter of credit in favor of the seller in another country

(b) The Issuing Bank- is the bank in the country of the customer to which the
customer applies for the issuance of a letter of credit

(c) The Beneficiary- who is the party in another country who is the creditor of
the customer. Usually, he is the one selling goods to the customer
(d) The Advising Bank – is the bank in the country of the beneficiary which
communicates to the beneficiary the notice of the credit issued by the
issuing bank

(e) The Confirming/Correspondent Bank- is the bank that undertakes that

the letter of credit will be fully paid. Usually the confirming bank is also the
advising bank, otherwise it is utilized to lend credence to the letter of
credit issued by a lesser known issuing bank and is directly liable to the
beneficiary.
The relationships of the parties are to be
governed as follows:

(a)Issuing bank and applicant/buyer/importer –

Their relationship is governed by the terms of the

application and agreement for the issuance of the letter
of credit by the bank. Unless the contrary is provided for,
the liability of the issuing bank is solidary with the buyer
(b) Issuing bank and beneficiary/seller/exporter –

Their relationship is governed by the terms of the letter of credit issued by

the bank, and

(c) Applicant and beneficiary –

Their relationship is governed by the sales contract.

It is clearly settled in law that there are thus three contracts which make up
the letter of credit transaction:

• The contract between

* buyer and seller,
* buyer and issuing bank, and
* the letter of credit proper.

These transactions are to be maintained in a state of perpetual separation.

 The essential conditions of a letter of credit
are:

(a) That it be issued in favor of a definite person

and not to order; and

(b) That it be limited to a fixed and specified

amount, or to one or more undetermined
amounts, but within a maximum the limits of
which has to be stated exactly.
 The common types of letters of credit are:

(a) Irrevocable vs. revocable –

An irrevocable letter of credit obligates the issuing bank to honor drafts

drawn in compliance with the credit and can be neither cancelled nor
modified without the consent of all parties, including in particular the
beneficiary/exporter.

A revocable letter of credit can be cancelled or amended at any time

before payment; it is intended to serve as a means of arranging payment
but not as a guarantee of payment
(b) Confirmed vs. unconfirmed –

A letter of credit issued by one bank can be confirmed by another, in which

case both banks are obligated to honor drafts drawn in compliance with the
credit.

An unconfirmed letter of credit is the obligation only of the issuing bank.

Why would an exporter want a foreign bank’s letter of credit confirmed by a
domestic bank? One reason could be if he has doubts
 Other types:

(a) Revolving Letter of Credit-

one that provides for renewed credit to become

available as soon as the opening bank has advised the
negotiating or paying bank that the drafts already
drawn by the beneficiary have been reimbursed to the
opening bank by the buyer
(b) Back to Back Letter of Credit-

a credit with identical documentary requirements and

covering the same merchandise as another letter of
credit, except for the difference in price of the
merchandise as shown by the invoice and draft. The
second letter of credit can only be negotiated after the
first is negotiated.