UNIT SEVEN LETTERS OF CREDIT: VARIATIONS Special Terms Advised Letter of Credit: A letter of credit issued by a bank and forwarded to the beneficiary by a second bank in his area, The second bank validates the signatures and attests to the legitimacy of the first bank. Amendment: A change in the original letter of credit. The verb form is amend. Back-to-back Letter of Credit: Two letters of credit with identical documentary requirements, except for a difference in the price as shown by the invoice and draft. Banker's Acceptance: A usance draft (see next page) drawn on a bank that stamps ACCEPTED across the face, thereby making it a prime obligation of that bank to pay. It is used to finance specified short-term, self-liquidating transactions, including foreign trade. Bid or Performance Bond: A financial guarantee, given by a contracting company, which states that it has the capability ‘to start and satisfactorily complete a project. Confirmed Letter of Credit: A letter of credit issued by one bank to | which a second bank adds its commitment to pay (confirms). \ Deferred Payment Letter of Credit: A letter of credit under wich the documents are forwarded to the importer’s bank, while a sight draft is presented at a later date. Discount: To sell a bill of exchange to a bank at less than the face amount of what is due at a future,date. This process is usually effected when a seller wants funds immediately. | a Scanned with CamScannerINTERNATIONAL FINANCE Irrevocable Letter of Credit: A letter of credit that cannot be “canceled nor amended without agreement of all parties. Promissory Note: A writtun promise made by a borrower to repay a loan with interest by a stated future date. Red Clause Letter of Credit: A letter of credit permitting the beneficiary to receive a sum prior to shipment. , Revocable Letter of Credit: A letter of credit that may be canceled at a any moment without prior notice to the beneficiary. Revolving Letter of Credit: A letter of credit calling for renewed credit to be made available when the issuing bank informs the beneficiary that the buyer has reimbursed the issuing bank for the drafts already drawn. Sight: Presentation of a note or draft to the maker or draftee. Standby Letter of Credit: A letter of credit that can be drawn against, . but only if another business transaction is not performed. Transferable Letter of Credit: A letter of credit that can be utilized by someone designated by the original beneficiary. Traveler's Letter of Credit: A letter of credit issued by a bank, addressed to all its correspondents, permitting the bearer to draw drafts up to the total amount named in the letter. Trust Receipt: An agreement between a bank and a borrower whereby the bank turns over possession of the merchandise, which it held as collateral, but retains title to the goods until the borrower repays the bank. Usance Draft: A draft that has been drawn to be. payable after a specified number of days. Vocabulary Practice 1. What is the difference between a revocable and an irrevocable letter of credit? 2. What is a red clause letter of credit? 3. What is a deferred payment letter of credit? 4. How does a confirmed letter of credit differ from an advised letter of credit? Scanned with CamScannera a INTERNATIONAL FINANCE \ tivated in the 5. What is a trust receipt? documents , apts the 6, What is a back-to-back letter of credit? 1 the to ‘7. What is an amendment? . , How is a bill of exchange discounted? 2 9. How does a usance draft become a banker's acceptunce? 10, What is a traveler's letter of credit? 11. What is a transferable letter of credit? 12. What is unusual about a standby letter of credit? 13, What is a revolving letter of credit? 14. What is a bid or performance bond? 15. Define promissory note. 16. What is sight? Letters of Credit: Variations The flexibility of the letter of credit is one of its great strengths. The basic sight letter of credit can be modified t in a number of ways to fit the needs of the customer. Letters of credit may be either revocable or irrevocable, but the latter is used more frequently. The revocable letter of credit carries a risk to the seller. It may be amended or canceled at any moment without prior notice to the beneficiary. The irrevocable letter of credit can neither be amended nor canceled without agreement of all * ~ parties. Letters of credit may call for drafts payable after a specified number of days after sight. The documents are prepared by the shipper exactly as before, except that now he draws the usance draft payable, for example, at ninety days after sight. This arrangement has Scanned with CamScanner(deeduoD yar, Aqrenng uxso0y fex,mo0D) -sormdoose siq7mmq © Surmoseg Aqazrp Freq “S]. ¥ Aq paydacos useq sy yp YyeErp souEs, 82 sez pre He ee Bz g g gos E OX Mal an $s. mt0. of GES See “00 @ VZO0NEN INVENIO g 10D IsnUL, VED wadbn or gs- 2 B 38 902 $12 O Gon OOOO SEZ 2s see @ 55 325502 9804 000% Br ys Bura5 pug ‘rr28y3 4z04 Aan parse 69S068 “ON 9/1 AzOR nen Jo|AundwOG uBreng anus, SEVTIOM ~~ nnn nn maa anna: mn nnn nnn nampa nnn nnn nmnn dan an sez s¢----o0t/o0 5 3 re JO WGxO FHL OL iva Wis ULV stva-4------ 8 Ba o1z Wr Dre's "ser er \ Scanned with CamScannerbeen previously agreed to at the buyer's request and is indicated in the underlying contract and letter of credit application. ‘The documents are negotiated, but instead of paying the seller, the bank accepts the draft—thus making it a banker's acceptance—and returns it to the seller. He may hold it until maturity and then present it to the bank to receive the full amount; or he may sell it in the current market for banker's acceptances, receiving a discounted amount. Such usance letters of credit enable the: tuyer to receive financing. He obtains the documents immediately upon negotiation from the bank by signing a trust receipt. He does not have to pay for the merchandise until the specified time has elapsed. In some instances, the seller may be forced to meet competition by offering credit terms for as long as several years. This is particularly true for large capital goods equipment, such as electric generators. With a deferred letter of credit, the documents are forwarded to the importer’s bank, while a sight draft is presented at a later date. This gives the importer the opportunity to clear the goods prior to paying for them, In this case the seller is financing the buyer, but he still knows that the opening bank will pay upon future presentation of the draft. Normally, deferment would not exceed a period of one year. The red clause letter of credit derives its name from the old custom of writing this particuiar clause in red ink to make it more noticeable. It is often used when the letter of credit is opened by the importer in favor of his agent. For example, a United States importer may have an agent in the Philippines who will purchase copra from various farmers and then ship it. The agent needs cash to purchase the crop. The importer requests in his application that the letter of credit contain a clause (the red clause) permitting the agent to draw funds from a Philippine bank that are guaranteed by the importer through his bank. The agent can take the letter of credit to the Philippine bank and draw funds by signing a receipt, which the local bank forwards to the United States bank for reimbursement. When the agent has shipped the copra, he presents the required documents to the Philippine bank for a normal drawing by way of drafts from which the amonnt of the advance is deducted. The advantage of this red clause, of course, is that it is ¢ simple device enabling an agent to draw the necessary funds in advance of the shipment, A letter of credit may be utilized only by the named beneficiary. ‘There are instances, however, wher the importer instead wishes to make the letter of credit transferable to another person or company to be designated by the original beneficiary. The importer instructs the Scanned with CamScannerPan a ANTEKNATIONAL riNANCE 4 [asevccate HE CHASE MANHATTAN BANK, NA. eauceait Orne aS os tor ae BEMEFICIARY 1. a le J concen We MERENY AUINONZE YOU TO DRAW ON gee Chase Manbattan Bank KA, Bev York, New York wr onctz OF ( szcount Party ) ‘Ano 108 ACCOUN! OF Bane Wh 10 AN AGGREGAIE AMOUNT OF U48,$ [AvA\ANLE AY YOUE OLAFIS AT aight to be presented 31 days after the date of the bill of lading ssccosseoog = Mos folloving docunsate are required and sust be presented at tine of shipeent accompanied by your Latter suthoriting ws to release the docusents to our custonar for pay- ant Go dis date as per the letter of credit conditions, (Docume te to be spect tied) DANS MUST BE OFAWHE AND NEGOINAIEO NOT LAIEE HAN(aLD days After BALL of lading date actual, date to be inserted) Ing AMOUIIS IMEELOF MUSH AE ENUCHSEO ON Tous KLTIER OF CREDIT, WE NEEEEE ACHE WHIM THE DRAWERS. ENOOESEAS, aM Hoe MO\DERS OF ALL RAFTS oBAWHE Uncta and o COMPUIANCE With Iné TERMS OF TnS CEEDIE, THAT SUCH DRAFTS WIL BE OULY HONOHEO Grom ecstrstation 1 tne Okswee Tu CALBIT SUBECT 10 THE “UNORM CUSIOMS AND PRACICE FOR DOCUMENTARY CHEOITS (1967 Seine) WATEETATIONAL CHAMIEE CF COMMERCE HEOCHUAE HO. 772 ours veer mur SPECIMEN | Deferred payment letter of credit. (Courtesy The Chase Manhattan Bank, N.A.) opening bank to prepare a transferable letter of credit addressed to the beneficiary “and/or transferee”; the beneficiary may then negotiate with a supplier and then notify the bank that he has transferred it to yet another specified party. Then the bank accepts drafts, invoices, Scanned with CamScanner\ omar unr Bunk of America 2. RATIONAL BINALAE CATO aerce me tn a Internat tonal forvicas Dept, 61 Re roa at ratenese cote po a i Sy eee ester eer care crete Aoarteds reveal 8" Dal WHO ayia hoy East” L Miterate they, Guetenete, cA, own Ws RAva ntay REQUEETEO FY Hants Bank A.t., Braman, Carmeny yo upriex roo rear they aun canner xo, 600/93955 e+ Youn ravoa ramen, Garmany wr hetter says seranunan ranon Don FOR ACCOUNT OF Eckard & Rualler 6. [AYAILABLA To 71H AoOREOATE WOM OF USY},275.00 (THALL THOUSAND TWO WIMORED SEVENTY-E IVE Ura, poutans) tamale cme coffee "AVALON" based 12 without brokans #USHN7.50 par 50 Seaport of Guatensla,"” sport to Braman, ‘snipment lotent July 15, 1963 from Guatemala Poctlal thiprents are nat peraltt Wa'sre Inforoed that Insurance Is covered In Germany, We are authorised Co make temporary advances to you up Co an aggr amount of $2,000.00 which fe available against presentation of staple rei your written undertaking to effect sbipaaat of the oqutpes credit, and athe credit valdity of in the fase to refund same pluc faterest eccured. Tho balance of $1,273.00 Le avails wont{oned documents Letter of credit with a red clause, permitting payment in part to be drawn by exporter prior to shipment. (Courtesy Bank of America) and other documents drawn by, or;’in the name of, the new beneficiary. If the opener wishes to peymit the beneficiary to transfer the letter of credit to more than one party, the opening bank issues the letter of credit to the named beneficiary “and/or transferees.” Each Scanned with CamScanner4 INIEHNA LIONAL FINANCE wze only a portion of the letter of credit, so that the total ngs do not exceed the maximum amount. This kind of letter of edit also allows purtial shipments. The revolving letter of credit is used when a series of identical shipments is made over a fixed period of time, such as monthly. The opening bank might prefer to open a letter of credit for each shipment. However, to avoid issuing a new letter of credit each “month, the bank may include a proviso in the original letter of credit that permits the letter of credit to be reinstated once the opening bank notifies the beneficiary. When the bank has paid, and has been reimbursed by its customer, the importer, the revolving letter of credit is reinstated by the opening bank with a new shipping date. The back-to-back letter of credit is considerably more complex. It is actually two letters of credit that are identical, except for the amounts. The first letter of credit is usually opened in favor of an agent, who then obtains a second letter of credit from his bank by depositing the first letter of credit. He also gives his bank advance invoices and a draft. When the beneficiary under the second letter of credit draws the specified amount, the second bank substitutes the invoices and draft in its possession. Leaving all the other documents exactly as they are, it draws on the first letter of credit to reimburse itself for the payment it has made. Any slight difference in the amounts reflects the agent’s fee. Such back-to-back letters of credit may be used to shield the identity of the ultimate buyer or to comply with regulations of foreign countries. Ultimately, these letters of credit permit an intermediary to utilize the credit standing of the principal for a specific transaction. Occasionally, the bank is requested by a desirable customer to issue a traveler's letter of credit, sometimes also called a circular letter of credit. This simply provides a traveler with access to large sums as he makes a trip. The only document required is a draft drawn by him. This kind of letter of credit is in much less demand these days because most people prefer the convenience of traveler's checks and credit cards, : The standby letter of credit is not used to cover a specific shipment. Instead, it is utilized in the event that a third party does not do something. For example, it may be used in place of a bid bond or a performance bond, in a construction project, or perhaps to guarantee the repayment of a third party's promissory note. A foreign subsidiary of a United States company may desire to borrow from a foreign bank. Scanned with CamScannerINTERNATIONAL FINANCE pawocent © He crtnoe MANHATTAN BANK. A eae whet greta puri = March 3, 1976 br 0nott OF Carton Coffee importers, Dayton, Onto Avo FoR ACCOUNT OF Same Ur 10 AN AGGREGATE AMOUNT OF ULB. 25,000 __ = Revolving Jenthly Boa Cumulative avananié ¥¥ youn oars at Sight Accompanieo 7 Iotucance tm duplicate, Tull at clean on board oceas ni endorsed coverine shipment 460 snacks Coloahlan catles, ‘Tevolving Letter of credit aod tbe full kauat again eoomas available under the shoe terms 4nd conditions, on tbe Firat day of auch aucteeding caleedar mouth, the fanared portion of ary monthly period {1 not cumulative to the succeeding month or month. ita otal amount available under this latter of credit {4 maxima § 150,000.00 DIATIS MUST HE OIAWH AND MEGOKAIED NOT LAILE Hoan ApeLl 30, 1976 THE AMOUNIS OHEMOF MUST KE ENOORSEO OM OHS LITER OF CHLOKE WE MGUY ACHEE WIDE THE DAWES, IHOOESEES, AND OWA FDL MOLESES OF alt oBasTS Daawne ONoER AND ih ZOMPUANCE wate Int TDS OF HS CEEOL, InAT SUCH. ORAHI KL Bf DLAT MONOALO, [row Pacsentation 10 THE ORAwtt as S SUINECI 10 THE UNFORS CUSIOMS. ANO PEACICE 408 OCUMENIARY CHLDWIS (IME AUvsiON, INFEALORAL CHAMBER OF COMMERCE MLOCHURL HO TPE ous we Revolving letter of credit. The expiration date is advanced with each reinstatement. (Courtesy The Chase Manhattan Bank, N.A.) ‘The foreign bank may require the United States parent company to guarantee that if the subsidiary dots not pay its loan at maturity, the foreign bank can draw on-a United States bank that has opened a standby letter of credit on behalf of the parent company. When Scanned with CamScannerINTERNATIONAL FINANCE Stes BOE AMERICA Katina q caves nee os THE MERCHANDISING co, I dovemvtn me Indie Crt Ne 575 nacADWAY mewn, NEY Your Le =] WE NQOE MURR mDULSTEL ay THE GERMAN BANK, BREMEN, GERAAMY ‘yo AUNISE YOU THAT THEY HAVE 137 v0 HOR ACLOUNT UF SPRING & COIL CO, BREMEN, CEAMAM AVAILABLE TO THE AUKAECATE Ses OF 5,000.00 (FIVE THOUSAND UB DOLLARS) invoice vALuE or 3,000 STEEL cont SPRINGS AT 11.00 Fea CoML corn ied to order, 1 x The Cermen Bank, sana tates soy 20,1973. PARTIAL SHIFHENTS NOT PEMAITT TELE rhronaeo Tear THSURANGE 1 COWTRED ABROAD. {WE AsiouNeT AND DATE OF EACH SEGOTIATION MUST AK EXDORSED OX [LHe INL HOSUREL OS DELIVERY OF DOCESIENTS AS auty 31,1973 eee HIVE ML UKUTS DABS ASD PRESENTED AS ABOVE YOURS VRAY TALLY, BANK OF AMERICA Back-to-back letters of credit. establishing a standby letter of credit, the United States bank should not become involved in any dispute concerning performance or quality of workmanship. The standby letter of credit Should be very , aa ve aes Scanned with CamScannerINTERNATIONAL FINANCE aa BANK OF eee ast are JULY 7.1995 u.s, steet com co, Medicare ne tens ene 3008S PITTSIUKG, PEXWSYLUANIA L CMANDESING CO.» 378 BROADWAY, EW YORE, WT. stor s 4,000 STERL COLL SPRINGS AT $.50 CENTS FER COIL cer stDaK, ocumenrs SULEMENT LATEST. JULY 15,1975. PARTIAL SHUPHENTS NOT PERHITT Tear tromets Twat 1NSUUSCE COVERED ARLOAD, ALL NEGOTIATING DANKS CHARGES ARE FOR ACCOUNT OF. THE BENEFICIARY, Aus Seay SNe eEAIe SoS nn geeat ‘Om Cerone ty 20.1995 BANK OF AMERICA (Courtesy Bank of America) and a statement by the foreign bank that it was not paid. Because of the many recent abuses in the handling of standby ” letters of credit, United States banks are now required to include the totals of standby letters of credit with other forms of customer debt in Scanned with CamScannerune bank's legal lending limit to the customer, _the letters of credit discussed so far are examples in which a states bank opens a letter of credit on behalf of one of its local vers. These can be broadly described as import letters of edit. i Ue ehct ane SPECIMEN iL ' Gt Me mete vinowUe yOu 10 OtaW ON The Gnase Paabatten Desk Hokey Nev Yarky Hew York Ar ONDER OF Ab, Molding Company, Mew York AnD Ok ACCOUNI OF sane UF 10 AN AGGREGATE Amour OF y,a,$ 750,000.00 _ (USDOLLARS SEVEN MUNORED HTT TwCUSAND) stant Acco “ . A.é, CONSTAUCTORS LTD. = Your atgued statement that has aot performed in accordance vith the con Aitions of contract Mo, 119-6 4 for Adentification = Reference in this letter of credit to Contract to, 1149-4 14 purposes only. said Contract 14 not incorporated in nor side part of this Letter of credit. preseated at this office LEAS must AE Liners ano /ebsBoUR NOK LATER IAN Hay 3), 1977 ‘on tis cE11E8 OF CAEOIT foil ink Gta FEORSERS, AND HOt HOVERS OF AL OEAFTS OFAWN SHO COwbvrarQt wat tnt H's OF IS CRED, IWAE SUCH ORAFTS WiLL BE OULY HONORED {Cl 10 tnt urtGam CUSIOMS AND PRACHCE FOF DOCUMEN aAY CREDITS 11967 es malEsnalioriat CHamlt GH COHMEBCE BROCHUEE NO 227 roves veer tauty Standby letter of credit. (Courtesy The Chase Manhattan Bank, N.A.} Scanned with CamScanner --—— ~--From a U.S. bank’s point of view, an export letter of credit is when the exporter is located in the U.S, Since American exporters prefer involvement by U.S. banks, they may request their foreign buyers to arrange for the opening of letters of credit through a U.S, bank, Buyers may do so through the assistance of their local banks. Many foreign banks are not well known internationally. Because of this, a foreign bank usually sends its letters of credit through a United States bank—rather than directly to the beneficiary—and asks the United States bank to advise or confirm them. This results in advised letters of credit and confirmed letters of credit, When the foreign bank asks the United States bank to advise their letter of credit, the United States bank verifies the authenticity of the signatures of the opening bank from its signature book and perhaps answers any questions about the bank that the exporter may have, This is, however, merély a courtesy to the correspondent bank, and it conveys no commitment on the part of the United States bank to pay drafts. If the foreign bank should ask the United States bank to confirm their letter of credit, then a definitely stated commitment is involved on the part of the United States bank to pay any drafts properly drawn under the letter of credit. In some countries, exchange controls limit a bank's ability to pay in dollars. The United States exporter may not wish to accept any of these risks, however. Thus, it is common for banks, particularly in developing countries, to have letters of credit confirmed by a major, well-known United States bank. The request for a confirmed letter of credit must be made by the buyer to his bank and then to the United States bank, The United States seller cannot request the United States bank to confirm a letter of credit, since it is a credit responsibility of the foreign bank. ‘When a letter of credit is confirmed, all of the risks of the issuing bank are then borne by the confirming bank for a fee. If the foreign bank should go out of business, the confirming bank is still obligated to honor the drafts. However, because major international banks in the United States and elsewhere encourage International trade and are quite knowledgeable about the financial soundness of smaller banks, major banks are very willing to confirm letters of credit as part of their correspondent banking relationships. Discussion 7 1. Why would a bank issue a red“clause letter of credit? Scanned with CamScannerIN TRUNA HONAL FINANCE, g What does a transferable letter of credit permit that is not permitted in a regular letter of credit? 3. How does a usance draft become a banker's acceptance, and why would the buyer and seller both use it? 4. What is the difference for a bank between issuing a letter of credit for $1,000,060 and issuing a revolving letter of credit for $25(),000 if in both cases the shipments are made periodically over four months? 5. Why does a bank require a trust receipt when there is a usance draft? 7 Why would an exporter ask for a confirmed letter of credit? How does the agent receive his fee in a back-to-back letter of credit transaction? = What is the danger in issuing a standby letter of credit? » How does a traveler's letter of credit differ from a sight import 2 letter of cred? 10. When is a deferred payment letter of credit used? J1. How does a deferred payment letter of credit differ from a usance letter of credit? How does a revocable letter of credit differ from a standby letter 12. of credit? 13, Why would a letter of credit be advised? 14. What is an amendment used for? Why cannot the exporter ask his bank to confirtn another bank’s ' 15. letter of credit? Scanned with CamScannerINTERNATIONAL FINANCE Review : Hae If you work ina bank's letter of credit section and each of tt following statements is made by a customer, explain the type of letiv of credit you would recommend. Write down the words or clause yc would insert in a letter of credit to make your suggestion effective 1. “My purchasing manager is going to Japan to buy dinner sets fre: a number of manufacturers, each of whom will want a letter of credi I want him to take one letter of credit with him for this.” 2. “Our company’s overseas purchasing manager lives in Brazil. need to get money to him so he can purchase coffee from the inlan growers and then ship it on a letter of credit.” 3, “I have a contract to purchase sugar from Haiti over the next si months. I know my credit line is only for $50,000, but how can ! get letter of credit good for the entire shipment of $200,000?” 4, “The buyer of my motorcycles needs six months before he can pa me. I can’t wait that long for my money, but I want to make thi sale.” 5. “I just receivcd this letter of credit from Jamaica. Is the bank good How do I know I'll gét paid?” 6, “Iam the agcnt for New York's largest department store. It want to buy furs from Russia, but it doesn’t want the Russians to know it i buying, so I will make the purchase in my name. The Russians want . letter of credit. The complete order is $1,000,000. What do I do?” Scanned with CamScanner