Letter of Credit- The letter of credit also known as documentary credits is an irrevocable

undertaking issued by a bank on behalf of the buyer (importer), to the seller (exporter) to
pay for the goods and services, provided, that the seller presents documents which comply
with the terms and conditions of the documentary credit.
Letter of Credit is a financial document from a bank which guarantees payment from a buyer
to the seller if certain criteria are met. L/C often used in oil trade, are employed to effect
payment under a contract governed by English Law and will usually be subject to the
Uniform Customs and Practice for Documentary Credits.
A letter of credit is required when there have been no dealings between the parties in the
past and the seller wants to avoid the risk of eventual non-payment by the buyer. One way
to avert this risk for the parties to substitute, for the uncertain prospect of eventual
payment by the buyer, the prospect of near-certain payment by a reliable paymaster;
namely, a first-class bank.
Letter of credit is required when there is a trade between a buyer and a seller from different
countries. For eg. A buyer resides in India wants to purchase computer equipment from a
seller residing in China. Here both the parties are interested to do business, but they are
scared to trust each other as it is the first time. To solve this problem the ICC (International
Chamber of Commerce) introduced the UCP 600 (Uniform Customs and Practice for
Documentary Credit) in 2007. UCP 600 are rules that apply to any documentary credit
(including any standby letter of credit) when the text of the credit expressly indicates that it
is subject to these rules. They are binding on all parties thereto unless expressly modified or
excluded by the credit. The UCP rules are so expressive of modern banking practice that no
appreciable difference is likely to exist between the application of English Law. The letter of
credit is subject to the UCP rules.
In Forestal Minosa Ltd. vs Oriental Credit Ltd., the court had to consider the compatibility
of the UCP rules, expressly incorporated into the documentary credit by means of a
marginal note, with the remaining terms of the credit. The apparent meaning of the issuing
bank’s express undertaking was therefore countered by the credit.
A letter of credit is an insurance that is provided by the bank to the seller that they will
receive the money in return of the goods they sell to the buyer and thereby assuring the
buyer that they will receive the goods they wanted.
A letter of credit operates in a very methodical way.
A buyer in India wants to purchase computer equipment from a seller in China
The buyer in India will be called an importer or the applicant and the seller will be called the
exporter or the beneficiary.
Step 1- the buyer from India will request a L/C from his issuing bank or the opening bank.
The issuing bank or the opening bank will be nominated by the buyer in his jurisdiction.
Similarly, the seller will have his own advising bank at his jurisdiction.
Step 2- the buyer’s issuing bank will forward the L/C to the seller’s advising bank.
Step 3- the advising bank will forward the letter of credit to the seller in China.
Step 4- After the receiving the letter of credit from the buyer, the seller will have the
confidence to send the goods to the buyer. The letter of credit will give the seller an
assurance that he will get the money from the buyer in return of the goods sent.
Step 5- Once the seller ships his goods to the buyer, the seller will issue the bill of lading to
his nominated or negotiating bank. A nominated or negotiating bank can be a separate bank
or it can be the same as the advising bank.
Step 6- After checking the documents the nominated bank will make the payment to the
seller.
Step 7- after the payment, the nominating bank will send all the documents to the buyer’s
issuing bank and will demand the payment.
Step 8- the buyer’s issuing bank will send the documents to the buyer for approval.
Step 9- once the documents are approved by the buyer, he will make the required payment.
In the meantime, the goods sent by the seller from China will reach the buyer in India.
Step 10- Once the issuing bank gets the payment from the buyer, he will forward the
amount to the seller’s nominated or negotiating bank.
Sometimes the advising bank thinks that the credit score of an issuing bank is less, the
advising bank may ask for a guarantee from another confirming bank with a better credit
score. If the issuing bank fails to make the payment, the confirming bank is liable to pay the
amount.
Characteristics of L/C-
1) A L/C is issued against a collateral such as Bank Deposits, FD etc.
2) The bank charges a fee for issuing the letter of credit.
3) A L/C should have the details such as Name of the seller, Date, amount, product
name, quantity, and other details
4) It should be clear and precise
5) A bank will reject the payment in case of the slightest mistakes such as misspelling of
the seller’s name or product name, shipping day, date and so on.
6) All parties in a L/C deal in documents and not goods or services.
7) The payment in the L/C will not depend on the defects in the goods and services.
Advantages of L/C-
For Seller-
Protection against buyer’s payment default
Reduced production risk in case order is changed or cancelled.
For Buyer-
Certainty of the goods to be received
L/C shows solvency for the buyer and allows the buyer to reduce or eliminate initial
payment.
Article 14 of the UCP 600 deals with Standard for Examination of Documents-
Ar. 14(e) states that “In documents other than the commercial invoice, the description of
goods, services or performance, if stated, may be in general terms not conflicting
with their description in the credit.”
A letter of credit requiring an invoice without further definition will be satisfied by any time
of invoice presented such as a commercial invoice, customs invoice or a tax invoice
final invoice, consular invoice, etc. But invoices identified as “provisional”, “pro-
forma” or the like are not acceptable under letters of credit rules and standard
banking practices.
i) An invoice which is stamped with a name and addressAr. 18 of the UCP 600
states that a commercial invoice must appear to have been issued by the
beneficiary except the situation when there is more than one beneficiary. The
commercial invoice must be made out in the name of the applicant except the
amount of credit, any unit price stated therein, the expiry date, the period of
presentation, or the latest shipment date or given period for shipment, %
insurance and beneficiary name. The commercial invoice must be made out in
the same currency as the credit and may or may not be signed. Therefore, an
invoice which is stamped with a name and address might not be considered a
discrepancy.
ii) An invoice made out in a different currency to the credit is to be considered a
discrepancy as Ar. 18 (a) (iii) specifically mentions that the currency terms in the
L/C must be made in the same currency as mentioned in the commercial invoice.
iii) An invoice issued for ‘new/factory showroom automobiles’ instead of
‘automobiles’ is a discrepancy as Ar. 18 (C) states that the description of the
goods, services or performance in a commercial invoice must correspond with
that appearing in the credit.