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Letter of Credit - Origin

The name "letter of credit" came from the
French word "accréditation", a power to do
something
Origin is from Latin "accreditivus",
meaning trust.

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Faculty of Management and Commerce ©Ramaiah University of Applied Sciences
 LETTER OF CREDIT
/DOCUMENTARY CREDIT

Letter of Credit is an undertaking issued by a

Bank (Issuing Bank), on behalf of the buyer
(the importer), to the seller (exporter) to pay
for goods and services provided that the seller
presents documents which comply with the
terms and conditions of the Letter of Credit

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 LETTER OF CREDIT
UCPDC – 600 Edition effective from 1st
July 2007
Documentary Credit means any
arrangement that is irrevocable and thereby
constitutes a definite undertaking of the
issuing bank to honour a complying
presentation.

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 Complying presentation

a presentation that is in accordance with

• the terms and conditions of the credit,

• the applicable provisions of these rules (UCP 600) and
• international standard banking practice.

Honour

a. to pay at sight if the credit is available by sight payment.

b. to incur a deferred payment undertaking and pay at maturity if

the credit is available by deferred payment.

c. to accept a bill of exchange ("draft") drawn by the beneficiary

and pay at maturity if the credit is available by acceptance.

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 LETTER OF CREDIT

• Three main contracts underlying LC

- Sale Contract between Buyer & Seller
-Application-cum-Guarantee between
Applicant(Buyer) and Issuing Bank
- LC itself (contract between
Issuing Bank and
Beneficiary/Seller)
( LC independent of other two
contracts)
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Faculty of Management and Commerce ©Ramaiah University of Applied Sciences
 MechanicsofDocumentaryCredit
CONTRACT

GOODS GOODS

IMPORTER DOCS DOCS EXPORTER

Letter of
Credit
P ENS
O
R EDIT A
C d
v
i
s
Negotiating
i Bank/ PAYMENT
PAYMENT
Confirming
n Bank
g
Reimbursing Bank 6
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Faculty of Management and Commerce b ©Ramaiah University of Applied Sciences
 Parties to Letter of Credit
• Opener/Buyer
• Issuing Bank
• Advising Bank
• Beneficiary/Seller
• Nominated Bank/Negotiating Bank
• Confirming Bank
• Reimbursing Bank

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 Letter of Credit - Definition
A letter from a bank guaranteeing that a
buyer's payment to a seller will be received
on time and for the correct amount.
The bank will make full or part of the
purchase price (shortfall) in case the buyer
defaults to make payment.
In today’s competitive world banks face
increasing competition.

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 Letter of Credit - Definition
ICC in the Uniform Custom and Practice for
Documentary Credit (UCPDC) defines L/C as:
"An arrangement, however named or
described, whereby a bank (the Issuing bank)
acting at the request and on the instructions
of a customer (the Applicant) or on its own
behalf :
Is to make a payment to or to the order third
party ( the beneficiary ) or is to accept bills
of exchange (drafts) drawn by the
beneficiary.
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 Letter of Credit - Definition
Authorized another bank to effect such
payments or to accept and pay such bills
of exchange (draft).
Authorized another bank to negotiate against
stipulated documents provided that the
terms are complied with.

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Faculty of Management and Commerce ©Ramaiah University of Applied Sciences
 Letter of Credit - Elements
A payment undertaking given by a bank
On behalf of a buyer
To pay a seller for a given amount of
money
On presentation of specified documents
representing the supply of goods / services
Within specified time limits
Documents must conform to terms
and conditions set out in the letter of
credit
Documents to be presented at a
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Faculty of Management and Commerce specified place ©Ramaiah University of Applied Sciences
 Why Letters of Credit
are important
Nature of international dealings.
Distance between seller and buyer.
Differing laws of various countries.
Difficulty to know each party personally.
To break the deadlock between the buyer and
seller.

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Faculty of Management and Commerce ©Ramaiah University of Applied Sciences
 Terms commonly used in LCs
Sight LC - requires payment to be
made immediately to the beneficiary
upon presentation of the correct
documents.
Time or date LC - specifies when payment
is to be made at a future date.
Negotiation - giving of value for draft(s)
or document(s) by the bank authorized
to negotiate, with the nominated bank.

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Faculty of Management and Commerce ©Ramaiah University of Applied Sciences
 Terms commonly used in LCs
Presentation – Submission of
documents against LC or the document
itself
Complying presentation – When
the presentation is as per the
terms and conditions of credit
applicable provisions of UCP
international standard banking
practice
Confirmation— a definite undertaking from
the confirming bank to honor or negotiate a
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complying presentation in addition©Ramaiah
Faculty of Management and Commerce to thatUniversity of Applied Sciences
 Terms commonly used in LCs
Letter of Credit— an irrevocable
commitment of the issuing bank to honor a
complying presentation
Honor - to act according to commitment of
the LC. Based on type of facility
presentations are honored in various ways
making payment at sight for sight LC
paying at maturity for deferred payment LC.
accepting a Draft drawn by the beneficiary
and paying at maturity for deferred
acceptance LC
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 Legal principles - LCs
Payment obligation is independent from
the underlying contract of sale or any other
contract in the transaction {article 4(a) of
UCP}.
Banks deal with documents only - not
concerned with the goods (article 5 of the
UCP).

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Faculty of Management and Commerce ©Ramaiah University of Applied Sciences
 Legal principles - LCs
The “principle of strict compliance” to be
applied. Hence, if the documents tendered
under the credit deviate from the language
of the credit the bank is entitled to withhold
payment.
General legal maxim de minimis non curat
lex is not applicable in this field. De minimis
is a Latin expression meaning about minimal
things.

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 Types of LCs

There are broadly two types:

Commercial Letter of Credit
primary payment mechanism
Standby Letter of Credit
secondary payment mechanism

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 Types of LCs
Standby Letter of Credit assures the
beneficiary of the performance of the
customer's obligation.
The beneficiary is able to draw under the
credit by presenting evidence that the
customer has not performed its obligation.
The bank is obligated to make payment if
the documents presented comply with the
terms of the letter of credit.
Standby letters of credit are issued by
banks to stand behind monetary
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obligations.
Faculty of Management and Commerce ©Ramaiah University of Applied Sciences
 Types of LCs
Import/Export LC – Same LC is import LC for
importer and export LC for exporter.
Revocable—The buyer and the bank are able
to manipulate the LC or make corrections
without informing from the seller. According
to UCP 600, all LCs are Irrevocable.
Irrevocable—Any amendments or
cancellation of the LC is done by the
applicant through the issuing Bank. It must
be authenticated and approved by the
beneficiary.
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 Types of LCs
Confirmed—An LC is said to be confirmed
when a second bank adds its confirmation
to honor a complying presentation at the
authorization of the issuing bank.
Unconfirmed—Does not require the
other bank's confirmation.

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 Types of LCs
Transferrable—The exporter has the right to
make the credit available to one or more
subsequent beneficiaries.
Untransferable—A credit that seller
cannot assign all or part of to another
party.

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 Types of LCs
Deferred / Usance— A credit that is not
paid/assigned immediately after presentation, but
after an indicated period that is accepted by both
buyer and seller.
At Sight—A credit that the issuing bank
immediately pays after inspecting the carriage
documents from the seller.
Red clause - L/C that carries a provision which
allows a seller to draw up to a fixed sum from the
paying bank in advance of the shipment or
before presenting the prescribed documents.

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 Types of LCs
Back to Back—A pair of LCs in which one is
to the benefit of a seller who is an agent. In
that event, a second credit is opened for
another seller to provide the desired goods.
Generally this is used by trading houses.
A revolving LC is issued when the seller
sends regular shipments to a particular buyer
as part of long-term supply contract. Once
the buyer reimburses the amount paid to
seller by the issuing bank, the LC amount is
reinstated.
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Faculty of Management and Commerce ©Ramaiah University of Applied Sciences
 Risks in import LC
The financial standing of the importer
Goods
Exporter risk
Country risk
Foreign exchange risk

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Faculty of Management and Commerce ©Ramaiah University of Applied Sciences
 Documents in LCs
Bill of Exchange
Invoice, packing list
Shipping documents
License
Embassy
legalization
Origin certificate
Inspection
certificate
Insurance policy
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