Legal Services India - Intricacies In An International Transaction By Letter Of Credit
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Intricacies In An International Transaction By Letter Of Credit

Written by: Raghvendra Singh Raghuvanshi - III Yr, NLIU, Bhopal
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In this project I endeavor to address the intricacies involved in an international transaction by a Letter of Credit, the different types of Letters of Credit, and the differing obligations of the buyer and seller attached to each of the transactions. In the course of my discussions I will also be analyzing as to how, the Letter of Credit has gained prominence in the international trade and the discrepancies, which flow along with it.

Documentary letters of credit or documentary drafts are often used to protect the interests of both buyer and seller. These two methods require that payment be made based on the presentation of documents conveying the title and that specific steps have been taken. Letters of credit and drafts can be paid immediately or at a later date. Drafts that are paid upon presentation are called sight drafts. Drafts that are to be paid at a later date, often after the buyer receives the goods, are called time drafts or date drafts.

Letters of Credit
'A letter of credit adds a bank's promise to pay the exporter to that of the foreign buyer provided that the exporter has complied with all the terms and conditions of the letter of credit. The foreign buyer applies for issuance of a letter of credit from the buyer's bank to the exporter's bank and therefore is called the applicant; the exporter is called the beneficiary'.

'A letter of credit is a written commitment by a bank to make payment at sight of a defined amount of money to a beneficiary (exporter) according to the terms and conditions specified by the importer (applicant). The letter of credit should set a time limit for completion and specify which documents are needed to confirm the transaction's fulfilment.'

The scope of an irrevocable letter of credit is explained thus in Halsbury's Laws of England.
"It is often made a condition of a mercantile contract that the buyer shall pay for the goods by means of a confirmed credit, and it is then the duty of the buyer to procure his bank, known as the issuing or originating bank, to issue an irrevocable credit in favour of the seller by which the bank undertakes to the seller, either directly or through another bank in the seller's country known as the correspondent or negotiating bank, to accept drafts drawn upon it for the price of the goods, against tender by the seller of the shipping documents. The contractual relationship between the issuing bank and the buyer is defined by the terms of the agreement between them under which the letter opening the credit is issued; and as between the seller and the bank, the issue of the credit duly notified to the seller creates a new contractual nexus and renders the bank directly liable to the seller to pay the purchase price or to accept the bill of exchange upon tender of the documents. The contract thus created between the seller and the bank is separate from, although ancillary to, the original contract between the buyer and the seller, by reason of the bank's undertaking to the seller, which is absolute. Thus the bank is not entitled to rely upon the terms of the contract between the buyer and the seller which might permit the buyer to reject the goods and to refuse payment therefore; and, conversely, the buyer is not entitled to an injunction restraining the seller from dealing with the letter of credit if the goods are defective."

More properly called a documentary letter of credit, it is important to remember that a letter of credit is an additional contract dealing with credit between the applicant (importer) and the issuing bank and separate from the original grain contract.

Payment under A Documentary Letter Of Credit is based on documents, not on the terms of sale or the physical condition of the goods. The letter of credit specifies the documents that are required to be presented by the exporter, such as an ocean bill of lading (original and several copies), consular invoice, draft, and an insurance policy. The letter of credit also contains an expiration date. Before payment, the bank responsible for making payment, verifies that all document conform to the letter of credit requirements. If not, the discrepancy must be resolved before payment can be made and before the expiration date.

Tips on Using a Letter of Credit

# When preparing quotations for prospective customers, exporters should keep in mind that banks pay only the amount specified in the letter of credit - even if higher charges for shipping, insurance, or other factors are incurred and documented.
# Upon receiving a letter of credit, the exporter should carefully compare the letter's terms with the terms of the exporter's pro forma quotation. This step is extremely important, since the terms must be precisely met or the letter of credit may be invalid and the exporter may not be paid. If meeting the terms of the letter of credit is impossible or if any of the information is incorrect or even misspelled, the exporter should contact the customer immediately and ask for an amendment to the letter of credit.
# The exporter must provide documentation showing that the goods were shipped by the date specified in the letter of credit or the exporter may not be paid. Exporters should check with their freight forwarders to make sure that no unusual conditions may arise that would delay shipment.
# Documents must be presented by the date specified for the letter of credit to be paid. Exporters should verify with their international bankers that there will be sufficient time to present the letter of credit for payment.
# Exporters may request that the letter of credit specifies those partial shipments and transhipment will be allowed. Specifying what will be allowed can prevent unforeseen last minute problems.

Proper Letters Of Credit Have The Following Basic Components
Applicant: The party applying for the letter of credit, usually the importer in a grain transaction.
The Issuing Bank: The bank that issues the letter of credit and assumes the obligation to make payment to the beneficiary, usually the exporter.
Beneficiary: The party in whose favor the letter of credit is issued, usually the exporter in a grain transaction.
Amount: The sum of money, usually expressed as a maximum amount, of the credit defined in a specific currency.
Terms: The requirements, including documents that must be met for the collection of the credit.

Expiry: The final date for the beneficiary to present against the credit.
These are the necessary components of any letter of credit for the credit to become a valid, operable instrument. In addition, letters of credit come in various forms that define their level of risk. A revocable letter of credit allows the issuing bank (at the applicant's request) to amend or cancel the credit at any time without the approval of the exporter (beneficiary) and is the most risky form. In contrast, an irrevocable letter of credit has terms and conditions that cannot be amended or changed without the expressed consent of all parties, the issuing bank, the exporter (beneficiary) and the importer (applicant). Finally, the addition of a commitment by a bank other than the issuing bank to irrevocably honor the payment of the credit, provided the exporter meets the terms and conditions of the credit, results in a confirmed irrevocable letter of credit.

A change made to a letter of credit after it has been issued is called an Amendment.
Amendment of a Letter of Credit: For the seller to change the terms noted on an irrevocable letter of credit, it must request an amendment from the buyer. The amendment process is as follows:
1. The seller requests a modification or amendment of questionable terms in the letter of credit;
2. If the buyer and issuing bank agree to the changes, the issuing bank will change the letter of credit;
3. The buyer's issuing bank notifies the seller's advising bank of the amendment; and
4. The seller's advising bank notifies the seller of the amendment. Tips for Buyers and Sellers.

Banks also charge fees for this service. It should be specified in the amendment if the exporter or the buyer will pay these charges. Every effort should be made to get the letter of credit right the first time since these changes can be time-consuming and expensive.

To expedite the receipt of funds, wire transfers may be used. Exporters should consult with their international bankers about bank charges for such services.

Information To Be Provided In The Letter of Credit By The Parties

Once the exporter and importer have concluded a transaction that calls for payment under some form of letter of credit, the importer makes application for the credit to the bank, either locally or in another country that will issue the credit.

The importer/applicant will give the issuing bank instructions that cover such items as:
The full, correct name addresses and contacts information of the beneficiary, usually the exporter.
A brief description of the grain involved, including the quantity, quality and unit price.
The method, place and form of shipment, the location of the final destination and other shipping issues including transhipment, partial shipment and the latest shipping date.
The full, correct description of the documents required, including the period of time after the documents are issued within which they must be presented for payment. In addition, the credit should specify if payment is to be immediate (at sight) or with some degree of deferment (i.e., four days after acceptance).
Details of the letter of credit itself, including the amount (usually expressed as a maximum), the expiry date, how the credit will be made available and the transferability of the credit.

Tarapore and Co., Madras v. Tractoroexport, Moscow - AIR 1970 SC 891.
Facts: The suit has been brought by M/s. Tarapore & Co., Madras (hereinafter referred to as the ("Indian firm"). That firm had taken up on contract the work of excavation of a canal as a part of the Farakka Barrage Project. In that connection they entered into a contract with M/s. V/O Tractoro export, Moscow (which will hereinafter be referred to as the "Russian firm"), for the supply of construction machinery such as scrapers and bulldozers. In pursuance of that contract, the Indian firm opened a confirmed, irrevocable and divisible Letter Of Credit with the Bank of India Ltd., for the entire value of the equipment, i.e., Rs. 66,09,372, in favour of the Russian firm negotiable through the bank for foreign trade of the U.S.S.R., Moscow. Under the said Letter Of Credit the Bank of India was required to pay to the Russian firm on production of the documents particularised in the Letter Of Credit along with the drafts. One of the conditions of the Letter Of Credit was that 25 per cent, of the amount should be paid on the presentation of the specified documents and the balance of 75 per cent, to be paid one year from the date of the first payment. The agreement entered into between the Bank of India and the Russian firm under the Letter Of Credit.

The Russian firm supplied all the machinery it undertook to supply by about the end of December, 1960, which were duly taken possession of by the Indian firm and put to work at Farakka Barrage Project. They are still in the possession of the Indian firm. After the machinery was used for some time, the Indian firm complained to the Russian firm that the performance of the machinery supplied by it was not as efficient as represented at the time of entering into the contract and consequently it had incurred and continues to incur considerable loss. In that connection there was some correspondence between the Indian firm and the Russian firm.

Thereafter the Indian firm instituted a suit on the original side of the High Court of Madras seeking an injunction restraining the Russian firm from realizing the amount payable under the Letter Of Credit. During the pendency of that suit the parties arrived at an agreement on August 14, 1966, at Delhi. The portion of that agreement which is relevant for our present purpose reads as follows:
(1) Tarapore and Co., Madras, agree to withdraw immediately the court case filed by them against Tractoroexport, Moscow, in the Madras High Court.
(2) Immediately on Tarapore withdrawing the case, V/O Tractoroexport agree to instruct the bank for foreign trade of the USSR in Moscow, not to demand any further payment against L.C. established by Tarapore and Co., Madras, for a period of six months from the due dates in the first instance. During this period both the parties shall do their best to reach an amicable settlement.

(3) In case the settlement between the two parties is not completed within this period of six months V/O Tractoroexport shall further extend the period of payment by a further period of six months for the settlement to be completed.

(4) Tarapore and Co. shall authorise their bank to keep the unpaid portions of L.C. valid for the extended period as stated above.

The Russian firm had received from the Bank of India 25 percent, of the money payable under the Letter Of Credit very soon after it supplied to the Indian firm the machinery mentioned earlier. In pursuance of the aforementioned agreement the Indian firm withdrew the suit. Thereafter there were attempts to settle the dispute. In the meantime the Indian rupee was devalued.

The contract between the Indian firm and the Russian firm contains the following term:
"Payment for the delivered goods shall be made by the Buyers in Indian rupee in accordance with the trade agreement between the USSR and India dated 10th June, 1963. All the prices are stated in Indian rupee. One Indian rupee is equal to 0.186621 grammes of pure gold. If the above gold content of Indian rupee is changed the prices and the amount of this contract in Indian rupee shall be revalued accordingly on the date of changing the gold parity of the Indian rupee."
This clause will be hereinafter referred to as the "gold clause". In view of that clause, the price fixed for machinery supplied stood revised. Consequently, under the contract the Indian firm had to pay to the Russian firm an additional sum of about rupees twenty-six lakhs. Accordingly, the bankers of the Russian firm called upon the Indian firm to open an additional Letter Of Credit for payment of the extra price payable under the contract. They also intimated the Indian firm that the extension of time for the payment of the price of the machinery supplied, agreed to at Delhi, will be given effect to only after the Indian firm arranges for the additional Letter Of Credit asked for. The Indian firm objected to this demand.

In that suit the only substantive relief asked for is that the Bank of India as well as the Russian firm should be restrained from taking any further steps in pursuance of the Letter Of Credit opened by the Indian firm in favour of the Russian firm.

Decision: The parties shall continue to be bound by the original contract subject to the extension of the time granted under the Delhi agreement for the payment of the price and thus, the appeal was allowed.

Hamzeh Malas and Sons v. British Imex Industries Ltd. - [1958] 2 Q.B. 127, (C.A.).
Facts: Therein the plaintiffs, a Jordanian firm, contracted to purchase from the defendants, a British firm, a large quantity of reinforced steel rods, to be delivered in two instalments. Payment was to be effected by opening in favour of the defendants of two confirmed letters of credit with the Midland Bank Ltd., in London, one in respect of each instalment. The letters of credit were duly opened and the first was realized by the defendants on the delivery of the first instalment.
The plaintiffs complained that that instalment was defective and sought an injunction to bar the defendants from realizing the second Letter of Credit. Jenkins L.J., refused the application and observed thus:
"We have been referred to a number of authorities, and it seems to be plain enough that the opening of a confirmed Letter of Credit constitutes a bargain between the banker and the vendor of the goods, which imposes upon the banker an absolute obligation to pay, irrespective of any dispute there may be between the parties as to whether the goods are up to contract or not. An elaborate commercial system has been built up on the footing that bankers' confirmed credits are of that character, and, in my judgment, it would be wrong for this court in the present case to interfere with that established practice."

Obligations of Buyer And The Seller When Transaction Through A Letter of Credit Is Involved

Seller
1. Before signing a sales contract, the seller should make inquiries about the buyer's creditworthiness and business practices. The seller's bank will generally assist in this investigation.
2. In many cases, the issuing bank will specify the advising and/or confirming bank. These designations are usually based on the issuing bank's established correspondent relationships. The seller should ensure that the advising/confirming bank is a financially sound institution.
3. The seller should confirm the good standing of the buyer's issuing bank if the letter of credit is unconfirmed.
4. For confirmed letters of credit, the seller's advising bank should be willing to confirm the letter of credit issued by the buyer's bank. If the advising bank refuses to do so, the seller should request another issuing bank as the current bank may be or is in the process of becoming insolvent.
5. The seller should carefully review the letter of credit to ensure its conditions can be met. All documents must conform to the terms of the letter of credit. The seller must comply with every detail of the letter of credit specifications; otherwise the security given by the credit is lost.
6. The seller should ensure that the letter of credit is irrevocable.
7. If amendments are necessary, the seller should contact the buyer immediately so that the buyer can instruct the issuing bank to make the necessary changes quickly. The seller should keep the letter of credit's expiration date in mind throughout the amendment process.
8. The seller should confirm with the insurance company that it can provide the coverage specified in the letter of credit and that insurance charges listed in the letter of credit are correct. Typical insurance coverage is for CIF (cost, insurance and freight) often the value of the goods plus about 10 percent.
9. The seller must ensure that the goods match the description in the letter of credit and the invoice description.
10. The seller should be familiar with foreign exchange limitations in the buyer's country that could hinder payment procedures.
Buyer
1. When choosing the type of letter of credit, the buyer should consider the standard payment methods in the seller's country.
2. The buyer should keep the details of the purchase short and concise.
3. The buyer should be prepared to amend or re-negotiate terms of the letter of credit with the seller. This is a common procedure in international trade. With irrevocable letters of credit, the most common type, all parties must agree to amend the document.
4. The buyer can reduce the foreign exchange risk by buying forward currency contracts.
5. The buyer should use a bank experienced in foreign trade as its issuing bank.
6. The validation time stated on the letter of credit should give the seller ample time to produce the goods or to pull them out of stock.
7. A letter of credit is not fail-safe. Banks are only responsible for the documents exchanged and not the goods shipped. Documents in conformity with the letter of credit specifications cannot be rejected on grounds that the goods were not delivered as specified in the contract. The goods shipped may not in fact be the goods ordered and paid for.
8. Purchase contracts and other agreements pertaining to the sale between the buyer and seller are not the concern of the issuing bank. Only the letter of credit terms are binding on the bank.
9. Documents specified in the letter of credit should include those the buyer requires for customs clearance.

Halsbury stresses that in every case the party claiming must act strictly within the terms and limitations of the letter. Possession of the letter was not sufficient evidence that the person presenting it was the grantee. This point was also highlighted in a decision of the Supreme Court, which we shall presently note.

In Urquhart Lindsay and Co. Ltd. v. Eastern Bank Ltd, the King's Bench held that the refusal of the defendants bank to take and pay for the particular bills on presentation of the proper documents constituted a repudiation of the contract as a whole and that the plaintiffs were entitled to damages arising from such a breach. It may be noted that in that case the price quoted in the invoices was objected to by the buyer and he had notified his objection to the bank. But under the terms of the Letter of Credit the bank was required to make payments on the basis of the invoices tendered by the seller.

The court held that if the buyers had an enforceable claim that adjustment must be made by way of refund by the seller and not by way of retention by the buyer.
Similar opinions have been expressed by the American courts. The leading American case on the subject is:
Dulien Steel Products Inc., Washington v. Bankers Trust Co. - Federal Reporter, 2nd Series, 298.

Facts: The plaintiffs, Dulien Steel Products Inc., Washington, contracted to sell steel scrap to the European Iron and Steel Community. The transaction was put through M/s. Marco Polo Group Project Ltd. who were entitled to commission for arranging the transaction. For the payment of the commission to Marco Polo, plaintiffs procured an irrevocable Letter of Credit from Seattle First National Bank. As desired by Marco Polo this Letter of Credit was opened in favour of one Sica. The defendant-bankers confirmed that Letter of Credit.

The credit stipulated for payment against:
(1) A receipt of Sica for the amount of the credit; and
(2) A notification of Seattle Bank to the defendants that the plaintiffs had negotiated documents evidencing the shipment of the goods.

Sica tendered the stipulated receipt and the Seattle Bank informed the defendants that Dulien had negotiated documentary drafts. Meanwhile after further negotiations between the plaintiffs and the vendees the price of the goods sold was reduced and, consequently, the commission payable to Marco Polo stood reduced but the defendants were not informed of this fact. Only after notifying the defendants about the negotiation of the drafts drawn under the contract of sale, the Seattle Bank informed the defendants about the changes underlying the transaction and asked them not to pay Sica the full amount of the credit. The defendants were also informed that Sica was merely a nominee of Marco Polo and had no rights of his own to the sum of credit. Sica, however, claimed payment of the full amount of the credit. The defendants asked for further instructions from Seattle Bank but despite Seattle Bank's instructions decided to comply with Sica's request. After informing Seattle Bank of their intention, they paid Sica the full amount of the credit.

The plaintiffs thereupon brought an action in the District Court of New York for the recovery of the moneys paid to Sica.

Decision: Trial court dismissed the action and that decision was affirmed by the Court of Appeal. This decision establishes the well-known principle that the Letter of Credit is independent of, and unqualified by, the contract of sale or underlying transaction. The autonomy of an irrevocable Letter of Credit is entitled to protection.

R. D. Harbottle (Mercantile) Ltd. v. National Westminster Bank Ltd.- (1977) 2 All ER 862.
Facts: The plaintiffs in that case were merchants who had extensive dealings with buyers in Egypt. The plaintiffs had contracted with Egyptian buyers for the sale of goods under three separate contracts. Each of the contracts provided that the plaintiffs were to be paid by the buyers by means of irrevocable confirmed letters of credit and that any dispute was to be resolved by arbitration. The contracts provided that the plaintiffs were to establish a guarantee confirmed by a bank of five per cent of the price in favour of the buyers. The guarantees were in effect performance bonds, their purpose being to provide security to the buyers for the fulfilment by the plaintiffs of their obligations under the contracts. These were to be established with two Egyptian banks. That was done by the plaintiffs instructing their own bank ('the bank') to confirm the guarantees to the respective Egyptian banks, which in turn confirmed the guarantees to the buyers. The guarantees were backed by counter-indemnities by the plaintiffs to the bank. The plaintiffs agreed to indemnify the bank in the widest terms and gave irrevocable authority for payment under the guarantees and to debit the plaintiffs' account accordingly. The guarantees themselves simply provided that payment would be made on the buyers first demand without proof of any breach of contract by the plaintiffs or any other safeguard against abuse by the buyers. In the event disputes arose between the plaintiffs and the buyers and in such case the buyers demanded payment under the guarantees without, so the plaintiffs alleged, any justification.

Once the demands had been made the bank took the view that it had no option but to pay, but the plaintiffs on learning of the bank's intention, instituted proceedings against the bank, the Egyptian banks and the buyers, and obtained ex parte interim injunctions restraining the bank and the Egyptian banks from paying and the buyers from obtaining payment under the guarantees.

The bank subsequently applied for the discharge of the injunctions issued against it, having previously acquiesced in them. None of the other defendants entered an appearance. At the hearing of the bank's application the plaintiffs contended firstly that on the evidence the buyers were not entitled to payment under the guarantees and that their demands for payment were fraudulent and secondly that since the only application before the Court was the application by the bank to discharge the injunctions against itself, the Court had no jurisdiction to discharge the injunctions against the other defendants and to discharge the injunction against the bank would therefore be against the balance of convenience since it would lend to a break in the chain of payments or encourage the other defendants to disregard the injunctions against them.

Decision: It was held that the injunctions against the defendants would be discharged.

Types of Letter of Credit

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.

International Chamber of Commerce

Article 8 of the Brochure says;

" In documentary credit operations all parties concerned deal in documents and not in goods. Payment, acceptance or negotiation against documents which appear on their face to be in accordance with the terms and conditions of a credit by a bank authorised to do so, binds the party giving the authorization to take up the documents and reimburse the bank which has effected the payment, acceptance or negotiation....."
Documentary Revocable Letter of Credit: Revocable credits may be modified or even cancelled 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 cancelled 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. Both the buyer and the seller must approve changes in the credit. 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.

Two Forms of Irrevocable Credits

Unconfirmed credits (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.

Where it was noted that the commercial letters of credit might be of two types, revocable and irrevocable. Irrevocable letters of credit might be confirmed or unconfirmed. It was stated therein that the contractual relationship between the issuing bank and the buyer is defined by the terms of the agreement between them under which the letter opening the credit is issued; and its between the seller and the banker, the issue of the credit duly notified to the seller creates a new contractual nexus and renders the banker directly liable to the seller to pay the purchase price or to accept the bill of exchange upon tender of the documents.

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 fulfil its payment commitments. Standby letters of credit are used, for example, to guarantee repayment of loans, to ensure fulfilment 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, non-transferable 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 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.

The revocable credit, the irrevocable credit or the confirmed irrevocable letter of credit. Upon approval of the credit application by the issuing bank, the letter of credit is usually advised to the exporter; that is, the bank makes the exporter (beneficiary) aware that a letter of credit is opened. A bank other than the issuing bank often does the advising, and this second bank may also confirm the credit. Once the importer and exporter are satisfied that the credit is operable, the exporter ships against the original grain contract and presents the required documents and a draft (the instrument by which the exporter directs the importer to make payment) to the confirming, correspondent or issuing bank, as the case may be. Upon checking the documents for accuracy, the bank(s) passes the documents onto the importer and makes payment against the draft to the exporter.

Besides, common types of letters of credit include divisible and indivisible letter of credits, transferable and non-transferable letter of credit, revolving and non-revolving letter of credit, and foreign and local letter of credit. The distinctions between revocable and irrevocable letters of credit and confirmed and unconfirmed letters of credit are particularly important.

Revocable Vis. A Vis. Irrevocable Letter of Credit

A revocable letter of credit contains no absolute undertaking by the bank to pay upon presentation of the documents. As a result, a revocable letter of credit does not provide the seller with the type of security which a letter of credit is primarily designed to afford, transfer of the obligation to pay from the buyer to a recognised financial or banking institution of known credit-worthiness. This effect is achieved only by means of an irrevocable letter of credit. Therefore, the distinction between revocable and irrevocable credits is of utmost importance; the contract of sale must specify in unambiguous language what type of documentary credit is to be provided. In the absence of such indication, the credit is usually deemed to be revocable.

An irrevocable credit is the issuing bank's undertaking to the beneficiary that the provisions for payment, acceptance, or negotiation contained in the credit will be duly fulfilled, provided that the beneficiary complies with the terms of the credit. An irrevocable letter of credit is, therefore, an independent undertaking by a bank which is not to be discharged or reduced by set-off or similar monetary obligations between the seller and the buyer. The special feature of this mode of payment is that the bank becomes directly liable to the beneficiary for damages, normally equal to those that could be collected from the buyer upon default, if it cancels or modifies the credit.

The bank's obligation to pay the beneficiary depends, therefore, on the fulfillment of the terms and conditions of the letter of credit, not on performance of the underlying contract of sale, which it finances. The bank agrees to pay the credit amount on the presentation of specified documents, not on supply of goods.
Two rules emerge. First, the bank must satisfy itself that the documents appear on their face to be in accordance with the requirements of the letter of credit. Second, the bank must not concern itself with the content of the underlying contract of sale between its customer and the beneficiary. If the seller furnishes the documents stipulated in the credit, the bank is absolutely bound to make payment even if it knows that the seller has not performed the contract of sale.
Because the bank need not inspect the goods before paying over the credit, the buyer should stipulate that the documents that are to be presented to the bank include a certification by an independent inspection firm that the goods conform to the sales contract specifications. Great care should be exercised in instructing the inspection firm that the standards which must be met for certification relate not merely to the apparent physical conditions of the goods, but to their chemical and/or operational qualities also. Otherwise, a certificate accepting to satisfactory physical appearance might be accepted as valid tender although the goods are of inferior quality. Other documents normally to be demonstrated in order to obtain payment under a letter of credit are invoices, packing lists, certificates of origins, insurance policy, bills of lading and other such transport documents.

The term "confirmed credit" is sometimes confused with the concept of "irrevocable credit". The term "confirmation", however, refers to a different matter altogether: the introduction of another bank into the transaction. The second bank is generally a correspondent of the issuing bank, which is situated at the place where the documents are to be tendered. Where this second bank "confirms" the irrevocable credit, it undertakes an obligation to the seller equivalent to that of the issuing bank. In such a case the credit is both irrevocable and confirmed, providing additional reassurance to the seller.

Needless to say, the payment by letter of credit substantially reduces the seller's credit risk, and he should therefor to able to offer a better price than if he were to have less security for payment. Under a collection arrangement, for instance, the seller has no security that the buyer will pay, or accept a draft, upon being presented with the shipping documents through the collecting bank. When selling to buyers in countries with a foreign exchange licensing system, sellers further more need to protect themselves by insisting on documentary credits, not only to guard against the risk of buyer's insolvency or unwillingness to pay but also against the possibility that the buyer will be refused permission to pay in foreign currency. This is where confirmation of the credit by a bank of his own nationality becomes valuable to the seller.

International Chamber of Commerce

Article 3 of the brochure says that:
"An irrevocable credit is a definite undertaking on the part of an issuing bank and constitutes the engagement of that bank to the beneficiary or, as the case may be, to the beneficiary and bona fide holders of drafts drawn and/or documents presented there under, that the provisions for payment, acceptance or negotiation contained in the credit will be duly fulfilled, provided that all the terms and conditions of the credit are complied with.

An irrevocable credit may be advised to a beneficiary through another bank without engagement on the part of that other bank (the advising bank), but when an issuing bank authorises another bank to confirm its irrevocable credit and the latter does so, such confirmation constitutes a definite undertaking on the part of the confirming bank either that the provisions for payment or acceptance will be duly fulfilled or, in the case of a credit available by negotiation of drafts, that the confirming bank will negotiate drafts without recourse to drawer.

Such undertakings can neither be modified nor cancelled without the agreement of all concerned."

Article 9, which reads:

"Banks assume no liability or responsibility for the form, sufficiency, accuracy, genuineness, falsification or legal effect of any documents, or for the general and/or particular conditions stipulated in the documents or superimposed thereon; nor do they assume any liability or responsibility for the description, quantity, weight, quality, condition, packing, delivery, value or existence of the goods represented thereby, or for the good faith or acts and/ or omissions, solvency, performance or standing of the consignor, the carriers or the insurers of the goods or any other person whomsoever."

The law on this point has been reviewed by the Supreme Court in the case of United Commercial Bank v. Bank of India . There the Supreme Court reiterated that a bank issuing or confirming a Letter of Credit was not concerned with the underlying contract between the buyer and the seller. Duties of a bank under a Letter of Credit were created by the document itself, but in any case it had the power and was subject to the limitations which were given or imposed by it, in the absence of appropriate provision in the Letter of Credit. IN view of the banker's obligation, according to the Supreme Court, under an irrevocable Letter of Credit to pay his buyer customer could not instruct him not to pay.

Any interference with that mechanism is bound to have serious repercussions on the international trade of this country. Except under very exceptional circumstances, the court should not interfere with that mechanism.

In Tarapore and Co., Madras v. Tractoroexport, Moscow, The Supreme Court reiterated there that it was held that the opening of a confirmed Letter of Credit constituted bargain between the banker and the seller of the goods, which imposed on the banker an absolute obligation to pay.

Edward Owen Engineering Ltd. v. Barclays Bank International Ltd. where Lord Denning M. R. observed as follows:
"All this leads to the conclusion that the performance guarantee stands on a similar footing to a Letter of Credit. A bank who gives a performance guarantee must honour that guarantee according to its terms. It is not concerned in the least that the relations between the supplier and the customer; not that the question whether the supplier has performed his contracted obligation or not; nor that the question whether the supplier is in default or not. The bank must pay according to its guarantee: on demand it so stipulated, without proof or conditions. The only exception is when there is a clear fraud of which the bank has notice."

Benefits of Using A Letter of Credit

By conducting an export sales transaction under an irrevocable Letter of Credit, the Seller does not have to determine the credit standing of the foreign buyer. Letters of Credit are issued in many different forms from foreign banks and financial institutions. The variations are due to differences in customs and regulations of trade and finance in the country of origin of the issuing bank or financial institution. If, for any reason, a Seller cannot comply with one or more conditions of a Letter of Credit, it is absolutely imperative for the Seller to contact the buyer to arrange for one or more amendments to the original agreement.

Letter of Credit Discrepancies

If there is a disagreement between a sale contract's shipping and documentation requirements and those in a Letter of Credit, the Seller must take immediate action before shipping to arrange for an amendment to the Letter of Credit. If the Seller does not arrange for such an amendment, the seller may experience payment problems. Full compliance with all conditions for payment are interpreted by banks rigidly. Any disagreement, however small, represents grounds to reject the payment draft.

On a worldwide basis, approximately 60% of document presentations on Letters of Credit are presented with discrepancies. Banks charge for EACH discrepancy. Therefore, it is extremely important to ensure document presentations are accurate and complete to avoid additional costs and delays in payment processing.
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Conclusion
After an extensive research and analyzing various aspects of Letter of Credit, it can be concluded that:
Letters of credit have in them the complexities of international trade because of they have come to play a very important role.

A bank guarantee is very must like a Letter of Credit though not exactly same. The courts will do their utmost to enforce it according to its terms. They will not in the ordinary course of things interfere by way of injunction to prevent its due implementation. The bank which gave a performance guarantee is bound to honour that guarantee according to its terms.

The opening of a confirmed Letter of Credit, according to the Supreme Court, constituted a bargain between the banker and the seller of the goods, which imposed on the banker an absolute obligation to pay. However, the banker was not bound or entitled to honour the bills of exchange drawn by the seller unless they, and such accompanying documents as might be required there under were in exact compliance with the terms of the credit. Such documents, the Supreme Court emphasized, must be scrutinized with meticulous care.

By conducting an export sales transaction under an irrevocable Letter of Credit, the Seller does not have to determine the credit standing of the foreign buyer. Letters of Credit are issued in many different forms from foreign banks and financial institutions. The variations are due to differences in customs and regulations of trade and finance in the country of origin of the issuing bank or financial institution. If, for any reason, a Seller cannot comply with one or more conditions of a Letter of Credit, it is absolutely imperative for the Seller to contact the buyer to arrange for one or more amendments to the original agreement.

The author can be reached at: raghav_nliu@legalserviceindia.com / Print This Article

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