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Introduction
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-transferrable
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.
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.
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