Tuesday, February 6, 2007

Documentary Letters of Credit

A Documentary Letter of Credit (LC) is a written undertaking given by a bank on behalf of an Importer to pay the Exporter a given sum of money within a specified time, providing that the Exporter presents documents which comply with
the terms laid down in the Letter of Credit.

Letters of Credit can be for any amount, in any freely traded currency, and, subject to the presentation of compliant documents, may be payable:
at sight, which means as soon as a compliant set of documents are presented to the paying bank; or, after a specified term, e.g. at 30, 60, 90 or 180 days of sight or Bill of Lading date.

If the documents are not presented exactly as specified in the Letter of Credit, payment will not be made unless the Importer gives their authority to waive or amend the specified condition.

A fundamental principle of Letters of Credit is that banks deal with documents and not with the goods to which the documents refer.

For example, if the Importer is not happy with the quality of the goods but the documents comply with the terms and conditions of the Letter of Credit, the Importer's bank is obliged to pay the Exporter.

Parties involved in a Letter of Credit transaction

In the process of a Letter of Credit transaction, there are essentially four parties involved. These parties can be referred to by a number of terms, outlined below.

Buyer meaning Importer, Applicant, Accountee or Accreditor.
In this guide we use the term Importer.

Seller meaning Exporter or Beneficiary; here we use the term Exporter.

The Issuing or Opening Bank (Importers Bank)

The Advising/Confirming Bank - usually a bank in the Exporters country which may or may not be the Exporters Bank.

Types of Letter of Credit

This is an LC that can be cancelled or amended by the applicant or the Opening Bank without prior notice to the Exporter.

With an irrevocable Letter of Credit the Issuing Bank gives its irrevocable undertaking to pay if all the terms of the LC are met. The Issuing Bank can only amend or cancel its undertaking if all parties to the LC consent to the change.

NB: Although there are two types of Letter of Credit: revocable and irrevocable, LCs dealt with by ‘Bank’ are irrevocable. Under UCP 500 (Uniform Customs and Practice for Documentary Credits), if a LC is not stated to be revocable or irrevocable, it will be considered to be irrevocable.

A Confirmed LC is one to which a second bank, usually in the Exporter's country and at the Exporter's request, adds its own commitment (confirmation) that payment will be made. Confirmation is generally used when there is perceived to be some risk that the bank issuing the Letter of Credit may not be able to fulfil its obligation to pay. This could be due to bank failure or instability in the country of the Issuing Bank.

If the LC is unconfirmed, the Advising Bank merely informs the Exporter of the terms and conditions of the LC without adding its own undertaking to pay or accept under the terms of the LC.

A Transferable Letter of Credit is one that can be transferred from the first Beneficiary to one or more additional Beneficiaries by the Transferring Bank.

It is normally used in situations where a supplier sells through an intermediary or 'middleman' to the ultimate Importer and is in a strong enough bargaining position to insist upon payment by Letter of Credit. By using a Transferable Letter of Credit, the intermediary is able to provide payment by LC to their supplier without the need for their own credit line with the transferring bank. An LC is only transferable if it is expressly stated to be so by the Issuing Bank.

There are other less commonly used variations of Letter of Credit, for example Back-to-Back, Red Clause and Revolving.
‘Bank’ can advise you of the type of Letter of Credit best suited to meet your needs. More detailed information on other types of LC.

Special Types of letters of Credit

Transferable Letters of Credit are used when the Exporter is acting as an intermediary between the Importer and Exporter in a commercial transaction. In this instance, all of the rights and obligations of the LC are transferred from the intermediary to the ultimate supplier. The intermediary has no liability.

The terms of the transferred LC must be the same as the original except for the amount, unit price, expiry date, latest presentation date and period of shipment. All of these may be reduced, or brought forward.

The identities of the Importer and the ultimate supplier may need to be withheld from each other. Careful drafting of the original and transferred Letter of Credit is needed to ensure this occurs. (NB: ‘Bank’ assumes no liability or responsibility for any disclosure).

In this instance, two LCs are established completely independently of each other. The Importer establishes theirs in the Exporter's favour. The Exporter can then arrange a second LC in favour of the ultimate supplier of the goods or the supplier of raw materials.

This type of LC should only become necessary where the underlying contracts are on terms which do not match or where a Transferable LC is unable to maintain secrecy on a particular aspect of the transaction.

Due to the greater risk involved with this type of LC, they are rarely issued.

If an Exporter makes regular shipments to a particular Importer under a long term supply contract, it may be beneficial for a series of shipments to be secured by a single documentary LC.

A Revolving LC can achieve this by the LC being reinstated for the original amount after a given period, and allowing the value of the LC to be drawn each time a shipment of goods is undertaken.

Be aware that as this is a continuing liability, it will have an impact on banking facilities.

Advance Payments (or Red Clause)
An LC that contains a clause, which authorises the nominated bank to advance a portion of the value of the LC to the
Exporter before shipping documents are presented. This enables the Exporter to purchase raw materials or to pay other costs before receiving the full payment, once conforming documents have been presented.

Advances are made at the risk of the Importer. Drawings under an LC are made against a simple receipt from the Exporter that they will refund the amount if they do not ship the goods as required. The Importer's account is debited as soon as an advance has been made.

A Standby Letter of Credit is a type of trade debt guarantee that is only drawn against in the event that the Importer defaults in some way, eg. fails to pay for a consignment within an agreed period. A standby LC includes an expiry date, but no latest shipment date. Standby LCs will normally call for a statement of default from the Exporter and also
evidence of default. ‘Bank’ is happy to discuss whether or not a Standby Letter of Credit is appropriate to your needs.

Features & Benefits Documentary Letters of Credit

Gives Exporters guaranteed payment without affecting credit limits
Gives Importers more control over the terms of the trade - especially valuable with new suppliers
Enhances competitive position
Known payment date, currency and revenue, helps cashflow management
Could be used to help raise finance through discounting
May enable Importers to negotiate longer credit periods and attribute costs to the Exporter

The Documentary Letters of Credit (LC) Process

1. Importer & Exporter negotiate terms of the contract
2. Importer instructs their bank, the Issuing Bank, to open a LC in favour of the Exporter
3. Importer's Bank, the Issuing Bank, issue the LC to the Exporter's Bank, the Advising Bank
4. LC is received by Advising Bank which checks the LC, then passes it on to the Exporter
5. Goods are shipped
6. Shipping documents are prepared and submitted to the Advising Bank by the Exporter
7. Advising Bank checks the documents. If they comply with LC they send the documents to Issuing Bank and may pay the Beneficiary/ Exporter in advance of being reimbursed by the Issuing Bank
8. Issuing Bank checks documents again, if correct they are released to Importer and the Importer's account is debited
9. Issuing Bank reimburses Advising Bank
10. Payment sent to Beneficiary/Exporter if this didn't occur in stage seven

Key Stage 1. Importer & Exporter negotiate terms of the contract

Financial considerations
Supply Considerations
Shipping Considerations
Agreeing terms of LC
Financial considerations

Name and address of the Importer's bank
Status enquiry on the Importer. (Provided by one of ‘Bank’ registered credit rating companies)
Standing of Importer's bank (Confirming Bank)
Currency exchange rate fluctuation
Risk of non-payment by Importer's bank due to country risk (NB: Your ‘Bank’ contact can advise you about the banks and countries ‘Bank’ are happy to confirm, together with the applicable pricing).

Importers will need to request a specific bank facility for Documentary Letters of Credit before any instructions can be issued. In assessing the level of facilities required, you will need to consider:
The anticipated turnover. The facility will need to cover the total value of LCs the Importer expects to have outstanding at any one time
The Importer's maximum potential period of liability. This includes both the maximum validity period of the LC and the maximum term of the contract. The Importer may need to allow the Exporter some 'lead time' in order to organise the goods ready for transportation
Currency exchange rate fluctuation.

To keep the costs of the transaction down, the Importer should keep the validity period and any extended credit terms as short as possible, thus reducing the overall level of facilities required.

Supply Considerations
Delivery periods on goods
Delays with particular goods (eg. through manufacturing delays)
Pre-shipment inspection.

Shipping Considerations
Methods of transport available, direct or indirect
Frequency of departures
Approximate costs of alternative methods/routes
Type of packing
Correct Incoterms (latest version) according to contract/transport mode.
Optimum delivery point, ie. transported from where to where?
Goods insurance
Delays for consular work or inspection formalities.

Agreeing Terms of LC
To reduce unnecessary costs and delays in?amending the Letter of Credit after it has been established, we strongly recommend that the Exporter sends the Importer a template of the terms and conditions that they wish to be included.

Key Stage 2. Importer instructs their bank, the Issuing Bank, to open an LC in favour of the Exporter
Application Form
Terms of Payment
Special Types of Letters of Credit
Application Form

At this stage the importer fills in the bank's Letter of Credit application form with full details to replicate the contract agreed with the Exporter. The importer must ensure the form avoids ambiguity, fully reflects the commercial contract and is not so complex as to make the transaction unworkable.

Terms of Payment
Documentary credits may be made available in one of four ways.

Sight Payment
This is where payment is made to the Exporter, upon presentation of conforming documents. A sight Bill of Exchange, also called a draft, is usually called for, though payment can be made against documents alone.

Deferred Payment
A deferred payment does not require the presentation of a draft. The Paying Bank is authorised to make payment at an agreed future date against presentation of conforming documents. The future date for payment is defined in the Letter of Credit usually as a number of days after the date of despatch of goods or after the date of presentation of the documents.

An Acceptance LC requires presentation of a draft drawn on the bank nominated as Accepting Bank. If the terms of the LC are met, the draft is then accepted by the bank and is payable at a determinable future date. This will be detailed in the Letter of Credit as either a fixed future date, or a specific number of days from the date of despatch of goods, or from the date of presentation of the documents.

With a Negotiable LC, the Issuing Bank must reimburse the bank which negotiates drafts or documents drawn under its documentary LC. The credit may be made freely negotiable with any bank, or negotiation may be restricted to a bank nominated by the issuing bank. Under this type of LC, the Exporter is responsible for any negotiation interest unless the Importer specifically authorises the Negotiating Bank to charge interest to their account.

Payment at the counters of the Issuing Bank
In this case the conforming documents have to be received by the Issuing Bank within the presentation period. Payment is only then made to the Beneficiary or Advising Bank.

Key Stage 3. Importer's Bank, the Issuing Bank, issue the LC to the Exporter's Bank, the Advising Bank

Assuming that the value of the Letter of Credit is within the Importers' facilities, their bank, the Issuing Bank, issues the Letter of Credit in favour of the Exporter.

Key Stage 4. LC is received by Advising Bank, which checks the LC, then passes it on to the Exporter

The Letter of Credit will be received by a bank in the Exporter's country, which will authenticate it and check that its terms and conditions are workable. They then pass the Letter of Credit on to the Exporter.

Please note that if the bank is merely passing the Letter of Credit on to the Exporter, they are known as the Advising Bank.

However, if the bank is adding their undertaking to pay, they become the Confirming Bank Accepting Bank.

Checking the LC & Amendments and Checking the LC

The Exporter, or Beneficiary, should make the following checks when the LC arrives to ensure that the terms match those originally agreed with the Importer.

1. Is the Letter of Credit subject to the latest version of the Uniform Customs and Practice for Documentary Credits (UCP) of the International Chamber of Commerce?
2. Check the authenticity of the LC
If LCs are received that depart from the routine of being sent to the Exporter from an Advising/Confirming Bank in the UK, they should be handled with caution. Likewise, if the UK bank is not recognised, check its authenticity with ‘Bank’.
3. Does the type of LC give the required level of security?
Is confirmation of the LC required? If so, establish whether the LC is in fact confirmed, thus carrying the extra and separate undertaking of a second bank, usually in the UK. Also establish whether it is revocable or irrevocable. Remember revocable LCs can be cancelled without the Exporter's prior knowledge. LCs issued under UCP500 are irrevocable unless otherwise stated.
4. Is the LC payable when and where requested?
The LC may specify payment at sight, ie. when the correct documents are presented to the Paying Bank, or at a later date, a set period of time after the documents have been accepted. The LC can either be made payable in the UK, with little or no delay after checking by the Paying Bank, or abroad with possible delays. With payment abroad please note that the Exporter is responsible for postal delays in presenting documents overseas within the time limits set by the expiry date.
5. Is the value of the LC correct?
Ensure the LC covers the full invoice value, incorporating any additional costs such as freight and/or inspection fees.
6. Are the Importer and Exporter's details correct?
Ensure the Exporter's name and address are spelt correctly and that they are shown exactly as they are on the invoice heading. Similarly, ensure the Importer's name and details are copied from the invoice.
7. Are the terms of shipment correct?
Ensure that the terms of shipment are the same as you quoted and that they match the price properly.
8. Are all the charges correct?
Ensure that only the bank charges that have been agreed to pay are stated. Pay particular attention to bank reimbursing charges with an LC not expressed in sterling.
9. Can the expiry date be met?
Ensure that the Exporter can present the documents within the terms of the LC.
10. Make sure that time is allowed for the following:
· production and packaging
· inspection
· shipment
· chamber of commerce and consular work
· obtaining the inspection certificate
· assembling and checking documents
· presenting documents to the bank.
· Note that the last four stages must be completed within the number of days as stated with the LC, taken as 21 days if no other time limit specified.
11. Can you provide the transport documents called for?
Ensure that you are able to provide any transport documents required.


If the Letter of Credit is wrong or ambiguous in any way, or the Exporter cannot comply with any of the terms, the Exporter should contact the Importer to request that the LC is amended. If this is agreed, the Importer would then ask their bank to issue an amendment. If no amendment is made, there is a risk of non-payment.

If you are in doubt about any of the terms of the LC, always consult ‘Bank’ and/or the Advising Bank for advice. Also remember that only the Importer can authorise amendments or extensions through their bank.

It is advisable for an individual within the Exporter's company to act as a co-ordinator of progress of the transaction for the Letter of Credit between the insurance company, the freight forwarder and all departments within the company.

Key Stage 5. Goods are shipped

Goods should be despatched according to the specific terms of the Documentary Letter of Credit.

Key Stage 6. Shipping documents are prepared and submitted to the Advising Bank by the Exporter

When all details of the transaction have been decided, the goods are despatched. The Exporter then prepares the shipping documents and submits them to the Advising Bank.

Preparation of Shipping Documents
Submission of documents to the Advising Bank
Documents must all be in order
Preparation of Shipping Documents

When assembling the documents for presentation to the bank, the Exporter must make sure that the documents match the LC. The following must be ensured:

1. The Exporter has the correct number of copies and originals
Also ensure that they contain the information called for, that the title of all the documents is correct and they are issued by the party specified in the LC. The document name must match exactly what the LC calls for.

2. They are consistent with each other
The shipping marks, quantities/weights, transport details, references and general descriptions must all?be consistent to ensure?that they clearly relate to the same shipment.

3. The description of the goods is correct
Goods may be described in general terms in all documents except the invoice, where the exact LC description must be reproduced.

4. The documents are authenticated
Import regulations in some countries require the documents to be signed manually and any alterations or additions witnessed.

Submission of documents to the Advising Bank

Once prepared, the shipping documents need to be presented to the Advising Bank without delay. Be aware of the following:

The documents must be complete and delivered to the bank by close of business on the expiry date and within the transport document time limit, whichever is earlier
The transport document time limit is 21 days from the date of shipment unless the credit gives a longer or shorter period
The import license expiry date is important and it may not be possible to extend
If any discrepancies are found and they can be put right, the corrected documents must still be presented to the bank by the original expiry date and within the presentation period.

The following documents must all be in order

Transport Document
Ensure these include the right type of transport, places and ports, have the correct consignor and consignee, date of shipment and 'freight paid' notation.

Insurance Document
Ensure that this is of the correct type, amount and currency as stipulated in the LC. The date must be no later than the date of issue of the transport document, unless the insurance document clearly states that cover takes effect from the date of shipment/receipt of cargo, ie. warehouse-to-warehouse.

The Importer and Exporter's names and details, the description of the goods and the clauses or statements must all appear exactly as they are in the LC. The value must not be more than the LC permits, though you can under certain conditions sometimes under-draw by up to 5%. A 5% variation is sometimes permitted, alternatively the LC may permit a specific variation such as an 'about' amount having a 10% variation.

Bills of Exchange
Ensure that the date, amount and currency are all correct, that the words and figures agree and that it is drawn on the correct party. Also check the endorsement, clause, and Letter of Credit reference number and ensure the signature identifies the signatory.

Covering note/letter to Advising bank
The note/letter must include the Exporter's contact details.
Include a request that the bank notifies any discrepancies by fax or telephone rather than mail. Indicate how to be paid and include account details. Provide details if the Exporter has a forward currency contract.

Any other documents
Ensure all other documents are from the correct issuer, have the correct wording and content, clearly relate to the goods invoiced and are all signed and endorsed as necessary.

Also ensure that all communications are correctly set out, addressed and dated and that no documents are enclosed that are not required

Key Stage 7. Advising Bank checks the documents. If they comply with LC they send the documents to Issuing Bank and may pay the Exporter in advance of being reimbursed by the Issuing Bank

When the documents are received by the Advising Bank, they are checked, then if correct, they are sent to the Issuing Bank.

When documents comply with the Letter of Credit
When documents do not comply to the Letter of Credit
Common discrepancies
When Documents comply with the Letter of Credit

If the Advising Bank is happy after checking the documents that they comply with the Letter of Credit, then the process of payment to the beneficiary can occur.

This process is dependent on where payment is stipulated in the original Letter of Credit.

If payment is stipulated to be at the Exporter's bank, then payment is released to the beneficiary on presentation and checking of the documents at the Exporter's bank
If payment is stipulated to be at the Importer's bank, then payment is released to the beneficiary only after the Issuing Bank has received the documents, checked them and then sent funds to the Advising Bank, who will then pass the payment to the Exporter.

When documents do not comply to the Letter of Credit

Discrepancies can occur between the documents presented and the terms and conditions expressed in the Letter of Credit.

If this does occur, the following courses of action are open to the Exporter:
Correct the discrepancy within the original expiry date.
If the Exporter is able to make any amendments within the original expiry date and presentation period then this is acceptable. Any alteration to the documents must be authorised by the party that issued them. If possible a clean document should be obtained.

Ask for payment despite discrepancies.

The Advising Bank can be asked to contact the Issuing Bank for permission to effect payment despite discrepancies in the documents. This can take a little time and the costs must be met by the Exporter, however, it can produce a final result more quickly.
Send documents on 'inspection'. “ Approval Basis”

This can occur within the security of the LC, but cashflow is seriously hindered and an unscrupulous Importer may try to take advantage by offering a reduced price for a quick settlement against documents 'as presented'. With documents 'on inspection' the bank should be requested to instruct the Issuing Bank that release of the documents to the Importer is to be only against payment being authorised.

Please Note:
The above measures normally allow the Exporter to retain control over the goods depending on the circumstances as the Importer often cannot take delivery without the documents, which are still in the Exporters control ?. However the Importer is in effect being asked if they still want the goods but are prepared to accept the discrepancies in the documents. They are still quite free to refuse.

Please note:
When the above documents and any other documents are required by a Letter of Credit, they should:
Comply with the stipulated conditions of the LC
Be properly signed
Have all alterations properly authenticated
Be marked on their face as 'original' except those which the LC specifically state can be copies.

Key Stage 8. Issuing Bank checks documents again, if correct they are released to Importer and the Importer's account is debited

The Issuing Bank, or Importer's bank, again checks documents and providing that they comply with all the terms and conditions, and are correct, they are released to the Importer and the Importer's account is debited

Key Stage 9. Issuing Bank reimburses Advising Bank

The Issuing Bank, ie. the Importer's bank then reimburses the Exporter's bank, the Advising Bank.

Common Discrepancies

All mistakes cause extra work and are sometimes accompanied by additional charges. They can also lead to delays in receiving payment, price reductions and even the avoidance of liability by the Importer altogether.

To help avoid discrepancies, we have highlighted the common mistakes for the documents below.

Bill of Exchange
Drawn incorrectly, or the amount differs from that of the invoice.
Capacity of the signatories is not stated if required.
Not endorsed or incorrectly endorsed.

Description of the goods differs from that in the LC.
Amount differs from that of the LC.
Amount differs from that of the Bill of Exchange.
Prices of goods differ from those indicated in the LC.
Price basis and shipment terms omitted.
Extra charges included that are not specified in the LC.
Is not certified, notarised or signed as required by the credit.
Does not contain a declaration required under the LC.
Importer's name differs from that mentioned in the LC.
Is not issued by the Exporter.
Be consistent with each other.

Bill of Lading
Not presented in full set when requested.
Alterations not authenticated by an official of the shipping company or its agents.
Is not clean, ie. carries remarks that the condition and/or the packaging of the merchandise is defective.
Is not marked 'on board' when so required.
'On board' notation not dated.
Is not endorsed by the Exporter when drawn 'to order'.
Is not marked 'freight paid' as stipulated in the LC in respect of Cost & Freight and Cost Insurance & Freight contracts.
Is made out 'to order' when the LC stipulated 'direct to consignee' (Importer) and vice versa.
Is dated later than the latest shipping date specified in the LC.
Is not presented within 21 days after date of shipment or such time as specified in the LC.
Description of goods other than that specified in the LC.
Rate at which freight is calculated, and total amount, not shown when LC requires these details.

The following are only acceptable if expressly allowed in the Letter of Credit:
Shipment 'on deck', ie. the goods are not stored in the hold.
Shipment from a port or to a destination other than that stipulated.
Presentation of types of Bills of Lading not specifically authorised in the LC, eg. a Charter party Bill of Lading, or a Forwarding agent's Bill of Lading.

Amount of cover is sufficient.
Does not include risks mentioned in the LC.
Is not endorsed by the insured and/or signed by the insurers.
Certificate or policy bears a date later than the date of shipment/despatch, except where warehouse-to-warehouse is indicated.
Incorrect description of goods.
Alterations are not authenticated.
Is not in transferable form when required.
Carrying vessel's name not recorded.
Does not cover transhipment when Bills of Lading indicate it will take place.