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  • A letter of credit is a document issued by a financial institution, or a similar party,

  • assuring payment to a seller of goods or services provided certain documents have been presented

  • to the bank. "Letters of Credit" are documents that prove the seller has performed the duties

  • under an underlying contract and the goods have been supplied as agreed. In return for

  • these documents, the beneficiary receives payment from the financial institution that

  • issued the letter of credit. The letter of credit serves as a guarantee to the seller

  • that it will be paid regardless of whether the buyer ultimately fails to pay. In this

  • way, the risk that the buyer will fail to pay is transferred from the seller to the

  • letter of credit's issuer. The letter of credit can also be used to ensure that all the agreed

  • upon standards and quality of goods are met by the supplier, provided that these requirements

  • are reflected in the documents described in the letter of credit.

  • Letters of credit are used primarily in international trade for transactions between a supplier

  • in one country and a customer in another. Most letters of credit are governed by rules

  • promulgated by the International Chamber of Commerce known as Uniform Customs and Practice

  • for Documentary Credits. They are also used in the land development process to ensure

  • that approved public facilities will be built. The parties to a letter of credit are the

  • supplier, usually called the beneficiary, the issuing bank, of whom the buyer is a client,

  • and sometimes an advising bank, of whom the beneficiary is a client. Almost all letters

  • of credit are irrevocable, i.e., cannot be amended or canceled without the consent of

  • the beneficiary, issuing bank, and confirming bank, if any. In executing a transaction,

  • letters of credit incorporate functions common to giros and travelers' cheques.

  • Terminology Origin of the term

  • The name "letter of credit" derives from the French word "accréditation", a power to do

  • something, which derives from the Latin "accreditivus", meaning trust.

  • Related terms A sight LC means that payment is made immediately

  • to the beneficiaryexporter upon presentation of the correct documents in the required time

  • frame. A time or date LC will specify when payment will be made at a future date and

  • upon presentation of the required documents. Negotiation means the giving of value for

  • draft(s) or document(s) by the bank authorized to negotiate, viz the nominated bank. Mere

  • examination of the documents and forwarding the same to the letter of credit issuing bank

  • for reimbursement, without giving of value / agreed to give, does not constitute a negotiation.

  • Documents that can be presented for payment To receive payment, an exporter or shipper

  • must present the documents required by the letter of credit. Typically, the payee presents

  • a document proving the goods were sent instead of showing the actual goods. The Original

  • Bill of Lading is normally the document accepted by banks as proof that goods have been shipped.

  • However, the list and form of documents is open to negotiation and might contain requirements

  • to present documents issued by a neutral third party evidencing the quality of the goods

  • shipped, or their place of origin or place. Typical types of documents in such contracts

  • might include: Financial Documents

  • Bill of Exchange, Co-accepted Draft Commercial Documents

  • Invoice, Packing list Shipping Documents

  • Transport Document, Insurance Certificate, Commercial, Official or Legal Documents

  • Official Documents License, Embassy legalization, Origin Certificate,

  • Inspection Certificate, Phytosanitary certificate Transport Documents

  • Bill of lading, Airway bill, Lorry/truck receipt, railway receipt, CMC Other than Mate Receipt,

  • Forwarder Cargo Receipt, Deliver Challan...etc Insurance documents

  • Insurance policy, or Certificate but not a cover note.

  • Legal principles governing documentary credits One of the primary peculiarities of the documentary

  • credit is that the payment obligation is independent from the underlying contract of sale or any

  • other contract in the transaction. Thus the bank’s obligation is defined by the terms

  • of the letter of credit alone, and the sale contract is irrelevant. The defenses available

  • to the buyer arising out of the sale contract do not concern the bank and in no way affect

  • its liability. Article 4(a) UCP states this principle clearly. Article 5 the UCP further

  • states that banks deal with documents only, they are not concerned with the goods. Accordingly,

  • if the documents tendered by the beneficiary, or his or her agent, appear to be in order,

  • then in general the bank is obliged to pay without further qualifications.

  • Policies behind adopting the abstraction principle are purely commercial, and reflect a party’s

  • expectations: first, if the responsibility for the validity of documents was thrown onto

  • banks, they would be burdened with investigating the underlying facts of each transaction,

  • and less inclined to issue documentary credits as the transaction would involve great risk

  • and inconvenience. Second, documents required under the letter of credit could in certain

  • circumstances be different from those required under the sale transaction. This would place

  • banks in a dilemma in deciding which terms to follow if required to look behind the credit

  • agreement. Third, the fact that the basic function of the credit is to provide a seller

  • with the certainty of payment for documentary duties suggests that banks should honor their

  • obligation notwithstanding allegations of misfeasance by the buyer. Finally, courts

  • have emphasized that buyers always have a remedy for an action upon the contract of

  • sale, and that it would be a calamity for the business world if, for every breach of

  • contract between the seller and buyer, a bank were required to investigate said breach.

  • Theprinciple of strict compliancealso aims to make the bank’s duty of effecting

  • payment against documents easy, efficient and quick. Hence, if the documents tendered

  • under the credit deviate from the language of the credit the bank is entitled to withhold

  • payment even if the deviation is purely terminological. The general legal maxim de minimis non curat

  • lex has no place in the field of documentary credits.

  • Definitions of related terms The Bank which advises a Letter of Credit

  • to the Beneficiary at the request of the issuing Bank is known as the Advising Bank

  • Applicant: Applicant is the party on whose request the issuing bank issues a credit .

  • Banking day: The day on which a bank is regularly open at the place at which an act to be performed.

  • Beneficiary: Beneficiary is the party who is to receive the benefit of the LC. The consignee

  • of an LC and the beneficiary may not be the same. The credit is issued in his favor.

  • Presentation: Presentation is either delivery of documents against an LC or the document

  • itself.Complying presentation : A presentation is said to be complying presentation when

  • it is in accordance with: i. the terms and conditions of the credit,

  • ii. the applicable provisions of UCP and iii. international standard banking practice.Confirmation:

  • Confirmation is a definite undertaking from the confirming bank to honor or negotiate

  • a complying presentation in addition to that of the issuing bank.Confirming bank: The Bank

  • which adds confirmation to an LC is termed as Confirming Bank. It does so at the request

  • of the issuing bank and taking authorization from the issuing bank.Letter of Credit/ Credit:

  • Credit is a definite undertaking of the issuing bank to honor a complying presentation. According

  • to UCP all credit must be Irrevocable.Honour: Honour means act according to commitment of

  • the LC. Presentations are honored in different ways depending on the type of credit like.

  • i. Making payment at sight for sight LC ii.By incurring a deferred payment undertaking and

  • paying at maturity deferred payment LC. iii. by accepting a Draft drawn by the beneficiary

  • and paying at maturity for Deferred Acceptance LC.

  • Issuing bank: The bank which issues a credit is known as issuing bank.Nominated Bank: The

  • bank with which credit is available is termed as Nominated Bank of that credit. If no bank

  • is mentioned in the credit as nominated bank, all banks are nominated bank.

  • Negotiation: A bank is said to negotiate a document if it purchases a draft or documents

  • under a complying presentation either by making advance or agreeing to advance funds to the

  • beneficiary on or before the date on which reimbursement is due to the nominated bank

  • . A draft drawn on a nominated bank can not be purchased by itself.

  • Different types of letters of credit Import/export Letter of Credit

  • The same credit can be termed as import and export LC depending on whose perspective it

  • is being looked upon. For the importer it is termed as Import LC and for the Exporter

  • of goods, Export LC. Revocable Letter of Credit

  • In this type of credit, buyer and the bank which has established the LC, are able to

  • manipulate the letter of credits or make any kinds of corrections without informing the

  • seller and getting permissions from him. According to UCP 600, all LCs are Irrevocable, hence

  • this type of LC used no more. Irrevocable LC

  • In this type of LC, Any changes or cancellation of the LC is done by the Applicant through

  • the issuing Bank. It must be authenticated by the Beneficiary of the LC. Whether to accept

  • or reject the changes, depends on the beneficiary. Confirmed LC

  • An LC is said to be confirmed when another bank adds its additional confirmation to honor

  • a complying presentation at the request or authorization of the issuing bank.

  • Unconfirmed LC This type of letter of credit, does not acquire

  • the other bank's confirmation. Transferrable LC

  • A Transferable Credit is the one under which the exporter has the right to make the credit

  • available to one or more subsequent beneficiaries. Credits are made transferable when the original

  • beneficiary is a middleman and does not supply the merchandise himself but procures goods

  • from the suppliers and arrange them to be sent to the buyer and does not want the buyer

  • and supplier know each other. The middleman is entitled to substitute his own invoice

  • for the one of the supplier and acquire the difference as his profit in transferable letter

  • of credit mechanism. Important Points of Consideration:

  • A letter of credit can be transferred to the second beneficiary at the request of the first

  • beneficiary only if it expressly states that the letter of credit is "transferable". A

  • bank is not obligated to transfer a credit. A transferable letter of credit can be transferred

  • to more than one second beneficiary as long as credit allows partial shipments.

  • The terms and conditions of the original credit must be indicated exactly in the transferred

  • credit. However, in order to keep the workability of the transferable letter of credit below

  • figures can be reduced or curtailed. • Letter of credit amountany unit price

  • of the merchandisethe expiry datethe presentation period orthe latest shipment

  • date or given period for shipment. The first beneficiary may demand from the

  • transferring bank to substitute his name for that of the applicant. However, if a document

  • other than invoice required in the transferable credit must be issued in a way to show the

  • applicant's name, in such a case that requirement must be indicated in the transferred credit

  • will be given free. Transferred credit cannot be transferred once

  • again to any third beneficiary according to the request of the second beneficiary.

  • Untransferable LC It is said to the credit that seller cannot

  • give a part or completely right of assigned credit to somebody or to the persons he wants.

  • In international commerce, it is required that the credit will be untransferable.

  • Deferred / Usance LC It is kind of credit that won't be paid and

  • assigned immediately after checking the valid documents but paying and assigning it requires

  • an indicated duration which is accepted by both of the buyer and seller. In reality,

  • seller will give an opportunity to the buyer to pay the required money after taking the

  • related goods and selling them. At Sight LC

  • It is a kind of credit that the announcer bank after observing the carriage documents

  • from the seller and checking all the documents immediately pays the required money.

  • Red Clause LC In this kind of credit assignment, the seller

  • before sending the products, can take the pre-paid or part of the money from the bank.

  • The first part of the credit is to attract the attention of the acceptor bank. The reasoning

  • behind this, is the first time this credit is established by the assigner bank, it is

  • to gain the attention of the offered bank. The terms and conditions were written by red

  • ink, going forward it became famous with that name.

  • Back to Back LC This type of LC consists of two separated

  • and different types of LC. First one is established in the benefit of the seller that is not able

  • to provide the corresponding goods for any reasons. Because of that reason according

  • to the credit which is opened for him, neither credit will be opened for another seller to

  • provide the desired goods and sends it. Back-to-back L/C is a type of L/C issued in

  • case of intermediary trade. Intermediate companies such as trading houses are sometimes required

  • to open L/Cs by supplier and receive Export L/Cs from buyer. SMBC will issue a L/C for

  • the intermediary company which is secured by the Export L/C. This L/C is called "Back-to-back

  • L/C". The price of letters of credit

  • All the charges for issuance of letter of credit, negotiation of documents, reimbursements

  • and other charges like courier are to the account of applicant or as per the terms and

  • conditions of the letter of credit. If the Letter of Credit is silent on charges, then

  • they are to the account of the Applicant. The description of charges and who would be

  • bearing them would be indicated in the field 71B in the letter of credit.

  • Legal basis Legal writers have failed to satisfactorily

  • reconcile the bank’s undertaking with any contractual analysis. The theories include:

  • the implied promise, assignment theory, the novation theory, reliance theory, agency theories,

  • estoppels and trust theories, anticipatory theory, and the guarantee theory. Davis, Treitel,

  • Goode, Finkelstein and Ellinger have all accepted the view that documentary credits should be

  • analyzed outside the legal framework of contractual principles, which require the presence of

  • consideration. Accordingly, whether the documentary credit is referred to as a promise, an undertaking,

  • a chose in action, an engagement or a contract, it is acceptable in English jurisprudence

  • to treat it as contractual in nature, despite the fact that it possesses distinctive features,

  • which make it sui generis. Although documentary credits are enforceable

  • once communicated to the beneficiary, it is difficult to show any consideration given

  • by the beneficiary to the banker prior to the tender of documents. In such transactions

  • the undertaking by the beneficiary to deliver the goods to the applicant is not sufficient

  • consideration for the bank’s promise because the contract of sale is made before the issuance

  • of the credit, thus consideration in these circumstances is past. However, the performance

  • of an existing duty under a contract may be a valid consideration for a new promise made

  • by the bank, provided that there is any practical benefit to the bank Ltd), or a promise to

  • perform owed to a third party may also constitute a valid consideration.(Scotson v Pegg)

  • A theory sustains that is feasible to typify letter of credit as a Collateral Contract

  • for a Third-Party Beneficiary because there are in fact three different entities participating

  • in the letter of credit transaction the seller, the buyer, and the banker. Because letters

  • of credit are prompted by the buyer’s necessity and in application of the theory of Jean Domat

  • the cause of a Letter of Credit is to release the buyer of his obligation to pay directly

  • to the seller with legal tender. Therefore, Letter of Credit theoretically fits as a collateral

  • contract accepted by conduct or in other words, an Implied-in-fact contract under the framework

  • for third party beneficiary where the buyer participate as the third party beneficiary

  • with the bank acting as the stipulator and the seller as the promisor. The term "beneficiary"

  • is not used properly in the scheme of a letter of credit because a beneficiary in the broadest

  • sense is a natural person or other legal entity who receives money or other benefits from

  • a benefactor. Note that under the scheme of letters of credit, banks are neither benefactors

  • of sellers nor benefactors of the buyers, and the seller doesn’t receive money in

  • gratuity mode. Thus is possible thatletter of creditwas one of those contracts that

  • needed to be masked to disguise theconsideration or Privity requirment”, as a result this

  • kind of arrangement, would make letter of credit to be enforceable under the action

  • assumpsit because of its promissory connotation. A few countries including the United States

  • have created statutes in relation to the operation of letters of credit. These statutes are designed

  • to work with the rules of practice including the UCP and the ISP98. These rules of practice

  • are incorporated into the transaction by agreement of the parties. The latest version of the

  • UCP is the UCP600 effective July 1, 2007. The previous revision was the UCP500 and became

  • effective on 1 January 1994. Since the UCP are not laws, parties have to include them

  • into their arrangements as normal contractual provisions. .

  • International Trade Payment methods International Trade Payment method can be

  • done in the following ways. Advance payment

  • Where the buyer parts with money first and waits for the seller to forward the goods

  • Documentary Credit Subject to ICC's UCP 600, where the bank gives

  • an undertaking to pay the shipper the value of the goods shipped if certain documents

  • are submitted and if the stipulated terms and conditions are strictly complied with.

  • Here the buyer can be confident that the goods he is expecting only will be received since

  • it will be evidenced in the form of certain documents called for meeting the specified

  • terms and conditions while the supplier can be confident that if he meets the stipulations

  • his payment for the shipment is guaranteed by bank, who is independent of the parties

  • to the contract. Documentary collection

  • Also called "Cash Against Documents". Subject to ICC's URC 525, sight and usance, for delivery

  • of shipping documents against payment or acceptances of draft, where shipment happens first, then

  • the title documents are sent to the [collecting bank] buyer's bank by seller's bank [remitting

  • bank], for delivering documents against collection of payment/acceptance

  • Direct payment Where the supplier ships the goods and waits

  • for the buyer to remit the bill, on open account terms.

  • Risk situations in letter-of-credit transactions Fraud Risks

  • The payment will be obtained for nonexistent or worthless merchandise against presentation

  • by the beneficiary of forged or falsified documents.

  • Credit itself may be funded. Sovereign and Regulatory Risks

  • Performance of the Documentary Credit may be prevented by government action outside

  • the control of the parties. Legal Risks

  • Possibility that performance of a Documentary Credit may be disturbed by legal action relating

  • directly to the parties and their rights and obligations under the Documentary Credit

  • Force Majeure and Frustration of Contract Performance of a contractincluding an

  • obligation under a Documentary Credit relationshipis prevented by external factors such

  • as natural disasters or armed conflicts Risks to the Applicant

  • Non-delivery of Goods Short shipment

  • Inferior Quality Early /Late Shipment

  • Damaged in transit Foreign exchange

  • Failure of Bank viz Issuing bank / Collecting Bank

  • Risks to the Issuing Bank Insolvency of the Applicant

  • Fraud Risk, Sovereign and Regulatory Risk and Legal Risks

  • Risks to the Reimbursing Bank no obligation to reimburse the Claiming Bank

  • unless it has issued a reimbursement undertaking. Risks to the Beneficiary

  • Failure to Comply with Credit Conditions Failure of, or Delays in Payment from, the

  • Issuing Bank See also

  • Bank Payments Obligation Buyer's Credit

  • Documentary collection Uniform Customs and Practice for Documentary

  • Credits References

  • External links Letter of Credit Information, Procedure and

  • Videos. Anatomy of a Letter of Credit, showing an

  • actual negotiated letter of credit Letters of Credit and How They Work

  • (in Persian) Letter of Credit, its Relation with Stipulation

  • for the Benefit of a Third Party

A letter of credit is a document issued by a financial institution, or a similar party,

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信用證 (Letter of credit)

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