CAIIB-BFM-MODULE-A-Documentary Letters of Credit Documentary Letters of Credit 1. In international trade, where buyers and sellers are far apart in two different countries, or even continents, the Letter of Credit acts as a most convenient instrument, giving assurance to the sellers of goods for payment and to the buyers for shipping documents, as called for under the Credit.
2. In order to bring an uniformity in matters pertains to LC Documents and Transactions, International Chamber of Commerce formed rules and procedures. Those are called as Uniform Customs and Practices for Documentary Credits (UCPDC).
3. The International Chamber of Commerce (ICC)was established in 1919 headquartered at Paris.
4. The first UCPDC published in 1933 and has been revised from time to time in 1951, 1962,1974,1983,1993 and recently in 2007.
5. The updated UCPDC in 2007 is called as UCPDC 600. And it has been implemented w.e.f 1-7-2007.
6. Documentary Credit/Letter of Credit: LC/DC cane be defined as a signed or an authenticated instrument issued by the buyer’s Banker, embodying an undertaking to pay to the seller a certain amount of money, upon presentation of documents, evidencing shipment of goods, as specified, and compliance of other terms and conditions.
7. IN an LC Parties are as follows: a. The buyers/Importers or the applicant – on whose behalf LC is opened. b. The Sellers/Exporters or the Beneficary of the LC c. The opening Bank (Buyer’s Bank), who establishes the LC d. The advising bank (Bank in sellers country), who acts as an agent of the issuing bank and authenticates the LC. e. The confirming Bank- Who undertakes to pay on behalf of the issuing bank. f. The negotiating Bank ( Seller’s bank or Bank nominated by the opening Bank) g. Reimbursing Bank – Who reimburses the negotiating or confirming bank. For example, in a hypothetical Situation given below: Mr Ram, (Banking with Dhanlaxmi Bank) an agriculture entrepreneur growing vegetables in green house technology in Khammam wants to update his farm house with modern machinery. He is importing the same from a Chinese manufacturer M/s Zuanch LLC, Beijing who are banking with China Development Bank for total cost of US$ 4500. M/s Zaunch LLC has issued an invoice stating the sale transaction must be backed by LC. As such, Mr Ram approaches Dhanlaxmi Bank for opening of Letter of Credit (Foreign) in FCY USD. Dhanlaxmi Bank’s China Foreign Correspondent Bank is Bank of China, Beijing. Applicant of LC - Mr Ram, Khammam Beneficiary of LC - M/s Zaunch LLC LC Opening/ Issuing Bank - Dhanlaxmi Bank Advising Bank /Confirming Bank - Bank of China Negotiating bank China - Development Bank Reimbursing Bank -Bank of China in China
8. Types of Letters of Credit a. Revocable LC b. Irrevocable LC c. Irrevocable Confirmed LC d. Transferable LC e. Red Clause LC f. Sight/Acceptance, Deferred Payment, or Negotiation LC g. Back to Back LC
9. Revocable LC can be amended or cancelled at any moment by the issuing bank without the consent of any other party, as long as the LC has not been drawn or documents taken up.
10. In case the Negotiating Bank has taken up the documents under revocable LC, prior to receipt of cancellation notice, the issuing bank is liable to compensate/reimburse the same to the negotiating bank.
11. Irrevocable LC which holds a commitment by the issuing bank to pay or reimburse the negotiating bank, provided conditions of the LC are complied with.
12. Irrevocable LC cannot be amended or cancelled without the consent of all parties concerned.
13. The irrevocable LC is an unconditional undertaking by the issuing bank to make payment on submission of documents conforming to the terms and conditions of the LC
14. All LCs issued, unless and otherwise specified, are irrevocable Letter of Credits.
15. Irrevocable confirmed LC is an L/c which has been confirmed by a bank, other than the issuing a bank, usually situated in the country of the exporter, thereby taking an additional undertaking to pay on receipt of documents conforming to the terms & conditions of the LC
16. The Conforming Bank can be advising Bank, which on receipt of request from the issuing bank takes this additional responsibility.
17. The conforming bank steps into the shoes of the issuing bank and performs all functions of the issuing bank.
18. Transferrable LC is available for transfer in full or in part, in favour of any party other than beneficiary, by the advising bank at the request of the issuing bank.
19. Red Clause LC enables the beneficiary to avail pre-shipment credit from the nominated/advising bank. The LC bears a clause in “RED Letter” authorizing the nominated bank to grant advance to the beneficiary, prior to shipment of goods, payment of which is guaranteed by the Opening Bank, in case of nay default or failure of the beneficiary to submit shipment documents.
20. Under a Sight LC, the beneficiary is able to get the payment on presentation of documents conforming to the terms and conditions of the LC at the nominated bank’s countries.
21. Under the Acceptance Credit, the bill of exchange or drafts are drawn with certain Usance period and are payable upon acceptance, at a future date, subject to receipt of documents conforming to the terms and condition of the LC.
22. A Deferred Payment Credit is similar to Acceptance Credit, except that there is no bill of exchange or draft drawn and is payable on certain future date, subject to submission of credit confirmed documents. The due date is generally mentioned in the LC
23. A Negotiation Credit, the issuing Bank undertakes to make payment to the Bank, which has negotiated the documents.
24. In a Negotiation LC, LC may be freely negotiable or may be restricted to any bank nominated by the LC issuing Bank.
25. Back to Back LC: when an exporter arranges to issue an LC in favour of Local supplier to procure goods on the strength of export LC received in his favour, it is known as Back to Back LC.
26. UCP 600 come into force w.e.f. 01/07/2007.
27. Important Changes in the Articles of UCP 600 and their implication for the Banks:- # A reduction in the number of articles from 49 to 39 # New articles on "Definitions" and "Interpretations" providing more clarity and precision in the rules # A definitive description of negotiation as "purchase" of drafts of documents # The replacement of the phrase "reasonable time" for acceptance or refusal of documents by a maximum period of five banking days # New provisions allow for the discounting of deferred payment credits # Banks can now accept an insurance document that contains reference to any exclusion clause
28. UCP 600 does not apply by default to letters of credit issued after July 1st 2007. A statement needs to be incorporated into the credit (LC), and preferably also into the sales contract that expressly states it is subject to these rules.
29. Revocable Credits (Article 2): One of the most important changes in UCP 600 is the exclusion of any verbiage regarding revocable letters of credit, which can be amended or canceled at any time without notice to the seller. .Actually,Article 2 explicitly defines a credit as "any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation."
30. Article 3 states that "A credit is irrevocable even if there is no indication to that effect." and Article 10makes it clear that "a credit can neither be amended nor cancelled without the agreement of the issuing bank, the confirming bank, if any, and the beneficiary" (seller).Therefore, it is prudent for the seller to stipulate in the sales contract that the "buyer will open an irrevocable letter of credit", and to check that the buyer's credit does, in fact, either describe itself as "irrevocable" or state that it incorporates UCP 600 (without exclusion).