18letter of credit.docx

18letter of credit.docx

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18letterofcredit

Introduction:

WhatIsALetterOfCredit?

Aletterofcreditisbasicallyadocumentissuedbyabankguaranteeingaclient'sabilitytopayforgoodsorservices.Abankorfinancecompanyissuesaletterofcreditonbehalfofanimporterorbuyer,authorizingtheexporterorsellertoobtainpaymentwithinaspecifiedtimeframeoncethetermsandconditionsoutlinedintheletterofcreditaremet.Theletterofcreditactslikeaninsurancecontractforboththebuyerandsellerandpracticallyeliminatesthecreditriskforbothparties,whileatthesametimereducingpaymentdelays.Aletterofcreditprovidestheexporterorsellerwiththegreatestdegreeofsafetywhenextendingcredit.Itisusefulwhentheimporterorbuyerisnotwellknownandwhenexchangerestrictionsexistorarepossible.

AccordingtoThompson’sDictionaryaletterofcreditis,“adocumentissuedbythebankerauthorizingthebankertowhomitisaddressedtohonourthechequeofthepersonnamedtotheextentoftheamountandtochargethesumstotheaccountofthegrantor.”

AccordingtoDictionaryofBankingbyF.EPerryaletterofcreditmeans,“anarrangementmadebyabankforacustomerproposingtostayabroadforaperiodwhowishesalwaystobesureofbeingabletoobtainmoneywhereverhemaybe.Thebankagreestoatotalsumtothecustomer,debitshisaccountinadvanceandwritestoacorrespondentbank,authorizingittoencashondemand,anychequeordraftdrawnbythebeneficiary,chargingthesumstothedebitoftheissuingbank.”

Legally,theletterofcreditisrequiredtobeinnoparticularform.Historicallyithaslongbeenanintegralpartofthebankingbusiness,eventhoughtheearlyformsofletterofcreditbearlittlemoreresemblancetothemodernforms.Formerlythemainobjectofsuchdocumentarycreditwastoenableamerchanttoenterintocontractsforthepurchaseofgoodsabroadandwasgivenbeforehewasinapositiontorequestwithreferencetoanyparticulartransaction.Tounderstandtheoriginofmoderndocumentarycredit,onehastostartwiththetraditionalletterofcredit,thesalientfeaturesofwhichcouldbestatedas,“theletterofcreditisacontract.Theissuingparty-usuallyabank-promisestopaythe‘beneficiary’–traditionallyasellerofgoods-ondemandifthebeneficiarypresents,whateverdocuments,thelettermayrequire.Therearenormallytwopartiesinvolvedinthecontract.Thebank,whichissuesaletteracreditasaprincipal,notasagentforasaagentforitscustomer,andengagesitsowncredit.Theletterofcreditthus,evidences-irrevocableobligationtohonourthedraftpresentedbythebeneficiaryuponcompliancewiththetermsofthecredit”

TypesOfLetterOfCredit

Banksmayissueseveraltypesoflettersofcredit.Itisbestforimportersandexporterstomeetwiththeirbankingofficertodeterminewhichtypeofcreditbestsuitstheirneeds.Themostcommontypeoflettersofcreditaredescribedfollows:

Revocable

Arevocableletterofcreditallowsforamendments,modificationsandcancellationofthetermsoutlinedintheletterofcreditatanytimeandwithouttheconsentoftheexporterorbeneficiary.Becausethisplacestheexporteratrisk,revocablelettersofcreditarenotgenerallyacceptedandareregardedasworthless.

Irrevocable

Anirrevocableletterofcreditrequirestheconsentoftheissuingbank,thebeneficiaryandapplicantbeforeanyamendment,modificationorcancellationtotheoriginaltermscanbemade.Thistypeofletterofcreditiscommonlyusedandpreferredbytheexporterorbeneficiarybecausepaymentisalwaysassured,providedthedocumentssubmittedcomplywiththetermsoftheletterofcredit.Irrevocablelettersofcreditcanbebothconfirmedandunconfirmed.Suchcreditorscannotbewithdrawnbytheissuingbankerwithouttheconsentofthebeneficiaryevenifhiscustomeri.e.buyerrequirestodoso.AccordingtotheBankingdictionaryofPerry,‘oncethistypeofcredithasbeenarranged,itstermscannotbevariedorchangedwithouttheconcurrenceofthepartiestoit.Anexporterwhoisinsufficientlystrongbargainingpositiontodososhouldthereforealwaysinsistonpaymentthroughirrevocablecredit.’

TheCalcuttaHighCourtinB.S.AujilaCo.Pvt.Ltd.v.KaluramPrasadclarifiedthedistinctionbetweenarevocableandirrevocableletterofcreditandthenatureofcontractbetweentheissuingbankandtheintermediarybankandthebeneficiarybank.Thecourtobservedthatrevocableandirrevocablelettersofcreditstandondifferentfooting.Arevocableletterofcreditcanberevokedbeforenegotiations.Irrevocablelettersofcreditmaybeconfirmedorunconfirmed.Therelationshipunderthecontractbetweentheissuingbankandthebuyerisdeterminedinthetermsofagreementbetweenthemforopeningaletterofcredit.Asbetweenthesellerandthebankertheissueofletterofcreditunderintimationtothesellercreatesacontractualnexusandmakesthebankerdirectlyliabletothesellertopaythepurchasepriceortoacceptthebillofexchangewhendocumentsaretendered.

Transferable

Anirrevocableletterofcreditmayalsobetransferable.Withatransferableletterofcredit,theexportercantransferallorpartofhisrightstoanotherparty.Transferablelettersofcreditareoftenusedwhentheexporteristheimporter'sagentoramiddlemanbetweensupplierandimporter,andnottheactualsupplierofmerchandise.Withatransferableletterofcredit,theexporterusesthecreditstandingoftheissuingbankandavoidshavingtoborroworusehisownfundstobuygoodsfromasupplier.Hence,itisaviablepre-exportfinancingvehicle.Beforetransfercanbemade,theexportermustcontact,inwriting,thebankhandlingthedisbursementoffunds-thetransferringbank.Transferablelettersofcreditcanonlybetransferredbasedonthetermsandconditionsspecifiedintheoriginalcredit,withcertainexceptions.Therefore,itmaybedifficulttoachieveflexibilityandconfidentialitywiththisfinancemethod.

Thetransferringbank,whetherithasconfirmedtheletterofcreditornot,isonlyobligatedtoeffectthetransfertotheextentandinthemannerexpresslyspecifiedintheletterofcredit.Transferablelettersofcreditinvolvespecificrisks.Whenabankopensatransferableletterofcreditforabuyer,neitherpartycanbecertainofwhowillbetheultimatesupplier.Bothpartiesmustrelyupontheimporter'sassessmentoftheexporter'sreputationandabilitytoperform.Toreduceoverallriskandpreventtheshipmentofsubstandardgoods,anindependentcertificateofinspectioncanberequiredinthedocumentation.

Forsimplicity'ssake,manybanksprefersingletransferanddiscouragemultipletransfers,butwilldomultipletransfersifconditionsareright.Partialtransferscanalsobemadetooneorseveralsuppliersifthetermsoftheoriginalletterofcreditallowforpartialshipments.Theprocessingofthistypeofletterofcreditcanbecomecomplicatedandtricky,requiringlogisticscoordinationandthehighestlevelofprecision.Incompleteand/orambiguousinformationonthetransferableletterofcreditalmostalwaysleadstoproblems.Furthermore,thebeneficiaryofthetransferableletterofcreditmustbeavailablethroughouttheentirenegotiationprocesstoassistthetransferringbank.

Otherformsofirrevocablelettersofcredits,thoughnotwidelyused,areunconfirmed,confirmedandback-to-back.

Confirmed

Aconfirmedletterofcreditiswhenasecondguaranteeisaddedtothedocumentbyanotherbank.Theadvisingbank,thebranchorthecorrespondentthroughwhichtheissuingbankroutestheletterofcredit,addsitsundertakingandcommitmenttopaytotheletterofcredit.Thisconfirmationmeansthattheseller/beneficiarymayalsolooktothecreditworthinessoftheconfirmingbankforpaymentassurance.

Unconfirmed

Anunconfirmedletterofcreditiswhenthedocumentbearstheguaranteeoftheissuingbankalone.Theadvisingbankmerelyinformstheexporterofthetermsandconditionsoftheletterofcredit,withoutaddingitsobligationtopay.Theexporterassumesthepaymentriskoftheissuingbank,whichistypicallylocatedinaforeigncountry.

Back-to-BackLettersofCredit

Back-to-backlettersofcreditaretwoindividuallettersofcreditthattogetherofferanalternativetoatransferableletterofcredit.ItisatermgivenintheUnitedStatesofAmericatoanancillarycredit,whichariseswherethesellerusesthecreditgrantedtohimbytheintermediaryorissuingbankertosupportanothercreditgrantedbytheseller’sbankertohissupplier.Theback-to-backletterofcreditallowsexporters（sellersormiddlemen）whodonotqualifyforunsecuredbankcredittousealetterofcreditassecurityforasecondletterofcreditinfavorofasupplier.Inotherwords,ifaforeignbuyerwillissuealetterofcredittoanexporter,certainbanksandtradefinancecompanieswillissueindependentlettersofcredittotheexporter'ssupplierssothattherequiredgoodscanbepurchased.Eveniftheinitialletterofcreditisnotsuccessfullycompleted,thesecondremainsvalid,andtheissuingbankisobligatedtopayunderitsterms.

Althoughback-to-backlettersofcreditprovidesmallandmediumexportersvirtuallyunlimitedworkingcapitaltofinancetheirsalesandcompletemoreexporttransactions,manybanksarereluctanttotakeonthistypeofarrangement.Becauseback-to-backlettersofcreditinvolvetwoseparatetransactions,itislikelythatseveralparticipatingbankswillbeinvolvedandtheriskofconfusionanddisputeishigh.Toprotectitself,abankgenerallywillrequirethattheexporter