Letters of Credit
Letters of Credits are unique financial instruments that connects the movement of physical goods that are being bought and sold with the funding of these goods as they move through the channels of trade. Over the years, certain terms and modality has been established which are reflected through specific Incoterms through which the Buyer, Seller and the transporting company know when the responsibility for the goods move from one party to another and when title to the underlying goods transfers from one party to another.
Generally a Letter of Credit will be irrevocable and at sight. This means that the Letter of Credit issuing bank is irrevocably committing to pay the Seller once the seller meets the terms of the Letter of Credit. 'At Sight" means that when the Letter of Credit issuing bank receives the documents from the Seller and 'sees' them the issuing bank is obligated to pay if all the Letter of Credit documents are in order.
A documentary credit is a (conditional) bank undertaking of payment. It is a written undertaking by a bank (issuing bank) given to the seller (beneficiary) at the request, and on the instructions of the buyer (applicant) to pay at sight or at a determinable future date up to a stated sum of money, within a prescribed time limit and against stipulated documents or other conditions. The issuing bank is putting out its credit and good name for the sake of the buyer.
Because the documentary credit is a conditional undertaking, payment is made on behalf of the buyer against documents, which may represent the goods and give the buyer rights to them.
Because the documentary credit is a bank undertaking, the seller can look to the bank for payment, instead of relying upon the ability or willingness of the buyer to pay.
Types of Letters of Credit:
Documentary; Merchandise, Commercial, Trade
The majority of LCs issued are in payment for goods in shipment or current services performed. Payment is normally made against documents for goods shipped. (Article 2 UCP 600)
Normally, this type of LC functions like a guarantee. This type of credit can be drawn against only upon performance of service or financial obligation default. It is a definite undertaking of the issuing bank. The standby letters of credit from Trade and Merchant Trust and GEBS both state that they are governed by UCP 600. If that is the case, should we mention ISP98.
Under UCP 600 a letter of credit is revocable even if there is no indication to that effect (article 3).
Bears only the obligation of the issuing bank. The beneficiary should look to the credit worthiness of only the issuing bank, and not to any intermediary (Article 7 UCP 600)
Is a credit in which a second obligation is added to the letter of credit by another bank (Article 8 UCP 600)
Payment is at sight, which means that the drafts and documents are honored, if in order, by making payment without delay.
The draft honored by accepting it for payment at a future date. Payment is delayed until the maturity of the draft.
Can be transferred by the original beneficiary to one or more other parties. It is normally used when the first beneficiary does not supply the merchandise himself, but is a middleman and wants to transfer all or part of his rights to the actual supplier (Article 38 UCP 600)
Some common Incoterms:
FOB (Free on Board)
Transportation or carriage is to be arranged by the Buyer.
CIF (Cost, Insurance and Freight)
Freight and insurance to be arranged by the Seller.
CFR (Cost and Freight)
Same as CIF except the insurance is the responsibility of the Buyer.
FAS (Free Alongside Ship)
Transportation to be arranged by the Buyer.
EXW (Ex Works)
Transportation to be arranged by the Buyer who is responsible to pick up the goods from the Seller's warehouse.
DDP (Delivered Duty Paid)
Transportation to be arranged by the Seller.