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
* Types of Letter of Credit
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 Barclays are irrevocable. Under UCP600 (Uniform Customs and Practice for Documentary Credits), LCs are assumed 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. Barclays 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: Barclays 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. Barclays is happy to discuss whether or not a Standby Letter of Credit is appropriate to your needs.
NB: For definitions of the regular types of Letters of Credit please refer to the Documentary Letter of Credit page.
Terms of Payment
Documentary credits may be made available in one of four ways.
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.
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.