|موضوع: payment method 4/5/2011, 05:10|| |
Understanding and Using Letters of Credit,
Letters of credit accomplish their purpose by substituting the credit of
the bank for that of the customer, for the purpose of facilitating
trade. There are basically two types: commercial and standby. The
commercial letter of credit is the primary payment mechanism for a
transaction, whereas the standby letter of credit is a secondary payment
Commercial Letter of Credit
Commercial letters of credit have been used for centuries to facilitate
payment in international trade. Their use will continue to increase as
the global economy evolves.
Letters of credit used in international transactions are governed by the
International Chamber of Commerce Uniform Customs and Practice for
Documentary Credits. The general provisions and definitions of the
International Chamber of Commerce are binding on all parties. Domestic
collections in the United States are governed by the Uniform Commercial
A commercial letter of credit is a contractual agreement between a bank,
known as the issuing bank, on behalf of one of its customers,
authorizing another bank, known as the advising or confirming bank, to
make payment to the beneficiary. The issuing bank, on the request of its
customer, opens the letter of credit. The issuing bank makes a
commitment to honor drawings made under the credit. The beneficiary is
normally the provider of goods and/or services. Essentially, the issuing
bank replaces the bank's customer as the payee.
Elements of a Letter of Credit
A payment undertaking given by a bank (issuing bank)
On behalf of a buyer (applicant)
To pay a seller (beneficiary) for a given amount of money
On presentation of specified documents representing the supply of goods
Within specified time limits
Documents must conform to terms and conditions set out in the letter of credit
Documents to be presented at a specified place
The beneficiary is entitled to payment as long as he can provide the
documentary evidence required by the letter of credit. The letter of
credit is a distinct and separate transaction from the contract on which
it is based. All parties deal in documents and not in goods. The
issuing bank is not liable for performance of the underlying contract
between the customer and beneficiary. The issuing bank's obligation to
the buyer, is to examine all documents to insure that they meet all the
terms and conditions of the credit. Upon requesting demand for payment
the beneficiary warrants that all conditions of the agreement have been
complied with. If the beneficiary (seller) conforms to the letter of
credit, the seller must be paid by the bank.
The issuing bank's liability to pay and to be reimbursed from its
customer becomes absolute upon the completion of the terms and
conditions of the letter of credit. Under the provisions of the Uniform
Customs and Practice for Documentary Credits, the bank is given a
reasonable amount of time after receipt of the documents to honor the
The issuing banks' role is to provide a guarantee to the seller that if
compliant documents are presented, the bank will pay the seller the
amount due and to examine the documents, and only pay if these documents
comply with the terms and conditions set out in the letter of credit.
Typically the documents requested will include a commercial invoice, a
transport document such as a bill of lading or airway bill and an
insurance document; but there are many others. Letters of credit deal in
documents, not goods.
An advising bank, usually a foreign correspondent bank of the issuing
bank will advise the beneficiary. Generally, the beneficiary would want
to use a local bank to insure that the letter of credit is valid. In
addition, the advising bank would be responsible for sending the
documents to the issuing bank. The advising bank has no other obligation
under the letter of credit. If the issuing bank does not pay the
beneficiary, the advising bank is not obligated to pay.
The correspondent bank may confirm the letter of credit for the
beneficiary. At the request of the issuing bank, the correspondent
obligates itself to insure payment under the letter of credit. The
confirming bank would not confirm the credit until it evaluated the
country and bank where the letter of credit originates. The confirming
bank is usually the advising bank.
Letter of Credit Characteristics
Letters of credit are usually negotiable. The issuing bank is obligated
to pay not only the beneficiary, but also any bank nominated by the
beneficiary. Negotiable instruments are passed freely from one party to
another almost in the same way as money. To be negotiable, the letter of
credit must include an unconditional promise to pay, on demand or at a
definite time. The nominated bank becomes a holder in due course. As a
holder in due course, the holder takes the letter of credit for value,
in good faith, without notice of any claims against it. A holder in due
course is treated favorably under the UCC.
The transaction is considered a straight negotiation if the issuing
bank's payment obligation extends only to the beneficiary of the credit.
If a letter of credit is a straight negotiation it is referenced on its
face by "we engage with you" or "available with ourselves". Under these
conditions the promise does not pass to a purchaser of the draft as a
holder in due course.
Letters of credit may be either revocable or irrevocable. A revocable
letter of credit may be revoked or modified for any reason, at any time
by the issuing bank without notification. A revocable letter of credit
cannot be confirmed. If a correspondent bank is engaged in a transaction
that involves a revocable letter of credit, it serves as the advising
Once the documents have been presented and meet the terms and conditions
in the letter of credit, and the draft is honored, the letter of credit
cannot be revoked. The revocable letter of credit is not a commonly
used instrument. It is generally used to provide guidelines for
shipment. If a letter of credit is revocable it would be referenced on
The irrevocable letter of credit may not be revoked or amended without
the agreement of the issuing bank, the confirming bank, and the
beneficiary. An irrevocable letter of credit from the issuing bank
insures the beneficiary that if the required documents are presented and
the terms and conditions are complied with, payment will be made. If a
letter of credit is irrevocable it is referenced on its face.
Transfer and Assignment
The beneficiary has the right to transfer or assign the right to draw,
under a credit only when the credit states that it is transferable or
assignable. Credits governed by the Uniform Commercial Code (Domestic)
maybe transferred an unlimited number of times. Under the Uniform
Customs Practice for Documentary Credits (International) the credit may
be transferred only once. However, even if the credit specifies that it
is nontransferable or nonassignable, the beneficiary may transfer their
rights prior to performance of conditions of the credit.
Sight and Time Drafts
All letters of credit require the beneficiary to present a draft and
specified documents in order to receive payment. A draft is a written
order by which the party creating it, orders another party to pay money
to a third party. A draft is also called a bill of exchange.
There are two types of drafts: sight and time. A sight draft is payable
as soon as it is presented for payment. The bank is allowed a reasonable
time to review the documents before making payment.
A time draft is not payable until the lapse of a particular time period
stated on the draft. The bank is required to accept the draft as soon as
the documents comply with credit terms. The issuing bank has a
reasonable time to examine those documents. The issuing bank is
obligated to accept drafts and pay them at maturity.
Standby Letter of Credit
The standby letter of credit serves a different function than the
commercial letter of credit. The commercial letter of credit is the
primary payment mechanism for a transaction. The standby letter of
credit serves as a secondary payment mechanism. A bank will issue a
standby letter of credit on behalf of a customer to provide assurances
of his ability to perform under the terms of a contract between the
beneficiary. The parties involved with the transaction do not expect
that the letter of credit will ever be drawn upon.
The standby letter of credit assures the beneficiary of the performance
of the customer's obligation. The beneficiary is able to draw under the
credit by presenting a draft, copies of invoices, with evidence that the
customer has not performed its obligation. The bank is obligated to
make payment if the documents presented comply with the terms of the
letter of credit.
Standby letters of credit are issued by banks to stand behind monetary
obligations, to insure the refund of advance payment, to support
performance and bid obligations, and to insure the completion of a sales
contract. The credit has an expiration date.
The standby letter of credit is often used to guarantee performance or
to strengthen the credit worthiness of a customer. In the above example,
the letter of credit is issued by the bank and held by the supplier.
The customer is provided open account terms. If payments are made in
accordance with the suppliers' terms, the letter of credit would not be
drawn on. The seller pursues the customer for payment directly. If the
customer is unable to pay, the seller presents a draft and copies of
invoices to the bank for payment.
The domestic standby letter of credit is governed by the Uniform
Commercial Code. Under these provisions, the bank is given until the
close of the third banking day after receipt of the documents to honor
Procedures for Using the Tool
The following procedures include a flow of events that follow the
decision to use a Commercial Letter of Credit. Procedures required to
execute a Standby Letter of Credit are less rigorous. The standby credit
is a domestic transaction. It does not require a correspondent bank
(advising or confirming). The documentation requirements are also less
Buyer and seller agree to conduct business. The seller wants a letter of credit to guarantee payment.
Buyer applies to his bank for a letter of credit in favor of the seller.
Buyer's bank approves the credit risk of the buyer, issues and forwards
the credit to its correspondent bank (advising or confirming). The
correspondent bank is usually located in the same geographical ********
as the seller (beneficiary).
Advising bank will authenticate the credit and forward the original credit to the seller (beneficiary).
Seller (beneficiary) ships the goods, then verifies and develops the
documentary requirements to support the letter of credit. Documentary
requirements may vary greatly depending on the perceived risk involved
in dealing with a particular company.
Seller presents the required documents to the advising or confirming bank to be processed for payment.
Advising or confirming bank examines the documents for compliance with the terms and conditions of the letter of credit.
If the documents are correct, the advising or confirming bank will claim the funds by:
Debiting the account of the issuing bank.
Waiting until the issuing bank remits, after receiving the documents.
Reimburse on another bank as required in the credit.
Advising or confirming bank will forward the documents to the issuing bank.
Issuing bank will examine the documents for compliance. If they are in order, the issuing bank will debit the buyer's account.
Issuing bank then forwards the documents to the buyer.
Standard Forms of Documentation
When making payment for product on behalf of its customer, the issuing
bank must verify that all documents and drafts conform precisely to the
terms and conditions of the letter of credit. Although the credit can
require an array of documents, the most common documents that must
accompany the draft include:
The billing for the goods and services. It includes a description of
merchandise, price, FOB origin, and name and address of buyer and
seller. The buyer and seller information must correspond exactly to the
description in the letter of credit. Unless the letter of credit
specifically states otherwise, a generic description of the merchandise
is usually acceptable in the other accompanying documents.
Bill of Lading
A document evidencing the receipt of goods for shipment and issued by a
freight carrier engaged in the business of forwarding or transporting
goods. The documents evidence control of goods. They also serve as a
receipt for the merchandise shipped and as evidence of the carrier's
obligation to transport the goods to their proper destination.
Warranty of Title
A warranty given by a seller to a buyer of goods that states that the
title being conveyed is good and that the transfer is rightful. This is a
method of certifying clear title to product transfer. It is generally
issued to the purchaser and issuing bank expressing an agreement to
indemnify and hold both parties harmless.
Letter of Indemnity
Specifically indemnifies the purchaser against a certain stated
circumstance. Indemnification is generally used to guaranty that
shipping documents will be provided in good order when available.
Common Defects in Documentation
About half of all drawings presented contain discrepancies. A
discrepancy is an irregularity in the documents that causes them to be
in non-compliance to the letter of credit. Requirements set forth in the
letter of credit cannot be waived or altered by the issuing bank
without the express consent of the customer. The beneficiary should
prepare and examine all documents carefully before presentation to the
paying bank to avoid any delay in receipt of payment. Commonly found
discrepancies between the letter of credit and supporting documents
Letter of Credit has expired prior to presentation of draft.
Bill of Lading evidences delivery prior to or after the date range stated in the credit.
Stale dated documents.
Changes included in the invoice not authorized in the credit.
Inconsistent description of goods.
Insurance document errors.
Invoice amount not equal to draft amount.
Ports of loading and destination not as specified in the credit.
Description of merchandise is not as stated in credit.
A document required by the credit is not presented.
Documents are inconsistent as to general information such as volume, quality, etc.
Names of documents not exact as described in the credit. Beneficiary information must be exact.
Invoice or statement is not signed as stipulated in the letter of credit.
When a discrepancy is detected by the negotiating bank, a correction to
the document may be allowed if it can be done quickly while remaining in
the control of the bank. If time is not a factor, the exporter should
request that the negotiating bank return the documents for corrections.
If there is not enough time to make corrections, the exporter should
request that the negotiating bank send the documents to the issuing bank
on an approval basis or notify the issuing bank by wire, outline the
discrepancies, and request authority to pay. Payment cannot be made
until all parties have agreed to jointly waive the discrepancy.
Tips for Exporters
Communicate with your customers in detail before they apply for letters of credit.
Consider whether a confirmed letter of credit is needed.
Ask for a copy of the application to be fax to you, so you can check for
terms or conditions that may cause you problems in compliance.
Upon first advice of the letter of credit, check that all its terms and
conditions can be complied with within the prescribed time limits.
Many presentations of documents run into problems with time-limits. You
must be aware of at least three time constraints - the expiration date
of the credit, the latest shipping date and the maximum time allowed
between dispatch and presentation.
If the letter of credit calls for documents supplied by third parties,
make reasonable allowance for the time this may take to complete.
After dispatch of the goods, check all the documents both against the
terms of the credit and against each other for internal consistency.
The use of the letters of credit as a tool to reduce risk has grown
substantially over the past decade. Letters of credit accomplish their
purpose by substituting the credit of the bank for that of the customer,
for the purpose of facilitating trade.
The credit professional should be familiar with two types of letters of
credit: commercial and standby. Commercial letters of credit are used
primarily to facilitate foreign trade. The commercial letter of credit
is the primary payment mechanism for a transaction.
The standby letter of credit serves a different function. The standby
letter of credit serves as a secondary payment mechanism. The bank will
issue the credit on behalf of a customer to provide assurances of his
ability to perform under the terms of a contract.
Upon receipt of the letter of credit, the credit professional should
review all items carefully to insure that what is expected of the seller
is fully understood and that he can comply with all the terms and
conditions. When compliance is in question, the buyer should be
requested to amend the credit.
Letters of credit is the safest payment method in International trade
|موضوع: رد: payment method 4/5/2011, 05:12|| |
Understanding and Using Letters of Credit