LETTER OF CREDIT IF ASSIGNMENT
Submitted By: Group NO Kunjan Shah (36) Nikhil Joshi (43) Digant Desai (57) Rohan Shah (65) Robin (72) Swapnil Naik( 96)
Contents 1. Introduction ......................................................................................................3 1.2 Documents a beneficiary has to present in order to receive payment: ........................................................................................................................... 4 1.3 Concept of an LC:......................................................................................... 5 1.4 A detail Flowchart depicting the concept of an LC ........................................ 6 ....................................................................................................................... 6 1.5 Pitfalls Of Letter Of Credit: ........................................................................... 7 1.6 Executing a Letter of Credit: ...................................................................... 7 2. Type of letter of Credit:.....................................................................................8 2.1 Revocable Credit.......................................................................................... 8 2.2 Irrevocable Credit ......................................................................................... 8 2.3 Revolving LC:............................................................................................... 9 2.4 Standby LC:................................................................................................ 10 2.5 Transferable letters of credit:..................................................................... 10 2.6 Confirmed LC:............................................................................................. 12 2.7 Unconfirmed credit .................................................................................... 13 3.Assignment of proceeds:..................................................................................13 4.ANNEXURE I: A Typical Format of Assignment of Proceeds ..............................14 ...........................................................................................................................14
1. Introduction A standard, commercial letter of credit (LC) is a document issued mostly by a financial institution, used primarily in trade finance, which usually provides an irrevocable payment undertaking.
1.1
What Does Letter Of Credit Mean?
A letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase. Letters of credit are often used in international transactions between a supplier in one country and a customer in another to ensure that payment will be received. Due to the nature of international dealings including factors such as distance, differing laws in each country and difficulty in knowing each party personally, the use of letters of credit has become a very important aspect of international trade. The letter of credit can also be a source of payment for a transaction, meaning that redeeming the letter of credit will pay an exporter. The bank also acts on behalf of the buyer (holder of letter of credit) by ensuring that the supplier will not be paid until the bank receives a confirmation that the goods have been shipped. In such cases the International Chamber of Commerce Uniform Customs and Practice for Documentary Credits applies. The parties to a letter of credit are: •
Applicant - the buyer in a transaction
•
Beneficiary - the seller or ultimate recipient of funds
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Issuing bank - the bank that promises to pay
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Advising bank - helps the beneficiary use the letter of credit.
Almost all letters of credit are irrevocable, i.e., cannot be amended or cancelled without prior agreement of the beneficiary, the issuing bank and the confirming bank, if any. In executing a transaction, letters of credit incorporate functions common to giros and Traveller’s cheques.
1.2
Documents a beneficiary has to present in order to receive payment: 1. Financial Documents 1.1.
Bill of Exchange, Co-accepted draft.
2. Commercial Documents 2.1.
Invoice, Packing list
3. Shipping Documents 3.1.
Transport Document, Insurance Certificate, Commercial, Official or Legal
Documents.
4. Official Documents 4.1.
License, Embassy legalization, Origin Certificate, Inspection Certificate.
5. Transport Documents 5.1.
Bill of Lading (ocean or multi-modal or Charter party), Airway bill, Lorry/truck
receipt, railway receipt, CMC Other than Mate Receipt, Forwarder Cargo Receipt, Deliver Challan...etc.
6. Insurance documents 6.1.
Insurance policy, or Certificate but not a cover note.
However, the list and form of documents is open to imagination and negotiation and might contain requirements to present documents issued by a neutral third party evidencing the quality of the goods shipped, or their place of origin. Letters of credit are common in international trade because the bank acts as an uninterested party between buyer and seller. For example, importers and exporters might use letters of credit to protect themselves. In addition, communication can be difficult across thousands of miles and different time zones. A letter of credit spells out the detail s so that everybody's on the same page. The bank will only issue a letter of credit if they know the buyer will pay. Some buyers have to deposit (or already have) enough money to cover the letter of credit, and some customers use a line of credit with the bank. Sellers must trust that t he bank issuing the letter of credit is legitimate.
1.3
Concept of an LC:
Exemplification:
A business called RAICHAND & SONS from time to time imports goods from a business called GULABCHAND & SONS, which banks with Bank of America. RAICHAND & SONS holds an account at the Commonwealth Bank. RAICHAND & SONS wants to buy $500,000 worth of merchandise from GULABCHAND & SONS, who agrees to sell the goods and give RAICHAND & SONS 60 days to pay for them, on the condition that they are provided with a 90-day letter of credit for the full amount. The steps to get the letter of credit would be as follows:
RAICHAND & SONS goes to The Commonwealth Bank and requests a $500,000
letter of credit, with GULABCHAND & SONS as the beneficiary.
The Commonwealth Bank can issue a letter of credit either on approval of a
standard loan underwriting process or by RAICHAND & SONS funding it directly with a deposit of $500,000 plus fees which are typically between 1% and 8% of the face value of the letter of credit.
The Commonwealth Bank sends a copy of the letter of credit to the Bank of America,
which notifies GULABCHAND & SONS that payment is available and they can ship the merchandise RAICHAND & SONS has ordered with the full assurance of payment to them.
On presentation of the stipulated documents in the letter of credit and compliance
with the terms and conditions of the letter of credit, the Commonwealth Bank transfers the $500,000 to the Bank of America, which then credits the account of GULABCHAND & SONS for that amount.
Note that banks deal only with documents required in the letter of credit and not the
underlying transaction.
Many exporters have mistakenly assumed that the payment is guaranteed after
receiving the letter of credit. The issuing bank is obligated to pay under the letter of credit only when the stipulated documents are presented and the terms and conditions of the letter of credit have been met.
1.4
A detail Flowchart depicting the concept of an LC
Issues Letter of 4
Opening Bank
Advising Bank
8
Checks docs and pays if confirmed or passes doc to opening bank for pymt
5
7 8
3
Negotiati ng Bank
LC solutions presents to Negotiating bank 7
L/C terms agreed upon between buyer & Seller 2
Clean Documents
LC solutions Exporter forwards docs and LC to LC solutions 6
Exporter
Importer 1 Contract / Purchase Order
1.5
Pitfalls Of Letter Of Credit: Letters of credit make it possible to do business worldwide. They are important and helpful tools, but you should be careful when using letters of credit. As a seller, make sure you: 1. Carefully review all requirements for the letter of credit before moving forward with a deal. 2. Understand all the documents required. Can get all the documents required for the letter of credit 3. Understand the time limits associated with the letter of credit, and whether they are reasonable. 4. Know how quickly your service providers (shippers, etc) will produce documents for you can get the documents to the bank on time. 5. Make all the documents mentioned in Letter of Credit match exactly with the Letter of Credit application exactly 6. Also LOC is issued on submission of documents and not on quality of goods hence if the documents are Ok and the goods are not still the payment will be made and also if the goods are ok and documents are not the payment will not be made.
1.6
Executing a Letter of Credit: A seller only gets paid after performing specific actions that the buyer and seller agree to. For example, the seller may have to deliver merchandise to a shipyard in order to satisfy requirements for the letter of credit. Once the merchandise is delivered, the seller receives documentation proving that he made delivery. The letter of credit now must be paid even if something happens to the merchandise. If a crane falls on the merchandise or the ship sinks, it's not the seller's problem. To pay on a letter of credit, banks simply review documents proving that a seller performed his required actions. They do not worry about the quality of goods or other items that may be important to the buyer and seller.
2. Type of letter of Credit: 2.1 Revocable Credit A revocable credit is a credit that may be withdrawn, amended or cancelled by the credit opening (issuing) bank unilaterally at any moment and without notice or reference to the beneficiary. Consequently it does not constitute a legally binding undertaking between the banks and the beneficiary as the credit can be modified or cancelled at any time without notice to the beneficiary. A problem can arise if the letter of credit is withdrawn after the advising / negotiating bank has without notice of the withdrawal made payment. To protect the negotiating bank against this possibility, the issuing bank must: Reimburse another bank with which a revocable credit has been made available for sight payment, acceptance or negotiation, for any payment, acceptance or negotiation made by such bank prior to receipt by it or notice of amendment or cancellation, against documents which appear on their face to be in accordance with the terms and conditions of the credit. •
Reimburse another bank with which a revocable credit has been made available for deferred payment, if such branch or bank has, prior to receipt by it of notice of amendment or cancellation, taken up documents which appear on their face to be in accordance with the terms and conditions of the credit. •
In short the withdrawal, amendment or modification occurs only when the other bank receives the information from the opening bank. This is only fair
2.2
Irrevocable Credit An irrevocable letter of credit is on the other hand, a definite undertaking by the issuing bank that if the stipulated documents are presented and the terms and conditions of the credit are complied with. •
To pay on sight if the credit provides for sight payment.
To pay on the maturity date stipulated if the credit provides for deferred payment. •
To accept drafts drawn by the beneficiary if the credit provides for acceptance and payment at maturity if the credit stipulates that they are to be drawn on the applicant for the credit or any other drawee stipulated in the credit. •
To pay without recourse to drawers and for bonafide holders of the draft drawn by the beneficiary at sight (if a sight draft) or on the due date (if a usance draft) if the credit provides for negotiation. •
Irrevocable credits are more practical and popular as their terms cannot be changed without the agreement of all parties.
2.3
Revolving LC:
It is established when there are regular shipments of the same commodity between supplier and customer. It eliminates the need to issue an LC for each individual transaction. A revolving letter of credit functions much like a credit card, where the borrower can request funds up to the limit, pay some or all of the borrowings back, and then borrow more funds from the line. A Letter of Credit revolving in time is of two types: Cumulative: the sum unutilised in a period is carried over to be utilized in the next
period, Non-cumulative type: the sum unutilised in a period is not carried over.
The applicant and beneficiary may wish to have a letter of credit structured to satisfy a long-term contract requiring the constant supply of merchandise over a specific time period. This can be accomplished with a revolving letter of credit. A revolving letter of credit contains instructions, which allow the beneficiary to draw for specified amounts over specified periods. The revolving credit: uses the same letter of credit to cover numerous scheduled shipments over a long period without the necessity of issuing new credits or amending the existing credit, restricts the amount available for each shipment, and Controls the frequency of shipments and amounts available.
The revolving Letter of Credit may be used in shipments of a wide range of goods to a buyer within a period of time (several months to one year usually). For example: a credit might permit shipments up to $10,000 monthly for a twelvemonth period. Depending on which classification is indicated, this would mean one of the following: Cumulative: If one monthly shipment is less than $10,000, the shortfall may be added to a subsequent month. For example, if this month the beneficiary ships only $8,000, next month the shipment could be $12, 000. Non-Cumulative: Any portion not used in one month cannot be added to the next. So, if the shipment this month is $8,000, the beneficiary still cannot ship more than $10,000 next month.
2.4
Standby LC:
A standby letter of credit is a secondary payment mechanism. A bank will issue a standby letter of credit on behalf of a customer to provide assurances of its ability to pay a creditor . Normally, neither the seller nor the buyer expects that a standby letter of credit will be drawn upon. The standby letter of credit assures the beneficiary of payment. The beneficiary is able to draw under a standby Letter of Credit by presenting a draft, and other documentation indicating that the customer has not performed its obligation. Standby letters of credit are issued to: •
Stand behind monetary obligations,
To insure the refund of advance payment Funds given by the buyer of goods to the seller prior to shipment, often just a percentage of the value of the goods with the remainder paid after shipment, •
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To support performance and bid obligations, and
•
To insure the completion of a sales contract.
A standby letter of credit is often used to guarantee payment performance of a customer. If payment is made in accordance with the suppliers' terms, the letter of credit would not be drawn on. Under these provisions, the bank is given until the close of the third banking day after receipt of the documents to honour the draft.
2.5
Transferable letters of credit:
A transferable letter of credit is one, which specifically states that it is transferable. This will only occur if the applicant for the letter of credit (buyer) agrees. In a transferable letter of credit, the rights and obligations of the beneficiary are transferred to another party, usually a manufacturer or wholesaler. Transfer may be either full or partial. Most transfers involve a seller who, as beneficiary of the letter of credit, has a pending sale, but is unable to purchase the merchandise from the manufacturer on open account. Export brokers most often use transferable L/Cs. Transferring a portion of the export L/C to the manufacturer allows the broker to leverage the buyer's banker's credit by providing the manufacturer with assurance of payment if the manufacturer performs under the transferred L/C terms and conditions. Transfer of letters of credit is governed by Article 48 of the Uniform Customs and Practice for Documentary Credits (UCP 500) which states that banks are under no obligation to transfer a credit except to the extent and in the manner expressly consented to. Furthermore, the transferring bank must be specifically named in the letter of credit as the bank authorized to effect the transfer.
Transfer criteria vary from bank to bank, but may include such requirements as: •
The transferor being a customer of the transferring bank "Negotiation" of the credit being restricted to the transferring bank The issuing bank being a correspondent of the transferring bank All terms and conditions of the credit being acceptable to the transferring bank
The bank retains the right to decline a transfer request. It may consent if certain terms and conditions of the letter of credit are amended to meet its requirements. Any amendment to a letter of credit is subject to agreement of the buyer, the buyer's bank, and the beneficiary who is requesting the transfer. Banks retain the right to decline any transfer request. Things can be changed when transferring letter of credit:
Article 48 of the UCP 500 limits changes to the following:
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The L/C amount may be reduced
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Unit prices may be reduced
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The expiry and latest shipping dates may be curtailed
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2.6
The time period after the date of shipment for presenting documents to the bank may be curtailed The name of the beneficiary is substituted for the name of the applicant (buyer), but if the applicant's name is required to be stated in any document other than the invoice, this requirement must be adhered to If an insurance document is required, the coverage may be increased to provide coverage as required by the original L/C The place of payment or negotiation may be changed to the location of the transferee
Confirmed LC: A letter of credit which a bank other than the bank that opened it agrees to honor as though they had themselves issued it. This additional confirmation is in addition to the obligation of the bank which issued the letter of credit.
A confirmed letter of credit is one in which the advising bank, on the instructions of the issuing bank, has added a confirmation that payment will be made as long as compliant documents are presented. This commitment holds even if the issuing bank or the buyer fails to make payment. The added security to the exporter of confirmation needs to be considered in the context of the standing of the issuing bank and the current political and economic state of the importer's country. A bank will make an additional charge for confirming a letter of credit. In many cases, the
confirming bank is located in Beneficiary’s country. Confirmation costs will vary according to the country involved, but for many countries considered a high risk will be between 2%-8%. There also may be countries issuing letters of credit, which banks do not wish to confirm - they may already have enough exposure in that market or not wish to expose themselves to that particular risk at all. A confirmed credit, the advising bank adds its guarantee to pay the seller to that of the buyer's issuing bank. Once the advising bank reviews and confirms that all documentary requirements are met, it will pay the seller. The advising bank will then look to the issuing bank for payment. Confirmed Irrevocable letters of credit are used when trading in a high-risk area where war or social, political, or financial instability are real threats. Also common when the seller is unfamiliar with the bank issuing the letter of credit or when the seller needs to use the confirmed letter of credit to obtain financing its bank to fill the order. A confirmed credit is more expensive because the bank has added liability.
2.7
Unconfirmed credit The irrevocable credit not confirmed by the advising bank) In an unconfirmed credit, the buyer's bank issuing the credit is the only party responsible for payment to the seller. The seller's advising bank pays only after receiving payment from the issuing bank. The seller's advising bank merely acts on behalf of the issuing bank and, therefore, incurs no risk.
3. Assignment of proceeds: •
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•
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"Proceeds of a letter of credit" means the cash, check, accepted draft, or other item of value paid or delivered upon honors or giving of value by the issuer or any nominated person under the letter of credit. The term does not include a beneficiary's drawing rights or documents presented by the beneficiary. A beneficiary may assign its right to part or all of the proceeds of a letter of credit. The beneficiary may do so before presentation as a present assignment of its right to receive proceeds contingent upon its compliance with the terms and conditions of the letter of credit.
An issuer or nominated person need not recognize an assignment of proceeds of a letter of credit until it consents to the assignment.
An issuer or nominated person has no obligation to give or withhold its consent to an assignment of proceeds of a letter of credit, but consent may not be unreasonably withheld if the assignee possesses and exhibits the letter of credit and presentation of the letter of credit is a condition to honor.
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Rights of a transferee beneficiary or nominated person are independent of the beneficiary's assignment of the proceeds of a letter of credit and are superior to the assignee's right to the proceeds.
Neither the rights recognized by this section between an assignee and an issuer, transferee beneficiary, or nominated person nor the issuer's or nominated person's payment of proceeds to an assignee or a third person affect the rights between the assignee and any person other than the issuer, transferee beneficiary, or nominated person.
4. ANNEXURE I: A Typical Format of Assignment of Proceeds
