| Letters of Credit
Definition:
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.
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.
Seller:
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.
However, because the undertaking is conditional, the seller only has the right to demand payment if he meets all the requirements of the credit. It is, therefore, unwise for the seller to proceed with shipment until he is aware of these requirements and is satisfied he can meet them.
Summary:
Documentary credits therefore:
Are arrangements by banks for settling international commercial transactions.
Provide a form of security for the parties involved.
Ensure payment, provided that the terms and conditions of the letter of credit have been fulfilled.
Mean that payment by such means is based on documents only, and not on merchandise or services involved.
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 1&2, UCP 500)
Standby:
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. Similar to commercial LCs, standby's are governed by the International Standby Practices 1998 (ISP98)
Revocable:
A revocable letter of credit may be amended or canceled by the issuing bank at any moment and without prior notice to the beneficiary (Article 6 & 8, UCP 500)
Unconfirmed:
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 9, UCP 500)
Confirmed:
Is a credit in which a second obligation is added to the letter of credit by another bank (Article 9, UCP 500)
Sight:
Payment is at sight, which means that the drafts and documents are honored, if in order, by making payment without delay.
Time, Usance:
The draft honored by accepting it for payment at a future date. Payment is delayed until the maturity of the draft.
Transferable credit:
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 48, UCP 500)
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