AppArel exports

Demystifying the
Letter of

Credit
International garment trade is a complex and lengthy process. Vasant R. Kothari believes that Letters of Credit take away much of the risks involved in it.

Trading internationally can involve risks. Apparel exporters run the risk of importers failing to pay for the goods, while importers may risk paying but never receiving the goods. Because of the distances involved, it may be difficult to resolve any disputes. One way of reducing the risks is to use a letter of credit. LC can offer a guarantee to the exporter that they will be paid, and the importer can be sure that no payment will be made until they receive the goods.

90

APPAREL June 2011

LETTERS OF CREDIT HAVE BEEN A CORNERSTONE OF INTERNATIONAL TRADE [THEY] ARE AN IMPORTANT PAYMENT MECHANISM, WHICH HELPS ELIMINATE CERTAIN RISKS.

Tezzstock | Dreamstime.com

Letters of Credit have been a cornerstone of international trade dating back to the early 1900s. LC continues to play a critical role in world trade today. For any company entering the international market, Letters of Credit are an important payment mechanism, which helps eliminate certain risks. A Letter of Credit, simply defined, is a written instrument issued by a bank at the request of its customer, the Importer (Buyer), whereby the bank promises to pay the Exporter (Beneficiary) for goods or services, provided that the exporter presents all documents called for, exactly as stipulated in the Letter of Credit, and meets all other terms and conditions set out in the Letter of Credit. A Letter of Credit is also commonly referred to as a Documentary Credit. The International Chamber of Commerce (ICC) publishes internationally agreed-upon rules, definitions and practices governing Letters of Credit called Uniform Customs and Practice (UCP) for Documentary Credits. The UCP facilitates standardisation of Letters of Credit among all banks in the world that subscribe to it. These rules are updated from time to time; the last revision became effective July 1, 2007, and is referred to as UCP 600.

ElEmEnts of a lEttEr of CrEdit

A payment undertaking given by a bank (issuing bank) On behalf of a buyer (applicant) To pay to exporter (beneficiary) 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

lEttEr of CrEdit ProCEss

Once terms and conditions are fixed for sale of merchandise between exporter and importer, there will be exchange of Purchase Order and Proforma Invoice. The contract of sale establishes the method of payment. If it designates a Letter of Credit as the payment method, the importer must apply to its bank for a Letter of Credit in favour of the exporter. Basic Ordering Agreement: The importer and exporter agree to terms and conditions of the Credit. Application: The importer/applicant completes an LC application. The issuing bank reviews the importers application and credit.
APPAREL June 2011

Jscreationzs | Dreamstime.com

91

THERE ARE THREE AGREEMENTS BINDING THE VARIOUS PARTIES: SALES CONTRACT, APPLICATION AND AGREEMENT FOR COMMMERCIAL LC AND LETTER OF CREDIT.

There are typically three distinct agreements binding the various parties: Sales contract: a contract between the importer and the exporter; Application and Agreement for Commercial Letter of Credit: a contract between the applicant (buyer) and its bank; Letter of Credit: a specialised form of undertaking from the bank to the beneficiary (seller). The various parties involved with a Letter of Credit are described below, using Letter of Credit terminology. Applicant: The party that arranges for the Letter of Credit to be issued, usually the buyer or importer in a commercial transaction or the borrower in a financial transaction. Beneficiary : The party named in the Letter of Credit in whose favour the Letter of Credit is issued, usually the seller or exporter in a commercial transaction or the creditor in a financial transaction. Issuing Bank : The applicants bank that issues its undertaking to the beneficiary in the form of a Letter of Credit. Advising Bank : The bank, usually in the beneficiarys country, which informs the beneficiary that another bank has issued a Letter of Credit in its favour. Nominated Bank : A bank named in or otherwise permitted by the terms and conditions of the Letter of Credit to receive a presentation of documents and, if it complies, to give value to the beneficiary for the presentation against a right to obtain reimbursement from the issuing bank. A nominated bank is not obligated to act unless it also confirms the Letter of Credit. Paying Bank : A nominated bank authorised to give value by paying the beneficiarys presentation of documents. Customarily, a bank nominated to pay is also authorised to reimburse itself in advance of sending documents. Negotiating Bank : A nominated bank authorised to give value by negotiating the beneficiarys draft drawn on another, typically the issuing bank. Confirming Bank : The nominated bank which, at the request or with the consent of the Issuing Bank, adds its own undertaking to that of the issuing bank.

Issue: The bank issues the Credit through a bank in the exporters country. Advice: The corresponding bank advises the credit to the beneficiary. Ship: The exporter accepts the credit ships the goods to the applicant and prepares the documents Presentation: The exporter/beneficiary presents the documents to the negotiating bank, which sends them to the issuing bank.

Examination: The issuing bank examines the documents for compliance with the LC and reimburses the negotiating bank. Payment: The issuing bank debits the importers account or agrees to pay at maturity of the time draft. Documents: Bank releases the documents and pays the money to the exporter Claims Goods: The importer exchanges the shipping documents for the goods.

92

APPAREL June 2011

 Monika3stepsahead | Dreamstime.com

A bank may play several roles in a single transaction, e.g. Advising and Confirming Bank. In most exportimport transactions, there are at least two banks involved a bank in the importers country and a bank in the exporters country. If the same bank is having the branches in the export as well as import country then LC process can be done by one bank also.

lC: tErms & Conditions

Issue Date and Expiry Date: The date at which the Credit is issued and the date at which the Credit expires and is no longer valid. In determining the expiry date of a LC, importer must allow enough time for the exporter (beneficiary) to effect the shipment and present the documents required in the LC. The general rule is to take

THERE ARE AT LEAST TWO BANKS INVOLVED A BANK IN THE IMPORTERS COUNTRY AND [ONE] IN THE EXPORTERS COUNTRY.
the latest shipping date and add the number of days the exporter is allowed to present the documents. For example, if the Latest Shipping Date is November 1 and 10 days are allowed to present documents, then the expiry date of the LC would be November 11. Currency and Amount: The amount the Letter of Credit is obligated to pay, and in what currency. Writing the words about, approximately or circa before the amount indicates that the amount may vary up to +/- 10%. Variance is not restricted only to the percentages indicated above; parties can choose any other variances, e.g. +/- 15%. Partial Shipments: Check the appropriate box to indicate if partial shipments are allowed to take place under the Letter of Credit. Transshipment: Indicate whether or not transshipment is allowed. Choice depends on the method of shipment/transport document used. Generally, transshipment

94

APPAREL June 2011

 Clemmesen | Dreamstime.com

TRANSSHIPMENT MEANS THAT, DURING THE COURSE OF VOYAGE, MERCHANDISE IS UNLOADED AND RELOADED... FROM ONE MODE OF TRANSPORTATION TO ANOTHER.
means that, during the course of voyage, merchandise is unloaded and reloaded from one vessel to another vessel or from one mode of transportation to another. Transshipment must be allowed for multimodal and air transport documents for e.g., a shipment is destined for the Philippines but there is no carrier available to go directly to the Philippines. It must first stop in Japan and be transferred to another carrier destined for the Philippines. Shipment From: Name of the place/ port from where the goods will be shipped Port of Shipment. Shipment To: Name of the place/port where the goods will be shipped Port of Destination. Latest Shipping Date: The latest mutually acceptable date for the shipment to be made.
Krisdog | Dreamstime.com

Goods: Enter a brief description of the merchandise. The common practice is to use a Purchase Order or Pro forma Invoice number for e.g., Mens Formal Shirt as per Purchase Order #23456. Variances: A variance of 5% more or 5% less will be allowed as long as: the merchandise description is not stated in number of packing units or individual items; the amount of the Letter of Credit is not exceeded; and, the Letter of Credit does not stipulate that the quantity of goods specified must not be exceeded or reduced. Variance is not restricted to 5% Trade Terms: Issued by the ICC, these are commonly referred to as

INCO terms. They determine the obligations of the exporter and importer with respect to freight costs, insurance, taxes, duties, etc. Documents Required: The documents the importer chooses will be determined in the contract between the importer and the exporter. The following documents are commonly requested in a LC: Commercial Invoice Transport Documents Insurance Documents Other Documents Generalized System of Preference Certificate of Origin Customs Invoice Inspection Certificate Weight List Special Conditions: If any

96

APPAREL June 2011