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Bank Guarantee and Letter of Credit

Bank Guarantee and Letter of Credit

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BANK GUARANTEES (BG) INTRODUCTION In commercial transactions bank’s customers are very frequently required to offer a bank guarantee.

This is mostly an alternative to keep cash as a security deposit. The third party (called the beneficiary of the BG) who seeks the guarantee being un-aware of the customer’s financial standing, credibility, creditworthiness, integrity and financial soundness, prefers a bank guarantee. In turn, the bank which very well understands and has the knowledge of the financial standing of the customer, undertakes to guarantee the customer’s financial commitments or the performance of contracts by him. The bank charges commission for this service which depends on the security available and the financial stability of the customer. In this chapter you will learn what exactly a bank guarantee is, various types of bank guarantees, the precautions to be taken while issuing a bank guarantee and nonpayment of a bank guarantee, the distinction between a bank guarantee and an ordinary guarantee, why in a bank guarantee the banker’s duty to honour the guarantee is of prime importance and the limit to which this onerous liability can be extended. BANK GUARANTEES: The term “bank guarantee” briefly stated BG means: A guarantee or formal assurance or promise given by a bank to a third person, to pay him a certain sum of money on behalf of the bank’s customer, on the customer failing to fulfill a contractual or legal obligation or performance of a contract towards the third person. It pre-supposes that there should first be a commitment on the part of the customer to fulfill certain obligations to a third party. This could be contractual or legal i.e. imposed by law. This commitment of the customer is guaranteed by a bank and if the customer fails to honour his commitment the banker pays the amount it has promised or is obliged to pay. Once the bank gives a guarantee then its commitment to honour the guarantee is onerous and as such, it is prudent that a banker before issuing a guarantee on behalf of its customer takes appropriate security and also understands its rights and duties. Before we embark on a study of the banker’s duty to honour guarantees and the onerous obligation he undertakes on behalf of the customer when he issues a guarantee, there is an imperative need and urgency to understand the various kinds of guarantees that a banker usually issues. VARIOUS TYPES OF BANK GUARANTEES: Though under law bank guarantees have not been classified by the nature of the underlying contract entered into by the customer, in practice such classification has been made. Though there are various types of guarantees, the important ones which a banker would be regularly required to issue in the course of its business and transactions is as follows: 1. Financial Guarantees: 1

Performance Guarantees: These are guarantees issued by the bank on behalf of its customer whereby the bank assures a third party that the customer will perform the contract entered into with the beneficiary as per the condition stipulated in the contract. Deferred Payment Guarantees: Under this type of guarantee. These kinds of guarantees are mostly issued on behalf of customers dealing with government departments. the beneficiary up to the amount specified in the guarantee. In case the contractor does not fulfill his obligations then the government departments invoke the guarantee and collect the money from the banks. However. Though the bank assures that the conditions stipulated in the contract will be complied with by the customer. in lieu of the customer being required to deposit cash security or earnest money. failing which the bank will compensate the third party viz. This is so since banks by the nature of their expertise prefer to deal with documents and that they would not like to do beyond the contract and verify whether there has been a breach of the contract or not. in lieu of the earnest money government departments are generally willing to accept a bank guarantee. This type of guarantee is required when goods or machinery is purchased by a customer on credit and the payment is to be made in installments on specified dates. While issuing a deferred payment guarantee. the banker has to assess the ability and sources of funds of the customer to honour the repayment of installments on due dates. A mere demand from the beneficiary that there has been a default by the bank customer is sufficient for the bank to make payment. The banker guarantees due payment of these drafts. Towards this end government departments insist on an Earnest Money Deposit. 4. he should commit that he is willing to perform the contract. This also comforts the contractor who can utilize the funds for fulfilling his obligations under the contract. mostly banks do not insist on such evidence. A deferred payment guarantee constitutes an undertaking on the part of the bank to make payment of deferred installments to the seller (beneficiary) on due date in the event of default by the customer (buyer).These are guarantees issued by banks on behalf of the customers. 3. Statutory Guarantees: 2 . Most government departments insist that before the contract is awarded to the contractor. In terms of the contract of sale the seller draws drafts (bills) of different maturities on the buyer customer that are to be accepted by the customer. in practice the banks on being served a notice of default by the third party pays over the amount guaranteed without going into the technicality of the contract. 2. Though in certain performance guarantees a clause is inserted that proof of default on behalf of the customer is necessary. the banker guarantees payment of instalments spread over a period of time. These types of guarantees are usually issued by bankers on behalf of their customers who have entered into contracts to do certain things on or before a given date.

Customs Act. competence. This kind of guarantee is usually given under the Code Civil Procedure. Therefore. PAYMENT UNDER BANK GUARANTEE-PRECAUTIONS TO BE TAKEN Before making payment a banker has to ensure that the invocation of the guarantee has been properly done failing which he may not have any recourse against the debtor. Central Excise Act. In most bank guarantees banks undertake to make payment merely on demand by the beneficiary. therefore. pay orders. These are usually given in the form of a bond and the format of these guarantees are usually drawn up by the Courts or concerned authority or are already prescribed by the statute as per which the guarantee is required. LETTERS OF CREDIT (LC) INTRODUCTION The simplest form of payment in a business transaction is payment by cash. etc. Travelers Cheques. and also to authorities like the Sales Tax Commissioner. These all modes of payment require proximity between the buyer and seller and the element of trust between them. failing which the bank will compensate to the extend of amount guaranteed. having different legal systems and each is unaware of the other’s financial position. BANKER’S DUTY TO HONOUR GUARANTEE: Bank guarantees are called “the life blood of international commence” and even though they are an off shoot of a primary contract between the debtor and creditor these guarantees are independent commitments taken by bank on behalf of their customers. then the bank will be answerable for Contempt of Court. is absolutely necessary that irrespective of the contract and any dispute between the parties to the contract the bank make payment if the guarantee has been invoked properly. it would be preferable that both parties deal through their bankers. worth and means of each other to meet commitments and the transaction’s/ trade underlying obligations. standing. then come liquidity wise and preference wise payments by Drafts. Major Ports Act.These are guarantees issued by banks favours Courts and other statutory authorities guaranteeing that the customer will honor his commitments imposed on under law. to take of all these 3 . In International Trade the buyer and seller are miles apart and are at cross borders. In such cases. cheques etc. In case a banker makes payment in spite of there being an order by a competent Court in which the bank is party. We shall now examine this duty of the banker to honor his commitment under a guarantee and the grounds on which payment can be refused. They are not confident about the integrity. The banker should also see that no order of injunction has been passed by any Court of law prohibiting the bank from making payment. credit worthiness and integrity. Provident Find Commissioner. It.

The advising bank is also sometimes termed as the Notifying Bank.e makes payment on the bills drawn by the seller and accepts the documents. The advising bank only forwards the Letter of Credit to the beneficiary. These are not negotiable instruments.e the right to receive payment or to draw bills and receive payment as per the terms of the LC. thereby enabling the beneficiary to rely on its authenticity. then 4 . since he would be either purchasing goods or availing services for which payment has to be made there under. In this chapter. It is also called Opening Bank or Importer’s Bank. As a banker one will at some point of time in one’s carrier. (v) Negotiating Bank: The bank in the beneficiary /exporter’s country negotiable the bills i. LETTERS OF CREDIT (LC)-GENERAL CONSIDERATION An LC can be compared to a guarantee given by a bank on behalf of its customer to the effect that. PARTIES TO A LETTER OF CREDIT (i) Applicant-Buyer-Importer-Opener: He is the person who applies to the bank to open a Letter of Credit. (ii) Issuing Bank: It is the bank which opens the letter of credit on the request of the Applicant /Buyer. then any bank can be negotiating bank. If the LC specifies a bank that bank is the Negotiating Bank also called the Nominated Bank or Paying Bank. veracity and genuineness. If the LC however does not specify a bank. This device for payment is the creation of the British Merchants and it has now become a universally most accepted means and mode of payment. the bank would make payment to the beneficiary when the beneficiary presents the documents as is required in the LC. unless specifically stated so. If however in addition to advising the credit. (vi) Confirming Bank: The advising Bank is only required to advise the credit to the beneficiary. (iii) Beneficiary-Exporter-Seller :It is the person who is entitled to receive the benefit under a letter of credit i. (iv) Advising Bank: It is the bank in the beneficiary /exporter’s country through which the letter of credit is advised to the beneficiary. the Advising bank were to confirm it. the term letters of credit is used interchangeably as LC or credits and should not be mistaken as different term or connotation. a device used by the bankers to effect payment for goods supplied or services provided is called Banker’s Commercial Credit or letters of credit (LC for brevity). As such it is necessary and imperative that one must understand the various provisions relating to letters of credit and the legal aspects involved therein. since the issuing bank’s open invitation contained in the credit is an offer which is accepted as soon as the negotiating bank negotiates the bills and accepts the documents.uncertain aspects. be required to deal with letters of credit.

sometimes as per the terms of the Letter of Credit the bills will be payable over a period of time (such bills being called usance bills). The bills drawn on the various dates will be honored on its maturity. Paying or Confirming Bank. Confirmed Credit if a bank advising the credit to the beneficiary adds its own confirmation to the credit. 5 . The seller can either wait till the date of maturity to receive money or he can discount the bills and obtain immediate value for the goods supplied. Such Letters of Credit under which usance bills can be drawn is an Acceptance Credit or Time Credit. Irrevocable Credit An irrevocable credit is a credit that can neither be amended nor cancelled without the consent of the beneficiary. 3. Confirmation here means that the confirming bank would fulfill the obligation under the letter of credit if the beneficiary complies with the terms contained therein. Revocable Credit A Revocable LC is a credit that can be amended or cancelled by the issuing bank without prior notice to the beneficiary. However. Acceptance of Credit Ordinary Letters of Credit are usually sight credits i. 2. it would be liable without having any recourse to the “issuing bank”. (vii) Reimbursing Bank: It is the Bank which is appointed by the issuing Bank to make reimbursement to the Negotiating. Revocable credits are un-common or less common since the issuing bank can at anytime cancel the same which would leave the beneficiary without any recourse against the issuing bank or its appointed agents. then the credit would be called a confirmed credit. However. A confirming bank accepts this responsibility only on instructions by the issuing bank and as such if any of the terms in the LC have to be changed then the concurrence of all the parties would be necessary. 4. TYPES OF LETTERS OF CREDIT: 1. this is not mandatory and no liability is imposed on the bank if by oversight or other extraneous reason the notice is omitted. Though as a matter of goods business practice banks give notice of their intention to cancel the credit to the beneficiary.the advising bank will also be the confirming Bank. and as such if an advising bank were to confirm it. The issuing / opening bank is bound by the commitments mandated or stipulated in the credit. if any negotiating bank has acted on the credit and made payment prior to receipt by it of the notice of amendment or cancellation then the issuing bank is bound to reimburse the negotiating bank. This is one of the methods by which a buyer can obtain credit from the seller. Only irrevocable letters of credit can be confirmed.e immediate payment should be made of the bills drawn by the beneficiary. In such a case the confirming bank is deemed to undertake on its part the liabilities of the credit vis-à-vis the beneficiary or the Negotiating Bank. since in a revocable credit the issuing bank can amend or cancel the credit without notice.

First the bank issuing the original credit to the beneficiary. the second the advising bank through which the credit has been advised to the beneficiary and the third the bank which issues an ancillary credit against the security of the original credit.5. Red Clause LC is. This defence however is available to the beneficiary only on the bills drawn by him. a letter of credit is not a Negotiable Instrument. In a back-to-back credit. This type of LC not only permits Preshipment advance but also permits advances to the exporter to cover storage at the port of shipment. These credits contain a “red clause” (because the clause is printed in red) which authorises an intermediary bank to make an advance to the beneficiary before shipment. In case there is any discrepancy in the documents submitted then the beneficiary cannot avail any protection on a bill with the endorsement “without recourse”. though the bills of exchange drawn under it are negotiable. 9. However in certain credits the beneficiary will be entitled to get an advance of the price. Unless specifically stated an LC is not transferable. the beneficiary can exclude/exempt this liability by adding to the bill the following words “without recourse” which means that the right (recourse) against the drawer under the bill is not available. With Recourse and without Recourse credits When a beneficiary draws a bill under a Letter of Credit he is liable if the drawee fails to make payment. There are thus three banks involved in a back-to-back credit. Transferable Credits As stated earlier. 6. Back-to-Back Credits This is a credit which is an offshoot of the credit issued to the beneficiary. the beneficiary in whose favour an LC is issued uses the same to obtain another credit from his (beneficiary’s) bank in favour of the supplier on the strength of the first or underlying LC. 8. Anticipatory Letter to Credit Red Clause Letter of Credit In a usual LC transaction the beneficiary will be entitled to receive payment only on his handing over the documents and the bills drawn under the LC to the Negotiating Bank. In other words his liability is extinguished only on the drawee making payment. As such the rights under an LC cannot be transferred and are vested with the beneficiary. Green Clause Letter of Credits This is a refinement of the “Red Clause”. The Red Clause and Green Clause credits are called Anticipatory Credits since payment or an advance is provided for in anticipation of the seller making shipment. 7. Revolving Letter of Credit 6 . A transferable credit is one under which the beneficiary can transfer his rights to third parties (secured beneficiaries). however dying out/non-prevalent anymore. LC calling for these kinds of bills is with recourse LC. However.

the applicant refused to reimburse the issuing bank. This for brevity sake is called “bill” and is sometimes referred to as “draft” (to be distinguished from a “demand draft”). If fresh shipment is to be made another LC will have to be drawn. it can be renewed as soon as the earlier bills have been paid. The bill amount should be 7 . The matter of strict compliance as far as a bank is concerned has been emphasized by Courts of law all over the world. the entire transaction concludes. The other vital aspect thereof is the independent nature of the letter of Credit transactions. Bill of Exchange : This is the document on which payment is made.In a regular LC transaction once the bills are negotiated. within the ambit of the strict compliance doctrine comes the duty of a banker to ensure that the documents tendered must be strictly those specified in the Letter of Credit. However. In this context it would be worth noting the observation given more than half a century back by LORD SUMNER in Equitable Trust Co. vs. In a Letter of Credit transaction the right to draw a bill is conferred only on the beneficiary. due to a decoding error. inter alia. 1. while presenting the documents submitted a certificate signed by a single expert which was honoured by the advising bank and accepted by the issuing bank. In such cases it is preferable to open a Revolving Letter of Credit. Dawson Partners (27 Lloyds Law Reports 49) “These are mere documents which are almost the same or which will be just as well”. Any default on the part of issuing bank would forbid the bank from claiming reimbursement from its customer with the added disadvantage that it will not be entitled to claim any remuneration for the transaction. The beneficiary. As per the strict compliance doctrine all the parties to a Letter of Credit transaction should strictly observe the terms and conditions under which the credit is issued and on failure to do so by the defaulting party. In this type of credit though the amount is fixed. since the goods were defective. Due to the prime importance given to documents under a Letter of Credit transaction. In this the credit requires. However. DOCUMENTS UNDER A LETTER OF CREDIT: One of the two basic doctrines that underlie the letter of Credit transaction is the principle of strict compliance. This procedure becomes time consuming especially when there is regular trade between the same parties. The issuing bank owes a duty to its customer to ensure that the documents tendered by the beneficiary under the credit comply with the instructions given by its customer. therefore. a certificate testifying to the agreement of the purchase that was to be signed by an ‘experts’. the massage received by the advising bank required only a certificate signed by “an expert”. it is necessary for a banker to understand the documents that accompany a Letter of Credit. which was upheld by the Courts. A bank is not compelled to honour the credit unless the beneficiary peruses and conforms to every material particulars to the authority referred therein.

making the documents liable to be rejected. Invoice : This is the document that gives details of the sale. In case it is sent by postal system or courier. All the details mentioned in the invoice must tally with those mentioned in the Letter of Credit.15Lac and the goods shipped is worth Rs. 3 or 4 and all are termed as originals.15Lac be paid and residual Rs. failing which it may amount to a discrepancy. In case the goods are shipped the document evidencing the shipment of the goods is called the Bill of Lading. Unless otherwise specified in the Letter of Credit a Bill of Lading must be a “shipped” Bill of Lading and a “received for shipment” or “transportation” Bill of Lading or a “charter party Bill of Lading” is not acceptable. endorsement and the drawee should be the same as given in the letter of credit. Bills or Drafts can be payable on presentation (sight bills) or on a certain date (usance bill) 2. 8 . the combined transport bill through creation of modern age containerization of shipment which permits more than one means of carriage and is also known as Multimodal Transport. It should be made in the name of the opener /importer unless required otherwise in the Letter of Credit. This document should be distinguished from “Bills of Lading” which is transporting document and is discussed later on in this chapter. Where quantities are specified in a Letter of Credit. The two main modes of transport of goods are either by Sea or by Air. The tenor. In case the goods are transported by air the documents evidencing receipts of goods would be the Airway Bill in case the goods are directly handed over to an Airline or its agent. For example.20Lac. This would not be in compliance with the credit terms and the opener / importer would be legally entitled to reject the documents. 3. A banker should see that all the originals are received. Bill of Lading is a document to title to goods i.within the limit fixed in the letter of credit.e these are the symbols of the goods and holder of the same is entitled to get possession of the goods. A Bill of Lading is issued in sets of 2. the document evidencing receipt of goods would be either the Post Parcel receipts or the courier receipts Bill of Lading: Bills of lading are two types – one the traditional ship bill of lading and the other. with a request that Rs. Transport Documents: The dispatch of goods or the transporting of goods would depend on the terms of contract between the buyer and the seller and the same is incorporated in the letter of credit.5Lac collected be repaid later. the invoice should be accordingly be made and converting the measures to equivalent pounds or quintals would make it liable to be rejected. A further problem posed is whether it would be in order where as per the credit the value of the shipment is Rs. A Bill of Lading to a certain extent is negotiable inasmuch as a bona fide transfer of the same by endorsement entitles the transferee the right to the goods. the form in which these are specified should be adhered to. if the Letter of Credit calls for 100kg of Tea.

These were first formulated by the international Chamber of Commerce (ICC) in 1933 which thereafter underwent revision several times. ii. However. Post parcel receipt and courier receipts: When the goods to be sent are small in quantity then these are sent by post or courier. the Letter of Credit may also call for certain other documents among which are included certificate of origin. inasmuch as these have not been enacted by Parliament. but their incorporation in the Letter or Credit as one of the terms of the Letter of Credit makes the terms of UCP 500 contractually binding on all the parties to the letter of credit. etc. These are not law.Airway Bill: This is a document which evidences that the goods have been received by an airline company or its agent. Unlike a Bill of Lading an Airway Bill does not carry with it the right to the goods i. where it is specifically excluded. It should be signed by either an insurance company or underwriter or their agents. These are not title to goods and is only an evidence that the goods have been entrusted for transportation to either the postal department or the courier company. UNIFORM CUSTOMS AND PRACTICE FOR DOCUMENTARY CREDITS –UCPDC 500: The Uniform Customs and Practice for Documentary Credits are conditions as per which bankers issue or act on commercial credits. the latest being in 1993 which came into effect from 1st January 1994.e it is not document of title to the goods. The document issued by the postal department or the courier are similar in nature to the Airway Bill. They are called up UCP500. Other Documents: Over and above the major documents discussed above which are required in all Letter of Credit transactions. certificate of weight or quality or analysis. A Statutory letter of credit is similar to a bank guarantee and is issued by banks in countries where the law does not permit issuance of a bank guarantee. Such documents must be mandatarily enclosed with the other documents failing which payment can be refused. In interpreting these documents too the Courts have applied the principle of strict interpretation. Insurance Documents: The goods shipped if required to be insured under the terms of the Letter of Credit should be so insured and the insurance document as required in the Letter or Credit should be enclosed with the other documents. Health Authorities Certificate. i. The type of insurance cover should be the same as specified in the credit. These are virtually embodied in all letter of credit transactions and it would be worthwhile studying these in detail. here we would only be discussing in brief the important aspects as given in 49 Articles of UCP500. 9 As per Article 1 UCP is applied where these have been incorporated into the text to the credit and binds all parties except . If however the Letter of Credit terms permit acceptance of an Airway Bill then the banker is within his rights to accept it. Article 2 defines a documentary credit which includes a Statutory letter of credit.

If sent it will The issuing bank should advise the credit and any amendments thereto through the same advising bank. bank and the beneficiary (Article 9(d)(i)) ix. amendment or cancellation (Article 8). the confirming The beneficiary is bound by the terms of the original letter of credit till he accepts the amendments and communicates the same to the bank that issues the amendment. it advises the letter of credit to the beneficiary the advising bank should inform the beneficiary about it not being able to establish the authenticity (Article 7). Issuing bank in the case of revocable credit. If the credit is conveyed by the authenticated tele transmission then no mail confirmation should be sent.iii. 10 . (Article 3) In a letter of credit transaction all the parties involved therein deal only with the documents and not with the goods or services. [Article 11(b)] In case the instructions received are not clear then the advising bank need only inform the same to the beneficiary without any responsibility and must inform the issuing bank of the action taken and seek necessary information (Article 12). however. vi. As such Bank need comply only with the documentary requirements as stipulated in the letter of credit and need not go behind these documents (Article 4) v. be of no effect [Article 11(a)(i)]. it will be deemed to be an Irrevocable letter of credit (Article 6) The advising bank before advising should check that the Letter of Credit is authentic and if not. viii. The beneficiary should notify his acceptance or rejection of the amendments and in case he does not do so then his submission of the documents for negotiation will be deemed that he has from that moment accepted the amendments. inform the bank from where it has been issued that it cannot establish the letter of credit’s authenticity or veracity . If. [Article 9 (d)(iii)] x. vii. Banks are in no way concerned with the underlying sales or other contracts upon which the letter of credit is based. xii. In the absence of any indication in the letter of credit. xi. iv. must reimburse the advising bank which has acted on a credit before notice of An irrevocable letter of credit can be amended or cancelled only with the concurrence of the issuing bank.

If it is informed by the letter of credit opening bank that the documents negotiated by a bank are fraudulent and request for refund of money claimed there under. 20(b)] xxi. documents as tendered. The opening bank should not return the documents without getting the disposal instructions. (Article 15). both banks will . etc as original if duly authenticated unless the letter of credit stipulates otherwise. These three clauses should be read along with Article 4. the banks will accept the Noting prevents the beneficiary from presenting the documents directly to the opening bank. xviii. {Article 14(d)(ii)} If the letter of credit opening bank’s instructions are not carried out by the advising bank due to any reason. (Article 20). the negotiating bank will not do so if they had taken reasonable care. It states that the banks deal only in documents. xvii. not be held liable. For the first time UCP states that the time taken for returning should not exceed 7 days from receipt of documents. If the opening bank refuses the documents for discrepancies. (Article 16) xix. (Article 14(d)(ii)) xv. (Article 15) xvi. If these disclaimers are not provided the task of negotiating bank would be very onerous. Article 13 states that negotiating bank must examine all documents with reasonable care and if this is done the letter of credit opening bank has to reimburse. 11 Banks will accept photocopies. it must inform this aspect speedily to the negotiating bank and the related documents must be held for DISPOSAL INSTRUCTIONS. the banks will accept documents dated prior to the date of letter of credit. Banks must examine the documents with reasonable care (Article 13) and within a reasonable period. xx. These three clauses are very significant from the angle of a negotiating bank. Unless the letter of credit prohibits. [Article Unless the letter of credit specifically states the name of the issuing authority of documents. (See Article 14D) xiv. Banks have been given all round protection if the documents are proved to be false /forged provided these have fulfilled the requirements of Article 1 cited earlier.xiii. Bank assumes no liability or responsibility for the genuineness of the documents tendered. (Article 22).

e the transferee cannot further transfer the same. UCP does not state that the invoice should be signed. xxvi. xxviii. Banks will accept B. normal cases. But suitable certificate to be given by negotiating bank. if he ships in July the recourse under Letter of credit will not be available. circumstances may force trans-shipment. May. (Article 42).xxii. he loses the rights under the Letter of Credit for subsequent shipments (Article 41). but the Bill of Lading contains a clause of trans-shipment. but did not ship in June. documents will be accepted on the next working day. [Article 39(b)] xxx. [Article 34(c)] If the letter of credit prohibits transshipment. [Article 23(a)(i)] If the letter of credit does not specifically permit shipment on deck. xxxiii. June and July. xxxi. Bill of Lading showing shipment on deck WELL NOT BE LASH (Lighter Alongside Ship) Bill of Lading will be accepted even where trans-shipment is prohibited by Letter of Credit. e.g Goods are to be shipped in April. Hence. If letter of credit calls for shipment at monthly intervals and the exporter fails to ship in one month. A transferable letter of credit can be transferred once only i. Party has shipped in April and May. [Article 23(a)(ii)] xxv. if needed by them. for signed invoice. Unless Letter of credit prohibits. If the letter of Credit is expiring on a notified bank holiday. Even if the letter of credit prohibits and the Bill of Lading also shows that there will not be trans-shipment. this flexibility. If he is not able 12 . xxvii. (Article 23(d)). (Article 44(c)) xxxii. (Article 37) So the Letter of Credit opener / opening bank should call 5% tolerance in quantity is allowed in All Letter of Credits should contain a clause of last date of shipment and expiry. xxix. banks will accept Bill of Lading showing third party shipment (Article 31) Cover not issued by insurance broker will not be acceptable unless authorized in letter of credit. xxiii. (Article 31) xxiv. in case of danger to the ship. banks will accept the same as in order. Now.L indicating the name of the carrier and is duly authenticated. The final discretion of shipment rests with the shipping company. acceptable.

To overcome this payment problem. we shall deal with it here in more detail. B can give it back to A only. To avoid such a situation the exporter can request the importer to obtain a guarantee that the payment in installments will be made. This is the meaning of the maxim that letter of credit can be transferred once only. A transfers his letter of credit to B. Suppose a bank’s customer were to import capital goods on a deferred payment credit where the price is to be paid in installments spread over a 5 years period. PURPOSE OF DEFERRED PAYMENT GUARANTEE: When the import or export of raw materials or consumer goods is made the payment is done either immediately or generally within a maximum of 180 days. by which assignment of proceeds to anyone by the . the concept of deferred payment has been introduced in India. In the meantime the chances of the importer going bankrupt or failing to pay may arise. DEFERRED PAYMENT GUARANTEE (DPGs) Introduction Though we had touched this type of guarantee while studying bank guarantees. in brevity referred to as DPG. places the buyer at a great disadvantage. This guarantee of the bank. instead the price of the goods is paid in installments over a period of time as per terms mutually agreed to with the seller. [Article 48 (g)] xxxiv. since this type of guarantee is regularly issued by banks. therefore. B cannot transfer the letter of credit to C. This guarantee ensures timely payment of installment to the seller /exporter. To 13 A new article viz. Added to this the requirement of substantial amount of foreign exchange. failing which the guarantee can be invoked and payment received. In a deferred payment guarantee the payment of the installments is guaranteed by a third party.to fulfill the contract. As stated earlier in a deferred payment arrangement the buyer /importer is not required to make the entire payment of the goods at one time. beneficiary is permitted (Article49. he has to give back to the transferor. who can give it again to someone else. short-term credit would not be of much help to the buyer unless he has made arrangements to get a Term Loan. in the case of capital goods the amount involved being quite substantial. approach his banker to guarantee the payments in installments. “Deferred Payment Guarantee” as the name itself suggests is a guarantee that the deferred (postponed) payments will be made. However. the exporter will have to wait for each installment to mature till the whole amount is paid. assuring the exporter of the timely payment of the installments is in short called “Deferred payment guarantee”. The importer would. mostly banks and financial institutions. assignment of proceeds is included in UCP500. who in turn can transfer the letter of credit to C.

which are usance bills (being payable on a particular date and not immediately) and payments of these bills are guaranteed by the bank. if the documents are as required under the letter of credit and are valid. the banks undertake to make payment without any demur or protest. Some banks as a matter of abundant caution or to have better clarity of the payment schedule incorporate the same in the guarantee issued by them. The payment is usually done on the following terms: 1) Advance payment of 10% to 15% of the price of the goods.understand better the deferred payment guarantee. this being the consideration of the guarantee. which as stated earlier is issued by banks and financial institutions. 3) The unconditional and irrevocable assurance of the bank that it would make payment on the invocation of the guarantee. 2) The payment schedule of both the installment and the interest. Since the guarantee is mostly given prior to shipment of the goods. In certain cases the seller /export would draw bills on the buyer /importer for the amounts of the deferred installments including interest. it is necessary to understand how payment is made in a deferred payment contract and how the same is guaranteed by a bank. what is guaranteed is the timely payment of installments and interest. request the bank to stop the payment on a deferred payment guarantee on the grounds of defective goods. METHOD OF PAYMENT In a contract for import of goods on deferred payment terms. the importer is required to make payment in installments over a period of time which may range from 1 to 7 years in a normal deferred payment contract. The advantage of this method is that the seller/exporter can discount these bills with his banker and get immediate finance. 2) Another 10% to 15% on receipt of documents under letter of credit. 3) The balance amount is paid in installments spread over a period of 1 to 7 years. This is done by the bank issuing a deferred payment guarantee in which the following terms are mandatory: 1) The supply of goods by the seller to the buyer and the seller agreeing to postpone receiving the payment of the price. like all other bank guarantees. which is secured by a Deferred Payment Guarantee. As regards the supply of goods by the seller it is to be remembered that banks do not take the responsibility to ensure that the goods shipped are what is required by the buyer/importer. it is to be noted that the payment schedule is usually incorporated in the main contract between the buyer / importer and the seller/exporter and the bank guarantees the payment as stipulated in the schedule. the bank has been an 14 . In a Deferred Payment Guarantee. In the deferred payment guarantee. As regards the payment schedule. then the guarantee of the bank subsists and the buyer cannot after receipt of the goods. though it is for all purpose a verbatim reproduction of the payment schedule from the main contract. since as per the guarantee.

therefore. We have studied earlier while dealing with the bank guarantees that the bank’s liability in a guarantee is primary and independent of the underlying contract between the buyer /importer and the seller/exporter. These principles apply in to-to to a DPG also. 15 . of prime importance that the banker honour its commitment.unconditional and irrevocable assurance to the seller /exporter. It is. It is on such assurance that the seller/exporter has sold the goods.

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