DOCUMENTARY CREDITS

IN INTERNATIONAL TRADE
TRANSACTIONS

BASIC TERMINOLOGY

COMMERCIAL LETTER OF CREDIT

COMMERCIAL CREDIT
LETTER OF CREDIT (L/C)
DOCUMENTARY CREDIT

1
INTRODUCING THE DOCUMENTARY CREDIT
L/C is an irrevocable undertaking
from the importer’s bank to the exporter
that the exporter will get paid if he can prove
he has shipped the proper goods by providing
the corresponding documents required by the credit.

Bank deals with documents and not with goods.

PRESENTATION OF DOCUMENTS

The documents provide a proof that the goods

have been properly shipped.
In case of non-conforming documents
payment is refused.
An expiry – the last date by which documents
may be presented.

The documents must be presented within 21 days

of the date of shipment
indicated in the transport document.

2
 PARTIES TO DOCUMENTARY CREDIT
(depending on their role in the transaction)
1. The seller/exporter may be referred to as:
a. beneficiary
b. shipper
c. consignor
2. The buyer/importer may be referred to as:
a. opener
b. applicant
3. The banks

THE BANKS AND THEIR ROLES

IN DOCUMENTARY CREDIT TRANSACTION
1. Issuing/opening bank
2. Advising bank
3. Confirming bank
4. Negotiating bank

3
 ISSUING/OPENING BANK
Receives the importer’s application
and “issues” or “opens” the credit.
Located in the importer’s country.
Makes an irrevocable undertaking to pay
the beneficiary against conforming documents.

ADVISING BANK
Notifies or “advises” the exporter
that a credit has been opened.
Authenticates the credit and ensures
that the advice reflects the terms and conditions
of the credit.
Located in the exporter’s country.

4
 CONFIRMING BANK
Normally also the advising bank.
Adds its own irrevocable undertaking (“confirmation”)
in addition to that given by the issuing bank.
Commits itself to honouring
the presentation of conforming documents.
Exposes itself to the risk that will fail to detect
a discrepancy and thus will not recover the funds.

NEGOTIATING BANK
Examines the documents presented, then
“negotiates” the credit i.e.
in the case of a term draft, either advances
or agrees to advance funds to the beneficiary
on or before the maturity date of the draft.

5
 TYPES OF LETTERS OF CREDIT
1. irrevocable /revocable
2. confirmed
3. available at sight
4. available by deferred payment (usance)
5. available by acceptance
6. available by negotiation
7. transferable L/C
8. revolving L/C
9. red clause L/C

IRREVOCABLE LETTER OF CREDIT

It can not be amended or cancelled
without the permission of all parties.

REVOCABLE LETTER OF CREDIT

It can be amended or cancelled without
the permission of the beneficiary.

6
 CONFIRMED LETTER OF CREDIT
A credit is confirmed when a bank
(usually in the exporter’s country)
adds its own irrevocable undertaking
in addition to that of the issuing bank.

L/C AVAILABLE AT SIGHT

Payment is made immediately
after the required documents have been submitted,
provided the conditions in the L/C have been met.
L/C AVAILABLE BY DEFERRED PAYMENT
Payment is not made when the documents are
submitted, but at a later time defined in the L/C.
L/C AVAILABLE BY ACCEPTANCE
Payment is made at a later time defined in the L/C.

7
 L/C AVAILABLE BY NEGOTIATION
NEGOTIABLE CREDIT
Negotiation means the purchase
by the nominated bank of draft and documents
under a complying presentation,
by advancing or agreeing to advance funds
to the beneficiary on or before
the maturity date of the draft.

REVOLVING LETTER OF CREDIT

Used when the importer is a regular customer
of the exporter or the importer requests
partial deliveries at specific intervals.
The bank issues a credit for a certain maximum sum
which is automatically renewed at certain interval.
RED CLAUSE LETTER OF CREDIT
Allows pre-shipment advances
to be made to the exporter
at the risk and expense of the applicant.
The bank honours the exporters sight drafts
up to a specified percentage of the total credit
against production of preliminary documents.

8
 TRANSFERABLE LETTER OF CREDIT
Used when an exporter plays the role of
an intermediary between a supplier
and the importer.
The middleman – (first) beneficiary transfers
all or portion of its rights to a supplier –
the “second beneficiary”.
Enables the intermediary to reduce the extent
to which it uses its own funds to process transaction.

IRREVOCABLE LETTER OF CREDIT

APPLICATION FORM
1. Time of payment
2. Date and place of expiry of the credit
3. Latest date for shipment
and presentation of documents
4. Beneficiary’s name and address
5. Type/form of credit
6. Currency and amount
7. Shipment details
8. Description of goods
9. Documents required

9
 THE BASIC PRINCIPLES
OF DOCUMENTARY CREDIT PRACTICE
1. the independence of the credit
from the underlying contract
2. the requirement that documents strictly comply
with the terms of the credit

THE INDEPENDENCE OF THE CREDIT

The L/C is independent of the underlying contract.
If the exporter fulfils the documentary obligations of
the credit, payment must be effected regardless of
disputes connected to the sale contract.
The exporter’s breach of contract condition
is not sufficient to stop payment under the credit.
The principal exception to this rule
has to do with fraud.

10
 STRICT COMPLIANCE
Documents presented under the credit must comply
very precisely with terms and conditions of the credit.
Both exporter and the banks must
take care that data in documents is correct.
If the bank pays against even a single discrepancy,
an applicant can refuse to reimburse it
for that payment.

TRANSFERABLE CREDIT
It can be transferred in whole or in part by the original
beneficiary to one or more “second beneficiary(-ies)”.
It is used when the first beneficiary does not supply
the goods himself, but acts as a middleman
between the supplier and the ultimate buyer.

BACK-TO-BACK CREDIT
B/B credit transaction involves two separate credits:
1) master credit – issued by ultimate buyer’s bank
in favour of the middleman;
2) second credit (B/B credit) – issued by the middleman’s
bank in favour of the supplier.

11
 BACK-TO-BACK CREDIT
VS. TRANSFERABLE CREDIT
SIMILARITIES
1. Both credits involve a middleman as the initiator.
2. Both involve substitution of documents
by the middleman.
3. The terms and conditions are about the same
as their respective original credits except:
a) credit amount
b) expiry dates
c) latest shipment dates
d) insured amount if any.

BACK-TO-BACK CREDIT
VS. TRANSFERABLE CREDIT
BACK-TO-BACK CREDIT TRANSFERABLE CREDIT
• It can be issued by any bank • Transfer is only restricted to the bank
at its own discretion. where the credit is available.
• It will not be stipulated • It is necessary to be designated
as “B/B credit allowed” as transferable in the original credit.
in the master credit.
• A long chain of transactions • Transfer is restricted to one time
is allowed. only.
• The bank issuing the B/B credits is • Transferring bank has no payment
primarily liable to pay the supplier. obligation to the supplier.
• It allows more flexibility
e.g. currency differences, extra
documents submitted by supplier.
• Subject to all rules under UCP 600.

12