Letter of Credit

Letter of Credit (L/C)

A written undertaking by a bank (a “credit”) given to Seller at the Buyer’s request to effect
payment up to a stated amount within a stated time against presentation of a specified
document which comply with the terms and condition of the Credit (UCP 600 article 7).

(10) $
Seller (5)
Documents
Seller’s Bank
L/C advising
(3)
Documents
(4) Goods Letter of Credit (2) (6) (9) $
L/C
Issuance
Buyer (8)
Title Documents
(7)
Settlement Arrangement Buyer’s Bank
Request for L/C issuance
(1)
Parties Involved in L/C Transaction

Applicant Must exists  The party who requests Issuing Bank to issue
the L/C
 In most cases: is the Buyer named in the
contract
Beneficiary Must exist  The party in whose favor the L/C is issued
 In most cases: is the Seller named in the
contract
 Can be the “Shipper”, or not

Issuing Bank Must exist  The bank who issues the L/C based on
Applicant’s request
 Having credit relationship with the
Applicant
Advising Bank Must exist  Thebank who advises the L/C to the
Beneficiary
(seperti Tkg Pos)
“Nominated Bank” Must exist  The bank to which the Beneficiary can/must
present the document to draw the L/C
 Named/nominated in the L/C
 Can be the Advising Bank as well
Parties Involved in L/C Transaction

Negotiating Bank If any  Nominated Bank who decides to “giving

value” on or finance Beneficiary’s
receivable under the L/C
 In most cases: is Seller’s banker
 Can be the Advising Bank as well

Confirming Bank If any A bank who adds its undertaking on the

(Final paid) Uang
yang sudah di
bayar tidak bisa di
tarik
top of Issuing Bank’s undertaking
 In most cases: is the Nominated Bank
and the Advising Bank
 Eliminate financial risk/sovereign risk of
Issuing bank, in favor of Beneficiary

Reimbursing Bank If any  The bank who is appointed by Issuing

Bank to reimburse Negotiating Bank or
Confirming Bank
 In most cases: the bank with whom
Issuing Bank maintains an account
Availability of L/C
 Meaning: the way an L/C can be become “money” or having actual
financial value

 L/C becomes “available” only after presentation of documents

required by the L/C. The documents are to be presented by
Beneficiary or other party to whom Beneficiary has assigned its right
to claim (or its receivable)

 The documents are to be presented to Nominated Bank, or directly to

Issuing Bank

 So, in other words: Nominated Bank is the bank where the L/C is
available
Availability of L/C

“By Payment”  Oncethe L/C become “cash”, the payment is FINAL (no
recourse to the party who receives the money/the
Beneficiary)
 In
most cases: available with the Issuing
Bank/Confirming Bank, or other bank who pays by
debiting Issuing Bank’s account maintained with it
 Canbe “Sight Payment” (payable immediately), or
“Deferred Payment” (payable later on)
 For
Deferred payment L/C: the Issuing
Bank/Confirming Bank, or Nominated Bank, will issue
“Deferred Payment Undertaking”

“By Acceptance” A bank (can be Issuing Bank, Confirming bank, or

Nominated bank) is to issue “Acceptance” or
unconditional undertaking to pay at certain date
 “Acceptance”serves the same purpose as that of
“Deferred Payment Undertaking”
 Applicable under “Usance” L/C
Availability of L/C

“By Negotiation” A Nominated Bank can take a position to purchase

Beneficiary’s receivables against Issuing
bank/Confirming Bank, by “giving value” on such
receivables
Under this availability, Beneficiary can expect to receive
the money earlier, without having to wait for final
payment from Issuing Bank/Confirming Bank
Uponthis act of “Negotiation”, the Nominated Bank
becomes “Negotiating bank”
In widely accepted sense/interpretation: Negotiation is
done with recourse to beneficiary. Therefore, money
given under Negotiation is NOT final payment
Should the Negotiating Bank does not get reimbursed
by Issuing Bank/Confirming Bank, it will debit
Beneficiary’s account. Therefore, usually Negotiation is
done under credit facility extended by Negotiation Bank
to the Beneficiary
Negotiation in “action”

(6) Nego

Seller (5)
Documents
Seller’s Bank
L/C advising
(3)
Documents
(4) Goods Letter of Credit (2) (7) (10)
L/C $
Issuance
Buyer (9)
Title Documents
(8)
Settlement Arrangement Buyer’s Bank
Request for L/C issuance
(1)
Obligation of parties, in brief

• Issuing Bank: Obligated to honor/pay if presented documents

are in compliance with requirement in L/C,
without recourse

• Advising Bank: Authenticates and advises the L/C to

Beneficiary

• Confirming Bank: Not obligated to confirm, but if it does, it should

honor/pay if presented documents are in
compliance with requirement in L/C, without
recourse

•Negotiating Bank: Not obligated to honor documents, but if it does,

it will be done with recourse to beneficiary
TYPES OF L/C

• SIGHT VS USANCE (UCP 500 article 10)

pay when documents arrives; pay at maturity

• REVOCABLE VS IRREVOCABLE
without knowledge of parties involved; must be agreed by all parties

• NEGOTIABLE VS NON NEGOTIABLE

can be discounted; straight payment

• CONFIRMED VS NOT CONFIRMED

exporter’s bank guarantees the obligations and liabilities of the Issuing
Bank; exporter remains dependent on the undertaking of the Issuing Bank
SPECIAL LETTER OF CREDITS
• TRANSFERABLE L/C
more than one beneficiary

• BACK TO BACK L/C

similar to transferable L/C, but the middlemen use the primary L/C
as collateral to apply for opening of the second L/C

• REVOLVING L/C
credit amount is automatically renewed or reinstated without
specific amendments to L/C being required, and it may revolve
around time or value

• RED CLAUSE L/C

applicant advances part or whole amount to beneficiary before
presentation of documents, against simple receipt and a draft
Transferable L/C
6

Importer Middleman Exporter

(Applicant) (1st Beneficiary) (2nd Beneficiary)

11 2 12 8 9
3 4
5 9

Advising/Negotiating 7
Issuing Bank
Bank

3
10

Note:
1. Sales contract
2. Apply L/C from issuing bank
3. Advising L/C
4. Transfer instruction
5. Advising L/C to 2nd beneficiary
6. Shipping goods to applicant
7. Negotiating documents
8. Middleman re-invoicing
9. Negotiating bank payment
10. Reimbursement, and submission of shipping documents to Issuing Bank
11. Upon applicant payment or acceptance to pay, documents are released
12. Payment
Transferable L/C
L/C that can be transferred by the original (first) beneficiary to one or more second
beneficiaries
- The first beneficiary is not the ultimate supplier
- Shipment of goods is directly from the second beneficiary of the Transferable L/C applicant
- Fractions of the L/C can be transferred separately (I.e. more than one 2nd beneficiary), where
partial shipments/drawings are allowed
- No credit facility is needed

• Exceptions to the Transferable L/C

- Name and address of the 1st beneficiary can be substituted to that of the applicant of L/C
- Credit amount and unit price can be reduced
- Expiry date, presentation date for documents, and latest shipment date can be curtailed
- Insurance coverage can be increased (min. 110%)
- Documents to be substituted, i.e. invoice and drafts

• Risk to the Issuing Bank :

- Extend the undertaking to other parties

• Risk to the Transferring/Negotiating Bank :

- Pay or Accept documents that non compliant with the L/C, which then rejected by the Issuing Bank
(if original L/C was confirmed by the Transferring Bank) otherwise it does not constitute any obligation to pay

• Controls :
- The transfer can only be issued upon specific instruction of the1st beneficiary
- L/C has to be designated as “Transferable”
- L/C must comply with UCP 500 Art 48 with exception only described by Art 48 (H)
- Description of goods must be the same
Back to Back L/C 6

Importer Middleman Exporter

(Applicant) (1st Beneficiary) (2nd beneficiary)

13 12 2 8 9
3 4
5

Advising/Negotiating Bank 7
Issuing Bank
(Second Issuing Bank)

3
10
11

Note:
1. Sales contract 7. Present documents (2nd L/C) and Negotiate them
2. Apply L/C from Issuing Bank 8. Middlemen re-invoicing
3. Advising L/C 9. Negotiating bank pay spread to middleman
4. Apply for 2nd L/C 10. Dispatch documents to Issuing Bank
5. Advising 2nd L/C to 2nd beneficiary 11. Reimbursement
6. Shipping goods to applicant 12. Importer pay Issuing Bank (or acceptance to pay on maturity date)
13. Dispatch/release documents to importer
 Back to back L/C
L/C issued (2nd L/C) in favor of the supplier at the request of the middleman against the
security of a “master“ L/C (1st L/C) issued by the buyer.
- Usually applied by the beneficiary if unable to obtain a transferable letter of credit
- The beneficiary of the L/C is not the ultimate supplier
- The middleman need to perform some form of value adding to the goods or to hide the origin of goods
- Credit facility is required
The 2nd L/C :
- Terms and conditions should ideally mirror to the 1st L/C as afar as possible
- Alteration of terms: (i) credit amount and unit price reduced
(ii) expiry date, latest shipment date, and presentation period curtailed
(iii) insurance amount can be increased
(iv) documents to be substituted - invoice and drafts

• Risks to 2nd L/C issuing bank :

- Documents not complying with the terms and conditions of the master L/C (possibly double exposure)
- Non-payment by the Issuing Bank of the master L/C, i.e. the middleman does not produce the appropriate
documents for substitution
- Possibility of mismatch terms between the two L/Cs
i.e. middleman provide the buyer with 60 days terms, while supplier provide the middleman with 30 days terms
Controls :
- Keep the 2nd L/C variations minimal
- The 2nd L/C Issuing Bank must be comfortable with the financial standing and integrity of the middleman
- The 2nd L/C Issuing Bank must be confident of middleman’s ability to substitute invoice and drafts
- Goods involved should be the same under both L/Cs, plus have control over the goods
Revolving L/C
4
Importer Exporter
(Buyer) (Beneficiary)
1

3 5
8 7 2

3
Advising/Negotiating
Issuing Bank Bank
6

Note:
1. Sales Contract 6. Dispatch documents (and obtain reimbursement from Issuing Bank)
2. Apply L/C from Issuing Bank 7. Release documents (upon payment or acceptance to pay)
3. Advising L/C 8. Dispatch documents
4. Exporter ships the goods
5. Exporter negotiates the documents
Revolving L/C
L/C is renewed or reinstated without specified amendments to the L/C being required.
- To facilitate transaction which requires multi-shipments over an extended period
- It may revolve around time or value

• Importer buys :
same merchandise, at a pre-determined price, very regular basis, from the same supplier, with same
terms and conditions, over an extended period.

• Value : L/C amount is reinstated to the original value, within a given overall period of validity
a. automatic (riskier) : reinstate upon presentation of specific documents
b. amendment/non-automatic : reinstate only after receipt approval from Issuing Bank

• Time : L/C amount is established for fixed amount and is valid for fixed period
a. cumulative : any sum not drawn in previous months carries over the the next month
b. non-cumulative : amount of non-shipment by exporter cannot be carried over to the next month

• Risk : Involves buyer and Issuing Bank with incalculable liability, consequently is rarely used

• Controls :
- specify an overall amount that may be drawn ( a cap) or specify the total number of drawings that
may be made
- provide for reinstatement of the amount of the L/C by the nominated bank only on receipt of the
Issuing Bank’s “advice of reinstatement”
THIS IS AN IRREVOCABLE, NON-ACCUMULATIVE REVOLVING CREDIT. IT
IS AVAILABLE FOR DRAWING UP TO AN AGGREGATE AMOUNT NOT
EXCEEDING USDXXXX EACH CALENDAR MONTH.

KINDLY NOTE THAT THE AMOUNT UNDER THE RELATIVE SHIPMENT WILL
BE RE-INSTATED TO THE ORIGINAL AMOUNT OF THE L/C VALUE BASED
ON THE APPROVAL FROM THE L/C ISSUING BANK AND ON WHICH WE
SHALL ADVISE YOU OF THE RE-INSTATEMENT BY SUBSEQUENT WITH A
FORM OF AUTHENTICATE SWIFT/TESTED TELEX.
Red Clause L/C 8 7

1 6

Applicant Beneficiar
(Importer y Supplier
) (Exporter)

13 12 2 9
3&4

3 Advising/Negotiating
Issuing Bank
Bank

5
10
11

Note :
1. Sales contract
2. Apply L/C from Issuing Bank
3. Advising L/C
4. Advancing Payment
5. Reimbursement from Issuing Bank
6. Purchasing and payment to supplier
7. Supplier sends the goods
8. Exporter ship goods after being processed.
9. Negotiate documents to Negotiating Bank
10. Ship documents
11. Reimbursement from Issuing Bank
12. Importer pay Issuing Bank / acceptance to pay
13. Dispatch/release documents to importer
Red Clause L/C
Advance payment to beneficiary (exporter) prior to shipment against simple receipt and
a draft or Pre-export financing from the importer. Remaining balance is paid upon
presentation of confirmed documents which comply with the terms and conditions of the
Credit.

• Risks to importer :
- Exporter uses the funds for another purpose
- Exporter negotiates with other bank for the same L/C
- Documents presented for negotiation have discrepancies
Controls :
- Specify terms and conditions of the advance payment guarantee
- L/C is restricted

Negotiating Bank :
- Ensure advance granted adhere to the terms and conditions of the Red Clause
- L/C is restricted
Issuing Bank :
- Liable for repayment of the amount advanced and for all cost incurred
- Similar right of recourse against applicant for the advance payment or credit
SHIPPING TERMS
Determine at what point the seller has fulfilled his obligations so that
the goods in a legal sense could be said to have been delivered to
the buyer

• Who will arrange and pay for the carriage of the goods
from one point to another ?

• Who will bear the risk if something happen ?

Seller’s
Dock Dock
Factory

Ex Factory Free Along Side Free On Cost & Cost, Insurance Ex Dock
(FAS) Board Freight Freight
(FOB) (C&F) (CIF)