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9. Issuing Bank reimburses Advising Bank

The Issuing Bank, ie. theBuyer’s bank then reimburses the Seller’s bank, the Advising Bank.

8. Issuing Bank checks documents again, if correct they are released to Buyer and the Buyer’s account is debited

The Issuing Bank, or Buyer’s bank, again checks documents and providing that they comply with all the terms and conditions, and are correct, they are released to the Buyer and the Buyer’s account is debited.

7. Advising Bank checks the documents

If they comply with LC they send the documents to Issuing Bank and may pay the Seller in advance of being reimbursed by the Issuing Bank When the documents are received by the Advising Bank, they are checked, then if correct, they are sent to the Issuing Bank. When Documents comply with the Letter of Credit If the Advising Bank is happy after checking the documents that they comply with the Letter of Credit, then the process of payment to the beneficiary can occur. This process is dependent on where payment is stipulated in the original Letter of Credit. • If payment is stipulated to be at the Seller’s bank, then payment is released to the beneficiary on presentation and checking of the documents at the Seller’s bank • If payment is stipulated to be at the Buyer’s bank, then payment is released to the beneficiary only after the Issuing Bank has received the documents, checked them and then sent funds to the Advising Bank, who will then pass the payment to the Seller. When documents do not comply to the Letter of Credit Discrepancies can occur between the documents presented and the terms and conditions expressed in the Letter of Credit. If this does occur, the following courses of action are open to the Seller: • Correct the discrepancy within the original expiry date. If the Seller is able to make any amendments within the original expiry date and presentation period then this is acceptable. Any alteration to the documents must be authorized by the party that issued them. If possible a clean document should be obtained. • Ask for payment despite discrepancies. The Advising Bank can be asked to contact the Issuing Bank for permission to effect payment despite discrepancies in the documents. This can take a little time and the costs must be met by the Seller, however, it can produce a final result more quickly. • Send documents on ‘inspection’. This can occur within the security of the LC, but cashflow is seriously hindered and an unscrupulous Buyer may try to take advantage by offering a reduced price for a quick settlement against documents ‘as presented’. With documents ‘on inspection’ the bank should be requested to instruct the Issuing Bank that release of the documents to the Buyer is to be only against payment being authorized. Please Note: The above measures normally allow the Seller to retain control over the goods depending on the circumstances, as the Buyer often cannot take delivery without the documents, which are still in the Seller’s control. However the Buyer is in effect being asked if they still want the goods but are prepared to accept the discrepancies in the documents. They are still quite free to refuse. Common Discrepancies All mistakes cause extra work and are sometimes accompanied by additional charges. They can also lead to delays in receiving payment, price reductions and even the avoidance of liability by the Buyer altogether. To help avoid discrepancies, we have highlighted the common mistakes for the documents below. • Bill of Exchange Drawn incorrectly, or the amount differs from that of the invoice. Capacity of the signatories is not stated if required. Not endorsed or incorrectly endorsed. • Invoice Description of the goods differs from that in the LC. Not made out in the currency of the Credit. Amount differs from that of the LC. Amount differs from that of the Bill of Exchange. Prices of goods differ from those indicated in the LC. Price basis and shipment terms omitted. Extra charges included that are not specified in the LC. Is not certified, notarized or signed as required by the credit. Does not contain a declaration required under the LC. Buyer’s name differs from that mentioned in the LC. Is not issued by the Seller. Be consistent with each other. • Bill of Lading Not presented in full set when requested. Alterations not authenticated by an official of the shipping company or its agents. Is not clean, ie. carries remarks that the condition and/or the packaging of the merchandise is defective. Is not marked ‘on board’ when so required. ‘On board’ notation not dated. Is not endorsed by the Seller when drawn ‘to order’. Is not marked ‘freight paid’ as stipulated in the LC in respect of Cost & Freight and Cost Insurance & Freight contracts. Is made out ‘to order’ when the LC stipulated ‘direct to consignee’ (Buyer) and vice versa. Is dated later than the latest shipping date specified in the LC. Is not presented within 21 days after date of shipment or such time as specified in the LC. Description of goods other than that specified in the LC. Rate at which freight is calculated, and total amount, not shown when LC requires these details. • The following are only acceptable if expressly allowed in the Letter of Credit: Shipment ‘on deck’, ie. the goods are not stored in the hold. Shipment from a port or to a destination other than that stipulated. Presentation of types of Bills of Lading not specifically authorized in the LC, eg. a Charter party Bill of Lading, or a Forwarding agent’s Bill of Lading. • Insurance Amount of cover is sufficient. Does not include risks mentioned in the LC. Is not endorsed by the insured and/or signed by the insurers. Certificate or policy bears a date later than the date of shipment/dispatch, except where warehouse-to-warehouse is indicated. Incorrect description of goods. Alterations are not authenticated. Is not in transferable form when required. Carrying vessel’s name not recorded. Does not cover transshipment when Bills of Lading indicate it will take place. Please note: When the above documents and any other documents are required by a Letter of Credit, they should: • Comply with the stipulated conditions of the LC • Be properly signed • Have all alterations properly authenticated.

6. Shipping documents are prepared and submitted to the Advising Bank by the Seller

When all details of the transaction have been decided, the goods are dispatched. The Seller then prepares the shipping documents and submits them to the Advising Bank. Preparation of Shipping Documents When assembling the documents for presentation to the bank, the Seller must make sure that the documents match the LC. The following must be ensured: 1. The Seller has the correct number of copies and originals Also ensure that they contain the information called for, that the title of all the documents is correct and they are issued by the party specified in the LC. The document name must match exactly what the LC calls for. 2. They are consistent with each other The shipping marks, quantities/weights, transport details, references and general descriptions must all be consistent to ensure that they clearly relate to the same shipment. 3. The description of the goods is correct Goods may be described in general terms in all documents except the invoice, where the exact LC description must be reproduced. 4. The documents are authenticated Import regulations in some countries require the documents to be signed manually and any alterations or additions witnessed. Submission of documents to the Advising Bank Once prepared, the shipping documents need to be presented to the Advising Bank without delay. Be aware of the following: • The documents must be complete and delivered to the bank by close of business on the expiry date and within the transport document time limit, whichever is earlier • The transport document time limit is 21 days from the date of shipment unless the credit gives a longer or shorter period • The import license expiry date is important and it may not be possible to extend • If any discrepancies are found and they can be put right, the corrected documents must still be presented to the bank by the original expiry date and within the presentation period. The following documents must all be in order. Transport Document Ensure these include the right type of transport, places and ports, have the correct consignor and consignee, date of shipment and ‘freight paid’ notation. Insurance Document Ensure that this is of the correct type, amount and currency as stipulated in the LC. The date must be no later than the date of issue of the transport document, unless the insurance document clearly states that cover takes effect from the date of shipment/receipt of cargo, ie. warehouse-to-warehouse. Invoice The Buyer and Seller’s names and details, the description of the goods and the clauses or statements must all appear exactly as they are in the LC. The value must not be more than the LC permits, though you can under certain conditions sometimes under-draw by up to 5%. A 5% variation is sometimes permitted, alternatively the LC may permit a specific variation such as an ‘about’ amount having a 10% variation. Bills of Exchange Ensure that the date, amount and currency are all correct, that the words and figures agree and that it is drawn on the correct party. Also check the endorsement, clause, and Letter of Credit reference number and ensure the signature identifies the signatory. Covering note/letter to Advising bank The note/letter must include the Seller’s contact details. Include a request that the bank notifies any discrepancies by fax or telephone rather than mail. Indicate how to be paid and include account details. Provide details if the Seller has a forward currency contract. Any other documents Ensure all other documents are from the correct issuer, have the correct wording and content, clearly relate to the goods invoiced and are all signed and endorsed as necessary. Also ensure that all communications are correctly set out, addressed and dated and that no documents are enclosed that are not required.

5. Goods are shipped

Goods should be dispatched according to the specific terms of the Documentary Letter of Credit.

4. LC is received by Advising Bank, which checks the LC, then passes it on to the Seller

The Letter of Credit will be received by a bank in the Seller’s country, which will authenticate it and check that its terms and conditions are workable. They then pass the Letter of Credit on to the Seller. Please note that if the bank is merely passing the Letter of Credit on to the Seller, they are known as the Advising Bank. However, if the bank is adding their undertaking to pay, they become the Accepting Bank Checking the LC The Seller, or Beneficiary (of LC), should make the following checks when the LC arrives to ensure that the terms match those originally agreed with the Buyer. 1. Is the Letter of Credit subject to the latest version of the Uniform Customs and Practice for Documentary Credits (UCP) of the International Chamber of Commerce? 2. Check the Authenticity of the LC If LC’s are received that depart from the routine of being sent to the Seller from an Advising/Confirming Bank. The bank should be authenticated. 3. Does the type of LC give the required level of security? Is confirmation of the LC required? If so, establish whether the LC is in fact confirmed, thus carrying the extra and separate undertaking of a second bank. Also establish whether it is revocable or irrevocable. Remember revocable LCs can be cancelled without the Seller’s prior knowledge. LCs issued under UCP600 are assumed to be irrevocable. 4. Is the LC payable when and where requested? The LC may specify payment at sight, ie. when the correct documents are presented to the Paying Bank, or at a later date, a set period of time after the documents have been accepted. With payment abroad please note that the Seller is responsible for postal delays in presenting documents overseas within the time limits set by the expiry date. 5. Is the value of the LC correct? Ensure the LC covers the full invoice value, incorporating any additional costs such as freight and/or inspection fees. 6. Are the Buyer and Seller’s details correct? Ensure the Seller’s name and address are spelt correctly and that they are shown exactly as they are on the invoice heading. Similarly, ensure the Buyers’s name and details are copied from the invoice. 7. Are the terms of shipment correct? Ensure that the terms of shipment are the same as you quoted and that they match the price properly. 8. Are all the charges correct? Ensure that only the bank charges that have been agreed to pay are stated. Pay particular attention to bank reimbursing charges with an LC not expressed in sterling. 9. Can the expiry date be met? Ensure that the Seller can present the documents within the terms of the LC. 10. Make sure that time is allowed for the following: • production and packaging • inspection • shipment • chamber of commerce and consular work • obtaining the inspection certificate • assembling and checking documents • presenting documents to the bank. 11. Can you provide the transport documents called for? Ensure that you are able to provide any transport documents required. Amendments If the Letter of Credit is wrong or ambiguous in any way, or the Seller cannot comply with any of the terms, the Seller should contact the Buyer to request that the LC is amended. If this is agreed, the Buyer would then ask their bank to issue an amendment. If no amendment is made, there is a risk of non-payment. If you are in doubt about any of the terms of the LC, always consult the Advising Bank for advice. Also remember that only the Buyer can authorize amendments or extensions through their bank. It is advisable for an individual within the Seller’s company to act as a co-ordinator of progress of the transaction for the Letter of Credit between the insurance company, the freight forwarder and all departments within the company.

3. Buyer’s Bank, the Issuing Bank, issue the LC to the Seller’s Bank, the Advising Bank

Assuming that the value of the Letter of Credit is within the Buyers’ facilities, their bank, the Issuing Bank, issues the Letter of Credit in favor of the Seller.

2. Buyer instructs their bank, the Issuing Bank, to open an LC in favor of the Seller

Application Form

At this stage the Buyer fills in the bank’s Letter of Credit application form with full details to replicate the contract agreed with the Seller. The Buyer must ensure the form avoids ambiguity, fully reflects the commercial contract and is not so complex as to make the transaction unworkable.

Terms of Payment

Documentary credits may be made available in one of four ways.

 

1. Sight Payment

This is where payment is made to the Seller, upon presentation of conforming documents. A sight Bill of Exchange, also called a Draft, is usually called for, though payment can be made against documents alone.

 

2. Deferred Payment

A deferred payment does not require the presentation of a draft. The Paying Bank is authorized to make payment at an agreed future date against presentation of conforming documents. The future date for payment is defined in the Letter of Credit usually as a number of days after the date of dispatch of goods or after the date of presentation of the documents.

 

3. Acceptance

An Acceptance LC requires presentation of a draft drawn on the bank nominated as Accepting Bank. If the terms of the LC are met, the draft is then accepted by the bank and is payable at a determinable future date. This will be detailed in the Letter of Credit as either a fixed future date, or a specific number of days from the date of dispatch of goods, or from the date of presentation of the documents.

 

4. Negotiation

With a Negotiable LC, the Issuing Bank must reimburse the bank, which negotiates drafts or documents drawn under its documentary LC. The credit may be made freely negotiable with any bank, or negotiation may be restricted to a bank nominated by the issuing bank. Under this type of LC, the Seller is responsible for any negotiation interest unless the Buyer specifically authorizes the Negotiating Bank to charge interest to their account.

 

Payment at the counters of the Issuing Bank

In this case the conforming documents have to be received by the Issuing Bank within the presentation period. Payment is only then made to the Beneficiary or Advising Bank.

Special Types of Letters of Credit

Transferable

Transferable Letters of Credit are used when the Seller is acting as an intermediary between the Buyer and Seller in a commercial transaction. In this instance, all of the rights and obligations of the LC are transferred from the intermediary to the ultimate supplier. The intermediary has no liability.

 

The terms of the transferred LC must be the same as the original except for the amount, unit price, expiry date, latest presentation date and period of shipment. All of these may be reduced, or brought forward.

 

The identities of the Buyer and the ultimate supplier may need to be withheld from each other. Careful drafting of the original and transferred Letter of Credit is needed to ensure this occurs.

 

Back-to-Back

In this instance, two LCs are established completely independently of each other. The Buyer establishes theirs in the Seller’s favor. The Seller can then arrange a second LC in favor of the ultimate supplier of the goods or the supplier of raw materials.

 

This type of LC should only become necessary where the underlying contracts are on terms which do not match or where a Transferable LC is unable to maintain secrecy on a particular aspect of the transaction.

 

Revolving

If aSeller makes regular shipments to a particular Buyer under a long-term supply contract, it may be beneficial for a series of shipments to be secured by a single documentary LC.

 

A Revolving LC can achieve this by the LC being reinstated for the original amount after a given period, and allowing the value of the LC to be drawn each time a shipment of goods is undertaken.

 

Be aware that as this is a continuing liability, it will have an impact on banking facilities.

 

Advance Payments

An LC that contains a clause, which authorizes the nominated bank to advance a portion of the value of the LC to the Seller before shipping documents are presented. This enables the Seller to purchase raw materials or to pay other costs before receiving the full payment, once conforming documents have been presented.

 

Advances are made at the risk of the Buyer. Drawings under an LC are made against a simple receipt from the Seller that they will refund the amount if they do not ship the goods as required. The Buyer’s account is debited as soon as an advance has been made.

 

Standby

A Standby Letter of Credit is a type of trade debt guarantee that is only drawn against in the event that the Buyer defaults in some way, eg. fails to pay for a consignment within an agreed period. A standby LC includes an expiry date, but no latest shipment date. Standby LCs will normally call for a statement of default from the Seller and also evidence of default.

 

1. Buyer & Seller negotiate terms of the contract for the Product

Financial considerations

Seller:

• Name and address of the Buyer’s bank

• Status enquiry on the Buyer (Strength to hold a Letter of Credit)

• Confirm the Buyers Bank, verify strength of institution

• Currency exchange rate fluctuation

• Risk of non-payment by buyer’s bank due to country risk

Buyer:

Buyer will need to request a specific bank facility for Documentary Letters of Credit before any instructions can be issued. In assessing the level of facilities required, you will need to consider:

• The anticipated turnover. The facility will need to cover the total value of LCs the Buyer expects to have outstanding at any one time

• The Buyer’s maximum potential period of liability. This includes both the maximum validity period of the LC and the maximum term of the contract. The Buyer may need to allow the Seller some ‘lead time’ in order to organize the goods ready for transportation

To keep the costs of the transaction down, the Buyer should keep the validity period and any extended credit terms as short as possible, thus reducing the overall level of facilities required.

Supply Considerations

• Delivery periods on goods

• Delays with particular goods (eg. through logistic delays, such as loading, port space etc)

• Pre-shipment inspection.

Shipping Considerations

• Methods of transport available, direct or indirect

• Frequency of departures

• Approximate costs of alternative methods/routes

• Type of packing

• Correct Incoterms according to contract/transport mode.

• Optimum delivery point, ie. Transported from where to where?

• Goods insurance

• Delays for consular work or inspection formalities.

Agreeing Terms of Letter of Credit

To reduce unnecessary costs and delays in amending the Letter of Credit after it has been established, we strongly recommend that the Seller send the Buyer a template of the terms and conditions that they wish to be included.