Documentary Credit(Letter of credit) – Payment Under International Trade

Documentary credit is the most used means of payment in international transactions(trade); it implies for the exporter a greater level of security in the collection of his sales. Being a given order by the importer to the issuing bank, which executes the payment against the documents required within the credit´s terms and conditions. Again a documentary credit is an undertaking given by a bank (issuing bank) of a stated amount to the seller (beneficiary) on the instruction of the buyer (applicant) to pay at sight or to a future date. [Banco Nacional de Cuba]

On the contrary a Bank Guarantee is a commitment of payment of the issuing bank in favor of a beneficiary, is the instrument that accompanies international contracts and the supply of goods of all kind, the provision of services, the execution of labor and any other loan contracts. It is issued by the Bank guaranteeing the payment to Beneficiary in case the client does not execute the payment. [Banco Nacional de Cuba]

Letters of Credit Types

The documentary credit is one of the most secure payment methods in international trade, offering the exporter a conditional payment guarantee from the importer’s bank. A commercial Bank offers multiple types of LC-

Irrevocable Letter of Credit -An irrevocable letter of credit cannot be amended or cancelled without the consent of the issuing bank, the confirming bank, if any, and the beneficiary. The payment is guaranteed by the bank if the credit terms and conditions are fully met by the beneficiary. The words “irrevocable documentary credit” or “irrevocable credit” may be indicated in the L/C. In some cases, an irrevocable L/C received by the beneficiary may become invalid without the amendment or cancellation of such L/C, for example, when the trade between importing and exporting countries is suspended such as in a trade sanction, or when the issuing bank has ceased operation. There have been cases of an irrevocable L/C being amended without the consent of the beneficiary in the OEM arrangements. The beneficiaries affected were export-manufacturers from a developing country. The importers were able to convince and instruct the issuing bank to amend the latest date for shipment in the L/C, changing to a date earlier than the agreed upon date, at which time the beneficiary would not be able to ship the OEM products. The importers used sneaky tactics that aimed to cause the beneficiaries to default in the delivery. The intention of the importers was to cancel the orders from the existing OEM suppliers and buy from other suppliers in another developing country where the prices had become lower. In the event of an amendment like the above-mentioned case, the beneficiary must give notification of rejection of amendment to the bank that advised the amendment at once.[ AGRI EXCHANGE-GOVT OF INDIA]

Transferable Letter of Credit

Unconfirmed Letter of Credit

1. Letter of Credit at Sight: it requests the immediate payment.
2. Letter of Credit by Term: it´s a payment on future date according to terms established in the Letter of Credit.

Commercial Financing Modality: it´s granted by the exporter – the beneficiary is the importer (the issuer).

1. Bank financing Modality: under signed agreements among banks, Banco Nacional de Cuba executes the payment according to terms and conditions of the agreement.
2. Please Open Modality: For the opening of this Letter of Credit is not necessary the presentation of the Requesting model of Letter of Credit or Amendment, but the reception of a Swift MT-700 and MT-707 coming from a bank of the National System, which is directly rooted by the Operation Management area towards a specific machine in the Emission Management area.

Stand by Letter of Credit:

A standby documentary credit, on the other hand, is an undertaking which is activated only if something goes wrong between the buyer and the seller and the expected payment does not take place. It therefore allows the seller to enforce a claim. A standby documentary credit acts as a bank guarantee and is subject to international documentary credit rules and standby rules, whereas international guarantees are not subject to a common set of rules to the same extent.[Danske Bank London]

Restricted Negotiable and Freely Negotiable Letters of Credit :

Revolving Letter of Credit

Red Clause documentary credit –Red Clause documentary credit is a documentary credit authorizing the confirming bank of any other nominated bank to make advances to the beneficiary before presentation of the required documents.

The process of a documentary credit

1. The contract is made between the importer and the exporter.
2. The importer asks its bank to issue a documentary credit to the exporter.
3. The importer’s bank sends the documentary credit to the exporter’s bank (advising bank).
4. The exporter’s bank advises the exporter of the issue of the documentary credit.
5. After dispatch of the goods, the exporter delivers the required documents to its bank. The documents are examined against the terms and conditions stipulated in the documentary credit. If the requirements have been complied with, the exporter will be able to obtain payment.
6. The exporter’s bank sends the documents to the importer’s bank and receives payment either at sight or term.
7. The importer’s bank delivers the documents to the importer upon reimbursement, after which the goods may be handed over.

How does it work?

A documentary credit is a proven payment and processing instrument frequently used in cross-border transactions. It starts with a Contract. The contractual arrangement is triangular between the buyer, seller and the bank. It is evidenced by a Pro-Forma Invoice established by the seller which should feature[MCB Maldives]:

1. goods specifications
2. currency and amount payable
3. payment terms (sight or term)
4. shipment / delivery terms (CIF, FOB, etc)
5. mode of transport
6. latest shipment date
7. type of insurance (all risks, etc) (in case goods are insured by the supplier)
8. supplier’s bank details
9. for whose account are overseas bank charges ( buyer or seller)
10. whether the documentary credit needs to be confirmed by an overseas bank

Regulation and administration of  Documentary Credit

Documentary credits usually require the presentation of certain documents, which must be complied with before payment can take place. You must be aware that banks examine the documents only with respect to the documentary credit and do not look at contracts, agreements or the condition of the goods. Banks  have compiled a set of checklists to help you make sure that every document is filled in correctly [Danske Bank London]

Documentary credits are subject to a set of international rules entitled Uniform Customs and Practice for Documentary Credits (UCP), ICC Publication No. 600.

The rules are set forth by the International Chamber of Commerce (ICC) in Paris and are used by most banks worldwide.

In May 2000, the ICC appointed a task force to streamline international banking practice for documentary credit practitioners when checking documents.

The resulting guidelines – International Standard Banking Practice for the Examination of Documents under Documentary Credits (ISBP) – were intended to reduce the number of documents being rejected dramatically by encouraging a uniformity of practice worldwide. The ISBP was approved in 2002 and revised in 2007, making the documentary credit process easier and even more secure.

Standby letters of credit are usually subject to the same rules as commercial documentary credits, that is, UCP 600. But a growing number of standby documentary credits are subject to a newer set of rules, known as ISP98, which deals solely with this type of documentary credit.

Document checklist

1. Drafts/bills of exchange
2. Invoice
3. Bill of lading
4. Air waybill
5. CMR
6. Insurance
7. Packing list
8. Certificate of origin
9. Certificates and declarations
10. Legalising documents

Documentary credit checklist for EXPORTERS

• Is the text clear and unambiguous?
• Are the terms and conditions the same as those you agreed on with your customer?
• Is the documentary credit issued by an acceptable bank?
• Is the documentary credit subject to the international rules for documentary credits ?
• Can you comply fully with ALL the requirements?
• Are all the expressions in the documentary credit clear and unambiguous?
• Does the documentary credit contain contradictory requirements?
• Can the time limits for shipment and presentation of documents be met?
• Are the insurance requirements, if any, acceptable?
• Are the requirements for transport and transport documents acceptable?
• Is partial delivery or transhipment allowed, if needed?
• Are your name and address shown exactly as they appear in your documents?
• Are the buyer’s name and address shown correctly?
• Is the description of goods the same as in all the other documents?