assuring payment to a seller of goods or services provided certain documents have been presented

to the bank. "Letters of Credit" are documents that prove the seller has performed the duties

under an underlying contract and the goods have been supplied as agreed. In return for

these documents, the beneficiary receives payment from the financial institution that

issued the letter of credit. The letter of credit serves as a guarantee to the seller

that it will be paid regardless of whether the buyer ultimately fails to pay. In this

way, the risk that the buyer will fail to pay is transferred from the seller to the

letter of credit's issuer. The letter of credit can also be used to ensure that all the agreed

upon standards and quality of goods are met by the supplier, provided that these requirements

are reflected in the documents described in the letter of credit.

Letters of credit are used primarily in international trade for transactions between a supplier

in one country and a customer in another. Most letters of credit are governed by rules

promulgated by the International Chamber of Commerce known as Uniform Customs and Practice

for Documentary Credits. They are also used in the land development process to ensure

that approved public facilities will be built. The parties to a letter of credit are the

supplier, usually called the beneficiary, the issuing bank, of whom the buyer is a client,

and sometimes an advising bank, of whom the beneficiary is a client. Almost all letters

of credit are irrevocable, i.e., cannot be amended or canceled without the consent of

the beneficiary, issuing bank, and confirming bank, if any. In executing a transaction,

letters of credit incorporate functions common to giros and travelers' cheques.

Terminology Origin of the term

The name "letter of credit" derives from the French word "accréditation", a power to do

something, which derives from the Latin "accreditivus", meaning trust.

Related terms A sight LC means that payment is made immediately

to the beneficiaryexporter upon presentation of the correct documents in the required time

frame. A time or date LC will specify when payment will be made at a future date and

upon presentation of the required documents. Negotiation means the giving of value for

draft(s) or document(s) by the bank authorized to negotiate, viz the nominated bank. Mere

examination of the documents and forwarding the same to the letter of credit issuing bank

for reimbursement, without giving of value / agreed to give, does not constitute a negotiation.

Documents that can be presented for payment To receive payment, an exporter or shipper

must present the documents required by the letter of credit. Typically, the payee presents

a document proving the goods were sent instead of showing the actual goods. The Original

Bill of Lading is normally the document accepted by banks as proof that goods have been shipped.

However, the list and form of documents is open to negotiation and might contain requirements

to present documents issued by a neutral third party evidencing the quality of the goods

shipped, or their place of origin or place. Typical types of documents in such contracts

might include: Financial Documents

Bill of Exchange, Co-accepted Draft Commercial Documents

Invoice, Packing list Shipping Documents

Transport Document, Insurance Certificate, Commercial, Official or Legal Documents

Official Documents License, Embassy legalization, Origin Certificate,

Inspection Certificate, Phytosanitary certificate Transport Documents

Bill of lading, Airway bill, Lorry/truck receipt, railway receipt, CMC Other than Mate Receipt,

Forwarder Cargo Receipt, Deliver Challan...etc Insurance documents

Insurance policy, or Certificate but not a cover note.

Legal principles governing documentary credits One of the primary peculiarities of the documentary

credit is that the payment obligation is independent from the underlying contract of sale or any

other contract in the transaction. Thus the bank’s obligation is defined by the terms

of the letter of credit alone, and the sale contract is irrelevant. The defenses available

to the buyer arising out of the sale contract do not concern the bank and in no way affect

its liability. Article 4(a) UCP states this principle clearly. Article 5 the UCP further

states that banks deal with documents only, they are not concerned with the goods. Accordingly,

if the documents tendered by the beneficiary, or his or her agent, appear to be in order,

then in general the bank is obliged to pay without further qualifications.

Policies behind adopting the abstraction principle are purely commercial, and reflect a party’s

expectations: first, if the responsibility for the validity of documents was thrown onto

banks, they would be burdened with investigating the underlying facts of each transaction,

and less inclined to issue documentary credits as the transaction would involve great risk

and inconvenience. Second, documents required under the letter of credit could in certain

circumstances be different from those required under the sale transaction. This would place

banks in a dilemma in deciding which terms to follow if required to look behind the credit

agreement. Third, the fact that the basic function of the credit is to provide a seller

with the certainty of payment for documentary duties suggests that banks should honor their

obligation notwithstanding allegations of misfeasance by the buyer. Finally, courts

have emphasized that buyers always have a remedy for an action upon the contract of

sale, and that it would be a calamity for the business world if, for every breach of

contract between the seller and buyer, a bank were required to investigate said breach.

The “principle of strict compliance” also aims to make the bank’s duty of effecting

payment against documents easy, efficient and quick. Hence, if the documents tendered

under the credit deviate from the language of the credit the bank is entitled to withhold

payment even if the deviation is purely terminological. The general legal maxim de minimis non curat

lex has no place in the field of documentary credits.

Definitions of related terms The Bank which advises a Letter of Credit

to the Beneficiary at the request of the issuing Bank is known as the Advising Bank

Applicant: Applicant is the party on whose request the issuing bank issues a credit .

Banking day: The day on which a bank is regularly open at the place at which an act to be performed.

Beneficiary: Beneficiary is the party who is to receive the benefit of the LC. The consignee

of an LC and the beneficiary may not be the same. The credit is issued in his favor.

Presentation: Presentation is either delivery of documents against an LC or the document

itself.Complying presentation : A presentation is said to be complying presentation when

it is in accordance with: i. the terms and conditions of the credit,

ii. the applicable provisions of UCP and iii. international standard banking practice.Confirmation:

Confirmation is a definite undertaking from the confirming bank to honor or negotiate

a complying presentation in addition to that of the issuing bank.Confirming bank: The Bank

which adds confirmation to an LC is termed as Confirming Bank. It does so at the request

of the issuing bank and taking authorization from the issuing bank.Letter of Credit/ Credit:

Credit is a definite undertaking of the issuing bank to honor a complying presentation. According

to UCP all credit must be Irrevocable.Honour: Honour means act according to commitment of

the LC. Presentations are honored in different ways depending on the type of credit like.

i. Making payment at sight for sight LC ii.By incurring a deferred payment undertaking and

paying at maturity deferred payment LC. iii. by accepting a Draft drawn by the beneficiary

and paying at maturity for Deferred Acceptance LC.

Issuing bank: The bank which issues a credit is known as issuing bank.Nominated Bank: The

bank with which credit is available is termed as Nominated Bank of that credit. If no bank

is mentioned in the credit as nominated bank, all banks are nominated bank.

Negotiation: A bank is said to negotiate a document if it purchases a draft or documents

under a complying presentation either by making advance or agreeing to advance funds to the

beneficiary on or before the date on which reimbursement is due to the nominated bank

. A draft drawn on a nominated bank can not be purchased by itself.

Different types of letters of credit Import/export Letter of Credit

The same credit can be termed as import and export LC depending on whose perspective it

is being looked upon. For the importer it is termed as Import LC and for the Exporter

of goods, Export LC. Revocable Letter of Credit

In this type of credit, buyer and the bank which has established the LC, are able to

manipulate the letter of credits or make any kinds of corrections without informing the

seller and getting permissions from him. According to UCP 600, all LCs are Irrevocable, hence

this type of LC used no more. Irrevocable LC

In this type of LC, Any changes or cancellation of the LC is done by the Applicant through

the issuing Bank. It must be authenticated by the Beneficiary of the LC. Whether to accept

or reject the changes, depends on the beneficiary. Confirmed LC

An LC is said to be confirmed when another bank adds its additional confirmation to honor

a complying presentation at the request or authorization of the issuing bank.

Unconfirmed LC This type of letter of credit, does not acquire

the other bank's confirmation. Transferrable LC

A Transferable Credit is the one under which the exporter has the right to make the credit

available to one or more subsequent beneficiaries. Credits are made transferable when the original

beneficiary is a middleman and does not supply the merchandise himself but procures goods

from the suppliers and arrange them to be sent to the buyer and does not want the buyer

and supplier know each other. The middleman is entitled to substitute his own invoice

for the one of the supplier and acquire the difference as his profit in transferable letter

of credit mechanism. Important Points of Consideration:

A letter of credit can be transferred to the second beneficiary at the request of the first

beneficiary only if it expressly states that the letter of credit is "transferable". A

bank is not obligated to transfer a credit. A transferable letter of credit can be transferred

to more than one second beneficiary as long as credit allows partial shipments.

The terms and conditions of the original credit must be indicated exactly in the transferred

credit. However, in order to keep the workability of the transferable letter of credit below

figures can be reduced or curtailed. • Letter of credit amount • any unit price

of the merchandise • the expiry date • the presentation period or • the latest shipment

date or given period for shipment. The first beneficiary may demand from the

transferring bank to substitute his name for that of the applicant. However, if a document

other than invoice required in the transferable credit must be issued in a way to show the

applicant's name, in such a case that requirement must be indicated in the transferred credit

will be given free. Transferred credit cannot be transferred once

again to any third beneficiary according to the request of the second beneficiary.

Untransferable LC It is said to the credit that seller cannot

give a part or completely right of assigned credit to somebody or to the persons he wants.

In international commerce, it is required that the credit will be untransferable.

Deferred / Usance LC It is kind of credit that won't be paid and

assigned immediately after checking the valid documents but paying and assigning it requires

an indicated duration which is accepted by both of the buyer and seller. In reality,

seller will give an opportunity to the buyer to pay the required money after taking the

related goods and selling them. At Sight LC

It is a kind of credit that the announcer bank after observing the carriage documents

from the seller and checking all the documents immediately pays the required money.

Red Clause LC In this kind of credit assignment, the seller

before sending the products, can take the pre-paid or part of the money from the bank.

The first part of the credit is to attract the attention of the acceptor bank. The reasoning

behind this, is the first time this credit is established by the assigner bank, it is

to gain the attention of the offered bank. The terms and conditions were written by red

ink, going forward it became famous with that name.

Back to Back LC This type of LC consists of two separated

and different types of LC. First one is established in the benefit of the seller that is not able

to provide the corresponding goods for any reasons. Because of that reason according

to the credit which is opened for him, neither credit will be opened for another seller to

provide the desired goods and sends it. Back-to-back L/C is a type of L/C issued in

case of intermediary trade. Intermediate companies such as trading houses are sometimes required

to open L/Cs by supplier and receive Export L/Cs from buyer. SMBC will issue a L/C for

the intermediary company which is secured by the Export L/C. This L/C is called "Back-to-back

L/C". The price of letters of credit

All the charges for issuance of letter of credit, negotiation of documents, reimbursements

and other charges like courier are to the account of applicant or as per the terms and

conditions of the letter of credit. If the Letter of Credit is silent on charges, then

they are to the account of the Applicant. The description of charges and who would be

bearing them would be indicated in the field 71B in the letter of credit.

Legal basis Legal writers have failed to satisfactorily

reconcile the bank’s undertaking with any contractual analysis. The theories include:

the implied promise, assignment theory, the novation theory, reliance theory, agency theories,

estoppels and trust theories, anticipatory theory, and the guarantee theory. Davis, Treitel,

Goode, Finkelstein and Ellinger have all accepted the view that documentary credits should be

analyzed outside the legal framework of contractual principles, which require the presence of

consideration. Accordingly, whether the documentary credit is referred to as a promise, an undertaking,

a chose in action, an engagement or a contract, it is acceptable in English jurisprudence

to treat it as contractual in nature, despite the fact that it possesses distinctive features,

which make it sui generis. Although documentary credits are enforceable

once communicated to the beneficiary, it is difficult to show any consideration given

by the beneficiary to the banker prior to the tender of documents. In such transactions

the undertaking by the beneficiary to deliver the goods to the applicant is not sufficient

consideration for the bank’s promise because the contract of sale is made before the issuance