Letter of credit

The letter of credit (or letter of credit ) is an engagement of payment of a bank at another bank, generally of another country, against presentation of documents in conformity.

It is more known today under the name of credit on security , commonly called “crédoc”, and is sometimes indicated by “L/C”, abbreviation of letter off credit .

History

The letter of credit was one of the first tools for payment remotely emitted with the Moyen-âge by the bankers Hanseatic Lombards and as well as the templiers.

Practical

Objective and Context

The Credit on security today is very much used to make safe the transactions of international business.

The credit on security is the operation by which a transmitting bank engages of order and for account of its importing customer, the “client”, to regulate with an exporting third, the “recipient”, within a given period of time, via an intermediate bank (or banks advising) an amount determined against the handing-over of documents strictly in conformity justifying the value and the forwarding of the goods.

The credit on security is subjected to the Uniform Règles and Usances as regards credit on security of the international Chamber of commerce. The bank charge of the international Chamber of commerce revised these Rules and Usances by decision of October 25th, 2006 with coming into effect on July 1st, 2007. It is about the publication n° 600 of the CCI. The principal modifications of this new version of the RUU consist of a simplification of the applicable principles, the number of articles of the RUU having been tiny room from 49 to 39 besides.

Actors

the English client (: applicant ) is the purchaser or the Importateur who is the initiator of the credit on security near his bank.
the transmitting bank is that of the client who emits the credit on security.
the notifying bank is that which receives the credit on security and transmits it to the recipient. According to the cases it can confirm it.
the recipient is the exporter which receives the credit on security via its bank.
the negotiating bank: when the credit allows it, the recipient can give the documents and request the payment from another bank that the notifying bank.

Types of Appropriations

Notified/Confirmed : a notified credit is simply transmitted to the recipient by the advising bank, without any commitment to pay. In this case, the recipient is not protected from the default risk from the transmitting bank or the risk from not-transfer from the funds (" risk; pays" ). If the credit is confirmed, the advising bank is committed by its confirmation regulating the recipient against presentation of documents in conformity, including in the event of defect of the bank or the transmitting Country. The confirmation is primarily useful towards the countries known as " with risques". The study of the risk is only responsibility for the advising Bank (article 9 of the RUU). One needs that the confirmation is authorized, by the transmitting bank, in the opening. If it is not authorized, the advising bank can, however, bring a guarantee of payment to the recipient through a " confirmation silencieuse" or the concluding of a contract of " ducroire". This operation brings a safety to the salesman who, in the event of failure of the transmitting bank, will see himself paying by the setting concerned of this guarantee.

Revocable/Irrevocable : the uniform rules and usances 600 which come into effect on July 1st, 2007 remove the concept of credit revocable. A revocable credit can be cancelled by any of the parts. It is thus contrary with the spirit of the credit on security because no guarantee of payment brings. For this reason, the majority of the Credits on security are irrevocable today. They cannot then be cancelled that by a joint agreement of the whole of the parts.

Transferable/Nontransferable : if a credit is transferable, whole or part of the amount of the credit can be transferred to one or more profit seconds, without the agreement of the client not being necessary. It is in particular the case when the salesman is not the manufacturer of the goods and that it calls upon a subcontractor. Thus the payment can be solicited by another company that the recipient appearing in the opening. On the other hand, the change of recipient of a nontransferable credit must be the modification object requested from its bank by the client.

Negotiable any banks or near a bank only : if the credit is negotiable in all the banks (in general restricted with a country), the recipient can choose the bank near which it will negotiate the credit and will deposit the documents. In the contrary case, the bank is imposed.

Unfolding

the recipient and the client get along on a commercial contract .
the client (importing) request at his bank the opening of a credit on security in favor of the recipient, in accordance with the contract.
the banks transmitting emits the credit on security near the bank of its choice indicated then as Banque advising/Confirming. It then lists the whole of the details and conditions of the contract and begins to pay the bank of the recipient if this one presents documents strictly in conformity to him with the terms of the credit (and in agreement with the Rules and Usances RUU). The exchanges between the banks are generally made by means of the protected system SWIFT.
the banks Notificatrice transmits the credit to the recipient. If the credit is open in the form " confirmable" , the advising bank has the choice to confirm or not the credit (study of the Pays risk and Banque risk). In this case, it must warn the transmitting Bank of it and the credit is simply notified to the recipient, without engagement on behalf of the advising bank (article 9 of the RUU).
the profit (exporting salesman/), if it is in agreement with the whole of the conditions of the credit, is able to respect them and to present documents in conformity, can then carry out the contract and dispatch the goods. Failing this it will have to intervene with the client to make amend the credit by the transmitting Bank, this to be certain to respect the whole of the clauses and to obtain the payment.
the recipient gathers the whole of the documents necessary by making sure that none of them comprises irregularities within the meaning of the conditions of the credit and the Rules and Usances. If the least irregularity is raised, the documents could be rejected and the recipient will not receive any payment.
the recipient gives the documents to his bank. If the credit authorizes it and if the documents are in conformity, it can negotiate an advance of payment, under deduction of interests.
the bank negociator has 7 working days for to study the documents and to determine if they are in conformity.
* If it are in conformity , it transmits them to the transmitting bank for payment.
* If they comprise irregularities , it can nevertheless transmit them, with the agreement of the recipient, at the transmitting bank for acceptance, notwithstanding the irregularities.
the banks transmitting also has 7 days with reception of the documents to study them and notify possible reserves or irregularities at the bank which addressed the documents to him.
* If the documents are declared in conformity , it will have to regulate them according to the instructions of payment envisaged with the opening or specified by the giving Bank.
* If the documents are irregular , it can reject them or submit the irregularities to the client. The client can then refuse or accept the documents.
In the event of refusal of the documents, those are turned over to the recipient who remains owner of the goods. No payment is carried out.
When the documents are accepted, the transmitting bank sends an opinion of raised reserves to the bank negociator, if necessary.
the documents are transmitted to the client who becomes owner of the goods.
the transmitting bank regulates the bank negotiating in accordance with the credit:
* saw : the payment is carried out as soon as the documents are recognized in conformity or as of the lifting of the reserves.
* At the limit , in the other cases.

Documents

Essential documents:

commercial Invoice ( invoice in English). This one must indicate the description of the goods or the service, the amount to be regulated, the currency and the Incoterm
Document of transport, attesting forwarding of the goods. This one can be:

a maritime Bill of lading ( Bill off Lading in English), in the case of maritime transport.
a Consignment note ( Airway Bill in English), if forwarding by plane.
a Freight bill or CMR if forwarding by the road.

Additional documents can be necessary in order to make sure of the good execution of the contract:

Liste of weight/packing
Police or certificate of Assurance of the goods during its transport, if Incoterm of the group C (CIF/CIP) or D.
Certificate of origin, to allow the taking out of bond of the goods.
various Certificates, according to the nature of the goods.

List nonexhaustive.

Principal irregularities

English irregularities (: discrepancies ) is very frequent and deprives the recipient of very guaranteed payment. Most frequent concern:

fallen Credit : the credit on security comprises a date and a place of expiry. The recipient will have to respect this date and this place of expiry, in particular if the credit expires in the country of the client. He will have to then present the documents to his bank sufficiently early so that they are studied and transmitted before the expiry.
old Documents : the credit specifies usually a time of presentation of the documents at the bank as from the date of forwarding of the goods.
late Forwarding : the opening specifies a deadline of forwarding.
Errors of the wording of the coordinates of the recipient or the client in the documents : The indications of name, company name or addresses specified in the opening must be scrupulously respected in the documents.
etc

Amendments

The amendments with the credit follow the same course as the initial opening: asked by the client, they are emitted by the transmitting bank then notified to the recipient by the advising bank.

Advantages and disadvantages

Advantages

The credit on security makes safe the transactions of international business. It brings the safety of the guarantee of a bank in a context where the actors, their practices and their solvency are risk factors with difficulty appréhendables by an actor out of the country.

The credit on security formalizes the transaction by writing the contract in a standardized form. He encourages in that the International business of goods.

Disadvantages

The credit is only one engagement to pay on presentation of the documents. It does not constitute of anything an engagement on conformity goods! The purchaser does not have any recourse if the documents are in conformity but not the quality of the goods. The Acheteur (which will have had to cover the Banque payment carried out) is not nevertheless not stripped, insofar as it can always act against the Vendeur under the terms of their subjacent Contrat of Vente, whose the act of credit on security is thus abstract.

See Too

Books and official publications on the Letter of credit:

To find a list nonexhaustive of the books and publications of reference as regards Letter of credit which were indexed by specialists in the field: Letter of credit publications.

Internal bonds

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