LETTER OF CREDIT:

1. MEANING:

Letter of credit is considered to reduce risks in trade by shifting the

obligation to pay from the buyer to the bank which acts as a payment

guarantee in the transaction in return for the presentation of required

documents as mentioned in the letter of credit. In simpler words, A letter of

credit can be considered as a document issued by the bank that guarantees

the buyer’s payment to the seller, when the buyer is unable to make the

payment to the seller.

2. PARTIES INVOLVED:

 Applicant/Opener

 Bank

 Beneficiary

o APPLICANT/OPENER:

The buyer of goods becomes applicant for the letter of credit which is

issued on his request by the bank.

o BANK:

 ADVISING BANK: The bank operates in the beneficiary’s country and

involves instructing the letter of credit, attesting its authenticity to the

beneficiary.

 ISSUING BANK: The bank which issues the letter of credit and takes up

the responsibility of payment.

 CONFIRMING BANK: This bank also generally functions in the

beneficiary’s country. On the request or authorization of the issuing

bank, the confirming bank comes into the transaction to add its

guarantee to the letter of credit by taking responsibility in payment in

addition to the bank issuing letter of credit.

 NOMINATING BANK: The bank generally functions in the seller’s

country and is specifically given authorization by the issuing bank to

process the request and make the payment to the seller concerning the

letter of credit made by the issuing bank.

 REIMBURSING BANK: The bank in which generally the issuing bank has a

nostro account through which the payment is made to the nominated

bank and they are allowed to address the reimbursement claim posted .
o BENEFICIARY:

The seller in whose favor the letter of credit has been issued is beneficiary.

3. WORKING METHOD OF LETTER OF CREDIT:

o CONTRACT (Buyer to seller)

Buyer and seller belonging to different countries enter into a sales

contract, with a condition to make payment through letter of credit.

o APPLICATION (Buyer to issuing bank)

The buyer then files a letter of credit application to his Issuing Bank and

asks to issue the letter of credit against the pledge over documents

correlated to the transaction.

o LETTER OF CREDIT (Issuing bank to advising/confirming bank)

Issuing bank issues letter of credit and forwards it to advising/confirming

bank of the seller.

o EXAMINATION (Advising bank to the seller)

The seller’s bank scrutinizes the letter of credit issued and sends

information obtained to the seller.

o SHIPPING (Seller to buyer)
The seller after receiving the information dispatches the goods to the
buyer.

o PRESENTATION OF DOCUMENTS (Seller to advising bank)

The seller then presents all the necessary documents listed under the
letter of credit to the advising bank.

o PROCESSING OF DOCUMENTS (Advising bank to the issuing bank)

The presented documents are forwarded to the issuing bank for
scrutinization.

o PAYMENT BY ADVISING BANK (Advising bank to the seller)

If the documents needed are presented and in place, then the advising
bank initiates payment to the seller.

o REIMBURSEMENT (Issuing bank to the advising bank)

After scrutinization and verification of the documents produced, the
issuing bank initiates reimbursement for the payment made by the
advising bank to the seller.

o PAYMENT AND RELEASE OF DOCUMENTS (Buyer to the issuing bank)

Buyer to make payment to the issuing bank and the issuing bank to
release related documents after the payment.
4. TYPES OF LETTER OF CREDIT:

o REVOCABLE AND IRREVOCABLE LETTER OF CREDIT

The issuing bank in its power can cancel or amend the letter of credit

without the consent or prior notice to the beneficiary; such type is called

a revocable letter of credit. This type of credit is considered very non-

reliable as no bank will be ready to act as a confirmation bank in such

scenarios and whereas an irrevocable letter of credit cannot be made

subject to amendment or cancellation without the consent of the

parties.

o TRANSFERABLE LETTER OF CREDIT

In the case of transferable credit, the credit can be transferred by the

original beneficiary to others. It is pertinent to note that transfer can be

allowed only once and works only on the letter of credit which has a

clause that allows the transfer. This type of credit gives sellers their right

to instruct the advising bank to give credit to all the beneficiaries

involved in the transaction.

o BACK-TO-BACK LETTER OF CREDIT

In the event of the buyer unwilling to disclose his identity and unwilling

to initiate a transferable letter of credit, back-to-back credit comes into

play. In this type of credit, the beneficiary requests his banker to issue a

letter of credit in favour of the beneficiary’s supplier to help him with

the procurement of raw materials and goods required to fulfill the

contract made on the terms of the letter of credit.

o RED AND GREEN CLAUSE LETTER OF CREDIT

In the case of the red clause of the letter of credit, as per the authority

given by issuing bank to the nominated bank, the nominated bank

verifies the request of the beneficiary and provides pre-shipment credit

to the beneficiary. In the course of failure by the beneficiary to pay the

given advance amount to the nominated bank, the issuing bank shall be

held liable to make the due payment.

The green clause is similar to the red clause with certain additional

features like providing advance for the charges incurred in the process of

warehousing and insurance by obtaining warehouse receipts as security.

o CONFIRMED LETTER OF CREDIT

Confirmed letter of credit deals with only irrevocable credits. Along with

issuing bank, the confirmed banker also adds its own confirmation to the

letter of credit and becomes the party to such letter of credit.

o STANDBY CREDIT

In the event of indebtedness, borrowing of money, or any default in

performance of a contract suffered by the beneficiary, the issuing bank is

put forth in a position to be obligated to step forward to help the

beneficiary to perform his obligation.

o PAYMENT LETTER OF CREDIT

Payment or sight credit is a type that is more immediate and efficient

compared to other types of letter of credit. In this type, upon

presentation of the eligible documents to the issuing or nominating

banks, they are made available for payment on sight basis.

 o DEFERRED PAYMENT AND ACCEPTANCE LETTER OF CREDIT

The deferred payment is more like usance credit type, where the issuing

bank shall be responsible for the payment on the due date mentioned

on the letter of credit without drawing the bill of exchange. Whereas

acceptance letter is similar to deferred payment, except for the fact that

it mandates drawing of a bill of exchange.

o NEGOTIATION LETTER OF CREDIT

The negotiation in negotiation letter of credit can be restricted to a

specific bank or may be open to any bank willing to negotiate. Moreover,

in the failure of a negotiating bank to negotiate, it is always the

responsibility of the issuing bank to make the payments. A negotiating

bank becomes the holder in due course if its negotiation was effective.

5. ADVANTAGES OF USING A LETTER OF CREDIT

Letter of credit proves beneficial to both the seller and the buyer. It reduces

the risk of no-payment for the delivered goods on the part of the seller and

shifts the risk of the buyer to the bank. Developing trust in the process of

international trade is not easy, and a letter of credit provides a way through
 the risks that one may face. Since the letter of credit is beneficial to both

the seller and the buyer, it is important to discuss the benefits incurred by

both the parties.

FOR THE SELLER

 Bank has an obligation to pay for the shipped goods, this provides the seller

with sufficient assurance to carry forward its work.

 This same obligation reduces the risk of production in various cases, for

example, if the buyer changes the order, even then the seller has no

production risk.

 It also provides the seller with the opportunity of finance in the interim

period (this involves the period between the shipment of goods and

payment receipt).

 Since everything is mentioned in the letter of credit, it becomes easier for

the seller to strategize its production, since the date for shipment of goods

is given.

 Even on the complaint of goods, the buyer cannot refuse the payment to

the seller, this is yet another plus point of letter of credit.

Letter of credit does not only benefit the seller but also the buyer in various

aspects. The benefits incurred by the buyer has been discussed further:

FOR THE BUYER

 The bank can only pay the seller when after proper documentation and

scrutiny of whether the documents submitted are in line with the terms

mentioned in the letter of credit, this proves beneficial for the buyer.

 The buyer can control the various terms of the contractual relationship, for

example, the buyer can decide regarding the period required for the

shipment of goods and mention the same in the letter of credit.

 Letter of credits explicitly exhibits the solvency and willingness of the buyer.

 Letter of credit reduces the risk of repayment, and in cases of issuing a

letter of credit for delayed payments, the seller credits the buyer.

CASE LAWS:

1. Bawa Paulins Pvt. Ltd. v. UPS Freight Services India Pvt. Ltd. (2022)

2. Hindustan Steel Workers Construction Ltd. v. G.S. Atwal & Co. (1995)

3. Bank of Cochin Ltd. v. Mfrs. Hanover

4. Standard Retail Pvt. Ltd. & Ors v. M/s G.S. Global Corps & Ors
1. Bawa Paulins Pvt. Ltd. v. UPS Freight Services India Pvt. Ltd. (2022)

The Supreme Court of India ruled that a letter of credit is independent of the

underlying contract of sale. This case highlighted that the obligations under a

letter of credit are distinct and must be fulfilled regardless of any disputes

related to the sale transaction. The court reiterated that interference with the

autonomy of a letter of credit could lead to misuse by applicants, thereby

jeopardizing the interests of issuing banks in international finance.

2. Hindustan Steel Workers Construction Ltd. v. G.S. Atwal & Co.

(1995)

This landmark case established that a letter of credit is unqualified by the

contract of sale or any underlying transactions. The court emphasized the

autonomy of irrevocable letters of credit, asserting that courts should

refrain from interfering in such matters unless there is clear evidence of

fraud.

3. Bank of Cochin Ltd. v. Mfrs. Hanover

 This case dealt with confirming bank liability for wrongful honor of a letter

of credit, highlighting legal issues surrounding document compliance and

bank obligations in honoring LOCs. The court clarified that letters of credit

operate as financial instruments designed to allocate commercial risks, thus

underscoring the importance of adhering to specified conditions when

presenting documents for payment.

4. Standard Retail Pvt. Ltd. & Ors v. M/s G.S. Global Corps & Ors

In this case during the COVID-19 pandemic, the court rejected pleas to stay

honor on letters of credit due to external circumstances affecting contract

performance, affirming that LOCs are independent transactions not

influenced by disputes between contracting parties.

REFERENCE:

o www.ipleaders.com

o www.casetext.com
 INDEX

LETTER OF CREDIT

CONTENTS: PAGE NO.

1. MEANING 1
2. PARTIES INVOLVED 1-3
3. WORKING METHOD OF LETTER OF CREDIT 3-4
4. TYPES OF LETTER OF CREDIT 4-8
5. ADVANTAGES OF USING LETTER OF CREDIT 8-10

CASE LAWS:

1. Bawa Paulins Pvt. Ltd. v. UPS Freight Services India Pvt. Ltd. (2022)

2. Hindustan Steel Workers Construction Ltd. v. G.S. Atwal & Co.(1995)

3. Bank of Cochin Ltd. v. Mfrs. Hanover

4. Standard Retail Pvt. Ltd. & Ors v. M/s G.S. Global Corps & Ors