LETTER OF CREDIT
A written commitment to pay, by a buyer's or importer's bank (called the issuing
bank) to the seller's or exporter's bank (called the accepting bank, negotiating
bank, or paying bank).
A letter of credit guarantees payment of a specified sum in a specified currency,
provided the seller meets precisely-defined conditions and submits the prescribed
documents within a fixed timeframe. These documents almost always include a
clean bill of lading or air waybill, commercial invoice, and certificate of origin. To
establish a letter of credit in favor of the seller or exporter (called the beneficiary)
the buyer (called the applicant or account party) either pays the specified sum
(plus service charges) up front to the issuing bank, or negotiates credit.
Below are the most common documents required in an Import or Export Letter of
Credit1 and the definition of each document.
BILL OF LADING
A Bill of Lading is considered the most important document involved in a
shipment of merchandise. An exporter receives a Bill of Lading when delivering
the merchandise to the shipping company for transport to an importer.
ORDER BILL OF LADING
An Order Bill of Lading is a title document. Steamship companies issue one or
more original Order Bills of Lading per shipment, which allows an importer to
claim merchandise when it arrives. An exporter normally endorses the Bills of
Lading "in blank," which means that they are not endorsed to a specific person or
institution. The party possessing any one of the original Bills of Lading can take
possession of the goods.
AIRWAY BILL OF LADING (STRAIGHT BILL OF LADING)
This instrument does not convey title. Airline companies issue Straight Bills of
Lading called Airway Bills. Since an Airway Bill is issued only in non-negotiable
form, an exporter consigns it to a specific person or institution. A copy of the
Airway Bill accompanies a shipment, and an exporter is given the original to
present along with other required shipping documents. To take possession of the
merchandise, a party to which the merchandise is consigned needs to present
proper identification. Therefore, if the air shipment is consigned to a buyer, the
seller might lose control of the merchandise before payment is made. To help
prevent this, an Airway Bill should be consigned to Zions Bank.
COMMERCIAL INVOICE
A Commercial Invoice is a document that describes merchandise, as stated in the
Letter of Credit, and lists the costs. An importer may agree to pay, in addition to
the cost of the merchandise, charges involved in shipping the merchandise. The
description of the merchandise in the Commercial Invoice and the description of
the merchandise in the Letter of Credit must be identical in every way.
INSURANCE POLICY
Issued by an underwriting institution, the Insurance Policy states that a specified
party will be reimbursed an amount in the event merchandise is damaged or
destroyed. An Insurance Policy generally covers accidental losses and covers
voluntary losses when a cargo must be sacrificed to save a ship. For additional
cost, losses caused by spoilage, war, civil disturbance, riots and other risks can be
included in the coverage. Because commercial banks are not included in the
shipping business per se, questions regarding types of coverage should be
referred to a freight forwarder or a customs broker.
TYPES OF LETTER OF CREDIT
1. Irrevocable LC. This LC cannot be cancelled or modified without consent of the
beneficiary (Seller). This LC reflects absolute liability of the Bank (issuer) to the
other party.
2. Revocable LC. This LC type can be cancelled or modified by the Bank (issuer) at
the customer's instructions without prior agreement of the beneficiary (Seller).
The Bank will not have any liabilities to the beneficiary after revocation of the LC.
3. Stand-by LC. This LC is closer to the bank guarantee and gives more flexible
collaboration opportunity to Seller and Buyer. The Bank will honour the LC when
the Buyer fails to fulfill payment liabilities to Seller.
4. Confirmed LC. In addition to the Bank guarantee of the LC issuer, this LC type is
confirmed by the Seller's bank or any other bank. Irrespective to the payment by
the Bank issuing the LC (issuer), the Bank confirming the LC is liable for
performance of obligations.
5. Unconfirmed LC. Only the Bank issuing the LC will be liable for payment of this
LC.
6. Transferable LC. This LC enables the Seller to assign part of the letter of credit
to other party(ies). This LC is especially beneficial in those cases when the Seller is
not a sole manufacturer of the goods and purchases some parts from other
parties, as it eliminates the necessity of opening several LC's for other parties.
7. Back-to-Back LC. This LC type considers issuing the second LC on the basis of
the first letter of credit. LC is opened in favor of intermediary as per the Buyer's
instructions and on the basis of this LC and instructions of the intermediary a new
LC is opened in favor of Seller of the goods.
8. Payment at Sight LC. According to this LC, payment is made to the seller
immediately (maximum within 7 days) after the required documents have been
submitted.
9. Deferred Payment LC. According to this LC the payment to the seller is not
made when the documents are submitted, but instead at a later period defined in
the letter of credit. In most cases the payment in favor of Seller under this LC is
made upon receipt of goods by the Buyer.
10. Red Clause LC. The seller can request an advance for an agreed amount of the
LC before shipment of goods and submittal of required documents. This red
clause is so termed because it is usually printed in red on the document to draw
attention to "advance payment" term of the credit.
