Letter of Credit: Details Included, Different Kinds and Documents Required

Details included in the Letters of Credit:

The documentary credit gives the following particulars, though the form and order vary among banks: 

1. Name of the issuing bank and type of credit with number and date.
2. One whose behalf the credit is issued (the applicant/buyer).
3. The amount (including the currency).
4. The date up to which the credit is valid (expiry date). The last date for shipment may also be specified.
5. Since the beneficiary is usually required to draw a bill of exchange (generally referred to as a ‘draft’ in documentary credits) a) the terms of the draft (i.e., sight or usance) b) whether the draft is to be drawn on a named bank of the buyer.
6. Brief details of the goods.
7. Documents required – usually the documents are Commercial Invoice, Packing List, Insurance Policy/Certificate, Inspection Certificate, Transport document Bill of Lading, Airway Bill or a Combined Transport Document.
8. Port(s) of shipment and destination of shipment (only the country’s name may be written).
9. Price and terms of shipment (whether FOB, C&F or CIF).
10. Whether the part shipment and transshipment are permitted.
11. Any other conditions apply to the credit.
12. Certificate of the issuing bank’s responsibility in the credit.
13. If the document is omitted, it may be implied from the type of credit indicated in (10 above, e.g., irrevocable, etc.
14. A statement that credit is subject to the Uniform Customs & Practices for Documentary Credits provisions.

Letter of Credit Transaction. Image source: letterofcredit.biz

Different Kinds of Letter of Credit:

There are various types of letters of credit. Let us discuss them in detail.

1. Revocable and Irrevocable Letter of Credit:

Under the revocable letter of credit, the issuing bank retains the right to cancel or modify the credit. In an irrevocable letter of credit, the issuing bank gives a binding undertaking to the beneficiary.

2. Confirmed Letter of Credit:

This implies that a banker other than the issuing bank, by adding its confirmation, assumes the responsibility of payment in the case of the issuing banker’s inability or refusal to pay.

3. Restricted Credits:

This refers that the issuing bank may restrict negotiations under a credit to a named bank.

4. Revolving Credit:

This process is arranged where the seller makes regular, continuing shipments. It may be available even after the credit has been utilized once.

5. Red Clause Letter of Credit:

This process is like pre-shipment finance given to the seller by the buyer. This credit thus enables the beneficiary to draw an advance against shipments. The advance is liquidated by the amount due on the presentation of documents.

6. Transferable Credit:

his allows the recipient to make the credit available, in whole or part, to one or more third parties (secondary beneficiaries). This can only be done if the credit clearly states it is ‘transferable’ (no other term is acceptable); it is used when the seller is a ‘middleman’ who transfers part of the credit to the supplier who ships the goods. Credit can be transferred once only.

7. Back to Back Letter of Credit:

The beneficiary of an irrevocable letter of credit may not be the supplier of the goods (he would be a middleman as in the case of the transferable credit). He will request his banker to open a further letter of credit (the back-to-back credit) favoring the supplier, based on the original credit.

8. Standby Credit:

This is similar to a performance Bond on Guarantee but in the form of a Letter of Credit. It thus assures the beneficiary that in the event of non-performance or non-payment of an obligation, the recipient may request payment from the issuing banker. The claim would be a draft accompanied by the necessary documentary evidence of non-performance as stipulated in the credit.

9. Deferred Payment Credit:

These credits are used where the supplier wishes to allow the buyer time to pay for the documents. He provides the beneficiary a specified time for payment after the presentation of the documents, which the bank will deliver to the applicant/buyer in the meantime.

10. Payment Credit:

This is a sight credit that will be paid on a sight basis against the presentation of required documents to the designated paying bank. In a payment credit, the beneficiary may or may not be called upon to draw a draft; in many countries, because of stamp duties even on sight drafts, it has become increasingly customary not to ask for drafts under a credit available by sight payment.

11. Acceptance Credit:

This is similar to Deferred Payment Credit, except that drawing a usance draft is a must in this credit. Under this credit, drafts must be drawn on the specified bank drawee for the specified period.

The designated bank will accept the drafts and honor the same by asking for payment on the due dates.

12. Negotiation Credit:

This can be sight credit or a usance credit. But drawing a draft is a must in Negotiation Credit. Further, the draft can be drawn on the beneficiary or any other drawee per credit terms. In a Negotiation Credit, the nomination can be restricted to a particular bank, or it may allow free negotiation, which is called a ‘Freely Negotiable Credit.’ Under a Negotiation Credit, if the bank nominated as a Negotiated Bank refuses to negotiate, then the responsibility of Issuing Bank would be to pay as per the terms of that credit.

13. Sight and Usance Credit:

When a Letter of Credit states that the bank will make the payment at sight, on-demand or presentation, such credit is called Sight Credit. However, a drawing of a draft is not always needed; payment can be made on the presentation of specified documents. Under Usance Credit, a Letter of Credit calls for drawing drafts at a stated usance period. This type of credit is also referred to as ‘Term Credit.’

14. Fixed and Revolving Credit:

When a credit is available for a fixed amount and period, it is called Fixed Credit. In this type of credit, the credit gets exhausted once it is utilized for the stipulated amount or after the stated validity date.

15. Under Revolving Credit:

Under this credit, the amount is revived or reinstated without requiring re-enhancement in credit.

16. Transit Credit:

This is issued in one foreign currency with the beneficiary in another but is advised through a usually confirmed by a bank in London.

Documents required under Letter of Credit:

According to Article 4 of the Uniform Customs and Practice for Documentary Credit, in credit operations, all parties concerned deal in documents and not in goods, services and or other performances to which the documents may relate. Hence, it is necessary that the beneficiary tenders documents in conformity with the requirements of the letter of credit. Usual documents prescribed in Letters of Credit are discussed below:

1) Bill of exchange: It is all instruments drawn by one person (the seller of the goods) 0n another (the buyer) directing him to pay to or to the order of drawer (i.e., the seller). The person whose payment is to be made is called the “payee,” who can be either the drawer or third person. Most letters of credit require the exporter to prepare the bill, call the draft and submit it to the banker along with other documents. It is documented through which payment is arranged.

2) Commercial Invoice: It is a document of content and the seller’s bill. It contains details about the goods sold, the price and any other charges, which may be on account of the buyer. It also contains information about any discounts, if given by the seller. A completed commercial invoice should conform to the sale contract or letter of credit, as the case may be.

3) Packing List: This gives details of the individual parcels/packets shipped to the buyer.

4) Transport Documents: As the shipment is the most essential condition for payment, all letters of credit insist on the lodgement of documentary evidence supporting the export’s contention of having shipped the goods. A Bill of Lading is issued by the shipping company in case goods are sent by a sea vessel. Airway bill is issued in the case of air consignment, Railway Receipt / Truck Challan in case the goods are sent by land route. A combined Transport Document is issued where the exporter chooses a multimodal transport system. These documents are accepted as proof of shipment.

5) Inspection Certificate: As the goods must conform to agreed quality standards, most letters of credit require an Inspection Certificate. The Inspection Certificate must be submitted as proof that the goods have been inspected by a qualified government or private agency.

6) Insurance Policy Certificate: The insurance policy is legal evidence of the insurance contract, showing full details of covered risks. The insurance certificate, applicable in the case of ‘Floating’ OR ‘Open’ cover, contains a declaration regarding the value of each shipment and is signed by the exporter himself. An insurance certificate is not ordinarily acceptable unless provided explicitly in the letter of credit.

Besides, some letters of credit require documents such as Certificate of Origin, Analysis and Weight Certificate, and Health and Sanitary Certificate to be submitted to the negotiating bank.