1、Chapter 3 Letter of credit,Section 1 Definition of documentary credits A documentary credit is the written promise of a bank, undertaken on behalf of a buyer to pay the seller the amount specified in the credit provided that the seller complies with the terms and conditions set forth in the credit.,

2、I. The features of documentary credit,(1) Documentary credit is a banking business, i.e. issuing bank acts as the credit medium with the participation of advising bank and negotiating bank. (2) Documentary credit only cares for the documents instead of caring for the actual shipment of goods, i.e. i

3、ssuing bank effects the payment if there is an apparent conformity between the documents and the terms and conditions of credit. (3)Although the issuance of a L/C is based on the terms and conditions of a sales contract, once it has been issued, it will be independent on the sales contract.,II. Role

4、s of banks under L/C,Banks act as the intermediary between the buyer and the seller. So, both sides take the banks as protectors of their interests. (1) Banks assume no responsibilities regarding the quality of goods shipped. They are only concerned that documents presented appear on their face to b

5、e consistent with the terms and conditions of the documentary credit. (2) Any disputes as to quality or quantity of goods delivered must be settled between the buyer and the seller.,III. Limitations of documentary credits,(1) They do not ensure that the goods actually shipped are as ordered, nor do

6、they insulate buyers and sellers from other disagreements or complaints arising from their relationship. (2) L/C is not fool proof (十分安全的). Opportunities for fraud do exist. Many opportunities for fraud center on the facts that banks deal with documents rather than goods, and therefore the seller ha

7、s opportunity for presenting fraudulent documents,IV. The uniform customs and practice for documentary L/C,The Uniform Customs and Practice for Documentary Credits (UCP) is the internationally recognized codification of rules unifying banks practice regarding documentary credits. The UCP was develop

8、ed by working committee attached to the ICC in Paris. It is revised and updated from time to time: the current valid version is ICC publication No.600.,V. Main parties to L/C,(1)The applicant (buyer/importer) Who initiates the documentary L/C by applying to his bank to issue a documentary L/C naming

9、 the seller as the beneficiary. (2) The issuing bank (buyers bank) who issues L/C at the request of applicant and sends it to advising bank. (3) The advising bank( sellers bank) Who authenticates L/C and notifies L/C to beneficiary. (4) The beneficiary (seller/exporter) Who effects the shipment of g

10、oods and presents documents for negotiation in order to get payment. (5) Negotiating banks (sellers bank) Who negotiates the documents and pay on behalf of issuing bank.,Section 2. The operation of L/C,I. L/C issuance Issuance describes the process of the buyers applying for and issuing a documentar

11、y credit at the issuing bank and the issuing banks formal notification of the seller through the advising bank.,II. Amendment,When the seller receives the documentary credit it must be examined closely to determine if the terms and conditions (a) reflect the agreement of the buyer and the seller, an

12、d (b) can be met within the time stipulated. Upon examination, the seller may find some problems. In this case, amendment is necessary for the seller to fulfill his obligation under documentary credit. Amendment describes the process whereby the terms and conditions of a documentary credit may be mo

13、dified after the credit has been issued.,III. Utilization,Utilization describes the procedure for the sellers shipping of the goods, the transfer of documents from the seller to the buyer through the banks, and the transfer of the payment from the buyer to the seller through the banks.,IV. Settlemen

14、t (Making Payment),Settlement refers to the process of payment of the beneficiary to the credit after presentation of documents under the credit. Utilization, availability of payment and settlement are all closely related and often the terms are used interchangeably. Utilization is the process of th

15、e seller shipping the goods, presenting documentation and getting paid. Availability of payment and settlement are part of the process, but refer more specifically to the seller getting paid. There are three primary means of payment: settlement by payment, settlement by acceptance, and settlement by

16、 negotiation.,1. Settlement by payment,If the credit is an irrevocable, confirmed credit, the value of the credit is available to the beneficiary as soon as the terms and condition of the credit have been In an unconfirmed credit the value of the credit is made available to the beneficiary once the

17、advising bank has received the funds from the issuing bank.,2.Settlement by acceptance,In settlement by acceptance the beneficiary presents the required documentation package to the bank along with a time draft drawn on the issuing, advising, or a third bank for the value of the credit. Once the doc

18、uments have made their way to the buyer and found to be in order, the draft is accepted by the bank upon which it is drawn (the draft is now called a bank acceptance) and it is returned to the seller who holds it until maturity.,3.Settlement by negotiation,In settlement by negotiation the buyer acce

19、pts the documents and agrees to pay the bank after a set period of time. Essentially, this gives the buyer time (a grace period) between delivery of the goods and payment. The issuing bank makes the payment at the specified time, when the terms and conditions of the credit have been met.,Section 3 T

20、ypes and Uses of Documentary Credits,I. Types of documentary credits Generally speaking, there are two types of documentary credits which are widely used in international trade. They are:,1. Irrevocable documentary credit,An irrevocable documentary credit constitutes a definite undertaking of the is

21、suing bank, provided that the stipulated documents are presented to the Nominated Bank or to issuing Bank and that the terms and conditions of the documentary credit are complied with, to say, accept draft and/or documents presented under the documentary credit (see UCP 600 Article 9, for a full des

22、cription of the obligations of the issuing bank under this kind of documentary credit.),continued,An irrevocable documentary credit gives the beneficiary greater assurance of payment, however, he remains dependent on an undertaking of a foreign issuing bank. The issuing bank irrevocably commits itse

23、lf to honor the exporters draft and/or documents provided that the stipulated documents are presented and all the stipulations of documentary credit are complied with. The irrevocable documentary credit can not be cancelled/modified without the express consent of the issuing bank, the confirming ban

24、k (if any) and the beneficiary.,2. Revocable documentary credit,(1) A revocable documentary credit is issued in favor of the beneficiary in accordance with the instructions of the applicant and gives the buyer maximum flexibility, since it can be amended, revoked or cancelled without the beneficiary

25、s consent and even without prior notice to the beneficiary up to the moment of payment by the bank at which the issuing bank has made the documentary credit available.,(2) risk of revocable L/C,The revocable documentary credit involves risks to the beneficiary since the documentary credit may be ame

26、nded or cancelled while the goods are in transit and before the documents are presented, or, although documents may have been presented, before payment has been made, or, in the case of a deferred payment documentary credit, before documents have been taken up. The seller then faces the problem of o

27、btaining payment directly from the buyer.,(3) The use of revocable L/C,The revocable documentary credit is normally accepted as usage between affiliated parties or subsidiary companies, or as a usage of a particular trade, or as a substitute for a promise to pay or a payment order.,Section 4 Uses of

28、 documentary credit,1. Irrevocable straight documentary credit An irrevocable straight documentary credit conveys a commitment by the issuing bank to only honor draft or documents as presented by the beneficiary of the credit. This means that the beneficiary of the documentary credit is supposed to

29、deal directly with the issuing bank in presenting drafts and documents under the terms of the credit.,Implication,It is quite normal for banks and other financial institutions to purchase the drafts and documents of a beneficiary at a discount. For example, a seller may possess a draft obligating th

30、e issuing bank to pay a stated sum in 90 days. If the seller needs the money he may wish to sell it to his bank at discount for immediate cash. The irrevocable straight documentary credit is typically used in domestic trade and for standby credit, both situations where confirmation or negotiation is

31、 considered unnecessary because of the reputation of the issuing bank.,The feature,The irrevocable straight documentary credit is of greatest advantage to the buyer who does not incur a liability to pay the seller until his own bank reviews the documents. The obligation of the issuing bank in an irr

32、evocable straight documentary credit is typically stated in the credit itself with wording such as: “We hereby engaged with you that each draft drawn and presented to us under and in compliance with the terms of this documentary credit will be duly honored by us”.,2. Irrevocable Negotiation document

33、ary credit,Under the irrevocable negotiation documentary credit, the issuing banks engagement is extended to third parties who negotiate or purchase the beneficiarys draft/documents presented under the documentary credit. This assures anyone who is authorized to negotiate drafts/documents under the

34、documentary credit that these drafts/documents will be duly honored by the issuing bank provided the terms and conditions of the documentary credit are complied with. A bank which effectively negotiates drafts/documents buy them from the beneficiary, thereby becoming a holder in due course.,The feat

35、ure,The engagement of the issuing bank is normally indicated in the documentary credit as available for negotiation by a nominated bank and expiring for presentation of documents at the offices of such a nominated bank. Alternatively, the engagement of the issuing bank may be stated more explicitly

36、as follows: “We hereby agree with the drawers, endorsers and bona fide holders of drafts/documents drawn under and in compliance with the terms and conditions of the credit that such drafts/documents will be duly honored on due presentation if negotiated or presented at this office on or before the

37、expiry date.”,3. Irrevocable Documentary Credit (unconfirmed),The issuing banks irrevocable documentary credit is advised through an advising Bank. The advising bank acts as agent of the issuing bank and does not assume any responsibility to the beneficiary under the documentary credit except for ta

38、king reasonable care to check the apparent authenticity of the documentary credit which it advises. The advising bank will inform the beneficiary that it is passing on the issuing banks documentary credit and will add to this advice the following: “This notification and the enclosed advice are sent

39、to you without any engagement on our part”.,4.Irrevocable confirmed documentary credit,A confirmation of an irrevocable documentary credit by a bank (the confirming bank) upon the authorization or request of the issuing bank constitutes a definite undertaking of the confirming bank, in addition to t

40、hat of the issuing bank, provided that the stipulated documents are presented to the confirming bank or to any other nominated bank on or before the expiry date and terms and conditions of the documentary credit are complied with, to pay, to accept drafts or to negotiate.,A double assurance of payme

41、nt,An irrevocable confirmed documentary credit gives the beneficiary a double assurance of payment, since it represents both the undertaking of the issuing bank and the undertaking of the confirming bank. The second obligor (the confirming bank) engages that the drawings under the documentary credit

42、 will be duly honored in accordance with the terms and conditions of the documentary credit.,Explanation,Normally, one considers the classification of the credit and the financial standing of the issuing bank. If an issuing bank is considered to be a first class bank, there may not be any need to ha

43、ve its documentary credit confirmed by another bank. Nevertheless, the beneficiary may desire that the documentary credit and payment be guaranteed by a bank located in his own country. In such a situation, such confirming bank becomes legally liable to the beneficiary to the same extent that the is

44、suing bank does. Despite the fact that UCP 600 Article 2 states “ For the purpose of these Articles, branches of a bank in different countries are considered another bank”, the beneficiary should review the confirmation of a documentary credit given by a branch or a subsidiary of the issuing bank to

45、 see whether it is indeed another separate and distinct bank obligation under the documentary credit.,5. Revolving documentary credit,under the terms and conditions thereof, the amount is renewed or reinstated without specific amendments to the documentary credit being required. The revolving docume

46、ntary credit may be revocable or irrevocable, and may revolve in relation to time or value.,(1) Revolving in time,In the case of a documentary credit that revolves in relation to time, e.g. which is initially available for up to USD 15,000 per month during a fixed period of time, say, six months, th

47、e documentary credit is automatically available for USD 15,000 each month irrespective of whether any sum was drawn during the previous month. A documentary credit of this nature can be cumulative or non-cumulative. If it is stated to be “cumulative”, any sum not utilized during the first period car

48、ries over and may be utilized during a subsequent period.,If it is “non-cumulative”, any sum not utilized in a period ceases to be available, that is, it is not carried over to a subsequence period. It must be remembered that under this kind of documentary credit and following this example, the obli

49、gations of the issuing bank would be for USD 90,000, i.e. six revolving periods each for USD15, 000, so while the face value of the documentary credit is given as USD15, 000 the total undertaking of the issuing bank is for the full value that might be drawn.,(2) Revolving in value,In the case of a d

50、ocumentary credit that revolves in relation to value, the amount is reinstated upon utilization within a given overall period of validity. The documentary credit may provide for automatic reinstatement immediately upon presentation of the specified documents, or it may provide for reinstatement only

51、 after receipt by the issuing bank of those documents or another stated condition. This kind of documentary credit involves the buyer and the banks in an incalculable liability. For that reason, it is not in common use. To maintain a degree of control, it would be necessary to specify the overall am

52、ount that may be drawn under the documentary credit. Such amount would have to be decided by the buyer and the seller to meet their requirements, and would have to agree to by the issuing bank.,6. Red clause documentary credit,A red clause documentary credit is a documentary credit with a special co

53、ndition incorporated into it that authorizes the confirming bank or other nominated bank to make advances to the beneficiary before presentation of the documents. The clause is incorporated at the specific request of the applicant, and the wording is dependent upon his requirements. The red document

54、ary credit is so called because the clause was originally written in red ink to draw attention to the unique nature of this documentary credit. The clause specifies the amount of the advance authorized, which, in some instances, may be for the full amount of the documentary credit.,The use of red cl

55、ause L/C,The red clause documentary credit is often used as a method of providing the seller with funds prior to shipment. Therefore, it is of value to middlemen and dealers in areas of commerce that require a form of pre-financing and when a buyer would be willing to make special concessions of thi

56、s nature. For example, a furniture manufacturer in Taiwan (the buyer/importer) through an issuing bank in Taiwan opens a red clause documentary credit naming a hardwood lumber dealer in Indonesia as beneficiary, with the dealers Indonesian bank as the confirming bank. The hardwood dealers draws agai

57、nst the red clause credit, obtaining funds from the bank to pay his supplier as he finds lumber that meets the needs of the furniture manufacturer in Taiwan.,Continued,If the hardwood dealer is unable to ship the lumber according to the terms and condition of the original credit, the confirming bank

58、 in Indonesia has recourse to the issuing bank in Taiwan, which also has recourse to the beneficiary (seller/hardwood dealer) in Indonesia. This kind of arrangement places the onus of final repayment on the applicant, who would be liable for repayment of the advances if the beneficiary failed to pre

59、sent the documents called for under the documentary credit, and who would also be liable for all costs - such as interest or foreign exchange hedging - incurred by the issuing bank, the confirming bank, the confirming bank, if any, or any other nominated bank.,7.Standby Credit,The standby credit is a documentary credit or similar arrangement, however, named or described, which represents an obligation to the beneficiary on the part of the issuing bank to: a. repay money borrowed by the applicant, or advanced to or for the account of the applicant; b