What Is Letter Of Credit ( L/C) | Export Import Document for Payment term

What Is Letter Of Credit ( L/C) | Export Import Document for Payment term

Chetan Kumar Verma
international Biz Consultant

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What Is Letter Of Credit ( L/C) | Export Import Document for Payment term

Anyone who wants to Start Export Import Business always needs a secure payment term and today in this article you will know What Is Letter Of Credit ( L/C) | Export Import Document for Payment term.

LETTER of credit (L / C) appears in the mechanism of international trade as a manifestation of a sales contract between the foreign seller and the international buyer as an agreed base contract regarding the terms of payment for their transaction. The Sales contract itself is an agreement made by the seller and buyer to buy and sell goods or services that contain items that they agree to.

Because sellers (exporters) and buyers (importers) are generally separated by distance and geography – compounded by differences in character, culture, and language -, it is natural that a condition of mutual distrust arises between them. Now, to bridge that, L / C is the best choice for international payment terms. The agreement in the sales contract is poured into the L / C content. However, L / C cannot be related to the sales contract. L / C is separate from the sales contract.

L / C itself is an agreement issued by a bank (issuing / opening bank) that acts at the request of its customers (importers / applicants / accountees) to make payments for export-import documents sent by recipients of L / C (exporters / beneficiaries).

But the conditions, the documents sent by the exporter must be in accordance with the terms and conditions specified in the L / C (complying presentation). Letter of Credit – L / C issued by issuing bank as PAYMENT GUARANTEE to exporters. That’s why a Letter of Credit L / C is also called Documentary Credit. So Now more in deep about What Is Letter Of Credit ( L/C) | Export Import Document for Payment term

A letter of credit is a documentary payment obligation for export-import business, and banks are mandatory to pay or required to pay on presentation of appropriate documents specified in the credit. This payment obligation applies even if a seller ships defective or nonexistent goods (empty crates/boxes). The buyer then has to sue for breach of contract. The interests of the buyer can be protected by structuring the L/C to require, as a condition of payment the following:

  • The presentation of a certificate of inspection executed by a third party certifying that the goods shipped conform to the terms of the contract of sale. If the goods are defective or non-conforming to the terms of the contract, the 3rd party will refuse to sign the certificate and the seller will not receive any kind of payment. In such cases, it is preferable to use an Irrevocable L/C.
  • • The presentation of a certificate of inspection executed or countersigned by the buyer. It is preferable to use a revocable L/C to allow the bank to cancel the credit.
  • A reciprocal standby L/C issued in favor of the buyer in which the latter could draw on this credit and obtain a return of the purchase price if the seller shipped non-conforming goods

Why was the letter of credit L / C chosen by exporters and importers as an instrument that bridged their transactions? Here is the answer:

1. Conflict of interest

It is the nature of the seller to want payment as quickly as possible, and send goods as late as possible. Meanwhile, the buyer would want the opposite. Goods are received as soon as possible, but payment is done as color as possible.

So, to bridge the conflict of interest, the letter of credit L / C was chosen. With L / C, the rights and obligations of exporters and importers become clear.  letter of credit L / C regulates when goods must be sent by the beneficiary and when the applicant must pay for them. With L / C, the business of buying and selling becomes more orderly and guaranteed.

2. Role of Banks under Letters of CreditThe need for financing from the bank

The buyer’s bank issues the letter of credit at the request of the buyer. The details of the credit are normally specified by the buyer. Since the seller wants a local bank available to which the seller can present the letter of credit for payment, an additional bank often becomes involved in the transaction.

The function of banks in letter of credit L / C is as a guarantor for L / C payments to beneficiaries. Applicants wishing to open an L / C are required to make a deposit in the amount of the L / C. Can be in the form of effective funds, current account balances that are blocked, or deposits that are blocked. Herein lies the strength of the guarantee. Funds to pay to beneficiaries are controlled by banks. As long as the documents presented by the beneficiary are in accordance with the terms of the L / C, the funds remain to be paid according to the due date stipulated in the L / C.

But the bank does not only function as a guarantor in the capacity to master the cover (funds) of payment from the applicant. Moreover, banks can take a deeper role by financing the export-import transaction process. Of course, this role makes the bank exposed to the risks that may arise. This bank financing policy is called Trade Finance.

An issuing bank may also request a bank to confirm the letter of credit.
A confirming bank promises to honor a letter of credit already issued by another bank and becomes directly obligated to the beneficiary (seller), as a process it had issued the letter of credit itself. It will pay, accept, or negotiate a letter of credit upon showing of required specific documents that comply with the terms and conditions of the Letter of credit. A confirming bank is entitled to reimbursement by the issuing bank, assuming that the latter’s instructions have been properly executed. It, however, faces the risk of nonpayment if the issuing bank or the buyer is unable or unwilling to pay the confirming bank, in which case it will be left with title to the goods and obliged to liquidate them to offset its losses.

What is the form of financing from a bank in the context of the L / C instrument? Here is the answer, seen from the side of the beneficiary and applicant.

1. Beneficiary

Exporters who receive financing facilities from banks can use it to receive payments faster, before the L / C is due. That means, exporters can already enjoy payment before the importer pays, because it was bailed out first by the bank. There are two types of financing for exporters based on L / C tenor:

a. Negotiation ==> Sight L / C Sight

letter of credit L / C is the L / C that is due at sight. That is, payments will be received by the beneficiary after the documents sent have been received by the L / C issuing bank, provided the documents fulfill the terms and conditions specified in the letter of credit L / C.

Well, before the issuing bank makes a payment, the beneficiary bank can take the position of a negotiating bank by negotiating or taking over the export bill of export that is billed to the applicant. After conducting an assessment stating that the beneficiary is eligible for negotiations, the bank disburses funds as a payment bailout for the beneficiary.

But the name is also a bailout facility, the bank certainly imposes a number of costs to the beneficiary, namely transit interest (interest charged until receiving payment from the importer), porto courier document fees, and / or fees from correspondent banks.

b. Discount ==> Usance L / C

Usance L / C is an L / C with maturity in accordance with the tenor, generally 30, 60, 90, 120, or 180 days. That is, payments will be received by the beneficiary according to the tenor. For example, with a tenor of 30 days, it means the due date is 30 days after the date of shipment of the goods, which is indicated from the date the goods were shipped on board to the Bill of Lading.

If in the sight beneficiary L / C receives the initial payment through negotiations, then in the usance L / C through a discount (discount). The process, after the issuing bank, declares approval to pay the L / C at the due date (acceptance), the beneficiary bank as a nominated bank then makes a discount, by bailout to pay the beneficiary early. Of course, after the bank goes through an assessment that the discount is feasible. This is because banks are faced with high risk by adopting policies like this. Not to forget, the beneficiary is also subject to discounted interest until the due date of payment from the importer, port of courier documents, and / or correspondent bank fees.

2. Applicant

From the importer side, banks can also provide payment facilities. The form is the provision of import L / C facilities, which are usually a package with a business credit facility. So, in general, the importer who gets this facility is a debtor at his bank. By getting import facilities, applicants do not have to deposit full funds to be able to open L / Cs, but only 10 percent, for example, according to the credit agreement provided by the bank. While the 90 percent obligation is completed when due. Because of that, generally, L / C opened in the form of usance letter of credit L / C so that the obligation to pay was not too fast.

Common Rejection reason & Discrepancies in Letters of Credit : – Over 80 percent of letters of credit documents are rejected by the bank upon presentation. It is thus important to ensure that errors are avoided or detected, and appropriate corrections made to avoid (nonpayment) delays in payments. Here are some of the common discrepancies:
• The draft is not signed, or it is not consistent with the letter of credit (in terms of the amount, maturity date, etc.) and shows evidence of forgery or alteration.
• Insurance policy is not consistent with the invoice, letter of credit dated after the date of bill of lading or not endorsed.
• The commercial invoice does not conform to the description of goods (including quantity, measurements, etc.) in draft or letter of credit and fails to show terms of shipment.
• Bill of lading/air waybills differ from the letter of credit, show evidence of forgery or alteration, or not endorsed. It may also be that onboard
notations are not dated or signed and that the bill of lading is incomplete
(missing originals).
• Incomplete documentation, description of merchandise not consistent between documents, letter of credit overdrawn/expired, or the draft and documents presented after time called for in the letter of credit.

3. The existence of universally standardized rules

letter of credit L / Cs are chosen by international trade actors because there is a product that provides limitations in practice using L / C. Differences inhabits and typical that certainly exists in international trade actors who cross-national, language and cultural boundaries can be bridged by this product.

The product is Uniform Customs and Practices for Documentary Credit (UCPDC). UCPDC is a product of the International Chambers of Commerce (ICC) which contains uniform and standardized practices of practices used as a reference in international trade using L / C as a payment system.

UCPDC was first introduced in 1933 and has undergone several revisions. 

But for one thing, UCPDC has no binding legal force. Once again, UCPDC is the formalization of customs that are uniformed in international trade practices that use L / C. UCPDC is useful to minimize disputes in export-import transactions, therefore the L / C opened needs to be affirmed subject to certain editions of the UCPDC. 

When the discrepancy stands (the discrepancy cannot be corrected or the
buyer refuses to waive or amend the terms of the credit), the seller can still
attempt to obtain payment by requesting the bank to obtain authority to pay or send the documents for collection (documentary collection) outside the terms of the L/C. If the buyer refuses to accept the documents, the bank will not pay the seller (exporter) and the exporter has to either find a buyer abroad or have the merchandise returned. If the confirming/issuing bank accepts documents that contain a discrepancy, then it cannot seek reimbursement from its respective customers (issuing bank/buyer, respectively).
When the issuing bank decides to refuse the document, it must notify
the party from which it obtained the document (the remitting bank or the
exporter) without delay, stating the reasons for the rejection and whether it
holds the documents at the disposal of, or is returning them to the presenter.

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