A documentary credit is a bank contract of payment. It is a written contract by the buyer’s (applicant’s) bank (issuing bank) provided to the seller / exporter (beneficiary) through an advising bank (contracted bank in the USA) to pay the seller / exporter at sight or at a determinable future date up to a stated sum of money, within a prescribed time limit and against stipulated documents or other conditions. The buyer of the goods cannot take possession of the cargo shipped until the letter of credit contract has been guaranteed payment by the issuing bank.
Most Common Types of Letters of Credit (LC)
Irrevocable Letter of Credit
A legal binding contract between a seller and buyer that is guaranteed payment by the buyer’s bank as long as the contract terms have been completed to specifications (in order without discrepancies). Any changes (amendments) or cancellation of the LC (except when it is expired) is done by the applicant through the issuing bank. However, any changes / cancellation of the letter of credit contract must be authenticated and approved by the beneficiary.
Normally, this type of LC functions like a guarantee. A standby letter of credit can be drawn against only upon performance of services or financial obligation default. It is an undertaking of the buyer’s bank (issuing bank).
The letter of credit bears only the obligation of the issuing bank to guarantee documents are in order (without discrepancies) and to guarantee payment to the seller / exporter (beneficiary). The beneficiary should look to the credit worthiness of only the issuing bank, and not to any intermediary (Article 7 UCP 600)* to decide if the export LC should be confirmed to protect payment.
Is a credit in which a second obligation is added to the letter of credit by another bank (Article 8 UCP 600)*
Shipment is paid for by the advising bank (US Bank) once documents have been examined and found in order (if the LC is confirmed) or the issuing bank (buyer’s bank) will provide payment once documents have been examined and found in order (if the LC is unconfirmed).
The draft honored by accepting documents for payment at a future date. Payment is delayed until the maturity of the draft.
Can be transferred by the original seller / exporter (beneficiary) to one or more parties. It is normally used when the first beneficiary does not supply the merchandise but is a middleman and wants to transfer all or part of rights to the actual supplier (Article 38 UCP 600)*.
* UCP 600 is the Uniform Customs and Practice for Documentary Credits, a set of rules on the issuance and use of letters of credit. The UCP is utilized by bankers and commercial parties in trade finance.
1 – Incoterms® 2010 do not deal with the parties’ obligations for stowage within a container and therefore, where relevant, the parties should do this in the sales contract.
2 – FCA Seller’s facility – Buyer pays inland freight; other FCA qualifiers. Seller arranges and loads pre-carriage carrier and pays inland freight to the “F” delivery place.
3 – Incoterms® 2010 does not obligate the buyer nor must the seller to insure the goods, therefore this issue must be addressed elsewhere in the sales contract.
4 – Charges paid by Buyer or Seller depending on contract of carriage.
5 – Charges paid by Seller if through Bill of Lading or door-to-door rate to Buyer’s destination.