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To point out the problems in the letter of credit

To enunciate the advantages and disadvantages of letter of credit mechanism
To detail upon the types of letter of credit which are used in various types of international
trade transaction.


The scope of the topic significance of letter of credit in international commercial trade widens
up to the examination and analysis of letter of credit.
The completion of this paper has required collection of relevant information through a number of
books by renowned authors on international trade law and several websites. Since letter of credit
is not a new concept, a plethora of information can be found easily.

This project report is based on analytical and descriptive Research Methodology. Secondary
and Electronic resources have been largely used to gather information and data about the topic.
Books and other reference as guided by Faculty have been primarily helpful in giving this
project a firm structure. Websites, dictionaries and articles have also been referred.
International trade law is becoming prevalent nowadays. The letter of credit plays an important
role in international trade from the inception of international trade and now its scope is

Letter of credit is derived from the French word accreditation which means the power to
perform or do something, which itself is derived from the latin term accreditivus which means

trust. This applies to any defense relating to the underlying contract of sale. This situation is as
long as the seller are committed to perform their duties to an extent that meet the requirements
contained in the letter of credit.1
Most of the financial organization issues a document which is known as letter of credit which
plays a primary role in trade finance, which provides an irrevocable payment undertaking.
The letter of credit is also used for the payment of transaction which means that redeeming the
letter of credit pays an exporter. It is the one of the important document which is used by many
importers and exporters in international trade transaction

In such cases, the International Chamber of Commerce Uniform Customs and Practice for
Documentary Credits applies (UCP 600 being the most recent form). 2 They are likewise utilized
as a part of land development and advancement methodology to guarantee that approved facility
(roads, walkways, storm water lakes, and so on.) will be provided. The parties to a letter of credit
are usually a beneficiary who is to receive the cash, the issuing bank of whom the beneficiary is
a customer, and the instructing bank concerning whom the beneficiary is a customer. Pretty
much, all letters of credit are irrevocable, i.e., can't be altered or wiped out without earlier
assentation of the beneficiary, the issuing bank and the affirming bank, if any. In executing an
transfer, letters of credit join capacities regular to giros and Traveler's cheques. Usually, the
records or documents a beneficiary needs to present so as to get payment including commercial
invoice, bill of lading, and a record demonstrating the shipment was guaranteed against damage
or harm in transit.

1 BEWARE SELLERS!!!!!!!!! - Page 2 - The eBay Community,

http://community.ebay.com/t5/Bidding-Buying/BEWARE-SELLERS/tdp/21973714/page/2 (accessed March 9, 2015).
2 Export Process, Flow & Documentation, http://rubaiyum.blogspot.com/ (accessed
March 9, 2015).

Under Article 2 UCP 600, a letter of credit is any arrangement, however named or described,
whereby a bank (the issuing bank) acts at the request and on the instructions of a customer (the
buyer/applicant) to make a payment to a third party (the seller/beneficiary) against stipulated
document(s), provided that the terms and conditions of the credit are complied with. Once the
buyer has concluded the contract with the seller in which a documentary credit clause has been
incorporated, the buyer will request its bank (the issuing bank) to open a letter of credit in favour
of the seller (the beneficiary). The buyer, as the applicant, will inform the issuing bank of the
documentary requirements that it wishes to have inserted into the letter of credit. The issuing
bank usually has its place of business in the buyer's country, whereas the seller operates from
another country. Therefore the issuing bank may request a bank in the seller's country (which can
be a branch office of the issuing bank) to take up the documents and make payment in its name
(the advising or nominated bank -- Article 6a UCP 600). The nominated bank then forwards the
documents to the issuing bank against reimbursement.3
All conditions stipulated in the letter of credit have to be documentary conditions. If a letter of
credit contains conditions without stating the document(s) to be presented in compliance
therewith, banks will deem such conditions as not stated and will disregard them (see Article 14h
UCP 600). In other words, the buyer cannot require that the seller prove a fact that is not capable
of being recorded in a document. All that he can require the seller to do is to submit
documentation that records certain facts or conditions.
The bank's promise to pay is conditional upon the seller presenting evidence that the goods have
been shipped to the port of destination, along with the other documents required by the sales
contract and thus stipulated in the letter of credit. With regard to the payment mechanism, the
whole transaction is based purely on documentation that the bank checks for compliance against
the letter of credit; the documents are deemed to represent the goods. The result is that neither
party to the transaction controls both the goods and the money at the same time. These
3 Electronic Library on International Commercial Law and the CISG,
http://www.cisg.law.pace.edu/cisg/biblio/bijl.html (accessed March 21, 2015).

requirements are essentially designed to ensure that the seller submits documentation that records
its compliance with its obligations under the underlying sales agreement, as well as to restrict the
bank's involvement to the examination of the documents. The bank deals with documents, not
with goods (see Article 5 UCP 600).

Types of Letter of Credit

Letters of credit in terms of opening bank commitments include4:
Revocable Letter Of Credit: This credit cant be given or changed by opening bank of credit
and credit partners and the affirming bank.
Affirmed letter of credit: It is letter of credit that an alternate bank notwithstanding opening
bank credit responsibility to installment acknowledges and transfers, if documents needed to be
given under the terms of credit. Affirming bank acknowledgement can be same as bank imparted
or an alternate bank.
Furthermore sorts of credit regarding transmission limit include:
1. Transferable Credit : It is irreversible letter of credit that beneficiary has the privilege to
request the bank to approve keeping in mind the end goal to sensible payment or to transfer that
aggregate or fractional credit will be accessible to the beneficiary or beneficiaries of auxiliary,
dependent upon that be transferable is unmistakably expressed.
2. Consecutive letter of credit: Beneficiary of the letter of credit may be mediated dealer and
have been deals concurrence with an alternate merchant to supply merchandise under to his/her
dedication to unique credit purchaser. On account of credit transferable and demanded second
dealer or merchants to pay by letter of acknowledge will meet for transfer credit of this requests
however without transferable credit, the first merchant by depended and backed first credit can
demand to opening credit for vender or sellers supplier of merchandise.

4 The Role of Letter of Credit in International Trade,

http://www.cprenet.com/uploads/archive/UJMSS_12-1291.pdf (accessed March 9,

3. Rotating Credit: It suggests to credit that in it a condition utilization of measure of the credit
will consequently be given again without correction.

Basis components of letter of credit

Candidate: The person requesting the letter of credit, generally the shipper in a grain transfer.
The Issuing Bank: The bank that issues the letter of credit and accepts the commitment to make
installment to the beneficiary, usually the exporter.
Beneficiary: The person in whose support the letter of credit is issued, usually the exporter in a
grain transfer.
Sum: The whole of cash, usually communicated as a greatest sum, of the credit characterized in
a particular currency.
Terms: The necessities, including records and documents that must be met for the accumulation
of the credit.
Expiry: The last date for the beneficiary to present against the credit.


To get payment, an exporter or shipper must present the documents needed by the letter of credit.
Commonly, the payee shows a report demonstrating that merchandise was sent as opposed to
representing the genuine products. The Original Bill of Lading is usually the documents
acknowledged by banks as evidence that merchandise have been dispatched. In any case, the
rundown and type of documents is interested in creative ability and transaction and may contain
prerequisites to present records issued by an impartial outsider proving the nature of the products
delivered, or their spot of birthplace or spot.
Typical types of documents in such contracts might include:
1. Financial Documents

a. Bill of Transfer, Co-accepted Draft

2. Commercial Documents
a. Invoice, Packing list
3. Shipping Documents
a. Transport Document, Insurance Certificate, Commercial, Official or Legal
4. Official Documents
a. License,





Certificate, Phytosanitary certificate

5. Transport Documents
a. Bill of Lading (ocean or multi-modal or Charter party), Airway bill, Lorry/truck
receipt, railway receipt, CMC Other than Mate Receipt, Forwarder Cargo Receipt,
Deliver Challan...etc
6. Insurance documents
a. Insurance policy, or Certificate but not a cover note.5

Standard Forms of Documentation

At the point when making payment for item in the interest of its client, the issuing bank must
confirm that all reports and drafts adjust correctly to the terms and conditions of the letter of
credit. In spite of the fact that the credit can oblige a show of records, the most well-known
documents that must go with the draft include:
Commercial invoice
The charging for the products and administrations. It incorporates a depiction of stock, value,
FOB birthplace, and name and location of purchaser and dealer. The purchaser and vender data
must compare precisely to the portrayal in the letter of credit. Unless the letter of credit
particularly states generally, a generic description of the stock is typically worthy in the other
going with reports.

5 Letter of credit - Wikipedia, the free encyclopedia,

http://en.wikipedia.org/wiki/Letter_of_credit (accessed March 9, 2015).

Bill of Lading
It is a document which shows that a particular goods is received by the concerned carrier and it
is issued by them. The documents mark control of merchandise. They likewise serve as a receipt
for the stock dispatched and as confirmation of the bearer's commitment to transport the
merchandise to their proper destination.
Warranty of Title
A warranty given by a merchant to a purchaser of merchandise that expresses that the title being
passed on is great and that the transfer is legitimate. This is a strategy for confirming clear title to
item transfer. It is for the most part issued to the buyer and issuing bank communicating consent
to repay and hold both sides harmless.
Letter of Indemnity
It particularly repays the buyer against a certain expressed situation. Indemnification is generally
used to guaranty that shipping documents will be provided in good order when available.

Legal principles governing letters of credit
One of the essential characteristics of the documentary credit is that the payment commitment is
unique and autonomous from the basic contract of offer or some other contract in the transfer. In
this manner the bank's commitment is characterized by the terms of the credit alone, and the sale
contract is irrelevant. The protections of the purchaser emerging out of the sale contract don't
concern the bank and not affects its liability. Article 4(a) UCP states this principles clearly.
Article 5 the UCP further expresses that banks only deals with documents; they are not
concerned with the products (realities). Accordingly, if the documents tendered by the
beneficiary, or his or her agents, give off an impression of being in place, then as a rule the bank
is obliged to pay without further capabilities.

Strategies behind adopting the abstraction principle are simply business, and reflects a party's
desires: in the first place, if the obligation regarding the legitimacy of records was tossed onto
banks, they would be troubled with examining the fundamental certainties of every transfer, and
would hence be less slanted to issue narrative credits as the transaction would include incredible
hazard and disadvantage. Second, documents needed under the credit could in specific
circumstances be not quite the same as those needed under the sale transaction. This would place
banks in an issue in choosing which terms to take after if needed to look behind the credit
agreement. Third, it is a well-known fact that the most important basic function of the credit is to
provide a seller with the certainty of payment for documentary duties which suggests that the
banks should honor their obligation notwithstanding allegations of misfeasance by the buyer. . At
last, courts have emphasized that purchasers dependably have a solution for an activity upon the
agreement of offer, and that it would be a disaster for the business world if, for each breach of
agreement between the merchant and purchaser, a bank were obliged to explore said break.
The "principles of strict compliance" additionally aims to make the bank's obligation of
effecting payment against easy documents, effective and brisk. Subsequently, if the documents
tendered under the credit go amiss from the language of the credit the bank is qualified for
withhold payment regardless of the fact that the deviation is absolutely terminological. The
general lawful proverb de minimis non curat lex has no spot in the field of documentary credits.
Letter of credit additionally refers to FIATA documents. More strictly, by and by cargo
forwarders common present FIATA documents and the inquiry is does FIATA documents can use
like a document for initiating letter of credit. In principle, the inquiry is not clear, as a result of
the shortcoming in UCP 600.

The Principle of Independence

In transactions involving a letter of credit, the bank is not party to the underlying contract. As
such, letters of credit have an abstract character. This implies that the bank is not concerned with
the specifics and the actual performance of the underlying contract. The conditions of the bank's
duty to pay are to be found exclusively in the terms of the letter of credit and do not in any way
depend on the performance of the seller's obligations under the contract of sale. Article 4(a) UCP
600 stipulates that:

'Credit by its nature is a separate transaction from the sale or other contract on which it
may be based. Banks are in no way concerned with or bound by such a contract, even if
any reference whatsoever to it is included in the credit. ...'
Accordingly, when deciding whether to make payment under the credit in favour of a
beneficiary, the bank may only look at the terms of the credit itself. The bank may not raise any
defenses that are available to the applicant in respect of the underlying agreement of sale. The
seller will thus always receive payment from the bank if he submits documents that comply with
the credit, regardless of any developments in the underlying sales agreement. The bank should
not be forced into the position in which it has to resolve disputes between the seller and buyer,
because this would lead to extensive delays in payment and would make the letter of credit
unattractive as a commercial service. If the doctrine of independence is not scrupulously
observed, the continuance of the letter of credit system as the primary means of payment in
international trade would be in danger.
The only exception to the principle of independence is fraud committed by the beneficiary when
tendering the documents. As Dr Roy has stated: 'No system can be effective if it is blind to
something which is manifestly unreasonable.' If the bank discovers fraud in the documents that
were tendered by the beneficiary, it is entitled to refuse payment even though the documents
appear to be in conformity with the terms of the letter of credit. This entails that the beneficiary,
if he had been truthful in his representations, would have tendered documents that did not strictly
comply with the terms of the letter of credit. The fraud, however, must be clear and evident to the
bank, without the need for additional proof or having to investigate the actual circumstances
surrounding the underlying contract. A mere suspicion of fraud is not sufficient to set aside the
independence principle. Thus, even if a bank suspects fraud, it is obliged to pay under the letter
of credit if the beneficiary has tendered documents that are in conformity with the letter of credit.

Elements of a letter of credit

A payment undertaking given by a bank (issuing bank).

On behalf of a buyer (applicant).

To pay a seller (beneficiary) for a given amount of money.

On presentation of specified documents representing the supply of goods.

Within specified time limits.

Documents must conform to terms and conditions set out in the letter of credit.

Documents to be presented at a specified place.6

Characteristics of letter of credit


Letters of credit are usually negotiable. The issuing bank is committed to pay the beneficiary, as
well as any bank named by the beneficiary. Negotiable instruments are passed unreservedly
starting with one party then onto the next pretty much in the same path as cash. To be negotiable,
the letter of credit must incorporate a clear guarantee to pay, on interest or at a clear time. The
nominated bank turns into a holder at the appointed time course. As a holder in the appropriate
time course, the holder assumes the letter of acknowledgment for value, in good faith with
common decency, without notice of any cases against it. A holder at the appropriate time course
is dealt with positively under the UCC. The transfer is viewed as a straight transaction if the
issuing bank's payment commitment stretches out just to the beneficiary of the credit. In the
6 Understanding and Using Letters of Credit, Part I - CRF online,
http://www.crfonline.org/orc/cro/cro-9-1.html (accessed March 9, 2015).

event that a letter of credit is a straight transaction it is referenced all over by "we captivate with
you" or "accessible with ourselves". Under these conditions the guarantee does not go to a buyer
of the draft as a holder at the appropriate time course.

Letters of credit may be either revocable or irrevocable. A revocable letter of credit may be
revoked or changed for any reason, whenever by the issuing bank without warning. A revocable
letter of credit can't be affirmed. On the off chance that a journalist bank is occupied with an
transfer that includes a revocable letter of acknowledge, it serves as the prompting bank. 7
When the reports have been presented and meet the terms and conditions in the letter of credit,
and the draft is regarded, the letter of credit can't be renounced. The revocable letter of credit is
not a usually utilized instrument. It is generally used to give rules to shipment. In the event that a
letter of credit is revocable it would be referenced all over.
The irrevocable letter of credit may not be revoked or revised without the understanding of the
issuing bank, the affirming bank, and the beneficiary. An irrevocable letter of credit from the
issuing bank protects the beneficiary that if the obliged records are displayed and the terms and
conditions are consented to, payment will be made. On the off chance that a letter of credit is
permanent it is referenced all over.

Transfer and Assignment

The beneficiary has the privilege to transfer or allot the privilege to draw, under a credit just
when the credit expresses that it is transferable or assignable. Credits administered by the
Uniform Commercial Code (Domestic) perhaps transfers a boundless number of times. Under
the Uniform Customs Practice for Documentary Credits (International) the credit may be transfer
7 Letters Of Credit - Creditworthy,
http://www.creditworthy.com/3jm/articles/cw041906.html (accessed March 9, 2015).

just once. Then again, regardless of the possibility that the credit details that it is nontransferable
or non-assignable, the beneficiary may transfer their rights before execution of states of the

Sight and Time Drafts

All letters of credit require the beneficiary to present a draft and indicated records with a specific
end goal to get payment. A draft is a composed request by which the party making it, requests an
alternate party to pay cash to an outsider. A draft is additionally called a bill of TRADE.8
There are two sorts of drafts: sight and time. A sight draft is payable when it is presented for
payment. The bank is permitted a sensible time to audit the reports before making payment. A
period draft is not payable until the breach of a specific time period expressed on the draft. The
bank is obliged to acknowledge the draft when the reports conform to credit terms. The issuing
bank has a sensible time to analyze those documents. The issuing bank is committed to
acknowledge drafts and pay them at development.
Standby letter of credit

The standby letter of credit serves a different function than the business letter of credit. The
business letter of credit is the essential payment instrument for an transfer. The standby letter of
acknowledge serves as an optional payment system. A bank will issue a standby letter of credit
for a client to give affirmations of his capacity to perform under the terms of an agreement
between the beneficiaries. The parties involved with the transaction don't expect that the letter of
credit will ever be drawn upon.
The standby letter of credit guarantees the beneficiary of the execution of the client's
commitment. The beneficiary has the capacity draw under the credit by exhibiting a draft,
8 Letters Of Credit - Creditworthy,
http://www.creditworthy.com/3jm/articles/cw041906.html (accessed March 9, 2015).

duplicates of receipts, with confirmation that the client has not performed its commitment. The
bank is committed to make payment if the reports comply with the terms of the letter of credit.
Standby letters of credit are issued by banks to remain behind fiscal commitments, to safeguard
the discount of development payment, to help execution and offer commitments, and to protect
the finish of a business contract. The credit has a expiry date.
The standby letter of credit is frequently used to ensure execution or to fortify the credit value of
a client. In the above case, the letter of credit is issued by the bank and held by the supplier. The
client is given open record terms. On the off chance that payments are made as per the suppliers'
terms, the letter of credit would not be drawn on. The merchant seeks after the client for payment
directly. On the off chance that the client is not able to pay, the vender exhibits a draft and
duplicates of receipts to the bank for payment.
Limitation of Letter of Credit
The utilization of letter of credit is the most widely recognized methodology for imports from
different nations in the cutting edge world and banks opening of letter of credit. Clearly, the
absence of backup for the keeping money has made genuine restrictions for industrialists and
those included in the import and fare of merchandise.
1. Absence of supporting banks in opening letter of credit from the builders who have little credit
and absence of acknowledge organisation by the banks.
2. Related deferrals to letter of credit stretched out because of political conditions, changes in
laws and regulations, administration TRADE. . .
3. In a few bargains that payments to outside organizations is carried out through opening a letter
of credit, once in a while prolongation of opening procedure prompted postpones in payment,
defers in getting credits and eventually making crevices in monetary administration of venture
and issues in money related arranging builder.
4. Complex administration of the boss to open letter of credit and therefore force expenses
coming about because of the deferral in the opening of foreman causes that in a few activities,

gear acquired and prepared to delivered however not yet issued letters of credit and is in the
labyrinth of organization.


Offers of products and administrations to outside purchasers have more contradictory dangers
that develop for exchanging the local business sector. Irreconcilable situations and newness and
guarantee purchaser and dealer together is brought on that making system called letter of credit
that consider premiums of both purchaser and merchant and halfway adjust the dangers of
contracting parties, so that give documentation conveying merchandise to a third organization
(bank) was viewed as characteristic of conveyance of products and as per it the payment done
through bank .Letter of credit payment component is, for example, blood stream in assortment of
global transfers. Letter of Credit, because of the need to have essential significance in global
transfers is free of the mother or the first transfer of procurement and deal and hence particular
issues independently from it.9
These days banks assume a vital part in encouraging residential and global business TRADEs
and transfers. Particularly in arena of global transfer can guaranteed that no transfer or universal
contract don't be without the contribution and help of banks in light of the fact that innovation
and utilization different instruments of bank, for example, letter of credit and bank assurances
tackled a large portion of the issues created by separation and direct contact between worldwide
merchants, while keep up two noteworthy qualities of organizations means the velocity and
Significance of letter of credit
9 The Role of Letter of Credit in International Trade,
http://www.cprenet.com/uploads/archive/UJMSS_12-1291.pdf (accessed March 9,

There are a number of uses of a letter of credit. These can be used as a mode of payment in the
transactions. There are a number of exporters who receive payment through these modes. The
letter of credit is becoming a crucial part of the land development processes where it ensures
growth of the public facilities.10 On the other hand, the letter of credit is becoming very
important for the international trade and commerce. It provides an easy transaction system for
the businesses where customer and the supplier belong to different nations.

They can be summarized:


Different legal system.


Currency system.


Trade rules are different.

Other important significances are :1. The Letters of Credit give importers the most extensively used and conventional international
trade payment means and finance instrument. By making Letter of Credit terms to permit
Deferred Payment or Trade Acceptance, a Letter of Credit facilitates financing to the
importer. It promises payment, provided the seller complies with the terms and conditions
inside the Letter of Credit. The Irrevocable letter of credit cant be canceled or varied without
the approval of all parties.
2. Letters of Credit provide importers the most broadly used and accepted worldwide trade
payment mechanism and business instrument. By structuring Letter of Credit terms to permit
Deferred Payment or Trade Acceptance an letter of credit can be operated to offer funding to
the importer. Most prominently global trading has a whole lot of money involved and if done
appropriately could build up a turnover capable of running a nation states budget; hence it is
significant that it is managed with care.
Significance for buyer and seller
Letter of credit advantages for the seller
10 http://finance.mapsofworld.com/credit/letter.html (accessed on March 12, 2015)

The seller has the obligation of buyer's banks to pay for the shipped goods;

Reducing the production risk, if the buyer cancels or changes his order

The opportunity to get financing in the period between the shipment of the goods and receipt
of payment (especially, in case of deferred payment).

The seller is able to calculate the payment date for the goods.

The buyer will not be able to refuse to pay due to a complaint about the goods

Letter of credit advantages for the buyer

The bank will pay the seller for the goods, on condition that the latter presents to the bank the
determined documents in line with the terms of the letter of credit;

The buyer can control the time period for shipping of the goods;

By a letter of credit, the buyer demonstrates his solvency;

In the case of issuing a letter of credit providing for delayed payment, the seller grants a
credit to the buyer.

Providing a letter of credit allows the buyer to avoid or reduce pre-payment.


A letter of credit may be issued by:
When issued by airmail, the standard format of the bank is filled in with the relevant details,
signed by the authorized signatories of the bank and mailed to the advising bank.


Where the letter of credit is to be issued by telecommunication, full details of the credit are
cabled/ telexed to the advising bank. Opening of a letter of credit by telecommunication is of
course costly. It is resorted to only when the applicant requires it and on his account.11

In global transfer that included dangers, for example, absence of commonality the transferd
individual, absence of coin, and separation, payment strategy needed to back its specialists to
transfer. Letter of acknowledge is perceived as fitting payment strategy and acquiring credit for
purchasers and merchants in global transfers. Letter of Credit is duty opening bank credit to pay
the cases of the beneficiarys as per the terms stipulated in credit that incorporate diverse sorts
and each of them gives distinctive profits and different to beneficiarys. Development and
utilization different apparatuses of bank, for example, letter of credit and bank assurances tackled
huge numbers of the issues brought on by separation and direct contact between worldwide
merchants lastly the pace and exactness.
It is stressed here once again that one of the main principles of the CISG is the preservation of
the contract. In letter of credit transactions as well, the avoidance of the contract is a remedy of
last resort. Only after all else has failed should a buyer be entitled to avoid the contract. This
decision should not be taken lightly. Both parties have, first and foremost, an obligation to
uphold their end of the bargain and not to hinder the performance by the other party.
11 Kaushik Mhatre, International Trade ,(Eastern Book Company) Third edition, Pg


Indira carr, International Trade Law and the WTO the federation press (Australia).

Aggarwal, Aradhna., The anti-dumping agreement and developing countries, Oxford

University Press, (New Delhi : | New York )


1. Bergami Robert, (2007), Will the UCP 600 Provide Solutions to Letter of Credit
Transactions? International Review of Business Research Papers, Vol.3 No.2, June 2007, Pp. 41
- 53 2.Dolan John, (2007),
2. The law of letters of credit The Wayne State University Law School Legal Studies Research,
Vol 1, April 2007, p149.



Klien Carter, (2005), Using Letters of Credit to Secure Lease Obligations, Law journal

Newsletter, Vol 18, No 4, September 2005, p.585