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Letterofcredit
FromWikipedia,thefreeencyclopedia

Aletterofcreditisadocumentfromabankguaranteeingthata
sellerwillreceivepaymentinfullaslongascertaindelivery
conditionshavebeenmet.

Intheeventthatthebuyerisunabletomakepaymentonthe
purchase,thebankwillcovertheoutstandingamount.Theyare
oftenusedininternationaltransactionstoensurethatpayment
willbereceivedwherethebuyerandsellermaynotknoweach
otherandareoperatingindifferentcountries.Inthiscasethe
sellerisexposedtoanumberofriskssuchcreditrisk,andlegal
riskcausedbythedistance,differinglawsanddifficultyin
knowingeachpartypersonally.Aletterofcreditprovidesthe
sellerwithaguaranteethattheywillgetpaidaslongascertain Afteracontractisconcludedbetween
deliveryconditionshavebeenmet.Forthisreasontheuseof abuyerandaseller,thebuyer'sbank
lettersofcredithasbecomeaveryimportantaspectof suppliesaletterofcredittotheseller.
internationaltrade.

Thebankthatwritestheletterofcreditwillactonbehalfofthe
buyerandmakesurethatalldeliveryconditionshavebeenmet
beforemakingthepaymenttotheseller.Mostlettersofcreditare
governedbyrulespromulgatedbytheInternationalChamberof
CommerceknownasUniformCustomsandPracticefor
DocumentaryCredits.Lettersofcreditaretypicallyusedby
importingandexportingcompaniesparticularlyforlarge
purchasesandwilloftennegatetheneedbythebuyertopaya
depositbeforedeliveryismade.

Theyarealsousedinlanddevelopmenttoensurethatapproved
publicfacilities(streets,sidewalks,stormwaterponds,etc.)will Sellerconsignsthegoodstoacarrier
bebuilt.Thepartiestoaletterofcreditarethesupplier,usually inexchangeforabilloflading.
calledthe"beneficiary","theissuingbank",ofwhomthebuyeris
aclient,andsometimesanadvisingbank,ofwhomthe
beneficiaryisaclient.Almostalllettersofcreditareirrevocable,i.e.,cannotbeamendedorcanceled
withoutmutualconsentofallparties.

Contents
1Terminology
1.1Origin
1.2Relatedterms
2Documentsthatcanbepresentedforpayment
3Legalprinciplesgoverningdocumentarycredits
4Types
5Pricing
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6Legalbasis
7InternationalTradePaymentmethods
8Risksituations
9Seealso
10References
11Externallinks

Terminology
Sellerprovidesthebillofladingto
Origin bankinexchangeforpayment.
Seller'sbankthenprovidesthebillto
Thename"letterofcredit"derivesfromtheFrenchword buyer'sbank,whoprovidesthebillto
"accrditation",apowertodosomething,whichderivesfromthe buyer.
Latin"accreditivus",meaningtrust.

Relatedterms

AsightLCcausespaymenttobemadeimmediatelytothe
beneficiary/seller/exporteruponpresentationofthecorrect
documents.AtimeordateLCspecifieswhenpaymentis
tobemadeatafuturedateanduponpresentationofthe
requireddocuments.

Negotiationmeansthegivingofvaluefordraft(s)or
document(s)bythebankauthorizedtonegotiate,withthe Buyerprovidesthebillofladingto
nominatedbank.Mereexaminationofthedocumentsand carrierandtakesdeliveryofthe
goods.
forwardingthesametotheLCissuingbankfor
reimbursement,withoutgivingofvalue/agreedtogive,
doesnotconstituteanegotiation.

AdvisingBankadvisesthebeneficiaryattherequestoftheissuingbank.

Applicantthepartyonwhoserequesttheissuingbankissuesacredit.

BankingdayThedayonwhichabankisregularlyopenattheplaceatwhichanacttobe
performed.

Beneficiarythepartywhoistoreceivethebenefit(payment)oftheLC.Theconsigneeofan
LCandthebeneficiarymaynotbethesame.Thecreditisissuedinthebeneficiary'sfavor.

PresentationeitherdeliveryofdocumentsagainstanLCorthedocumentitself.

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Complyingpresentationwhenthepresentationofdocumentsisinaccordancewith:

thetermsandconditionsofthecredit
theapplicableprovisionsofUCP
internationalstandardbankingpractice

Confirmationadefiniteundertakingfromtheconfirmingbanktohonorornegotiatea
complyingpresentationinadditiontothatoftheissuingbank.

ConfirmingbankaddsconfirmationtoanLC.Itdoessoattherequestoftheissuingbankand
takingauthorizationfromtheissuingbank.

Letterofcredit/creditanirrevocablecommitmentoftheissuingbanktohonoracomplying
presentation.

HonourtoactaccordingtocommitmentoftheLC.Presentationsarehonoredindifferentways
dependingonthetypeofcredit:

MakingpaymentatsightforsightLC.
IncurringadeferredpaymentundertakingandpayingatmaturityfordeferredpaymentLC.
AcceptingadraftdrawnbythebeneficiaryandpayingatmaturityfordeferredacceptanceLC.

IssuingbankissuestheLC.

NominatedBankthebankwithwhichcreditisavailable.Ifnobankismentionedinthecredit
asnominatedbank,allbanksare"nominated".

NegotiationAnominatedbankissaidtonegotiateadocumentifitpurchasesadraftor
documentsunderacomplyingpresentationeitherbymakinganadvanceoragreeingtoadvance
fundstothebeneficiaryonorbeforethedateonwhichreimbursementisduetothenominated
bank.Adraftdrawnonanominatedbankcannotbepurchasedseparately.

Documentsthatcanbepresentedforpayment
Toreceivepayment,anexporterorshippermustpresentthedocumentsrequiredbytheLC.Typically,
thepayeepresentsadocumentprovingthegoodsweresentinsteadofshowingtheactualgoods.The
originalbilloflading(BOL)isnormallythedocumentacceptedbybanksasproofthatgoodshavebeen
shipped.However,thelistandformofdocumentsisopentonegotiationandmightcontainrequirements
topresentdocumentsissuedbyaneutralthirdpartyevidencingthequalityofthegoodsshipped,ortheir
placeoforiginorplace.Typicaltypesofdocumentsinsuchcontractsinclude:

FinancialDocumentsBillofExchange,coaccepteddraft
CommercialDocumentsInvoice,packinglist
ShippingDocumentsTransportdocument,insurancecertificate,commercial,officialorlegal

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documents
OfficialDocumentsLicense,embassylegalization,origincertificate,inspectioncertificate,
phytosanitarycertificate
TransportDocumentsBilloflading(oceanormultimodalorcharterparty),airwaybill,
lorry/truckreceipt,railwayreceipt,CMCotherthanmatereceipt,forwardercargoreceipt
InsurancedocumentsInsurancepolicyorcertificate,butnotacovernote.

Legalprinciplesgoverningdocumentarycredits
Oneoftheprimarypeculiaritiesofthedocumentarycreditisthatthepaymentobligationisindependent
fromtheunderlyingcontractofsaleoranyothercontractinthetransaction.Thusthebanksobligation
isdefinedbythetermsoftheLCalone,andthesalecontractisirrelevant.Thedefensesavailabletothe
buyerarisingoutofthesalecontractdonotconcernthebankandinnowayaffectitsliability.[1]Article
4(a)oftheUCPstatesthisprincipleclearly.Article5oftheUCPfurtherstatesthatbanksdealwith
documentsonly,theyarenotconcernedwiththegoods(facts).Accordingly,ifthedocumentstendered
bythebeneficiary,orhisorheragent,areinorder,theningeneralthebankisobligedtopaywithout
furtherqualifications.

Thepoliciesbehindadoptingtheabstractionprinciplearepurelycommercialandreflectapartys
expectations:first,iftheresponsibilityforthevalidityofdocumentswasthrownontobanks,theywould
beburdenedwithinvestigatingtheunderlyingfactsofeachtransaction,andlessinclinedtoissue
documentarycreditsbecauseoftheriskandinconvenience.Second,documentsrequiredundertheLC
couldincertaincircumstancesbedifferentfromthoserequiredunderthesaletransaction.Thiswould
placebanksinadilemmaindecidingwhichtermstofollowifrequiredtolookbehindthecredit
agreement.Third,thefactthatthebasicfunctionofthecreditistoprovideasellerwiththecertaintyof
paymentfordocumentarydutiessuggeststhatbanksshouldhonortheirobligationnotwithstanding
allegationsofbuyermisfeasance.[2]Courtshaveemphasizedthatbuyersalwayshavearemedyforan
actionuponthecontractofsaleandthatitwouldbeacalamityforthebusinessworldifabankhadto
investigateeverybreachofcontract.

Theprincipleofstrictcompliancealsoaimstomakethebanksdutyofeffectingpaymentagainst
documentseasy,efficientandquick.Hence,ifthedocumentstenderedunderthecreditdeviatefromthe
languageofthecreditthebankisentitledtowithholdpayment,evenifthedeviationispurely
terminological.[3]Thegenerallegalmaximdeminimisnoncuratlexhasnoplaceinthefield.

Types
Import/exportThesamecreditcanbetermedanimportorexportLC[4]dependingonwhose
perspectiveisconsidered.FortheimporteritistermedanImportLCandfortheexporterof
goods,anExportLC.

RevocableThebuyerandthebankthatestablishedtheLCareabletomanipulatetheLCor
makecorrectionswithoutinformingorgettingpermissionsfromtheseller.AccordingtoUCP
600,allLCsareirrevocable,hencethistypeofLCisobsolete.

IrrevocableAnychanges(amendment)orcancellationoftheLC(exceptitisexpired)isdone
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bytheapplicantthroughtheissuingbank.Itmustbeauthenticatedandapprovedbythe
beneficiary.

ConfirmedAnLCissaidtobeconfirmedwhenasecondbankaddsitsconfirmation(or
guarantee)tohonoracomplyingpresentationattherequestorauthorizationoftheissuingbank.

UnconfirmedThistypedoesnotacquiretheotherbank'sconfirmation.

TransferrableTheexporterhastherighttomakethecreditavailabletooneormoresubsequent
beneficiaries.Creditsaremadetransferablewhentheoriginalbeneficiaryisamiddlemananddoes
notsupplythemerchandise,butprocuresgoodsfromsuppliersandarrangesthemtobesenttothe
buyeranddoesnotwantthebuyerandsupplierknoweachother.

Themiddlemanisentitledtosubstitutehisowninvoiceforthesupplier'sandacquirethe
differenceasprofit.

Aletterofcreditcanbetransferredtothesecondbeneficiaryattherequestofthefirstbeneficiary
onlyifitexpresslystatesthattheletterofcreditis"transferable".Abankisnotobligatedto
transferacredit.

Atransferableletterofcreditcanbetransferredtomorethanonealternatebeneficiaryaslongasit
allowspartialshipments.

Thetermsandconditionsoftheoriginalcreditmustbereplicatedexactlyinthetransferredcredit.
However,tokeeptheworkabilityofthetransferableletterofcredit,somefigurescanbereduced
orcurtailed.

Amount
Unitpriceofthemerchandise(ifstated)
Expirydate
Presentationperiod
Latestshipmentdateorgivenperiodforshipment.

Thefirstbeneficiarymaydemandfromthetransferringbanktosubstitutefortheapplicant.
However,ifadocumentotherthantheinvoicemustbeissuedinawaytoshowtheapplicant's
name,insuchacasethatrequirementmustindicatethatinthetransferredcredititwillbefree.

Transferredcreditcannotbetransferredagaintoathirdbeneficiaryattherequestofthesecond
beneficiary.

UntransferableAcreditthatthesellercannotassignallorpartoftoanotherparty.In
internationalcommerce,allcreditsareuntransferable.

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Deferred/UsanceAcreditthatisnotpaid/assignedimmediatelyafterpresentation,butafteran
indicatedperiodthatisacceptedbybothbuyerandseller.Typically,sellerallowsbuyertopaythe
requiredmoneyaftertakingtherelatedgoodsandsellingthem.

AtSightAcreditthattheannouncerbankimmediatelypaysafterinspectingthecarriage
documentsfromtheseller.

RedClauseBeforesendingtheproducts,sellercantaketheprepaidpartofthemoneyfrom
thebank.Thefirstpartofthecreditistoattracttheattentionoftheacceptingbank.Thefirsttime
thecreditisestablishedbytheassignerbank,istogaintheattentionoftheofferedbank.The
termsandconditionsweretypicallywritteninredink,thusthename.

BacktoBackApairofLCsinwhichoneistothebenefitofasellerwhoisnotabletoprovide
thecorrespondinggoodsforunspecifiedreasons.Inthatevent,asecondcreditisopenedfor
anothersellertoprovidethedesiredgoods.Backtobackisissuedtofacilitateintermediarytrade.
IntermediatecompaniessuchastradinghousesaresometimesrequiredtoopenLCsforasupplier
andreceiveExportLCsfrombuyer.

Pricing
Issuancecharges,coveringnegotiation,reimbursementsandotherchargesarepaidbytheapplicantoras
perthetermsandconditionsoftheLC.IftheLCdoesnotspecifycharges,theyarepaidbythe
Applicant.Chargerelatedtermsareindicatedinfield71B.

Legalbasis
Legalwritershavefailedtosatisfactorilyreconcilethebanksundertakingwithanycontractualanalysis.
Thetheoriesinclude:theimpliedpromise,assignmenttheory,thenovationtheory,reliancetheory,
agencytheories,estoppelsandtrusttheories,anticipatorytheoryandtheguaranteetheory.[5]

Althoughdocumentarycreditsareenforceableoncecommunicatedtothebeneficiary,itisdifficultto
showanyconsiderationgivenbythebeneficiarytothebankerpriortothetenderofdocuments.Insuch
transactionstheundertakingbythebeneficiarytodeliverthegoodstotheapplicantisnotsufficient
considerationforthebankspromisebecausethecontractofsaleismadebeforetheissuanceofthe
credit,thusconsiderationinthesecircumstancesispast.However,theperformanceofanexistingduty
underacontractmaybeavalidconsiderationforanewpromisemadebythebank,providedthatthereis
somepracticalbenefittothebank[6]Apromisetoperformowedtoathirdpartymayalsoconstitutea
validconsideration.[7]

Anothertheoryassertsthatitisfeasibletotypifyletterofcreditasacollateralcontractforathirdparty
beneficiarybecausethreedifferententitiesparticipateinthetransaction:theseller,thebuyer,andthe
banker.Becauselettersofcreditarepromptedbythebuyersnecessityandinapplicationofthetheory
ofJeanDomatthecauseofaLCistoreleasethebuyerofhisobligationtopaydirectlytotheseller.
Therefore,aLCtheoreticallyfitsasacollateralcontractacceptedbyconductorinotherwords,an
impliedinfactcontractundertheframeworkforthirdpartybeneficiarywherethebuyerparticipatesas
thethirdpartybeneficiarywiththebankactingasthestipulatorandthesellerasthepromisor.Theterm
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"beneficiary"isnotusedproperlyintheschemeofanLCbecauseabeneficiary(also,intrustlaw,cestui
queuse)inthebroadestsenseisanaturalpersonorotherlegalentitywhoreceivesmoneyorother
benefitsfromabenefactor.Notethatundertheschemeoflettersofcredit,banksareneitherbenefactors
ofsellersnorbenefactorsofbuyersandthesellerreceivesnomoneyingratuitymode.Thusispossible
thataletterofcreditwasoneofthosecontractsthatneededtobemaskedtodisguisethe
considerationorPrivityrequirement.Asaresultthiskindofarrangement,wouldmakeletterofcredit
tobeenforceableundertheactionassumpsitbecauseofitspromissoryconnotation.[8]

Afewcountries,includingtheUnitedStates(Article5oftheUniformCommercialCode)havecreated
statutesinrelationtolettersofcredit.Thesestatutesaredesignedtoworkwiththerulesofpractice
includingUCPandISP98.Theserulesofpracticeareincorporatedintothetransactionbyagreementof
theparties.ThelatestversionoftheUCPistheUCP600effectiveJuly1,2007.[9]SincetheUCParenot
laws,partieshavetoincludethemintotheirarrangementsasnormalcontractualprovisions.

InternationalTradePaymentmethods
InternationalTradePaymentmethodcanbedoneinthefollowingways.

Advancepayment(mostsecureforseller)Thebuyerpartswithmoneyfirstandwaitsforthe
sellertoforwardthegoods.

DocumentaryCredit(moresecureforselleraswellasbuyer)SubjecttoICC'sUCP600,the
bankgivesanundertaking(onbehalfofbuyerandattherequestofapplicant)topaythe
beneficiarythevalueofthegoodsshippedifacceptabledocumentsaresubmittedandifthe
stipulatedtermsandconditionsarestrictlycompliedwith.Thebuyercanbeconfidentthatthe
goodsheisexpectingonlywillbereceivedsinceitwillbeevidencedintheformofcertain
documentscalledformeetingthespecifiedtermsandconditionswhilethesuppliercanbe
confidentthatifhemeetsthestipulationshispaymentfortheshipmentisguaranteedbybank,
whoisindependentofthepartiestothecontract.

Documentarycollection(moresecureforbuyerandtoacertainextenttoseller)Alsocalled
"CashAgainstDocuments".SubjecttoICC'sURC525,sightandusance,fordeliveryofshipping
documentsagainstpaymentoracceptancesofdraft,whereshipmenthappensfirst,thenthetitle
documentsaresenttothebuyer'sbankbyseller'sbank,fordeliveringdocumentsagainst
collectionofpayment/acceptance

Directpayment(mostsecureforbuyer)Thesuppliershipsthegoodsandwaitsforthebuyerto
remitthebill,onopenaccountterms.

Risksituations
FraudRisks

Thepaymentwillbeobtainedfornonexistentorworthlessmerchandiseagainstpresentationby
thebeneficiaryofforgedorfalsifieddocuments.
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Credititselfmaybefunded.

SovereignandRegulatoryRisks

PerformanceoftheDocumentaryCreditmaybepreventedbygovernmentactionoutsidethe
controloftheparties.

LegalRisks

Possibilitythatperformanceofadocumentarycreditmaybedisturbedbylegalactionrelating
directlytothepartiesandtheirrightsandobligationsunderthedocumentarycredit.

ForceMajeureandFrustrationofContract

Performanceofacontractincludinganobligationunderadocumentarycreditrelationshipis
preventedbyexternalfactorssuchasnaturaldisastersorarmedconflicts.

Applicant

NondeliveryofGoods
Shortshipment
Inferiorquality
Early/lateshipment
Damagedintransit
Foreignexchange
Failureofbankvizissuingbank/collectingbank

IssuingBank

Insolvencyoftheapplicant
Fraudrisk,sovereignandregulatoryriskandlegalrisks

ReimbursingBank

noobligationtoreimbursetheclaimingbankunlessithasissuedareimbursementundertaking.

Beneficiary

Failuretocomplywithcreditconditions
Failureof,ordelaysinpaymentfrom,theissuingbank

Seealso
BankPaymentObligation
Buyer'sCredit
Documentarycollection

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UniformCustomsandPracticeforDocumentaryCredits

References
1. FicomS.A.v.SocializedCadex[1980]2LloydsRep.118.
2. UnitedCityMerchants(Investments)LtdvRoyalBankofCanada(TheAmericanAccord)[1983]1.A.C.168
at183
3. J.H.Rayner&Co.,Ltd.,andtheOilseedsTradingCompany,Ltd.v.HambrosBankLimited[1942]73Ll.
L.Rep.32
4. [1](http://www.bwtradefinance.com/letterofcreditlc)
5. Finkelstein,HermanNorman(1930).LegalAspectsofCommercialLettersofCredit
(https://books.google.com/books?id=ZsgMMwEACAAJ).
6. WilliamvRoffeyBrothers&Nicholls(contractors)Ltd
7. ScotsonvPegg
8. Menendez,Andres."LetterofCredit,itsRelationwithStipulationfortheBenefitofaThirdParty"
(http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2019474).Retrieved1June2013.
9. DominiqueDoise,The2007RevisionoftheUniformCustomsandPracticeforDocumentaryCredits(UCP
600)(http://www.alerionavocats.com/fr/expertise/publications/larevision2007desreglesetusances
uniformesrelativesauxcreditsdocumentairesruu600/)

Externallinks
LetterofCreditInformation,ProcedureandVideos.(http://www.bwtradefinance.com/letterof
creditlc/)
AnatomyofaLetterofCredit,showinganactualnegotiatedletterofcredit
(http://www.vulcanhammer.info/china/letterofcredit.php)
LettersofCreditandHowTheyWork(http://www.lancasterpollard.com/newsdetail/tcifall2007
felettersofcredit)
(inPersian)(http://banki.ir/danestaniha/214general/2468lc)
LetterofCredit,itsRelationwithStipulationfortheBenefitofaThirdParty
(http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2019474)
AplonTrade:AfreesampletoolforexportingLettersofCreditbyusingSWIFTmessages
(http://aplontrade.com/index.html#everyone)

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