Understanding Letters of Credit

Documentary Letters of Credit are effective in mitigating the commercial and financial risks associated with trading internationallyand are beneficial to both exporters and importers.

What is a Documentary Letter of Credit?

A Documentary Letter of Credit (also known as a Letter of Credit) is a written undertaking given by a bank onbehalf of an importer to pay the exporter an amount of money within aspecified period of time, provided the exporter presents to the bank documents which strictly comply with the terms and conditions laid down in the Letter of Credit.

Letters of Credit are subject to published worldwide standards defined by the International Chamber of Commerce – Uniform Customs and Practice for Documentary Credits (UCP). All parties dealing with Letters of Credit should be aware of and adhere to UCP.

Letters of Credit conforming to UCP standards should bear the clause”Subject to Uniform Customs and Practice for Documentary Credits(Latest Version).

The latest revision was published in July 2007 – UCP 600.

A Letter of Credit can be issued for any amount and in any freelytraded currency. It must stipulate when payment is to be made to theexporter. It can be payable either:

- At sight, ie: immediately following presentation of conformingdocuments to the bank authorised to pay or negotiate under the credit,or
- On a term basis, ie: after a specified and determinable periodspecified within the credit (eg: 30, 60 or 90 days after ’sight’ orpresentation of conforming documents to the bank). This type of creditwill be said to be available by deferred payment or acceptance.

It is the importer’s aim to receive the goods he has ordered in the desired quality and timeframe, whilst the exporter’s aim is to guarantee the payment for the goods.

Key points to remember:
-A Letter of credit is separate to the contract to which it relates

-All parties deal only in documents and not the goods or services to which the documents relate

-A Letter of Credit is not a guarantee that the exporter willdefinitely receive payment as it is subject to presentation ofconforming documentation within a specified timeframe. It is thereforevital that all key staff from Export Sales through to Finance and Shipping departments communicate with each other throughout the life cycle of a Letter of Credit to ensure that:

1. 1. The Letter of Credit is workable
2. 2. All documents presented to the bank comply strictly with the terms and conditions specified within the L/C

-A Letter of Credit is not a guarantee that the importer willdefinitely receive the ordered goods. The associated risks can bemitigated by the importer calling for specific documentation evidencingshipment and quality.

-A Letter of Credit is an effective negotiating tool for importers who may consider offering the guarantee of payment to overseas suppliers in return for improved / longer credit terms.

In a nutshell, in order to protect bottom line profits, it is essentialthat company personnel engaged at any stage in Letters of Credit – frominitial sale / purchase through to presentation of documents /application to the bank – are equipped with the appropriate skills andknowledge.

Mark Hayward
MJ Hayward Associates Ltd

Tel: 0800 043 4052

www.mjhayward.co.uk

“Helping you to Grow your Business through International Trade“