Letters Of Credit: A Primer

Walsh Enterprises Business & Financial Advisors Huntington Beach, California USA http://www.awalsh.us walshal1@AOL.COM (714) 465-2749 Letters of Credit A Primer Reprinted from a blog posted December 2008 at www.walshal.wordpress.com

Letters of Credit have been around for a long time as a standard tool of International Commerce – but a lot of people just don’t understand them. I’ve even run across senior executives of major corporations who are in the dark. Here’s a brief primer on the topic… Letters of Credit (hereafter referred to as L/Cs) are a form of payment guarantee. They are not a loan!

If an exporter (seller) want to ensure guarantee of payment for his goods, he requests that the importer (buyer) obtain a L/C. The buyer then goes to his bank, deposits the required money, and requests the issuance of the L/C. The issuing bank then issues the L/C to the exporter’s (seller’s) bank. This receiving bank is referred to as the Correspondent bank. The L/C will spell out who pays for wire transfer fees (usually the seller). The L/C will also spell out what currency the payment will be made in. Normally a U.S. exporter will ask for payment in U.S. dollars. The buyer has the responsibility for any currency exchange required (and related expenses) to deposit the proper amount of dollars with the L/C Issuing bank. The L/C will spell out the terms under which the seller gets paid – usually upon presentation to the Issuing bank of appropriate documents evidencing shipment or delivery. There might be other terms; for instance the buyer might demand in-country inspection of the goods prior to payment. The Issuing bank puts the terms into the L/C that the buyer stipulates, so make sure you get those terms worked out in advance.

An L/C can be issued for a single shipment, or for a number of shipments over a period of time; in which case a maximum L/C value is set (the maximum the Issuing bank will pay for all shipments under that L/C). The most common form is an Irrevocable L/C; which means that for a specified period of time spelled out in the L/C, the Issuing bank is obligated to make payment upon presentation of proper documentation. After that date, the bank is under no obligation to pay. So, as the seller you want to make sure that the date is far enough out to allow for shipping delays and other possible complications. A Revocable L/C (not often used) will spell out conditions under which the Issuing bank can refuse payment. Payment is usually made via wire transfer from the Issuing bank to the Correspondent (seller’s) bank.

The International Chamber of Commerce (ICC) issues standardized guidelines for L/Cs, and most banks follow those guidelines. It is normal practice for the Issuing bank to spell out conformance with ICC rules in the body of the L/C. English is the commonly-used language for L/Cs. Most banks these days know how to do L/Cs, but there are some that don’t; especially in developing countries. Make sure the buyer uses a bank that’s knowledgeable in these matters.

So, if you’re a U.S. exporter, work out the terms of sale & payment with the buyer and then ask for a ICC-conformant Irrevocable L/C, denominated in U.S. dollars, with a termination date that’s far enough out to allow for any delays. If your bank is not sophisticated in administering L/Cs, get another one to act as the Correspondent bank. Read the L/C carefully as soon as you get it to make sure there aren’t any mistakes, strange terms, or hidden fees. If the L/C is not correct, have your bank request that the Issuing bank issue a revised L/C. I’ve never experienced or heard of a bank that didn’t honor it’s commitment to pay if all terms of the L/C were met; and I’ve administered thousands of L/Cs. I suppose there could be an exception, but that bank would be quickly blackballed by the international business community.

Letters Of Credit: A Primer

by Alan Walsh on Jul 12, 2009

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