How Letters of Credit Work

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Information on how letters of credit work and why they sometimes don't work.

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How Letters of Credit Work

  1. 1. How Letters of Credit Work NACM Oregon/CMA Business Credit Learning Center Webinar May 21, 2009 Buddy Baker, Head of Trade Services Sales Fifth Third Bank [email_address] (847) 830-3038 If you can read this, your settings are not optimal for printing this presentation and will draw certain graphics incorrectly. Please re-print using the “Color” setting, even if printing using a black & white printer. (…and Why They Sometimes Don’t)
  2. 2. NOTE: This set of slides contains animation and “builds” designed to be viewed in Slide Show mode. Please switch to Slide Show mode. Printing the slides may produce partially obstructed slides and slides with missing elements. If your desire is to review the presentation on paper, when in the print dialog, choose “Print range: Custom Show: Handouts” and check “Print hidden slides.” Choose the “Color” setting, even if printing in black & white.
  3. 3. Walter (Buddy) Baker Walter (Buddy) Baker has over 30 years of experience in international trade finance. In May 2009 he joined Fifth Third Bank as the head of their Trade Services Sales team. Prior to Fifth Third, Buddy worked for Atradius Trade Credit Insurance, ABN AMRO Bank, Bank of America, Wachovia Bank, and The First National Bank of Chicago. Buddy is a recognized expert in trade finance and author of numerous magazine articles and the books Users’ Handbook to Documentary Credits under UCP600 , Documentary Payments & Short-Term Trade Finance , and The Regulatory Environment of Letters of Credit and Trade Finance . He owns the consulting firm Global Trade Risk Management Strategies, which specializes in educational training, and makes frequent presentations for national associations of exporters, importers, bankers and lawyers. Mr. Baker serves as a member-at-large of the National Letter of Credit Committee of the International Financial Services Association and is actively involved in establishing national and worldwide standard practices for LCs, such as the recent revision of the Uniform Customs and Practice for Documentary Credits (referred to as UCP600), the official ICC guide for examining letter of credit documents, called the International Standard Banking Practices for the Examination of Documents under Documentary Credits, the eUCP supplement to the UCP dealing with electronic documents, the International Standby Practices, and Article 5 of the Uniform Commercial Code. He acts as an advisor to the Wolfsberg Group, an international group that includes most of the largest banks in the world whose purpose is to set standards for combating money laundering, and to the Institute for International Banking Law and Practice. Buddy also serves on the Advisory Council of the Finance Credit and International Business Association (FCIB), a multinational association of export credit managers. Buddy earned his undergraduate degree at Yale University and his MBA at Northwestern. He can be reached at (847) 830-3038 or [email_address] .
  4. 4. How L/Cs Are Supposed to Work May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  5. 5. When Might a Letter of Credit Drawing Not Be Paid? <ul><li>Expired L/C </li></ul><ul><li>Discrepancies </li></ul><ul><li>Political or economic event </li></ul><ul><li>Fraud/injunction </li></ul><ul><li>L/C issued during bankruptcy preference period, covering pre-existing debt </li></ul><ul><li>Insolvent bank, liquidated </li></ul>May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  6. 6. What Is a Letter of Credit? <ul><li>An assurance of payment? </li></ul><ul><li>A guarantee? </li></ul><ul><li>A security interest? </li></ul><ul><li>Conditional or unconditional? </li></ul>May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker A letter of credit is a bank’s own engagement to make payment of a specified amount upon presentation of specified documents
  7. 7. Definition <ul><li>Letter of Credit an undertaking, usually on the part of a bank and at the request of one of the bank’s customers, to pay a named beneficiary a specified amount of money (or to deliver an item of value) if the beneficiary presents documents in accordance with the terms and conditions specified in the letter of credit. </li></ul>May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  8. 8. Uses of Letters of Credit <ul><li>Intended means of payment for goods </li></ul><ul><li>Secondary means of payment for goods (if buyer fails to pay directly) </li></ul><ul><li>Bid bond (seller is applicant) </li></ul><ul><li>Performance bond/warranty (seller is applicant) </li></ul><ul><li>Advance payment guarantee (seller is applicant) </li></ul><ul><li>Loan repayment </li></ul><ul><li>Direct loan repayment (bond enhancement) </li></ul><ul><li>etc., etc., etc. </li></ul>May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  9. 9. How Letters of Credit Work: Theory May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Buyer Seller Contract Buyer’s Bank Letter of Credit Application
  10. 10. How Letters of Credit Work: Theory May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Buyer Seller Contract Buyer’s Bank Letter of Credit Application Letter of Credit
  11. 11. How Letters of Credit Work: Theory May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Buyer Buyer’s Bank Seller Contract Letter of Credit Application Letter of Credit 3 parties 3 independent contracts
  12. 12. How Letters of Credit Work: Theory May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Buyer Buyer’s Bank Seller Contract Letter of Credit Application Letter of Credit Principles of Letters of Credit: Independent and Documentary Goods Documents
  13. 13. How Letters of Credit Work: Theory May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Buyer Buyer’s Bank Seller Contract Letter of Credit Application Documents Letter of Credit Goods Payment
  14. 14. How Letters of Credit Work: Theory May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Buyer Buyer’s Bank Seller Contract Letter of Credit Application Documents Letter of Credit Goods Documents Payment Debit
  15. 15. How Letters of Credit Work: Theory May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Buyer Buyer’s Bank Seller Contract Letter of Credit Application Documents Documents Payment Debit Letter of Credit Goods
  16. 16. Risk Mitigation Techniques May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker 1. It may be possible for the applicant to obtain a court injunction to stop payment of a non-negotiable L/C. 7. A receivable in a foreign currency made be sold, including the remaining currency fluctuation risk. 8. FX exposure depends on the currency of the credit.
  17. 17. A Typical Export L/C May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker <ul><li>Prepared MAR08/07 14:21 </li></ul><ul><li>KEY: SWIN 9603000708914700 SEQ NO: 960308500050 </li></ul><ul><li>RECEIVED FROM: ABN AMRO BANK N.V., SINGAPORE BRANCH </li></ul><ul><li>SINGAPORE </li></ul><ul><li>Authentication: CORRECT </li></ul><ul><ul><ul><li>: 1 :basic header : F 01 LASLUS44BXXX 1448 170261 </li></ul></ul></ul><ul><ul><ul><li>: 2 :application : 0 700 1519 968300 ABNASCSCAXXX 2456 743J92 960308 0709 N </li></ul></ul></ul><ul><ul><ul><li>message type : 700-Issue of Documentary Credit N-Normal Message </li></ul></ul></ul><ul><ul><ul><li>: 4 :message text : </li></ul></ul></ul><ul><ul><ul><li>:27 :sequence of total : 1/1 </li></ul></ul></ul><ul><ul><ul><li>:40A:applicable rules : UCP600 </li></ul></ul></ul><ul><ul><ul><li>:20 :doc credit number : L960477 </li></ul></ul></ul><ul><ul><ul><li>:31C:date of issue : 070308 </li></ul></ul></ul><ul><ul><ul><li>:31D:date/place of expiry : 070430 IN U.S.A. </li></ul></ul></ul><ul><ul><ul><li>:50 :applicant : ABC COMPANY </li></ul></ul></ul><ul><ul><ul><ul><li> 21 ANY STREET </li></ul></ul></ul></ul><ul><ul><ul><ul><li> SINGAPORE 659539 </li></ul></ul></ul></ul><ul><ul><ul><li>:59 :beneficiary : XYZ COMPANY </li></ul></ul></ul><ul><ul><ul><ul><li> 52 ANY STREET </li></ul></ul></ul></ul><ul><ul><ul><ul><li> GREENWOOD, IN 48182 </li></ul></ul></ul></ul><ul><ul><ul><ul><li> USA </li></ul></ul></ul></ul><ul><ul><ul><li>:32B:currency/amount : USD10,000.00 </li></ul></ul></ul><ul><ul><ul><li>:41D:available with…by… : ANY BANK </li></ul></ul></ul><ul><ul><ul><ul><li> BY NEGOTIATION </li></ul></ul></ul></ul><ul><ul><ul><li>:42C:drafts at : SIGHT </li></ul></ul></ul><ul><ul><ul><li>:42D:drawee : ABN AMRO BANK N.V., SINGAPORE BRANCH </li></ul></ul></ul><ul><ul><ul><li>:43P:partial shipments : NOT ALLOWED </li></ul></ul></ul><ul><ul><ul><li>:43T:transshipment : ALLOWED </li></ul></ul></ul><ul><ul><ul><li>:44A:place of taking in charge/dispatch from…/ </li></ul></ul></ul><ul><ul><ul><li>place of receipt : METROPOLIS, IN </li></ul></ul></ul><ul><ul><ul><li>:44B:place of final destination/for transportation to…/ </li></ul></ul></ul><ul><ul><ul><li>place of delivery : SINGAPORE </li></ul></ul></ul><ul><ul><ul><li>:44E:port of loading/ </li></ul></ul></ul><ul><ul><ul><li>airport of departure : USA PORT </li></ul></ul></ul><ul><ul><ul><li>:44F:port of discharge/ </li></ul></ul></ul><ul><ul><ul><li>airport of destination : SINGAPORE </li></ul></ul></ul><ul><ul><ul><li>:44C:latest date of shipment : 070415 </li></ul></ul></ul><ul><ul><ul><li>:45A:description of goods : 1 (ONE) UNIT - PORTABLE CHILLER, MODEL : MX-7, SAYR 415/ </li></ul></ul></ul><ul><ul><ul><ul><li> 50 AS PER APPLICANT’S P/O NO. 2075 FOB USA PORT </li></ul></ul></ul></ul><ul><ul><ul><li>:46A:documents required : ++ BENEFICIARY’S SIGNED COMMERCIAL INVOICE IN ONE ORIGINAL AND </li></ul></ul></ul><ul><ul><ul><ul><li> THREE COPIES </li></ul></ul></ul></ul><ul><ul><ul><ul><li> ++ FULL SET ORIGINAL CLEAN ON BOARD PORT TO PORT BILLS OF LADING </li></ul></ul></ul></ul><ul><ul><ul><ul><li> AND ONE N.N. COPY MADE OUT TO ORDER OF SHIPPER </li></ul></ul></ul></ul><ul><ul><ul><ul><li> BLANK ENDORSED MARKED FREIGHT COLLECT AND NOTIFY APPLICANT </li></ul></ul></ul></ul><ul><ul><ul><ul><li> INDICATING THIS CREDIT NUMBER. </li></ul></ul></ul></ul><ul><ul><ul><ul><li> ++CERTIFICATE OF USA ORIGIN IN ONE ORIGINAL AND ONE COPY ISSUED </li></ul></ul></ul></ul><ul><ul><ul><ul><li> BY BENEFICIARY/CHAMBER OF COMMERCE </li></ul></ul></ul></ul><ul><ul><ul><ul><li> ++ PACKING LIST IN ONE ORIGINAL AND ONE COPY </li></ul></ul></ul></ul><ul><ul><ul><li>:47A:additional conditions : +ALL DOCUMENTS MUST BE DISPATCHED TO US IN ONE LOT BY </li></ul></ul></ul><ul><ul><ul><ul><li> REGISTERED AIRMAIL + INSURANCE WILL BE COVERED BY APPLICANT </li></ul></ul></ul></ul><ul><ul><ul><li>:71B:charges : ALL BANK CHARGES AND COMMISSIONS OUTSIDE SINGAPORE INCLUDING </li></ul></ul></ul><ul><ul><ul><ul><li> REIMBURSEMENT CHARGES ARE FOR BENEFICIARY’S ACCOUNT </li></ul></ul></ul></ul><ul><ul><ul><li>:49 :confirmation instructions : WITHOUT </li></ul></ul></ul><ul><ul><ul><li>:53A:reimbursing bank : ABN AMRO BANK N.V. </li></ul></ul></ul><ul><ul><ul><ul><li> NEW YORK, NY </li></ul></ul></ul></ul><ul><ul><ul><li>:78 :instr to nominated bank : REIMBURSEMENT : PLEASE REIMBURSE YOURSELVES TO THE DEBIT </li></ul></ul></ul><ul><ul><ul><ul><li> OF OUR ACCOUNT WITH ABN AMRO BANK NV, NEW YORK, UNDER TESTED </li></ul></ul></ul></ul><ul><ul><ul><ul><li> TELEX ADVICE TO US. A DISCREPANCY FEE OF USD40.00 (OR ITS </li></ul></ul></ul></ul><ul><ul><ul><ul><li> EQUIVALENT) SHALL BE DEDUCTED FROM THE REIMBURSEMENT CLAIM/ </li></ul></ul></ul></ul><ul><ul><ul><ul><li> PROCEEDS UPON EACH PRESENTATION OF DISCREPANT DOCUMENTS AND THE </li></ul></ul></ul></ul><ul><ul><ul><ul><li> LEVY OF THE DISCREPANCY FEE DOES NOT IN ANY WAY ALTER THE TERMS </li></ul></ul></ul></ul><ul><ul><ul><ul><li> AND CONDITIONS OF THIS CREDIT. </li></ul></ul></ul></ul>
  18. 18. How Letters of Credit Work: Theory May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Buyer Buyer’s Bank Seller Contract Letter of Credit Application Documents Documents Payment Debit Letter of Credit Goods
  19. 19. How Letters of Credit Work: Reality May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Foreign Buyer Buyer’s Bank Advising Bank Seller’s Bank Seller NominatedBank Freight Forwarder Reimbursing Bank Contract L/C Appli- cation Docu- ments Debit L/C L/C L/C L/C & Documents Documents Payment Payment Reimbursement Authorization Reimbursement Goods Goods Reimbursement Claim
  20. 20. How Letters of Credit Work: Theory May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Buyer Buyer’s Bank Seller Contract Letter of Credit Application Documents Documents Debit Letter of Credit Goods Payment
  21. 21. How International Letters of Credit Work May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Buyer Seller Contract Nominated Bank Docu- ments Goods Debit Documents Payment Pay- ment Buyer’s Bank L/C Appli- cation L/C Advising Bank L/C Docu- ments
  22. 22. How Confirmed Letters of Credit Work May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Buyer Seller Docu- ments Pay- ment Goods Contract Confirming Bank L/C L/C Debit Documents Payment Buyer’s Bank L/C Appli- cation Docu- ments
  23. 23. Risk Mitigation Techniques May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  24. 24. Standby L/Cs and Guarantees May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  25. 25. What Is a Standby Letter of Credit? <ul><li>Standby Letter of Credit as opposed to a commercial letter of credit, a letter of credit that does not cover the direct purchase of merchandise, so called because it is often intended to be drawn on only when the applicant for whom it is issued fails to perform an obligation. Standby letters of credit are based on the underlying principle of letters of credit that payment is made against presentation of documents–whatever documents the applicant, beneficiary, and issuing bank may agree to, not necessarily documents evidencing shipment of goods. </li></ul>May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  26. 26. Characteristics of Standby L/Cs <ul><li>Similar to guarantees but independent in nature </li></ul><ul><li>Documentary </li></ul><ul><li>Not meant to be drawn on (generally) </li></ul>May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  27. 27. How Letters of Credit Work: Theory May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Buyer Buyer’s Bank Seller Contract Documents Documents Payment Debit Letter of Credit Letter of Credit Application Goods
  28. 28. How Standby Letters of Credit Work May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Applicant Applicant’s Bank Beneficiary Contract Letter of Credit Application Letter of Credit Documents Documents Payment Debit Payment
  29. 29. Risk Mitigation Techniques May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker 2. Preferential payment risk exists unless the standby is properly worded. 3. Country risks are covered if the L/C is confirmed by a “developed-world” bank.
  30. 30. Risk Mitigation Techniques <ul><li>Guarantees </li></ul><ul><li>Independent/demand guarantee </li></ul><ul><li>Accessory/contract guarantee, surety bond </li></ul>May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  31. 31. Standby L/Cs vs. Guarantees & Bonds May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Standby L/C Demand Guarantee Accessory/Contract Guarantee, Surety Bond Independent & payable against documents Independent & payable against documents Specified amount Specified amount Payable upon occurrence of specified event Amount of damages (usually with a maximum) Specified expiry Usually has a specified expiry Expiry event Rules: UCP or ISP (and UCC5 in the U.S.) Rules: URDG, ISP, or local law Rules: Local law
  32. 32. Risk Mitigation Techniques May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker 4. Country risks are covered if the guarantee is a ‘local guarantee’. 5. If the principal repudiates the contract, the guarantor may do the same.
  33. 33. Risk Mitigation Techniques May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker 4. Country risks are covered if the guarantee is a ‘local guarantee’. 5. If the principal repudiates the contract, the guarantor may do the same. Be sure you know which kind of guarantee you’re dealing with
  34. 34. Rules and Regulations to Be Aware Of <ul><li>The Uniform Customs and Practice for Documentary Credits (“UCP”) </li></ul><ul><li>The Uniform Commercial Code, Article 5 </li></ul><ul><li>International Standard Banking Practice for the Examination of Documents under Documentary Credits (“ISBP”) </li></ul><ul><li>The eUCP </li></ul><ul><li>The International Standby Practices (“ISP98”) </li></ul><ul><li>The Uniform Rules for Demand Guarantees </li></ul><ul><li>The Incoterms </li></ul><ul><li>Antiboycott regulations </li></ul><ul><li>OFAC sanctions </li></ul>May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  35. 35. Real-World Letter of Credit Mechanics May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  36. 36. How Letters of Credit Work: Theory May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Buyer Buyer’s Bank Seller Contract Letter of Credit Application Documents Documents Payment Debit Letter of Credit Goods
  37. 37. How Letters of Credit Work: Reality May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Foreign Buyer Buyer’s Bank Advising Bank Seller’s Bank Seller Nominated Bank Freight Forwarder Reimbursing Bank Contract L/C Appli- cation Docu- ments Debit L/C L/C L/C L/C & Documents Documents Payment Payment Reimbursement Authorization Reimbursement Goods Goods Reimbursement Claim
  38. 38. How Letters of Credit Work: Reality May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Foreign Buyer Seller Contract Buyer’s Bank L/C Appli- cation
  39. 39. How Letters of Credit Work: Reality May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Foreign Buyer Seller Contract L/C Appli- cation Buyer’s Bank Advising Bank L/C L/C
  40. 40. How Letters of Credit Work: Reality May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Foreign Buyer Advising Bank Seller Contract L/C Appli- cation L/C L/C Buyer’s Bank Reimbursing Bank Reimbursement Authorization
  41. 41. How Letters of Credit Work: Reality May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Foreign Buyer Buyer’s Bank Advising Bank Reimbursing Bank Contract L/C Appli- cation L/C L/C Reimbursement Authorization Seller Freight Forwarder L/C
  42. 42. How Letters of Credit Work: Reality May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Foreign Buyer Buyer’s Bank Advising Bank Reimbursing Bank Contract L/C Appli- cation L/C L/C L/C Reimbursement Authorization Seller Freight Forwarder Nominated Bank L/C & Documents Goods Goods
  43. 43. How Letters of Credit Work: Reality May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Foreign Buyer Buyer’s Bank Advising Bank Seller Freight Forwarder Reimbursing Bank Contract L/C Appli- cation L/C L/C L/C L/C & Documents Reimbursement Authorization Goods Goods Nominated Bank Reimbursement Claim Documents
  44. 44. How Letters of Credit Work: Reality May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Foreign Buyer Buyer’s Bank Advising Bank Seller Nominated Bank Freight Forwarder Reimbursing Bank Contract L/C Appli- cation L/C L/C L/C L/C & Documents Documents Reimbursement Authorization Goods Goods Reimbursement Claim Reimbursement
  45. 45. How Letters of Credit Work: Reality May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Foreign Buyer Buyer’s Bank Advising Bank Seller Freight Forwarder Reimbursing Bank Contract L/C Appli- cation L/C L/C L/C L/C & Documents Documents Reimbursement Authorization Goods Goods Reimbursement Claim Nominated Bank Payment Seller’s Bank Payment Reimbursement
  46. 46. How Letters of Credit Work: Reality May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Advising Bank Seller’s Bank Seller Nominated Bank Freight Forwarder Reimbursing Bank Contract L/C Appli- cation L/C L/C L/C L/C & Documents Documents Payment Payment Reimbursement Authorization Reimbursement Goods Goods Reimbursement Claim Foreign Buyer Buyer’s Bank Docu- ments Debit
  47. 47. How Letters of Credit Work: Reality May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Foreign Buyer Buyer’s Bank Advising Bank Seller’s Bank Seller Nominated Bank Freight Forwarder Reimbursing Bank Contract L/C Appli- cation Docu- ments L/C L/C L/C L/C & Documents Documents Payment Payment Reimbursement Authorization Reimbursement Goods Goods Reimbursement Claim Debit
  48. 48. Problems with Confirming Banks <ul><li>The Confirming Bank is chosen by the Issuing Bank </li></ul><ul><li>The Confirming Bank has a monopoly position </li></ul><ul><li>The Confirming Bank may be an affiliate of the Issuing Bank </li></ul><ul><li>The Confirming Bank can be enjoined from making payment # </li></ul>May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  49. 49. Replacing Confirmation <ul><li>Negotiation of documents without recourse </li></ul><ul><li>Often referred to as “silent confirmation” </li></ul><ul><li>Allows you to present all your L/Cs to your own bank for payment </li></ul><ul><li>Can request payment without recourse if documents comply with L/C requirements </li></ul><ul><li>Immediate availability of funds </li></ul>May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  50. 50. How Confirmed Letters of Credit Work May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Docu- ments Pay- ment Buyer Seller Goods Debit Documents Payment Docu- ments Contract Confirming Bank L/C L/C Buyer’s Bank L/C Appli- cation
  51. 51. How Silent Confirmation Works May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker Buyer A ‘silent confirmation’ is a commitment, issued in advance by the nominated bank, to purchase compliant documents without recourse Seller Goods Contract Debit Documents Payment Pay- ment Buyer’s Bank L/C Appli- cation Docu- ments Commit- ment L/C Advising Bank L/C Nominated Bank L/C Docu- ments
  52. 52. Risk Mitigation Techniques May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  53. 53. Usance Letters of Credit <ul><li>Time drafts vs. deferred payment </li></ul><ul><li>Significance of whom drafts are drawn on: </li></ul><ul><ul><li>obligations of the drawee </li></ul></ul><ul><ul><li>fixing maturity </li></ul></ul><ul><li>Discounting accepted drafts </li></ul><ul><li>L/C re-financing vs. time drafts </li></ul><ul><li>Effect of “discount charges for Buyer” clause </li></ul>May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  54. 54. An Extended Look at Standby L/Cs May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  55. 55. Using Standby L/Cs in Trade Transactions <ul><li>Credit line back-up </li></ul><ul><li>Bid bonds </li></ul><ul><li>Performance bonds </li></ul><ul><li>Warranty/retention money </li></ul><ul><li>Advance payment guarantees </li></ul>May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  56. 56. Why Was the ISP Created? <ul><li>Continuing problem with lawsuits involving standbys </li></ul><ul><li>UCP reflects commercial L/C practice </li></ul><ul><ul><li>standby practice sometimes differs (e.g., Articles 36 (Force Majeure), 32 (Instalment Drawings), 14c (Late Presentation), & 38   (Transfers)) </li></ul></ul><ul><ul><li>many standby practices are not covered in the UCP </li></ul></ul><ul><li>Sometimes UCP is unclear (or wrong) </li></ul><ul><li>URDG too vague </li></ul>May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  57. 57. UCP vs. ISP <ul><li>UCP assumes applicants want to pay </li></ul><ul><li>ISP assumes applicants don’t want to pay </li></ul><ul><li>ISP is more liberal re document examination </li></ul><ul><li>ISP is more liberal re time allowed to present </li></ul><ul><li>UCP is more concerned about originality of documents </li></ul><ul><li>ISP contains a few rules that are just missing from the UCP </li></ul><ul><li>ISP contains standby-specific rules (that no one wanted to put in the UCP) </li></ul><ul><li>Transfers work differently </li></ul>May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  58. 58. UCP vs. ISP May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker The ISP is designed for standbys UCP600 ISP98 Intended Use: L/Cs whose primary purpose is to serve as a means to exchange control of goods for payment. L/Cs whose primary purpose is to provide credit assurance <ul><ul><li>Assumption 1: </li></ul></ul>The documents have a time value <ul><ul><li>The documents have no intrinsic value </li></ul></ul><ul><ul><li>Assumption 2: </li></ul></ul>Applicants want to pay <ul><ul><li>Applicants don’t want to pay </li></ul></ul>
  59. 59. UCP vs. ISP May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker UCP600 ISP98 Force majeure L/C expires nonetheless Expiry extended 30 days after bank re-opens Consistency of documents Data in documents must not conflict Documents need not be consistent Time allowed for dishonor 5 banking days <4 days = reasonable >7 days = unreasonable Original documents “ In __ copies” means one original of each document “ Copies” means copies Transport documents Extensive, detailed requirements Treated like “other” documents Disposition of documents Strict requirements No requirements Deemed acceptance of amendments If documents comply w/ amended terms If documents will not comply w/o amendment Transfer One time but multiple partial transfers allowed Multiple times but always in entirety
  60. 60. Standby L/C Loopholes <ul><li>Court injunctions </li></ul><ul><li>Bankruptcy of the applicant </li></ul><ul><ul><li>Before receiving payment/performance from applicant </li></ul></ul><ul><ul><li>Within 90 days of receiving payment </li></ul></ul><ul><ul><li>Within 90 days of receiving L/C </li></ul></ul><ul><ul><ul><li>did the debt exist at the time the L/C was issued? </li></ul></ul></ul><ul><ul><ul><li>bank secured or unsecured when L/C was issued? </li></ul></ul></ul>May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  61. 61. Standby L/C Loopholes (cont’d) <ul><li>Insolvency of the issuing bank </li></ul><ul><ul><li>The FDIC will disaffirm all undrawn L/Cs </li></ul></ul><ul><ul><li>If the bank is sold, you will be made whole </li></ul></ul><ul><ul><li>If the bank is liquidated, you will have a ratable claim </li></ul></ul><ul><li>Abusive drawings </li></ul>May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker
  62. 62. Recap: When Might a Letter of Credit Drawing Not Be Paid? <ul><li>Expired L/C </li></ul><ul><li>Discrepancies </li></ul><ul><li>Political or economic event </li></ul><ul><li>Fraud/injunction </li></ul><ul><li>L/C issued during bankruptcy preference period, covering pre-existing debt </li></ul><ul><li>Insolvent bank, liquidated </li></ul>May 21, 2009 – BCLC – How L/Cs Work – Buddy Baker

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