NATIONAL LAW INSTITUTE UNIVERSITY

INTERNATIONAL TRADE LAW

A Project On

LETTER OF CREDIT

SUBMITTED TO:
SUBMITTED BY:

DR. MONICA RAJE AKSHEY JOSE

ASST.PROFESSOR 2013 B.A.LLB 39

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 Contents
Introduction...............................................................................................................................................................3

Meaning.....................................................................................................................................................................3

Types of Letters Of Credit.......................................................................................................................................4

Commercial Letters of Credit............................................................................................ 4

Standby Letters of Credit.................................................................................................. 5

Revocable Letters of Credit............................................................................................... 5

Irrevocable Letters of Credit............................................................................................. 5

Confirmed Letter of Credit................................................................................................ 6

Unconfirmed Letter of Credit............................................................................................ 6

Revolving Letter of Credit................................................................................................. 6

Sight Letter of Credit........................................................................................................ 6

Future or Credit Letter of Credit........................................................................................7

Standby Letter of Credit................................................................................................... 7

Transferable Letter of Credit............................................................................................. 7

Back-to-Back Letter of Credit............................................................................................ 8

Parties to Letters of Credit......................................................................................................................................8

Applicant.......................................................................................................................... 8

Beneficiary....................................................................................................................... 8

Issuing Bank..................................................................................................................... 8

Nominated Bank............................................................................................................... 9

Advising Bank................................................................................................................... 9

Confirming Bank............................................................................................................... 9

Reimbursing Bank............................................................................................................. 9

Steps in the Letter of Credit Process.....................................................................................................................10

Documents to Be Tendered.....................................................................................................................................11

Fundamental Principles of Letter Of Credit........................................................................................................11

Autonomy of the Credit.................................................................................................. 11

Doctrine of Strict Compliance......................................................................................... 12

Uses for Letter Of Credit.......................................................................................................................................12

Operative Instrument for Letter Of Credit..........................................................................................................13

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 Airmail............................................................................................................................ 13

Telecommunication......................................................................................................... 13

Difference between Bank Guarantee and Letter Of Credit................................................................................13

Bibliography............................................................................................................................................................15

Introduction

A letter of credit is a document issued by a financial institution, or a similar party, assuring payment to a seller
of goods and/or services. The seller then seeks reimbursement from the buyer or from the buyer's bank. The
document serves essentially as a guarantee to the seller that it will be paid by the issuer of the letter of credit
regardless of whether the buyer ultimately fails to pay. In this way, the risk that the buyer will fail to pay is
transferred from the seller to the letter of credit's issuer. The letter of credit also insures that all the agreed upon
standards and quality of goods are met by the supplier.

Letters of credit are used primarily in international trade for large transactions between a supplier in one country
and a customer in another. In such cases, the International Chamber of Commerce Uniform Customs and
Practice for Documentary Credits applies (UCP 600 being the latest version).They are also used in the land
development process to ensure that approved public facilities (streets, sidewalks, storm water ponds, etc.) will
be built. The parties to a letter of credit are the supplier, usually called the beneficiary, the issuing bank, of
whom the buyer is a client, and sometimes an advising bank, of whom the beneficiary is a client. Almost all
letters of credit are irrevocable, i.e., cannot be amended or cancelled without the consent of the beneficiary,
issuing bank, and confirming bank, if any. In executing a transaction, letters of credit incorporate functions
common to giros and travellers cheques.

The name letter of credit derives from the French word accrditation, a power to do something, which in
turn derives from the Latin accreditivus, meaning trust. This applies to any defence relating to the underlying
contract of sale. This is as long as the seller performs their duties to an extent that meets the requirements
contained in the letter of credit

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Meaning

A Letter of credit is the Buyers Bankers promise to the Bank of the Seller / Exporter that the bank will honour
the Invoice presented by the Exporter on due date and make payment, provided that the Seller/Exporter has
complied with all the requirements and conditions set by the Importer in the said Letter of credit or the Buyers
Purchase Order and produced documentary evidence to prove compliance, along with the necessary shipment
related documentation.
In other words, Letter of credit is a letter from a bank guaranteeing that a buyer's payment to a seller will be
received on time and for the correct amount. In the event that the buyer is unable to make payment on the
purchase, the bank will be required to cover the full or remaining amount of the purchase.

A letter of Credit is the Buyers Bankers promise to the Bank of the Seller / Exporter that the bank will honour
the Invoice presented by the Exporter on due date and make payment, provided that the Seller/Exporter has
complied with all the requirements and conditions set by the Importer in the said letter of credit or the Buyers
Purchase Order and produced documentary evidence to prove compliance, along with the necessary shipment
related documentation.

Types of Letters Of Credit

Traveler's letters of credit, which were commonly used in eighteenth century, were the first financial
instrument contains very similar characteristics with the contemporary letters of credit. From traveler's letters
of credit days to today's complex global economy, the letters of credit have been performing their duties as a
secure and reliable payment method. Actually, during this period letters of credit have gained a very flexible
structure that can satisfy different needs of different types of international trade practitioners. In this project,
we will discuss types of letters of credit.

Commercial Letters of Credit

Commercial letters of credit are mainly used as a primary payment tool in international trade such as exporting
and importing transactions. Majority of commercial letters of credit are issued subject to the latest version of
UCP (Uniform Customs and Practice for Documentary Credits). The ICC publishes UCP, which are the set of
rules that governs the commercial letters of credit procedures.

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Standby Letters of Credit

Commercial letters of credit are a means of payment to be utilized when the principal perform its duties. As an
example, let us consider an exporter who ships the goods according to the sales contract and apply to the
nominated bank for the payment. If the nominated bank decides that the presentation is conforming to the
terms and conditions of the credit and the UCP rules then exporter will be paid. This situation is just contrary
in standby letters of credit. A payment is made to the beneficiary of a standby letter of credit when there is a
breach of the principal's obligation. As an example, let us consider a construction company that has been
awarded with a tender. If this construction company cannot fulfill its obligations under the project contract
beneficiary of the standby letter of credit can apply to the nominated bank for the payment. However, the
nominated bank considers only the terms and the conditions of the standby letter of credit and the rules
governing the credit when deciding a complying presentation. One point that needs to be stressed is that
standby letters of credit have their own rules, which are called The International Standby Practices 1998
(ISP98). They are also published by ICC. However, a standby letter of credit can be issued subject to either the
UCP or the ISP.

Revocable Letters of Credit

Revocable letters of credit give issuer the amendment or cancellation right of the credit any time without prior
notice to the beneficiary. Since revocable letters of credit do not provide any protection to the beneficiary, they
are not used frequently. In addition, UCP 600 has no reference to revocable letters of credit. All credits issued
subject to UCP 600 are irrevocable unless otherwise agreed between the parties.

Irrevocable Letters of Credit

Irrevocable Letters of Credit cannot be amended or cancelled without the agreement of the credit parties.
Unconfirmed irrevocable letters of credit cannot be modified without the written consent of both the issuing
bank and the beneficiary. Confirmed irrevocable letters of credit need also confirming bank's written consent
in order any modification or cancellation to be effective.

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Confirmed Letter of Credit

A confirmed Letter of credit is one in which the advising bank, on the instructions of the issuing bank, has
added a confirmation that, payment will be made as long as compliant documents are presented. This
commitment holds even if the issuing bank or the buyer fails to make payment. In other words, when another
(local bank) of the seller country confirms the Letter of credit it becomes a confirmed Letter of credit. It is an
added protection.

Unconfirmed Letter of Credit

An unconfirmed Letter of credit is forwarded by the advising bank directly to the exporter without adding its
own undertaking to make payment or accept responsibility for payment at a future date, but confirming its
authenticity.

Revolving Letter of Credit

The revolving credit is used for regular shipments of the same commodity to the same importer. It can revolve
in relation to time or value. If the credit is time revolving once utilized it is re-instated for further regular
shipments until the credit is fully drawn. If the credit revolves in relation to value once utilized and paid the
value can be reinstated for further drawings.
The credit must state that it is a revolving Letter of credit and it may revolve either automatically or subject to
certain provisions. Revolving letters of credit are useful to avoid the need for repetitious arrangements for
opening or amending letters of credit.

Sight Letter of Credit

When the Letter of credit is opened, stipulating the condition that, on presentation of the negotiable set of
shipping document by the seller as per the terms of the Letter of credit are made, the buyers bank will make

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payment at sight meaning immediately to the sellers bank subject to fulfilment of terms and conditions of the
letter of credit being fulfilled, the letter of credit is called Sight letter of credit.

Future or Credit Letter of Credit

If the payment schedule under the said letter of credit stipulates payment at certain future dates after
presentation of negotiable set of shipping documents by the Seller and fulfilling the Letter of credit terms and
conditions, such a letter of credit is termed Future letter of credit or Credit letter of credit. It is quite normal for
sellers to extend credit of 30 days to 60 days under letter of credit. However the shipping documents would
have to be presented to the bank immediately so that they documents reach the buyer well ahead in time before
the consignment reaches the foreign shores and the buyer is able to clear the consignment and take delivery.

Standby Letter of Credit

A standby letter of credit is used as support where an alternative, less secure, method of payment has been
agreed. They are also used in the United States of America in place of bank guarantees. Should the exporter
fail to receive payment from the importer he may claim under the standby letter of credit. Certain documents
are likely to be required to obtain payment including: the standby letter of credit itself; a sight draft for the
amount due; a copy of the unpaid invoice; proof of dispatch and a signed declaration from the beneficiary
stating that payment has not been received by the due date and therefore reimbursement is claimed by letter of
credit. The International Chamber of Commerce publishes rules for operating standby letters of credit - ISP98
International Standby Practices.

Transferable Letter of Credit

A transferable letter of credit is one in which the exporter has the right to request the paying, or negotiating
bank to make either part, or all, of the credit value available to one or more third parties. This type of credit is
useful for those acting as middlemen especially where there is a need to finance purchases from third party
suppliers.Back-to-Back Letter of Credit
A back-to-back letter of credit can be used as an alternative to the transferable letter of credit. Rather than
transferring the original letter of credit to the supplier, once the letter of credit is received by the exporter from
the opening bank, that letter of credit is used as security to establish a second letter of credit drawn on the

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exporter in favour of his importer. Many banks are reluctant to issue back-to-back letters of credit due to the
level of risk to which they are exposed, whereas a transferable credit will not expose them to higher risk than
under the original credit.

Parties to Letters of Credit

Applicant

Applicant is the buyer of the goods or services supplied by the seller. Letter of credit is opened by the issuing
bank as per applicant's request. However, applicant does not belong one of the parties to a letter of credit
transaction. This is because of the fact that letters of credit are separate transactions from the sale or other
contract on which they may be based.

Beneficiary

Beneficiary is the seller of the goods or the provider of the services in a standard commercial letter of credit
transaction. Letter of credit is opened by the issuing bank in favour of the beneficiary.

Issuing Bank

Issuing Bank is the bank that issues a letter of credit at the request of an applicant or its own behalf. Issuing
bank undertakes to honour a complying presentation of the beneficiary without recourse.

Nominated Bank

Nominated bank is the bank with which the credit is available or any bank in the case of a credit available with
any bank.

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Advising Bank

Advising bank is the bank that advises the credit at the request of the issuing bank. An advising bank that is
not a confirming bank advises the credit and any amend mend without any obligation to honour.

Confirming Bank

Confirming bank is the bank that adds its confirmation to a credit upon the issuing bank's authorization or
request. Confirming bank may or may not add its confirmation to a letter of credit. This decision is up to
confirming bank only. However, once it adds its confirmation to the credit confirming is irrevocably bound to
honor or negotiate as of the time it adds its confirmation to the credit. Even if the issuing bank fails to honor,
confirming bank must pay to the beneficiary.

Reimbursing Bank

Reimbursing Bank shall mean the bank instructed and/or authorized to provide reimbursement pursuant to a
reimbursement authorization issued by the issuing bank.

Steps in the Letter of Credit Process

1. Buyer and seller agree to terms including means of transport, period of credit offered (if any), and latest
date of shipment acceptable.

2. Buyer applies to bank for issue of letter of credit. Bank will evaluate buyer's credit standing, and may
require cash cover and/or reduction of other lending limits.

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 3. Issuing bank issues LC, sending it to the Advising bank by airmail or electronic means such as telex or
SWIFT.

4. Advising bank establishes authenticity of the letter of credit using signature books or test codes, then
informs seller (beneficiary).

5. Seller should now check that LC matches commercial agreement and that all its terms and conditions can
be satisfied.

6. Seller ships the goods, then assembles the documents called for in the LC (invoice, transport document,
etc.).

7. The Advising bank checks the documents against the LC. If the documents are compliant, the bank pays
the seller and forwards the documents to the Issuing bank.

8. The Issuing bank now checks the documents itself. If they are in order, it reimburses the seller's bank
immediately.

9. The Issuing bank debits the buyer and releases the documents (including transport document), so the
buyer can claim the goods from the carrier.

Documents to Be Tendered

1. At least one original of each document stipulated in the credit must be presented.

2. A bank shall treat as an original any document bearing an apparently original signature, marks, stamp, or
label of the issue of the document; unless the document itself indicates that it is not an original.

3. If a credit requires presentation of copies of documents, presentation of either originals or copies is

permitted.

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 4. If a credit requires presentation of multiple documents by using terms such as in duplicate, this will be
satisfied by the presentation of at least one original and the remaining number in copies, except when the
document itself indicates otherwise.

5. A document may be signed by handwriting, perforated signature, stamp, symbol or any other mechanical
or electronic method of authentication.

Fundamental Principles of Letter Of Credit

Autonomy of the Credit

According to this principle the credit is separate from the independent of the underlying contract of sale or
other transaction. A bank which operates a credit is concerned only with whether the documents tendered by
the seller correspond to those specified in the instructions. The letter of credit transaction is thus a paper
transaction.

Doctrine of Strict Compliance

The legal principle that the bank is entitled to reject documents which do not strictly confirm with the terms of
the credit is conveniently referred to as the doctrine of strict compliance.
Policies behind adopting the abstraction principle are purely commercial, and reflect a partys expectations:
first, if the responsibility for the validity of documents was thrown onto banks, they would be burdened with
investigating the underlying facts of each transaction, and would thus be less inclined to issue documentary
credits as the transaction would involve great risk and inconvenience. Second, documents required under the
letter of credit could in certain circumstances be different from those required under the sale transaction. This
would place banks in a dilemma in deciding which terms to follow if required to look behind the letter of
credit. Third, the fact that the basic function of the letter of credit is to provide a seller with the certainty of
payment for documentary duties suggests that banks should honour their obligation notwithstanding
allegations of misfeasance by the buyer. Finally, courts have emphasize that buyers always have a remedy for
an action upon the contract of sale, and that it would be a calamity for the business world if, for every breach
of contract between the seller and buyer, a bank were required to investigate said breach.

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Uses for Letter Of Credit

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. 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:
Distance.
Different legal system.
Currency system.
Trade rules are different.

Operative Instrument for Letter Of Credit

A letter of credit may be issued by:

Airmail

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.

Telecommunication

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.

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Difference between Bank Guarantee and Letter Of Credit

A bank guarantee and a letter of credit are similar in many ways but they're two different things. Letters of
credit ensure that a transaction proceeds as planned, while bank guarantees reduce the loss if the transaction
doesn't go as planned. A letter of credit is an obligation taken on by a bank to make a payment once certain
criteria are met. Once these terms are completed and confirmed, the bank will transfer the funds. This ensures
the payment will be made as long as the services are performed. A bank guarantee, like a line of credit,
guarantees a sum of money to a beneficiary. Unlike a line of credit, the sum is only paid if the opposing party
does not fulfill the stipulated obligations under the contract. This can be used to essentially insure a buyer or
seller from loss or damage due to nonperformance by the other party in a contract.
For example a letter of credit could be used in the delivery of goods or the completion of a service. The seller
may request that the buyer obtain a letter of credit before the transaction occurs. The buyer would purchase
this letter of credit from a bank and forward it to the seller's bank. This letter would substitute the bank's credit
for that of its client, ensuring correct and timely payment. A bank guarantee might be used when a buyer
obtains goods from a seller then runs into cash flow difficulties and can't pay the seller. The bank guarantee
would pay an agreed-upon sum to the seller. Similarly, if the supplier was unable to provide the goods, the
bank would then pay the purchaser the agreed-upon sum. Essentially, the bank guarantee acts as a safety
measure for the opposing party in the transaction. These financial instruments are often used in trade financing
when suppliers, or vendors, are purchasing and selling goods to and from overseas customers with whom they
don't have established business relationships. The instruments are designed to reduce the risk taken by each
party.

Bibliography

Web Sources
www.investopedia.com
www.managementstudyguide.com
www.letterofcredit.biz
www.en.wikipedia.org
www.ec-finance.com
www.finance.mapsofworld.com

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Book Sources
Kaushik Mhatre, International Trade, Third Edition
International Trade Law, Course Material

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