LETTERS of CREDIT

1. Three separate transactions in LC

(a)Issuing bank and applicant/buyer/importer Their relationship is governed by

the terms of the application and agreement for the issuance of the letter of credit by
the bank. Unless the contrary is provided for, the liability of the issuing bank is
solidary with the buyer

(b) Issuing bank and beneficiary/seller/exporter- Their relationship is governed by

the terms of the letter of credit issued by the bank, and

(c) Applicant and beneficiary Their relationship is governed by the sales contract.

Process:

The buyer may be required to contract a bank to issue a letter of credit, the
issuing bank can authorize the seller to raw drafts and engage to pay
them upon their presentment simultaneously with the tender of documents
required by the letter of credit. The buyer and seller agree on what documents
are to be presented for payment, but ordinarily they are documents of title
evidencing or attesting to the shipment of the goods to the buyer

Once the letter of credit is established, the seller ships the goods to the buyer
and in the process secures the required shipping documents and documents of
title. To get paid, the seller executes a draft and presents it together with the
required documents to the issuing bank

The issuing bank redeems the draft and pays cash to the seller if it finds
that the documents submitted by the seller conform with what the letter of
credit requires. The bank then obtains possession of the documents upon paying the
seller. The transaction is completed when the buyer reimburses the issuing bank
and acquires the documents entitling him to the goods. The seller gets paid only if
he delivers the documents of title over the goods while the buyer acquires the
said documents and control over the goods only after reimbursing the bank.

2. Explain banks are responsible for examining documents in LC

The issuing bank in determining compliance with the terms of the letter of
credit is required to examine only the shipping documents presented by the
seller and is precluded from determining whether the main contract is
 actually accomplished or not. This arrangement assures the seller of prompt
payment, independent of any breach of the main sales contract.

3. Definition of LC

A letter of credit is basically an open letter of request whereby one person

requests another to advance money or give credit to a third person for a
certain amount and promises to repay the person advancing the money.

4. What does LC facilitate?

They are intended generally to facilitate the purchase and sale of goods by
providing assurance to the seller of prompt payment upon compliance with
specified conditions or presentation of stipulated documents without the
seller having to rely upon the solvency and good faith of the buyer.

5. What are the modes of payment?

Payment can be made in several different ways: by the buyer remitting cash
with his order; by open account whereby the buyer remits payment
at an agreed time after receiving the goods; or by documentary collection
through a bank in which case the buyer pays the collecting bank for account
of the seller in exchange for shipping documents which would include, in
most cases, the document of title to the goods. In the aforementioned methods
of payment, the seller relies entirely on the willingness and ability of the
buyer to effect payment.

6. What are the benefits?

General: LC is a substitute for, and therefore support, the agreement of

the buyer-importer to pay money under a contract or other arrangement.
This instrument is basically a credit security through availment of credit
facilities of the participating banks.

To The Exporter/Seller:
Letters of credit open doors to international trade by providing a secure
mechanism for payment upon fulfilment of contractual obligations.
A bank is substituted for the buyer as the source of payment for goods or
services exported.
 The issuing bank undertakes to make payment, provided all the terms
and conditions stipulated in the
letter of credit are complied with.
Financing opportunities, such as pre-shipment finance secured by a
letter of credit and/or discounting ofaccepted drafts drawn under letters of
credit, are available in many countries.
Bank expertise is made available to help complete trade transactions
successfully.
Payment for the goods shipped can be remitted to your own bank or a
bank of your choice.

To the Importer/Buyer
Payment will only be made to the seller when the terms and conditions
of the letter of credit are complied with.
The importer can control the shipping dates for the goods being
purchased.
Cash resources are not tied up.

7. Two kinds of LC

A. LOCAL- 3 parties are involved

(a) The Buyer- he is the one who procures the letter of credit and
obliges himself to reimburse the issuing bank upon receipt of the
documents of title
(b) The Issuing Bank- is the bank from whom the letter of credit is
procured and which undertakes to pay the seller upon receipt of the
draft and proper documents of titles and to surrender the documents to
the buyer upon reimbursement, and
(c) The seller- who in compliance with the contract of sale ships the
goods to the buyer and deliver the documents of title and draft to the
issuing bank to recover payment.

B. INTERNATIONAL

(a) The Customer- who is the party who applies to a bank in one
country for the opening of a letter of credit in favor of the seller in
another country
 (b) The Issuing Bank- is the bank in the country of the customer to
which the customer applies for the issuance of a letter of credit
(c) The Beneficiary- who is the party in another country who is the
creditor of the customer. Usually, he is the one selling goods to the
customer
(d) The Advising Bank is the bank in the country of the beneficiary
which communicates to the beneficiary the notice of the credit issued
by the issuing bank
(e) The Confirming/Correspondent Bank- is the bank that undertakes
that the letter of credit will be fully paid. Usually the confirming bank
is also the advising bank, otherwise it is utilized to lend credence to
the letter of credit issued by a lesser known issuing bank and is
directly liable to the beneficiary.

8. STATE OF PERPETAUL SEPARATION

It is clearly settled in law that there are thus three contracts which make up
the letter of credit transaction: The contract between buyer and seller, buyer
and issuing bank, and the letter of credit proper. These transactions are to be
maintained in a state of perpetual separation.

9. INDEPENDENCE PRINCIPLE

The issuing bank in determining compliance with the terms of the letter of
credit is required to examine only the shipping documents presented by the
seller and is precluded from determining whether the main contract is
actually accomplished or not. This arrangement assures the seller of prompt
payment, independent of any breach of the main sales contract. This known
as the independence principle in a letter of credit transaction.

The relationship of the buyer and the bank is separate and distinct from the
relationship of the buyer and seller in the main contract; the bank is not
required to investigate if the contract underlying the LC has been fulfilled or
not because in transactions involving LC, banks deal only with documents
and not goods (BPI v. De Reny Fabric Industries, Inc., L-2481, Oct. 16, 1970).
In effect, the buyer has no course of action against the issuing bank.

10. RULE on STRICT COMPLIANCE

 The rule of strict compliance in a letter of credit transaction means that the
documents tendered by the seller or beneficiary must strictly conform to the
terms of the letter of credit, i.e., they must include all documents required by
the letter of credit such as: (a) a draft which is also called a bill of exchange,
is an order written by an exporter/seller instructing an importer/buyer or its
agent to pay a specified amount of money at a specified time (b) a bill of
lading, which is a document issued to the exporter by a common carrier
transporting the merchandise, and (c) invoices.

Thus, a correspondent bank which departs from what has been stipulated
under the LC acts on its own risk and may not thereafter be able to recover
from the buyer or the issuing bank, as the case may be, the money thus paid
to the beneficiary. (Feati Bank and Trust Company v. CA, G.R. No. 940209,
Apr. 30, 1991)

11. FRAUD

12. FRAUD EXCEPTION PRINCIPLE

By way of exception to the independence principle, the Fraud exception rule

provides that the untruthfulness of a certificate accompanying a demand for
payment under a standby letter of credit may qualify as fraud sufficient to
support an injunction against payment. (Transfield v. Luzon Hydro, G.R. No.
146717, Nov. 22, 2004)

13. ESSENTIAL REQUISITES of LC

(a) That it be issued in favor of a definite person and not to order;

(b) and That it be limited to a fixed and specified amount, or to one or more
undetermined amounts, but within a maximum the limits of which has to
be stated exactly.
 Hence, a letter of credit is not a negotiable instrument because it is
required to be drawn in favor of a definite person.

Those which do not have any of the essential conditions shall be

considered merely as a letter of recommendation.

14. WAIVER TO ANNUL LC

The bank or drawer of a letter of credit shall be liable to the person on whom
it was issued for the amount paid by virtue thereof, within the maximum
fixed therein, while a notifying bank does not incur any liability except to
notify the beneficiary of the letter of credit. Before paying, it shall have the
right to demand the proof of the identity of the person in whose favor the
letter of credit is issued.

The drawer of a letter of credit may annul it, informing the bearer and the
person to whom it is addressed of such revocation. The waiver of the right to
annul makes the letter of credit irrevocable.

15. STANDBYLETTER OF CREDIT

A standby letter of credit is a bank-issued option on a loan involving three

parties: the bank issuing the credit, the party requesting for such issuance
(otherwise known as the account party) and the beneficiary. Under the terms
of standby letter of credit (SLC), the beneficiary has the right to trigger the
loan option (referred to as taking down the loan) if the account party fails to
meet its commitment, in which case the issuing bank disburses a specified
sum to the beneficiary and books an equivalent loan to its customer. SLCs
may support nonfinancial obligations such as those of bidders, or financial
obligations such as those of borrowers. In the latter case, the borrower
purchases an SLC and names the lender as beneficiary. Should the borrower
default, the beneficiary has the right to take down the SLC and receive the
principal balance from the issuing.

16. PRESCRIPTIVE PERIOD of LC

A letter of credit becomes void if the bearer of a letter of credit does not make
use thereof within the period agreed upon with the drawer, or, in default of a
period fixed,
a. within 6 months counted from its date, in any point in the Philippines,
 b. within 12 months anywhere outside thereof, it shall be void in fact and in
law.

17. RED CLAUSE LC

A red clause letter of credit incorporates a clause, traditionally written in red,
which authorizes the bank acting as the negotiating or paying bank to pay
the beneficiary in advance of shipment. This enables the purchase and
accumulation of goods from a number of different suppliers, and the
arrangement of shipment in accordance with the letter of credit terms. Such
advances will be deducted from the amount due to be paid when the
documents called for are presented under the letter of credit. If the
beneficiary fails to ship the goods or cannot do so before the expiry of the
letter of credit, the issuing bank is bound to reimburse the negotiating or
paying bank, recovering its payment from the applicant.

18. BACK TO BACK LC

Back to Back Letter of Credit is a credit with identical documentary
requirements and covering the same merchandise as another letter of credit,
except for the difference in price of the merchandise as shown by the invoice
and draft. The second letter of credit can only be negotiated after the first is
negotiated.

19. DEFERRED PAYMENT LC

Under a deferred payment letter of credit, the applicant does not pay until a
future date determined in accordance with the terms of the letter of credit.

20. TRANSFERRABLE LC
A transferable letter of credit allows the beneficiary to act as a middleman
and transfer his rights under a letter of credit to another party or parties who
may be suppliers of the goods. Depending on whether the letter of credit
permits partial shipments, fractional amounts may be transferred to more
than one beneficiary. The letter of credit however, can be transferred only
once: the secondary beneficiaries cannot transfer their rights to a third party.
Transfer of a letter of credit can be made on specific application by the
original beneficiary to the authorized transferring bank

To be transferable, a letter of credit must be so marked by the issuing bank

which can only do so on the applicants specific instructions. The applicant
 should be aware that any second beneficiary, the probable supplier, is usually
a party not likely known to the applicant.

21. SIGHT OR TERM/USANCE

Letters of credit can permit the beneficiary to be paid immediately upon
presentation of specified documents (sight letter of credit), or at a future date
as established in the sales contract (term/usance letter of credit).

22. REVOCABLE/ IRREVOCABLE

An irrevocable letter of credit obligates the issuing bank to honor drafts

drawn in compliance with the credit and can be neither cancelled nor
modified without the consent of all parties, including in particular the
beneficiary/exporter.

A revocable letter of credit can be cancelled or amended at any time before

payment; it is intended to serve as a means of arranging payment but not as
a guarantee of payment

23. UNCONFIRMED/ CONFIRMED LC

A letter of credit issued by one bank can be confirmed by another, in which

case both banks are obligated to honor drafts drawn in compliance with the
credit.

An unconfirmed letter of credit is the obligation only of the issuing bank

provided all terms and condition of LC have been complied with.
Why would an exporter want a foreign banks letter of credit confirmed by a
domestic bank? One reason could be if he has doubts.

24. CIRCULAR LC

The document is called a circular letter of credit when it is not addressed to

any particular correspondent. In effect, a letter of credit is a draft, save that
the amount is merely stated as a maximum not to be exceeded. Letters of
credit, mainly used by travellers, greatly simplify non-local business
transactions.

25. NEGOTIATION LC
 Under UCP 600 (Uniform Customs and Practice for Documentary Credits,
2007 revision, article 2) negotiation means the purchase by the nominated
bank of drafts (drawn on a bank other than the nominated bank) and/or
documents under a complying presentation, by advancing or agreeing to
advance funds to the beneficiary on or before the banking day on which
reimbursement is due to the nominated bank.

Unfortunately, the term "negotiable credit" is understood and applied in

different ways in different parts of the world.

26. REIMBURSEMENT LC

Any standard lc having special payment conditions that, the negotiating bank
is authorized to claim and get the payment against the lc directly from the
opening bank's nominated agency bank after presentation of credit confirmed
documents is known as reimbursement LC or direct reimbursement Lc. In
most of the cases payment of the import, thus is already effected prior to
receipt of the documents and consignment by the importer.

27. REVOLVING LC

Revolving Letter of Credit-one that provides for renewed credit to become

available as soon as the opening bank has advised the negotiating or paying
bank that the drafts already drawn by the beneficiary have been reimbursed
to the opening bank by the buyer.

Revolving letter of credit - is established when there are regular shipments of

the same commodity between supplier and customer. Eliminates the need to
issue an letter of credit for each transaction

28. CUMULATIVE/NON-CUMULATIVE

For a non-cumulative revolving letter of credit, the beneficiary can draw each
revolving amount for any given period, and any unused portions cannot be
drawn on the subsequent periods.

Cumulative revolving letter of credit means that the unused sums in the L/C
can be added to the upcoming shipments.
29. LOCAL CURRENCY CREDIT/ FOREIGN CURRENCY CREDIT

30. STRAIGHT CREDIT

A type of letter of credit. A straight credit can only be paid at the counters of
the paying bank or a named drawee bank that has been authorized to make
payment. Payment can only be made to the beneficiary named in the letter of
credit, and not to an intermediary or negotiating bank. The beneficiary
named in a straight credit must present documents at the paying bank or
named drawee bank on or before the expiration date stipulated in the letter
of credit. The term is derived from the fact that payment is made straight or
directly to the beneficiary.

A straight credit differs from a negotiable credit because payment in the

latter can be made to a negotiating bank. A straight credit contains clauses
such as we engage with you that all drafts drawn in compliance with the
credit terms will be duly honored upon presentation, which basically
highlight the restriction of payment to the beneficiary only.

31. ACCEPTANCE LETTER OF CREDIT

An acceptance credit is a type of letter of credit that is paid by a time draft

authorizing payment on or after a specific date, if the terms of the letter of
credit have been complied with. There are two types of acceptance credit,
confirmed and unconfirmed. Unconfirmed acceptance credit means that the
seller takes the risk that payment will not be made, due to any number of
contingencies such as shipment non-delivery, confiscation by customs
authorities, or any other problems. Confirmed acceptance credit means that
the bank upon which the credit has been issued, essentially guarantees
payment as long as the terms of the letter of credit have been complied with.

32. DOCUMENTARY LC
A documentary letter of credit is an obligation of the bank that opens the
letter of credit (the issuing bank) to pay the agreed amount to the seller on
 behalf of the buyer, upon receipt of the documents specified in the letter of
credit. The letter of credit is opened by the bank on the basis of the buyers
(importers) instructions, which are compiled in accordance with the terms of
the contract. Both the importer and exporter should take into account that
the letters of credit constitute a transaction separate from the purchase and
sale agreement or other agreements on which they are based. The banks
obligations under the letter of credit are set forth in the letter of credit itself,
and the bank deals exclusively with documents, not with goods or services.
Documentary letters of credit are the safest means for international trade
settlement both for importers and exporters of goods.

33. CLEAN LC

A letter of credit payable upon presentation of the draft, without any

supporting document being required.