Invitation Letter

A letter of credit is a document issued mostly by a financial institution, used primarily in trade finance, which usually provides an irrevocable payment undertaking (it can also be revocable, confirmed, unconfirmed, transferable or others e.g. back to back: revolving but is most commonly irrevocable/confirmed) to a beneficiary against complying documents as stated in the Letter of Credit. Letter of Credit is abbreviated as an LC or L/C, and often is referred to as a documentary credit, abbreviated as DC or D/C, documentary letter of credit, or simply as credit (as in the UCP 500 and UCP 600).

A Standby Letter of Credit, SBLC, is a credit enhancement device which helps secure a primary loan. Banks, after the current financial collapse, require standby letters of credit for most real estate development loans.

The LC can also be the source of payment for a transaction, meaning that redeeming the letter of credit will pay an exporter. Letters of credit are used primarily in international trade transactions of significant value, for deals between a supplier in one country and a customer in another. They are also used in the land development process to ensure that approved public facilities (streets, sidewalks, stormwater ponds, etc.) will be built. The parties to a letter of credit are usually a beneficiary who is to receive the money, the issuing bank of whom the applicant is a client, and the advising bank of whom the beneficiary is a client. Almost all letters of credit are irrevocable, i.e., cannot be amended or canceled without prior agreement of the beneficiary, the issuing bank and the confirming bank, if any. In executing a transaction, letters of credit incorporate functions common to giros and Traveler's cheques. Typically, the documents a beneficiary has to present in order to receive payment include a commercial invoice, bill of lading, and documents proving the shipment was insured against loss or damage in transit. However, the list and form of documents is open to imagination and negotiation and might contain requirements to present documents issued by a neutral third party evidencing the quality of the goods shipped, or their place of origin.

Terminology

The English name “letter of credit” derives from the French word “accreditation”, a power to do something, which in turn is derivative of the Latin word “accreditivus”, meaning trust. S.‘The Application of the Letter of Credit Form of Payment in International Business Transactions’ (2001) 10 Int’l Trade L.J. p. 37. In effect, this reflects the modern understanding of the instrument. When a seller agrees to be paid by means of a letter of credit, the creditor/seller is looking at a reliable bank that has an obligation to pay the amount stipulated in the credit notwithstanding 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 LC.

How it works

A business called the InCosmetika from time to time imports goods from a business called BLISS, which banks with the ABC Bank. InCosmetika holds an account at the Commonwealth Bank. InCosmetika wants to buy $500,000 worth of merchandise from BLISS, who agrees to sell the goods and give InCosmetika 60 days to pay for them, on the condition that they are provided with a 90-day LC for the full amount. The steps to get the letter of credit would be as follows:

• InCosmetika goes to The Commonwealth Bank and requests a $500,000 letter of credit, with BLISS as the beneficiary.
• The Commonwealth Bank can issue an LC either on approval of a standard loan underwriting process or by InCosmetika funding it directly with a deposit of $500,000 plus fees which are typically between 1% and 8% of the face value of the LC.
• The Commonwealth Bank sends a copy of the LC to the ABC Bank, which notifies BLISS that payment is available and they can ship the merchandise InCosmetika has ordered with the full assurance of payment to them.
• On presentation of the stipulated documents in the letter of credit and compliance with the terms and conditions of the letter of credit, the Commonwealth Bank transfers the $500,000 to the ABC Bank, which then credits the account of BLISS for that amount.
• Note that banks deal only with documents required in the letter of credit and not the underlying transaction.
• Many exporters have mistakenly assumed that the payment is guaranteed after receiving the LC. The issuing bank is obligated to pay under the letter of credit only when the stipulated documents are presented and the terms and conditions of the letter of credit have been met.

Availability

• DC being an irrevocable undertaking of the issuing bank makes available the Proceeds, to the Beneficiary of the Credit provided, stipulated documents strictly complying with the provisions of the DC, UCP 600 and other international standard banking practices, are presented to the issuing bank , then :
• i.if the Credit provides for sight payment – by payment at sight against compliant presentation
• ii.if the Credit provides for deferred payment – by payment on the maturity date(s) determinable in accordance with the stipulations of the Credit; and of course undertaking to pay on due date and confirming maturity date at the time of compliant presentation
• iii.a.if the Credit provides for acceptance by the Issuing Bank – by acceptance of Draft(s) drawn by the Beneficiary on the Issuing Bank and payment at maturity of such tenor draft, or
• iii.b. if the Credit provides for acceptance by another drawee bank – by acceptance and payment at maturity Draft(s)drawn by the Beneficiary on the Issuing Bank in the event the drawee bank stipulated in the Credit does not accept Draft(s) drawn on it,

or by payment of Draft(s) accepted but not paid by such drawee bank at maturity;

• iv. if the Credit provides for negotiation by another bank – by payment without recourse to drawers and/or bona fide holders, Draft(s) drawn by the Beneficiary and/or document(s) presented under the Credit, (and so negotiated by the nominated bank )

• Negotiation means the giving of value for Draft(s) and/or document(s) by the bank authorized to negotiate, viz the nominated bank. Mere examination of the documents and forwarding the same to DC issuing bank for reimbursement, without giving of value / agreed to give, does not constitute a negotiation.