Letters of Credit | Intelligent Economist

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1. The Buyer’s Application and Contract with the Issuing Bank

Once the buyer has finalized a sales contract calling for payment to the seller under a letter of credit, it is up to the buyer to apply for that letter of credit at a bank. The application for the credit, usually done on the bank’s form and accompanied by an initial fee, contains the buyer’s instructions and conditions upon which the issuing bank may honor the seller’s documents. The application will request the bank to issue a letter of credit to the seller promising to purchase the seller’s documents covering a certain quantity and description of the goods, with a value up to a certain amount of money, that are insured and shipped on or before a certain date.

The buyer may impose almost any conditions or requirements on the seller’s performance, as they pertain only to the seller’s performance. For example, the buyer could prohibit the bank from taking documents showing a partial shipment, or it could require a document that shows a specific method of shipping. However, the buyer must remember that this information is based on the buyer’s final agreement with the seller.

If the bank violates any terms of its contract with the buyer, then the buyer need not take the documents or reimburse the bank. For instance, if the buyer’s application requests the bank to issue a letter of credit calling for the seller to submit documents showing that it shipped “1,000 electric toasters”, and the bank, without approval, purchases documents showing that the seller shipped ‘1,000 toaster ovens,” then the bank is not entitled to reimbursement. The bank only deals with documents and money, not goods or inspection of goods.

2. Advising the Letter of Credit to the Beneficiary

The issuing bank will send the letter of credit to the seller via a foreign correspondent bank (a bank with whom the issuing bank has a reciprocal banking relationship) in the seller’s country. This bank is called the advising bank. An advising bank merely informs or “advises” the seller that the letter of credit is available to be picked up. The advising bank is not liable for the credit; it only provides the service of forwarding the letter of credit to the seller and checking the authenticity of the letter of credit.

3. Seller’s Compliance with Letter of Credit

The letter of credit tells the seller what it must do to be paid. It explains to him or her what to shop, how to ship, when to ship, and more. It contains specific terms and conditions drawn from the original sales contract and included in the letter of credit, such as the quantity and description of the goods, shipping dates, the type or amount of insurance, and so on. For example, a buyer in California wants to import foreign-made beanbag chairs that must meet California’s strict flammability standards for upholstered furniture. The letter of credit might call for an inspection certificate to show that the chairs passed California’s standards.

The seller should inspect the letter of credit to see if it keeps up with the agreement with the buyer in the underlying contract of sale. The seller should examine other conditions of the credit to be certain that they can be met, such as can the seller acquire materials and manufacture on time for the shipment date? If the seller is unable to comply wight he letter of credit for any reason, the buyer must be contacted, and an amended letter of credit can be issued.

4. Complying Presentation

presentation is the delivery of the seller’s documents and drafts to the nominated bank or directly to the issuing bank. A complying presentation is one in which:

  • The seller delivers all of the required documents
  • Within the time allowed for presentation and before the expiry date of the credit
  • Containing no discrepancies
  • Which complies with all other terms of the letter of credit, the provisions of the UCP, and standard banking practices.

The nominated bank is that bank, usually in the seller’s country, that has been appointed or “nominated” by the issuing bank to honor the documents. The nominated bank is often the advising bank that originally transmitted the documents to the seller. If no bank is nominated, then the letter of credit is said to be “freely available” and can be negotiated through any bank of the seller’s choice.

5. Examination of Documents for Discrepancies

The UCP permits banks only to examine the documents “on their face” to see whether they comply with the letter of credit or whether there is a discrepancy. Banks may not look to any outside sources or conduct an independent investigation to see if the seller’s shipment to the buyer is in good order. For example, a letter of credit calls for the shipment of “1,000 blood pressure monitoring kits.” The shipper’s invoice shows the sale and shipment of “1,000 sphygmomanometers and cuffs.” In this case, there is a discrepancy, and the documents will be rejected unless the discrepancy is waived by the buyer.

6. The Commercial Invoice

The commercial invoice is required by buyers, banks and customs authorities on every international sale. It need not be signed, notarized, or verified unless the credit requires. Where a commercial invoice is required, a preliminary “pro forma” invoice will not be accepted. The most important requirement is that the description of the goods in the commercial invoice must correspond to that in the credit.

7. The Ocean Bill of Lading

For transactions in which the letter of credit calls for presentment of an “onboard” bill of lading, the seller must present to the issuing bank a bill of lading showing the actual name of the ship, containing the notation “on board,” indicating that the goods have been loaded. Where the buyer and seller have agreed, and where it is approved in the letter of credit, it is acceptable for the bill of lading to show that the carrier has received the goods for shipment.

8. Certificated of Analysis or Inspection

Although these certificates are not required for the letter of credit transaction, sellers should ensure that certificates they include with their documents meet all the terms required by the letter of credit.