CHAPTER 24 - TYPES OF LETTER OF CREDIT
Revocable Letter of Credit
·
A revocable documentary credit may be amended or cancelled by
the Issuing Bank at any moment and without prior notice to the beneficiary.
·
Revocable documentary credits are no more used in LC’s.
·
Revocable documentary credit offers no security of payment to
the beneficiary.
·
If the nominated bank has already taken up documents or given
an undertaking to pay prior to receipt of notice of cancellation, the issuing
Bank is committed to reimburse the nominated bank.
Irrevocable Letter of Credit
·
An irrevocable documentary credit cannot be amended or
cancelled without the agreement of the Issuing Bank, the Beneficiary and
confirming Bank.
·
Irrevocability of documentary credit given by the Issuing
Bank provides lot of comfort to the beneficiary.
Confirmed Letter of Credit
·
Confirmation means a definite undertaking of the confirming
bank, in addition to that of the issuing bank, to honor or negotiate a
complying presentation.
·
Confirmation of a documentary credit helps the beneficiary in
mitigating:
§ Issuing Bank Risk
§ Country Risk (
Economic / Political / Transfer / Sovereign)
·
The beneficiary can depend on the confirming bank for payment
in case the payment is not forth coming from the Issuing Bank for various
reasons.
·
Charges are to be paid to the confirming bank for adding its
confirmation.
·
For adding confirmation to the letter of credit, the
confirming bank will require credit lines on the issuing bank and country of
issuing bank.
Unconfirmed Letter of Credit
·
A documentary credit which is backed only by the undertaking
of the issuing Bank is termed as unconfirmed documentary credit.
·
The beneficiary has to entirely rely on the undertaking of
the issuing Bank for obtaining the payment.
·
The beneficiary is open to Issuing Bank Risk & Country
Risk.
Transferable Letter of Credit
·
A transferable documentary credit is one wherein it could be
transferred to one or more second beneficiaries at the instructions of the
first beneficiary.
·
The second beneficiaries do not have the right to transfer
the documentary credit to other beneficiaries.
·
Ordering Customer is the First Beneficiary in Transferable
LC.
·
In case of transferable documentary credits, the buyer
accepts the risk or receiving goods from a third party, which not be known to
the buyer and with whom there may have been no previous business dealings.
·
The letter of credit should specifically indicate that it is transferable
for the same to be made transferable.
·
At the time of transferring the letter of credit to the
second beneficiary, the transferring bank could reduce or curtail the
following:
o Amount of the credit
o Unit price, if any
o Expiry date
o Last date for shipment
o Period for
presentation
·
The percentage of insurance could be increased to provide the
cover required under the original letter of credit.
·
The name of the first beneficiary may be substituted for that
of the applicant in the credit.
Non - Transferable Letter of Credit
·
A credit which cannot be transferred to second beneficiary is
termed as non transferable credit. This will be mentioned as a Condition in LC
issuance saying this LC should not be transferred.
Red Clause Letter of
Credit
·
Under a red clause documentary credit, the advising / nominated
bank is authorised by the issuing Bank (Applicants request) to pay a certain
sum of money to the beneficiary of the credit as advance for procuring raw
materials and meet part of the processing cost.
·
The advance given to the beneficiary is adjusted at the time
of making final payment against tender of shipping documents.
·
In case the beneficiary is unable to make the shipment and
hence unable to settle the advance payment, the advising / nominated bank advancing
the amount could recover the same from the Issuing Bank and Issuing Bank will
collect the Money from Applicant.
·
Red Clause documentary credit was once popular in Fur Trade
in China and Wool Trade in Australia.
·
Traditionally written or Typed in Red Ink before Swift
messages used.
Green Clause Letter of Credit
·
A documentary credit which permits negotiation of documents
or providing an advance to the beneficiary against a warehouse receipt (where
the goods have been stored in a warehouse awaiting arrival of the ship).
·
Long back the use of a green clause letter of credit is
often used in the agricultural business where a company can fund the harvest of a new crop by pledging available stock as collateral.
Revolving Letter of Credit
·
Revolving documentary credits are used between buyers and
sellers who have a long standing trading relationship and experience in the
shipment of goods described in the documentary credit.
·
This allows the amount thereof to be reinstated without any
specific amendment i.e on an automatic basis.
·
The amount of the documentary credit gets reinstated
automatically once shipment is effected.
·
The reinstatement could be based on a fixed amount to be
reinstated after a specific time interval or after shipment or a combination
e.g. AED 50,000 to be reinstated on 01st of each month. So Revolvement or Revolving LC is based on
Time or Value.
·
Further, the reinstatement could be cumulative or non - cumulative
/ automatic or not automatic.
Non-cumulative
revolving letter of credit
·
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.
·
Using the above example, the shipper could still ship USD
100.000,00 each month and be fully paid. If the shipper shipped USD
90.000,00 in a given month, they would still be paid provided that partial
shipment is allowed for each shipment, but they could not get the additional
USD 10.000,00 by shipping excessive amount on the upcoming months.
Cumulative
revolving letter of credit
·
Cumulative revolving letter of credit means that the unused
sums in the L/C can be added to the upcoming shipments.
·
Using the above example, the shipper could still ship USD
100.000,00 each month and be fully paid. If the shipper shipped USD
90.000,000 in a given month, they would still be paid, and they could get the
additional USD 10.000,00 by shipping extra in the next months until letter of
credit reaches to expiry.
Revolvement
- dependent on time
·
AED 50,000 may be drawn each month during the six months
validity of the documentary credit.
Revolvement
- dependent on value
·
Documentary credit may indicate that the amount is to revolve
upon utilization within the overall validity of the documentary credit.
Back to Back Letter of Credit
·
In a back to back documentary credit, the advising bank
issues another documentary credit in favour of different beneficiary based on
the security of the Master LC (Original LC or Prime LC). Here Advising Bank is
also known as Second Issuing Bank.
·
This is required for the original beneficiary to procure raw
material and goods for manufacture / shipment under the original documentary
credit.
·
The main risk associated in case of back to back documentary
credits are that the shipment under the back to back documentary credit may not
happen resulting in default under the original documentary credit as well.
·
Is also known as Countervailing Credit or Counter Credit or Reciprocal
Credit or Reciprocal LC or Second Letter of Credit.
Inoperative Letter of Credit
·
Issue of Pre Advice (MT705) is one of the kind of Inoperative
LC.
·
A preliminary advice (Pre Advice) of the issuance of a credit
or amendment shall only be sent if the issuing bank is prepared to issue the
operative credit or amendment. An issuing bank that’s ends a pre-advice is
irrevocably committed to issue of the operative credit or amendment, without
delay, in terms not inconsistent with the pre advice.
·
An Inoperative documentary credit which includes certain
conditions over which the beneficiary has no control.
§ e.g. payments are to
be made only once the goods have been cleared through customs.
§ e.g. The documentary
credit is to become operative only upon the issuance of an amendment that an
import license has been issued.
§ e.g. The documentary
credit is to become operative upon the
receipt of a performance guarantee acceptable to the issuing bank.
·
Inoperative letter of credit is not a good security to the
beneficiary till the same is made operative.
Restricted Letter of Credit (Nominated Bank)
·
A credit which is available for negotiation only with a
specified nominated bank is called a restricted credit.
Unrestricted Letter of Credit ( Any Negotiating Bank)
·
Is also known as Freely Negotiable Letter of Credit.
·
A Nominated Bank is not specified, which means that the
exporter can negotiate with any bank and receive a payment on an unrestricted
LC.
All the above Letter
of Credit is known as Commercial Letter of Credit, except the below Standby
Letter of Credit.
Standby Letter Credit (Commercial SBLC)(UCP) (Also See below Standby
Credit (ISP)
·
Normally a substitute for Bank Guarantee.
·
Operates like a Commercial Letter of Credit, except that
typically it is retained as a "standby" instead of being the intended
payment mechanism. UCP600 article 1 provides that the UCP applies to Standbys;
ISP98 applies specifically to Standby letters of Credit; In 1998 the
International Chamber of Commerce (ICC) added ISP98 (International Standby
Practices 98 89 Articles) as the rules to guide standby letters of credit,
since in UCP600 there is only 1 Article which may not be enough for a Standby
Transactions.
·
The ISP98 rules are slowly being adopted; however, many of
the standby letters of credit continue to rely on the ICC’s older guide, UCP600.
·
Such LCs is opened mostly by banks in countries where, by
law, they are prohibited from issuing Guarantees (e.g., USA) and the countries
where they don’t use Standby as per ISP98.
·
Is invoked in case of non-performance of the contract.
·
Documents to be presented under the SBLC are normally very
minimal.
