MESSAGE FROM ASSOC PROF PAMELA S EVERS ATTORNEY AT LAW This article has been offered by web posting to UNCW students for educational purposes only Articles posted may have been edited for clarity and format by Pamela S Evers Understanding and Using Letters of Credit Part I Letters of credit accomplish their purpose by substituting the credit of the bank for that of the customer for the purpose of facilitating trade There are basically two types commercial and standby The commercial letter of credit is the primary payment mechanism for a transaction whereas the standby letter of credit is a secondary payment mechanism Commercial Letter of Credit Commercial letters of credit have been used for centuries to facilitate payment in international trade Their use will continue to increase as the global economy evolves Letters of credit used in international transactions are governed by the International Chamber of Commerce Uniform Customs and Practice for Documentary Credits The general provisions and definitions of the International Chamber of Commerce are binding on all parties Domestic collections in the United States are governed by the Uniform Commercial Code A commercial letter of credit is a contractual agreement between a bank known as the issuing bank on behalf of one of its customers authorizing another bank known as the advising or confirming bank to make payment to the beneficiary The issuing bank on the request of its customer opens the letter of credit The issuing bank makes a commitment to honor drawings made under the credit The beneficiary is normally the provider of goods and or services Essentially the issuing bank replaces the bank s customer as the payee Elements of a Letter of Credit A payment undertaking given by a bank issuing bank On behalf of a buyer applicant To pay a seller beneficiary for a given amount of money On presentation of specified documents representing the supply of goods Within specified time limits Documents must conform to terms and conditions set out in the letter of credit Documents to be presented at a specified place Beneficiary The beneficiary is entitled to payment as long as he can provide the documentary evidence required by the letter of credit The letter of credit is a distinct and separate transaction from the contract on which it is based All parties deal in documents and not in goods The issuing bank is not liable for performance of the underlying contract between the customer and beneficiary The issuing bank s obligation to the buyer is to examine all documents to insure that they meet all the terms and conditions of the credit Upon requesting demand for payment the beneficiary warrants that all conditions of the agreement have been complied with If the beneficiary seller conforms to the letter of credit the seller must be paid by the bank Issuing Bank The issuing bank s liability to pay and to be reimbursed from its customer becomes absolute upon the completion of the terms and conditions of the letter of credit Under the provisions of the Uniform Customs and Practice for Documentary Credits the bank is given a reasonable amount of time after receipt of the documents to honor the draft The issuing banks role is to provide a guarantee to the seller that if compliant documents are presented the bank will pay the seller the amount due and to examine the documents and only pay if these documents comply with the terms and conditions set out in the letter of credit Typically the documents requested will include a commercial invoice a transport document such as a bill of lading or airway bill and an insurance document but there are many others Letters of credit deal in documents not goods Advising Bank An advising bank usually a foreign correspondent bank of the issuing bank will advise the beneficiary Generally the beneficiary would want to use a local bank to insure that the letter of credit is valid In addition the advising bank would be responsible for sending the documents to the issuing bank The advising bank has no other obligation under the letter of credit If the issuing bank does not pay the beneficiary the advising bank is not obligated to pay Confirming Bank The correspondent bank may confirm the letter of credit for the beneficiary At the request of the issuing bank the correspondent obligates itself to insure payment under the letter of credit The confirming bank would not confirm the credit until it evaluated the country and bank where the letter of credit originates The confirming bank is usually the advising bank Letter of Credit Characteristics Negotiability Letters of credit are usually negotiable The issuing bank is obligated to pay not only the beneficiary but also any bank nominated by the beneficiary Negotiable instruments are passed freely from one party to another almost in the same way as money To be negotiable the letter of credit must include an unconditional promise to pay on demand or at a definite time The nominated bank becomes a holder in due course As a holder in due course the holder takes the letter of credit for value in good faith without notice of any claims against it A holder in due course is treated favorably under the UCC The transaction is considered a straight negotiation if the issuing bank s payment obligation extends only to the beneficiary of the credit If a letter of credit is a straight negotiation it is referenced on its face by we engage with you or available with ourselves Under these conditions the promise does not pass to a purchaser of the draft as a holder in due course Revocability Letters of credit may be either revocable or irrevocable A revocable letter of credit may be revoked or modified for any reason at any time by the issuing bank without notification A revocable letter of credit cannot be confirmed If a correspondent bank is engaged in a transaction that involves a revocable letter of credit it serves as the advising bank Once the documents have been presented and meet the terms and conditions in the letter of credit and the draft is honored the letter of credit cannot be revoked The revocable letter of credit is not a commonly used instrument It is generally used to provide guidelines for shipment If a letter of credit is revocable it would be referenced on its face The irrevocable letter of credit may not be revoked or amended without the agreement of the issuing bank the confirming bank and the beneficiary An irrevocable letter of credit from the issuing bank
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