Application of a documentary credit in international settlements
A documentary credit is a monetary obligation of a bank that is issued on the basis of an instruction of its client-importer in favor of the exporter.
The issuing bank must make payment to the exporter or ensure payment by another bank. When issuing a letter of credit, the importer's bank replaces the creditworthiness of the importer with its creditworthiness, fully accepting the credit or financial risk to itself. If the beneficiary's documents comply with the terms and conditions of the letter of credit, the bank that issued the letter of credit (and, possibly, the confirming bank) undertakes to pay it regardless of the willingness or solvency of the importer. This obligation is conditional, since its implementation is related to the fulfillment by the exporter of certain requirements, primarily with the submission to the bank of documents stipulated by the letter of credit, confirming the fulfillment of all of its conditions.
What are the specific features of the letter of credit that make it possible to characterize it not only as a form of international settlements, but also as: a) securities; b) the method of crediting; c) how to secure the transaction.
The use of letters of credit in international settlements is governed by the Uniform Customs and Practices for Documentary Credits developed by ICC. These rules are periodically reviewed, currently in effect in the edition of the ICC publication 600 (UCP - 600).
The unified rules define the concepts and types of letters of credit, the methods and procedures for their execution and transfer, the obligations and liabilities of banks, the requirements for documents submitted under letters of credit and the procedure for submitting them, other issues arising in the practice of settlements under letters of credit give interpretation of various terms. The rules are mandatory for banks that have joined them and their customers who settle on letters of credit. The documentary credit necessarily includes the reservation that all issues arising under this letter of credit must be regulated in accordance with the Uniform Rules.
According to the Uniform Rules (Article 2), a L/C means any agreement, however it is named or designated, which is irrevocable and constitutes a firm obligation of the issuing bank to pay the proper performance on time. Payment on time means:
- payment upon presentation, if the letter of credit provides for payment upon presentation;
- make payment by installments and pay at the due date, if the letter of credit provides for payment by installments;
- to accept a bill ("draft"), exposed by the beneficiary, and pay at the due date, if the letter of credit provides for acceptance.
Parties but a letter of credit:
1. The applicant or the applicant (importer).
2. Beneficiary (exporter).
3. The issuing bank (issuer) is the bank issuing the letter of credit.
The advising bank verifies the authenticity of the letter of credit and transfers it to the beneficiary.
Executing bank - the bank making the payment. They may be the issuing bank itself, or it may authorize the exporter's bank or any other bank to execute the letter of credit by making a payment to the beneficiary, negotiating or accepting his drafts.
Negotiating bank (accounting bank) negotiates drafts on a letter of credit, i.e. provides a loan to the beneficiary and becomes the owner of the draft himself.
A confirming bank is a bank that is usually located at the location of the beneficiary and, at the direction of the issuing bank, "confirms" letter of credit; undertakes to provide payment to the beneficiary. Thus, the beneficiary receives the obligation of the confirming bank, in addition to the bank that issued the letter of credit, i.e. an additional guarantee of receipt of payment. Usually the confirming bank is the advising bank.
In international practice, the following main types of letters of credit are distinguished:
- revocable and irrevocable;
- Verified and Unconfirmed;
- revolver (renewable);
- covered and uncovered.
Revocable Letter of Credit can be changed or canceled by the issuing bank at any time without prior notice to the beneficiary. In this connection, irrevocable letters of credit are generally used in international trade, which, accordingly, can not be canceled or changed without the consent of all interested parties, and revocable letters of credit are extremely rare.
Confirmation of a letter of credit implies an additional guarantee of payment from another bank that is not an issuing bank. The bank that confirmed the letter of credit undertakes to pay for documents that comply with the terms of the letter of credit if the issuing bank refuses to make a payment. In international practice, letters of credit opened by the importer's bank are usually confirmed by the exporter's bank.
Advocated Letter of Credit - this term is used when the obligation of the issuing bank to pay or accept drafts or to fulfill the delayed obligation to make payment under the letter of credit extends only to the beneficiary under the letter of credit. In this case, the letter of credit uses the standard phrase We hereby undertake to pay you the drafts issued and submitted to us in accordance with the terms and conditions of the letter of credit. "
A non-negotiable letter of credit - under which the drafts may be negotiated by any bank wishing to purchase them. The obligation of the issuing bank to make payment extends not only to the beneficiary.
A transferable letter of credit provides for the possibility of its use, in whole or in part, by one or more persons, other than the beneficiary itself, by the second beneficiaries. The letter of credit can be transferred only once, and the transfer of the letter of credit is possible only when it is stipulated in the text of the letter of credit. Such letters of credit can be used for deliveries of complex equipment, when sub-suppliers can act as second beneficiaries.
Revenue transfer should not be confused with transferable letters of credit. In order for a L/C to be transferable, it must be clearly stated that it is "translated". However, the fact that a letter of credit is not identified as transferable does not affect the beneficiary's right to assign any part or all of the proceeds to which he has or may be entitled under such letter of credit. At the same time, this concerns the assignment of proceeds and does not extend to the right to work under a letter of credit.
Compensation Letter of Credit ( back-to-back L/C). As with the situation for transferable letters of credit, the beneficiary may be an intermediary between the supplier and the importer. As an alternative to a transferable letter of credit, the exporter may ask the advising bank or a third party to issue a second letter of credit to the name of his supplier using as security a letter of credit issued in his name by the importer.
The revolving (renewable) letter of credit is used in calculations for permanent deliveries, usually carried out according to the schedule fixed in the contract. Revolving letters of credit can provide for an automatic recovery of the amount of a letter of credit after a certain period of time as the letter of credit is used or restored to the original amount after each use. When opening a revolving letter of credit, banks usually indicate the amount of the quota, how many times and up to what limit the letter of credit will be restored.
Revolving letter of credit allows you to use the same letter of credit to pay for various deliveries provided by the schedule for a long period of time without the need to issue a new letter of credit or make changes to the existing one.
Renewable letters of credit are cumulative and non-cumulative.
Example: a letter of credit provides deliveries for up to $ 100,000, for 12 months.
1. Cumulative Letter of Credit. If the amount of one monthly supply is less than $ 100,000, then the missing amount can be added to the next month. For example, the schedule - 75 thousand, 25 thousand
2. Non-cumulative Letter of Credit. Any part unused this month can not be sent in the next. The schedule - 75 thousand, 100 thousand
Upon opening the covered letters of credit , the issuing bank shall first provide cash to the executing bank - covering the amount of the letter of credit for the term of its obligations with the condition of possible use of these funds for payment under the letter of credit. Coverage can be expressed by crediting the account of the executing bank in the issuing bank or in a third bank or giving the executing bank the right to debit the account of the issuing bank that is open to it for the amount of the letter of credit.
There is another type of letter of credit that provides for payment for unloaded goods - letter of credit "with a red reservation" . Such a letter of credit can be any type of letter of credit providing for the payment by the executing bank of the adviser of advances to a certain amount. Advances may be needed by the beneficiary for the purchase and payment of the goods intended for export (before it is shipped to the buyer). Banks issue advances against submission by the exporter of the obligation to make a shipment or a similar document. By opening letters of credit "with a red reservation", the issuing bank undertakes to reimburse the executing bank for the amount of advances paid, even if the shipment has not been completed after that.Historically, these letters of credit originated to ensure the supply of wool from Australia to Europe, and part of the amount that was provided as an advance to the seller was printed in red.
Letters of credit with a "green reservation" differ from letters of credit with a "red reservation" in that they provide for some provision of advances. That is, such letters of credit contain a condition that allows the executing bank to pay the beneficiary an advance before the shipment under security, for example, in the form of a temporary goods warehouse receipt confirming the placement of the goods in the warehouse prior to shipment to the name of the executing bank or issuing bank. If the beneficiary does not submit the documents within the period specified in the credit, the reimbursement obligations of the creditor can be repaid through collateral.
Standby Letter of Credit ( stand-by L/C) is a special type of letter of credit that is inherently more like a guarantee. The practice of using such letters of credit originated in the US, as US banks under the law could not directly issue guarantees. In contrast to the documentary letters of credit discussed above and providing primarily the interests of the exporter, the standby letter of credit as a payment instrument is more flexible. It can also act as a security for the return of an advance paid by the importer or payment of fines if the exporter does not perform the contract properly, i. protect the interests of the importer, being analogous to such contractual guarantees, as a performance guarantee or advance guarantee.
Reserve letters of credit do not normally cover the shipment of goods, and banks make payments against them against the submission by beneficiaries of drafts or statements indicating that the counterparty has not fulfilled its obligations, and banks are not required to verify the validity of such statements.
Calculations in the form of a documentary credit are made as follows (Figure 17.3).
Parties - the exporter and importer - enter into a contract (1), in which it is determined that payments for the delivered goods will be made in the form of a documentary credit. After the conclusion of the contract, the exporter prepares the goods for shipment, which the importer notifies (2). Having received such notification, the importer sends to his bank an application for the opening of a letter of credit (3). The bank that opens a letter of credit (issuing bank) acts on the basis of the instructions of the applicant (importer).
After the opening of the letter of credit, in which the issuing bank usually indicates how the funds will be credited, the letter of credit is sent to the exporter in favor of which the letter of credit is opened to the beneficiary. At the same time, the issuing bank usually sends the letter of credit to the beneficiary through the latter's servicing bank, whose task includes advising, i.e. notification of the exporter about the letter of credit (4). Thus, the beneficiary's bank is called the advising bank.
Having received notification from the advising bank about the opening of the letter of credit (5), the beneficiary checks it for compliance with the terms of the contract. At the same time, special attention should be paid to the following questions: is the letter of credit irrevocable, which bank is it exposed for, whether the reimbursement instructions of the letter of credit correspond to the payment instructions of the contract, at whose expense is the commission provided for? In case of any discrepancy, the beneficiary informs the advising bank about the conditional acceptance of the letter of credit (or even its non-acceptance) and at the same time directs the applicant of the letter of credit to make the necessary changes in the conditions of the letter of credit. If no comments are received from the beneficiary, for the bank this means that the beneficiary agrees with all conditions of the letter of credit opened in his favor.
All changes that the issuing bank introduces to the terms of the previously opened letter of credit, the advising bank should notify the beneficiary. If the letter of credit is irrevocable, any change in the terms of the letter of credit can take place only with the consent of the beneficiary. If the beneficiary does not agree with this or that change, he must report this to the advising bank.
The Exporter delivers the goods on time (6) and, upon receipt of transport documents from the carrier (7), presents them together with other required documents to their bank (8). The exporter's bank carefully checks the documents submitted to them in order to make sure that they correspond to each other and the terms of the letter of credit. Uniform rules set specific requirements for documents that are made and sent by letter of credit. In the preparation and verification of documents should be guided by the relevant articles of the Uniform Rules.
When checking by an employee of an executing bank of the documents submitted by the beneficiary for payment under the letter of credit, certain discrepancies may be found with the conditions of the letter of credit or with each other. The executing bank can not accept such documents.
If, as a result of the audit, the bank finds discrepancies, the documents are returned to the beneficiary for re-registration, indicating all the discrepancies found. The beneficiary makes the necessary corrections to the documents and brings them into compliance with the terms of the letter of credit or with each other. If the necessary corrections can not be made, the exporter must:
- ask the buyer to make appropriate changes to the letter of credit or instruct the issuing bank to accept documents with the discrepancies noted;
- contact the advising bank with a request to request the issuing bank to make appropriate changes.
The advising bank sends the documents to the issuing bank, listing all discrepancies in the documents. When sending documents for collection, the advising bank asks the issuing bank to issue documents to the buyer against the consent of the latter to pay for documents.
Having received the documents, the issuing bank checks them and makes a decision on accepting documents or refusing them. If the issuing bank decides to refuse to accept documents, it must report this without delay to the advising bank. Such notification shall specify the discrepancies, because of which the issuing bank refuses to accept documents.
The advising bank is not responsible for any consequences that may arise due to the submission by the beneficiary of documents containing discrepancies with the terms of the letter of credit, as well as for the refusal of the issuing bank to accept documents due to discrepancies.
After all submitted documents have been checked and found to be in compliance with each other and the terms of the letter of credit, the documents are prepared for sending to the issuing bank (9).
Having received the documents from the advising bank and having ascertained in full compliance with the terms of the letter of credit, the employee of the issuing bank's letter of credit department makes their payment, transfers the payment amount to the exporter's bank (11), debiting the importer's account (10). The exporter's bank credits the proceeds to the beneficiary (12), and the importer receives the documents (13).
Fig. 17.3. Settlements in the form of a documentary credit
The letter of credit is most beneficial to the exporter as it is a firm and reliable security for the payment received as a rule before the shipment starts. The payment under the letter of credit (if the submitted documents correspond to its terms) is not related to the buyer's consent to payment of the goods. In addition, the exporter has the opportunity to receive payment under the letter of credit in the fastest way, in some cases - before the arrival of the goods at the destination.
The contract concluded by the United States organization and the Austrian company provided for the obligation of the buyer (an Austrian firm) to open an irrevocable letter of credit in the contract period. It should not contain conditions not provided for by the contract, and the date of its opening, if it contains such conditions, the lat was considered to bring it into full compliance with contractual terms. Letter of credit, open purchase
Telem, did not fully comply with the requirements of the contract and contained a number of conditions directly contradicting them. Among them, in particular, included the prohibition of partial shipments, although the contract explicitly provided for their permission, and that the delivery should have been made in railway cars, and the volume of deliveries had to amount to thousands of tons of goods; to the documents subject to presentation for payment, the letter of credit presented other requirements than those stipulated by the contract; the letter of credit was opened for a shorter period. Changes made to the letter of credit by the buyer did not eliminate all its inconsistencies with the terms of the contract, in connection with which it could not be used by the seller. In the future, the seller filed a lawsuit in the arbitration court, demanding that the buyer pay a fine.
The example above demonstrates the importance of the parties fulfilling the terms of the contract that determine the terms of payment and the form of settlements, as well as the legal risks and liability of counterparties in the event of failure to perform or improper fulfillment of the contract provisions.
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