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Letter of Credit I.

Definition A letter of credit is a letter from a bank guaranteeing that a buyers payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment for the purchase, the bank will be required to cover the full or remaining amount of the purchase. II. Characteristics a. Negotiability - Letters of credit are often negotiable. The issuing bank is obligated to pay not only the beneficiary, but also any bank nominated by the beneficiary. - 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 the holder in due course. b. Revocability Letters of credit may be revocable or irrevocable. - Revocable L/C o A revocable letter of credit may be revoked or modified for any reason, at any time by the issuing bank without notification. o A revocable letter cannot be confirmed. If a correspondent bank is engaged in a transaction that involves a revocable letter of credit, it serves as advising bank. o Once the documents have been presented and meet the terms and conditions in the letter of credit and the draft is honoured, the letter of credit cannot be revoked. o A revocable letter of credit is not a commonly used instrument. It is generally used to provide guildlines for shipment. o If a letter is revocable, it would be referrence on its face. - Irrevocable L/C o An irrevocable letter of credit cannot be changed without agreement by all of the affected parties: the issuing bank, the confirming bank, the beneficiary. c. Transfer and assignment - Domestic letters of credit, which are governed by Uniform Commercial Code (UCC), may be transferred as many times as desired and will remain effective. - International letters of credit, governed by Uniform Customs Practice for Documentary Credits, may be transferred only once.

Even if the credit specifies that it is nontransferable or nonassignable, the beneficiary may transfer their rights prior to performance of conditions of the credit. d. Sight and time drafts - A sight draft must be paid when the letter is presented for payment. The bank is allowed a reasonable time to review the documents before making payment. - A time draft must be paid after a certain period of time has elasped. The bank is required to accept the draft as soon as the documents comply with credit terms. The issuing bank has reasonable time to examine those documents, is obligated to accept drafts and pay them at maturity.

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