DOCUMENTARY CREDIT

Need for Documentary Letter of Credit

Normally, in international trade, the exporter may not be ready to take risk of selling his goods
abroad unless he is sure of getting his payment. Likewise, the buyer may not buy goods in
international market from an unknown party due to risk of not meeting his requirements. Both
these risks are quite high, which may sometime result into major loss. This perception is not
congenial to development of international trade.

The seller, therefore, needs an assurance of payment on behalf of the buyer; similarly, a buyer
would want somebody to ensure due performance by the seller as per the contract.

Both the parties can feel satisfied, if a professional intermediator like bank lends his support by
issuing Documentary Credit on behalf of the buyer (importer) in favour of the seller (exporter).

What is a Documentary Credit

A Documentary Credit is an instrument, which can be used for settling the trade payments. It
may be defined as follows:
“Credit means any arrangement, however, named or described, that is irrevocable and thereby
constitutes a definite undertaking of the issuing bank to honour* a complying presentation.”

* Honour means:
(a) To pay at sight if the credit is available by Sight payment.
(b) To incur a deferred payment undertaking and pay at maturity if the credit is available by
deferred payment.
(c) To accept a bill of exchange (‘draft’) drawn by the beneficiary and pay at maturity if the
credit is available by acceptance.

In common parlance, documentary credit is like a bank guarantee except that the bank guarantee
covers a situation of non-performance of the contract (payment is made when our customer does
not perform as per the contract). Whereas a documentary credit covers a situation where payment
is made on performance of contract. From the definition, we can derive five important features
of documentary credits, viz.:
 It is an irrevocable undertaking in writing
 given by a Bank called the Opening Bank
 on behalf of its customer who is the importer or buyer
 to honour bills drawn by a third party who may be the beneficiary or the
transferee under the credit
 subject to compliance with terms and conditions of the credit
Parties to the Letter of Credit:

1. Opener (Importer/Buyer): means the party on whose request the credit is issued.
2. Issuing Bank: means the bank that issued a credit at the request of an applicant or on its
own behalf.
3. Advising Bank: means a bank that advises the credit at the request of the issuing bank.
4. Beneficiary (seller/ exporter): means the party in whose favor the credit is issued.
5. Nominated Bank: means the bank, with which the credit is available or any bank in the
case of a credit available with any bank.
6. Confirming Bank: means the bank which guarantees honouring of bills by the Opening
Bank under the credit i.e. if the Opening Bank fails for any reason to honour the
bills,Confirming Bank honours the same, wherever available.
7. Reimbursing Bank: the bank which pays claims made by the nominated bank after
negotiating bills drawn by the exporter under the credit.

Types of Letter of Credit

1. Irrevocable Letter of Credit: It carries a definite undertaking of the issuing bank

to honour the documents drawn strictly in conformity with the terms and
conditions of the credit. It cannot be amended nor cancelled without the consent
of all parties concerned. Any Credit issued subject to UCPDC 600 will be an
irrevocable credit,even if there is no indication to that effect.

2. Revocable Letter of Credit: this credit can be amended/modified/cancelled any

time by the opening bank without the consent of the beneficiary. Hence, this
credit is not a safe credit from the point of view of the beneficiary. However, in
practice, this type of credit is seldom issued. Even though the credit can be
cancelled any time, but the opening bank would be liable to the beneficiary for the
shipments made by him prior to receipt of notice by him about the cancellation of
credit by the issuing bank.

3. Confirmed Letter of Credit: means the bank that adds its confirmation* to a
credit upon the issuing bank’s authorisation or request.
* Confirmation means a definite undertaking of the confirming bank, in addition
to that of the issuing bank, to honour or negotiate a complying presentation.

4. Anticipatory Letter of Credit

(a) Red Clause Letter of Credit: In this credit, the issuing bank authorizes
nominated bank, which is in beneficiary’s country, to give pre-shipment credit to
the beneficiary. This advance is given to the beneficiary for purchase of raw-
material/processing/packing of the goods to be exported. It is given at the risk and
responsibility of the issuing bank and is unsecured.. The pre-shipment advance
given in this way would be adjusted against the documents tendered by the
exporter for negotiation. This type of L/C is known as `Red Clause Letter of
Credit’.
 (b) Green Clause Letter of Credit: This credit is an extended version of red clause
credit. In addition to whatever has been given in red clause credit, it covers
charges for warehousing of goods at the port of shipment and insurance charges
when waiting for ship or space.Generally, the advance under this credit is given to
the exporter after the goods are lodged in bonded warehouse and would be
adjusted once they are shipped on board. Under this credit, warehouse warrants
are given as a security for the advance.

5. Transferable Letter of Credit: means a credit that specifically states it is

“transferable”. A transferable credit may be made available in whole or in part to
another beneficiary (“second beneficiary”),at the request of the beneficiary (“first
beneficiary”).
 Transferring bank means a nominated bank that transfers the credit or, in a credit
available with any bank, a bank that is specifically authorised by the issuing bank
to transfer and that transfers the credit.
 A credit may be transferred in part to more than one second beneficiaries
provided partial shipments are allowed.
 Further such credits can be transferred only once ie from first beneficiary to a
second beneficiary but not thereafter.

6. Back-to back Letter of Credit: The beneficiary of the export credit, who is not
the manufacturer of the goods, may approach a bank to open a letter of credit in
favour of the manufacturer who is ready to supply the goods. Such a letter of
credit is opened on the strength of the export letter of credit and hence called
back-to-back letter of credit. Such a documentary credit should be opened only on
behalf of the good exporters and suppliers.

7. Revolving Letter of Credit:

 When a buyer wants a regular supply of goods from the foreign/ domestic supplier,
he may approach his banker to open a revolving letter of credit in supplier’s
favour.
 When the shipment is made and the documents are drawn on the opener as per the
terms of credit, the documents are negotiated and forwarded to the drawee for
payment.
 When the payment is made, the credit is reinstated and made available to the
beneficiary on receipt of the advice from the issuing bank.
 Further negotiations will take place after the advice of reinstatement is received.
 Revolving letter of credit should stipulate maximum drawings under the credit and
should have reinstatement clause.
.
8. Stand-by Letter of Credit: The very name of this credit suggests that it is not a
regular letter of credit, but a sort of stand-by or back-up credit. Standby letter of
credit is very similar in nature to a bank guarantee. These types of credits are
very much in vogue in Countries like U.S.A and Japan in place of guarantee.
These credits are generally used as substitutes for performance guarantee or for
securing loans. As per FEMA, now they can be issued in India for imports of
certain category as per FEDAI guidelines. Our exporters can freely receive
standby letter of credit to cover their exports of goods.
UNIFORM CUSTOMS & PRACTICE FOR DOCUMENTARY CREDIT

UCP 2007 ‘Latest revision’ (ICC 600) , became effective from 01.07.2007. There are 39
articles in the revised version.

Article 1. Application of UCP

Article 2.Definitions

Article 3. Interpretations

Article 4. Credits v. Contracts

Article 5. Documents v. Goods, Services or Performance

Article 6. Availability, Expiry Date and Place for Presentation

Article 7. Issuing Bank Undertaking

Article 8. Confirming Bank Undertaking

Article 9. Advising of Credits and Amendments

Article 10. Amendments

Article 11. Tele-transmitted and Pre-Advised Credits and Amendments

Article 12. Nominations

Article 13. Bank-to-Bank Reimbursement Arrangements

Article 14. Standard for Examination of documents

Article 15. Complying Presentation

Article 16. Discrepant Documents, Waiver and Notice

Article 17.Original Documents and Copies

Article 18. Commercial Invoice

Article 19. Transport Documents Covering at Least Two Different Modes of Trasport
 Article 20. Bill of Lading

Article 21. Non-Negotiable Sea Waybill

Article 22. Charter Party Bill of Lading

Article 23. Air Transport Document

Article 24. Road, Rail or Inland Waterway Transport Documents

Article 25. Courier Receipt, Post Receipt or Certificate of Posting

Article 26. “On Deck”, Shippers Load & Count, Said by Shipper to Contain and Charges
Additional to Freight.

Article 27. Clean Transport Document

Article 28. Insurance Document and Coverage

Article 29. Extension of Expiry Date or Last Day for Presentation

Article 30. Tolerance in Credit Amount, Quantity and Unit Prices

Article 31. Partial Drawing and shipments

Article 32. Installment Drawings or Shipments

Article 33. Hours of Presentation

Article 34. Disclaimer on Effectiveness of Documents

Article 35. Disclaimer on Transmission and Translation

Article 36. Force Majeure

Article 37. Disclaimer for Acts of an Instructed Party

Article 38.Transferable Credits

Article 39. Assignment of Proceeds

Details of important Articles are available in another handout.

(REVISED May. 2012)