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Diagram:  International Commercial Terms

   
 

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International Commercial Terms (INCOTERMS)

The INCOTERMS (International Commercial Terms) is a universally recognized set of

definitions of international trade terms, such as FOB, CFR and CIF, developed by the
International Chamber of Commerce (ICC) in Paris, France. It defines the trade contract
responsibilities and liabilities between buyer and seller. It is invaluable and a cost-saving tool.
The exporter and the importer need not undergo a lengthy negotiation about the conditions of
each transaction. Once they have agreed on a commercial term like FOB, they can sell and buy at
FOB without discussing who will be responsible for the freight, cargo insurance, and other costs
and risks.

The INCOTERMS was first published in 1936---INCOTERMS 1936---and it is revised

periodically to keep up with changes in the international trade needs. The complete definition of
each term is available from the current publication---INCOTERMS 2000. The publication is
available at your local Chamber of Commerce affiliated with the International Chamber of
Commerce (ICC).

Many importers and exporters worldwide are accustomed to and may still use the INCOTERMS
1980, the predecessor of INCOTERMS 1990 and INCOTERMS 2000.

Under the INCOTERMS 2000, the international commercial terms are grouped into E, F, C and
D, designated by the first letter of the term (acronym), as follows:
 International Commercial Terms
( INCOTERMS )

 GROUP  TERM     Stands for

E EXW Ex Works

F FCA Free Carrier

FAS Free Alongside Ship
FOB Free On Board

C CFR Cost and Freight

CIF Cost, Insurance and Freight
CPT Carriage Paid To
CIP Carriage and Insurance Paid To

D DAF Delivered At Frontier

DES Delivered Ex Ship
DEQ Delivered Ex Quay
DDU Delivered Duty Unpaid
Delivered Duty Paid
DDP

In practice, trade terms are written with either all upper case letters (e.g. FOB, CFR, CIF, and
FAS) or all lower case letters (e.g. fob, cfr, cif, and fas). They may be written with periods (e.g.
F.O.B. and c.i.f.).

In international trade, it would be best for exporters to refrain, wherever possible, from dealing in
trade terms that would hold the seller responsible for the import customs clearance and/or
payment of import customs duties and taxes and/or other costs and risks at the buyer's end, for
example the trade terms DEQ (Delivered Ex Quay) and DDP (Delivered Duty Paid). Quite
often, the charges and expenses at the buyer's end may cost more to the seller than anticipated.
To overcome losses, hire a reliable customs broker or freight forwarder in the importing country
to handle the import routines.

Similarly, it would be best for importers not to deal in EXW (Ex Works), which would hold the
buyer responsible for the export customs clearance, payment of export customs charges and
taxes, and other costs and risks at the seller's end.

EXW   {+ the named place}

Ex Works

Ex means from. Works means factory, mill or warehouse, which is the seller's premises.
EXW applies to goods available only at the seller's premises. Buyer is responsible for
loading the goods on truck or container at the seller's premises, and for the subsequent
costs and risks.

In practice, it is not uncommon that the seller loads the goods on truck or container at the
seller's premises without charging loading fee.

In the quotation, indicate the named place (seller's premises) after the acronym EXW, for
example EXW Kobe and EXW San Antonio.

The term EXW is commonly used between the manufacturer (seller) and export-trader
(buyer), and the export-trader resells on other trade terms to the foreign buyers. Some
manufacturers may use the term Ex Factory, which means the same as Ex Works.

FCA   {+ the named point of departure}

Free Carrier

The delivery of goods on truck, rail car or container at the specified point (depot) of
departure, which is usually the seller's premises, or a named railroad station or a named
cargo terminal or into the custody of the carrier, at seller's expense. The point (depot) at
origin may or may not be a customs clearance center. Buyer is responsible for the main
carriage/freight, cargo insurance and other costs and risks.
 In the air shipment, technically speaking, goods placed in the custody of an air carrier is
considered as delivery on board the plane. In practice, many importers and exporters still
use the term FOB in the air shipment.

The term FCA is also used in the RO/RO (roll on/roll off) services.

In the export quotation, indicate the point of departure (loading) after the acronym FCA,
for example FCA Hong Kong and FCA Seattle.

Some manufacturers may use the former terms FOT (Free On Truck) and FOR (Free On
Rail) in selling to export-traders.

FAS   {+ the named port of origin}

Free Alongside Ship

Goods are placed in the dock shed or at the side of the ship, on the dock or lighter, within
reach of its loading equipment so that they can be loaded aboard the ship, at seller's
expense. Buyer is responsible for the loading fee, main carriage/freight, cargo insurance,
and other costs and risks.

In the export quotation, indicate the port of origin (loading) after the acronym FAS, for
example FAS New York and FAS Bremen.

The FAS term is popular in the break-bulk shipments and with the importing countries
using their own vessels.

FOB   {+ the named port of origin}

Free On Board

The delivery of goods on board the vessel at the named port of origin (loading), at seller's
expense. Buyer is responsible for the main carriage/freight, cargo insurance and other
costs and risks.

In the export quotation, indicate the port of origin (loading) after the acronym FOB, for
example FOB Vancouver and FOB Shanghai.
 Under the rules of the INCOTERMS 1990, the term FOB is used for ocean freight only.
However, in practice, many importers and exporters still use the term FOB in the air
freight.

In North America, the term FOB has other applications. Many buyers and sellers in
Canada and the U.S.A. dealing on the open account and consignment basis are
accustomed to using the shipping terms FOB Origin and FOB Destination.

FOB Origin means the buyer is responsible for the freight and other costs and risks.
FOB Destination means the seller is responsible for the freight and other costs and risks
until the goods are delivered to the buyer's premises, which may include the import
customs clearance and payment of import customs duties and taxes at the buyer's country,
depending on the agreement between the buyer and seller.

In international trade, avoid using the shipping terms FOB Origin and FOB Destination,
which are not part of the INCOTERMS (International Commercial Terms).

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CFR   {+ the named port of destination}

Cost and Freight

The delivery of goods to the named port of destination (discharge) at the seller's expense.
Buyer is responsible for the cargo insurance and other costs and risks. The term CFR was
formerly written as C&F. Many importers and exporters worldwide still use the term
C&F.

In the export quotation, indicate the port of destination (discharge) after the acronym
CFR, for example CFR Karachi and CFR Alexandria.

Under the rules of the INCOTERMS 1990, the term Cost and Freight is used for ocean
freight only. However, in practice, the term Cost and Freight (C&F) is still commonly
used in the air freight.

CIF   {+ the named port of destination}

Cost, Insurance and Freight
 The cargo insurance and delivery of goods to the named port of destination (discharge) at
the seller's expense. Buyer is responsible for the import customs clearance and other costs
and risks.

In the export quotation, indicate the port of destination (discharge) after the acronym
CIF, for example CIF Pusan and CIF Singapore.

Under the rules of the INCOTERMS 1990, the term CIF is used for ocean freight only.
However, in practice, many importers and exporters still use the term CIF in the air
freight.

CPT   {+ the named place of destination}

Carriage Paid To

The delivery of goods to the named place of destination (discharge) at seller's expense.
Buyer assumes the cargo insurance, import customs clearance, payment of customs duties
and taxes, and other costs and risks.

In the export quotation, indicate the place of destination (discharge) after the acronym
CPT, for example CPT Los Angeles and CPT Osaka.

CIP   {+ the named place of destination}

Carriage and Insurance Paid To

The delivery of goods and the cargo insurance to the named place of destination
(discharge) at seller's expense. Buyer assumes the import customs clearance, payment of
customs duties and taxes, and other costs and risks.

In the export quotation, indicate the place of destination (discharge) after the acronym
CIP, for example CIP Paris and CIP Athens.

DAF   {+ the named point at frontier}

Delivered At Frontier
 The delivery of goods to the specified point at the frontier at seller's expense. Buyer is
responsible for the import customs clearance, payment of customs duties and taxes, and
other costs and risks.

In the export quotation, indicate the point at frontier (discharge) after the acronym DAF,
for example DAF Buffalo and DAF Welland.

DES   {+ the named port of destination}

Delivered Ex Ship

The delivery of goods on board the vessel at the named port of destination (discharge), at
seller's expense. Buyer assumes the unloading fee, import customs clearance, payment of
customs duties and taxes, cargo insurance, and other costs and risks.

In the export quotation, indicate the port of destination (discharge) after the acronym
DES, for example DES Helsinki and DES Stockholm.

DEQ   {+ the named port of destination}

Delivered Ex Quay

The delivery of goods to the quay (the port) at destination at seller's expense. Seller is
responsible for the import customs clearance and payment of customs duties and taxes at
the buyer's end. Buyer assumes the cargo insurance and other costs and risks.

In the export quotation, indicate the port of destination (discharge) after the acronym
DEQ, for example DEQ Libreville and DEQ Maputo.

DDU   {+ the named point of destination}

Delivered Duty Unpaid

The delivery of goods and the cargo insurance to the final point at destination, which is
often the project site or buyer's premises, at seller's expense. Buyer assumes the import
 customs clearance and payment of customs duties and taxes. The seller may opt not to
insure the goods at his/her own risks.

In the export quotation, indicate the point of destination (discharge) after the acronym
DDU, for example DDU La Paz and DDU Ndjamena.

DDP   {+ the named point of destination}

Delivered Duty Paid

The seller is responsible for most of the expenses, which include the cargo insurance,
import customs clearance, and payment of customs duties and taxes at the buyer's end,
and the delivery of goods to the final point at destination, which is often the project site
or buyer's premises. The seller may opt not to insure the goods at his/her own risks.

In the export quotation, indicate the point of destination (discharge) after the acronym
DDP, for example DDP Bujumbura and DDP Mbabane.

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Applicable Trade Terms

in Different Modes of Transportation

Mode of
 GROUP   TERM  Stands for
Transportation
  Land Ocean Air Multimodal

E EXW Ex Works  
 
Land Ocean Air Multimodal
 
 F FCA Free Carrier  
FAS Free Alongside      
Ship
FOB Free On Board      
 
Land Ocean Air Multimodal
 
C CFR Cost and Freight      
CIF Cost, Insurance      
and Freight
CPT Carriage Paid To  
CIP Carriage and  
Insurance Paid To
 
Land Ocean Air Multimodal
 
D DAF Delivered    
At Frontier
DES Delivered Ex Ship      
DEQ Delivered Ex Quay      
DDU Delivered
Duty Unpaid
DDP Delivered
Duty Paid

Outline of Trade Contract Responsibilities

of the Seller (Exporter) and Buyer (Importer)

LEGEND:
Seller is responsible
Buyer is responsible
 
1 Inland freight in Seller's country;
Delivery to the carrier or frontier
2 Customs clearance in Seller's country
3 Payment of customs charges and taxes in Seller's country
4 Loading to the main carrier or means of conveyance
5 Main carriage/freight
6 Cargo (marine) insurance
7 Unloading from the main carrier or means of conveyance
8 Customs clearance in Buyer's country
9 Payment of customs duties and taxes in Buyer's country
10 Inland freight in Buyer's country
11 Other costs and risks in Buyer's country

 GROUP   TERM  Trade Contract Responsibility

1
  1 2 3 4 5 6 7 8 9 11
0
E EXW
1
1 2 3 4 5 6 7 8 9 11
0
F FCA
FAS
FOB
1
1 2 3 4 5 6 7 8 9 11
0
C CFR
CIF
CPT
CIP
1
1 2 3 4 5 6 7 8 9 11
0
D DAF
DES
 DEQ
DDU
DDP
 
  Seller is responsible
 
  Buyer is responsible
Objectives
Incoterms are internationally accepted commercial terms, developed in 1936 by the International
Chamber of Commerce (ICC) in Paris. Incoterms 2000 define the respective roles of the buyer
and seller in the agreement of transportation and other responsibilities and clarify when the
ownership of the merchandise takes place. These terms are incorporated into export-import sales
agreements and contracts worldwide and are a necessary part of foreign trade.

Incoterms are used in union with a sales agreement or other methods of sales transactions and
define the responsibilities and obligations of both, the exporter and importer in Foreign Trade
Transactions.

The main objectives of Incoterms 2000 revolve around the contract of Foreign Trade concerned
with the loading, transport, insurance and delivery transactions. Its main function is the
distribution of goods and regulation of transport charges.

Another significant role played by Incoterms is to identify and define the place of transfer and
the transport risks involved in order to justify the ownership for support and damage of goods by
shipments sent by the seller or the buyer in an event of execution of transport.

Incoterms make international trade easier and help traders in different countries to understand
one another. These International Commercial Terms are the most widely used international
contracts protected by the ICC copyright.

Incoterms safeguard the following issues in the Foreign Trade contract or International Trade
Contract:

1. To determine the critical point of the transfer of the risks of the seller to the buyer
in the process forwarding of the goods (risks of loss, deterioration, robbery of the
goods) allow the person who supports these risks to make arrangements in
particular in term of insurance.
2. To specify who is going to subscribe the contract of carriage that is to say the
seller (exporter) or the buyer (importer).
3. To distribute between the seller and the buyer the logistic and administrative
expenses at the various stages of the process.
4. It is important to define who is responsible for packaging, marking, operations of
handling, loading and unloading, inspection of the goods.
5. Need To confirm and fix respective obligations for the achievement of the
formalities of exportation and importation, the payment of the rights and taxes of
importation as well as the sending of the documents. In dealing Foreign Trade
there are 13 Incoterms globally adopted by the International Chamber of
Commerce.

INTERNATIONAL INCOTERMS
Incoterms or International commercial terms make trade between different countries easier.
International Commercial Terms are a series of international trade terms that are used are used
worldwide to divide he transaction costs and responsibilities between the seller and the buyer and
reflect state-of-the-art transportation practices.

Incoterms directly deal with the questions related to the delivery of the products from the seller
to the buyer. This includes the carriage of products, export and import responsibilities, who pays
for what and who has the risk for the condition of the products at different locations within the
transport process.

Incoterms and world customs Incoterms deal with the various trade transactions all over the
world and clearly distinguish between the respective responsibilities of the seller and the buyers.

The 13 International Incoterms are:

Departure of goods by international transport with the risks and dangers to the Seller (Exporter)
and Buyers (Importers)

1. "EXW"- Ex Works

Title and risk pass to buyer including payment of all transportation and insurance
cost from the seller's door. Used for any mode of transportation.

Seller : In EXW shipment terms the Seller (Exporter) provides the goods for
collection by the Buyer (Importer) on the seller or exporter's promise.
Responsibility for the seller is to put the goods, in a good package which is
adaptable and disposable by the transport.

Buyer : The buyer or Importer arranges insurance for damage transit goods. The
Buyer or importer has to bear all costs and risks involved in shipment
transactions.

(However, if the parties wish the seller to be responsible for the loading of the
goods on departure and to bear the risks and all the costs of such loading, this
should be made clear by adding explicit wording to this effect in the contract of
sale. )

2. "FCA"- Free Carrier named point

"FCA"- Free Carrier named point: Title and risk pass to buyer including
transportation and insurance cost when the seller delivers goods cleared for export
to the carrier. Seller is obligated to load the goods on the Buyer's collecting
vehicle; it is the Buyer's obligation to receive the Seller's arriving vehicle
unloaded.

Seller : The Seller’s responsibility is to deliver the goods into the custody of the
 transporters at defined points. It is important for the chosen place of delivery to
have an impact on the obligations of loading and unloading the goods.

Buyer : The Buyer nominates the means of transport or shipping mode and pays
the shipment charges.

The seller and the buyer agree upon the place for delivery of goods. If the buyer
nominates a person other than a carrier or transporter to receive the goods, the
seller is deemed to fulfill his obligation to deliver the goods when they are
delivered to that person.

3. "FAS"- Free Alongside Ship

FAS- Free Alongside ship: Title and risk pass to buyer including payment of all
transportation and insurance cost once delivered alongside ship by the seller. Used
for sea or inland waterway transportation. The export clearance obligation rests
with the seller.

In FAS has price includes all the costs incurred in delivering the goods alongside
the vessel at the port or nominated place of the buyer but there is not applicable
charges to the seller for loading the goods on board of vessel and no ocean freight
charges and marine insurance.

Seller: The responsibility of the seller are fulfilled when the goods are placed
cleared along the ship.

Buyer: Buyer or Importer bear all the expenses and risks of loss or damage of
transit goods which are delivered along the ship.

4. "FOB" - Free On Board

The FOB (Free on Board) price is inclusive of Ex-Works price, packing charges,
transportation charges upto the place of shipment., Seller also responsible for o
clear customs dues, quality inspection charges, weight measurement charges and
other export related dues. It is important that the shipment term in the Bill of
Lading must carry the wording "Shipped on Board' it must bear with signature of
transporter or carrier or his authorized representative with the date on which
goods were "Boarded".

Seller :Seller responsible for clear customs dues, quality inspection charges,
weight measurement charges and other export related dues. It is important that the
shipment term in the Bill of Lading must carry the wording "Shipped on Board' it
must bear with signature of transporter or carrier or his authorized representative
with the date on which goods were "Boarded".

Buyer : The buyer indicates the ship and pays freight, transfer expenses and risks
 is done when the goods passes or forwarding to the buyers warehouse by rail or
ship.

5. "CFR"- Cost  And Freight

In this term the exporter bears the cost of carriage or transport to the selected
destination port, in this term the risk transferable to the buyers at the port of
shipment.

Seller: The chooses the carrier, concludes and bears the expenses by paying
freight to the agreed port of destination, unloading not included. The loading of
the duty-paid goods on the ship falls on him as well as the formalities of
forwarding. On the other hand, the transfer of risks is the same one as in FOB.

Buyer: The buyers supports all the risk of transport, when the goods are delivered
aboard by ship at the loading port, buyer receives it from the carrier and takes
delivery of the goods from nominated destination port.

6. "CIF"- Cost, Insurance And Freight

CIF- Cost, Insurance and Freight: Title and risk pass to buyer when delivered on
board the ship by seller who pays transportation and insurance cost to destination
port. Used for sea or inland waterway transportation.

This Term involves insurance with FOB price and ocean freight. The marine
insurance is obtained by the exporter at his cost against the risk of loss or damage
to the goods during the carriage.

Seller: The CFR extends additional obligation to the seller for providing a
maritime So insurance against the risk of loss or damage to the goods. The seller
pays the insurance premium.

Buyer: He supports the risk of transportation, when the goods have been delivered
aboard the ship at the loading port. He takes delivery of the goods from the carrier
to the appointed port or destination.

7. "CPT"- Carriage Paid To

CPT- Carriage Paid To: Title, risk and insurance cost pass to buyer when
delivered to carrier by seller who pays transportation cost to destination. Used for
any mode of transportation.
This term uses land transport by rail, road and inland waterways. The seller and
exporter are responsible for the carriage of goods to the nominated destination and
have to pay freight up the first carrier.

Seller: The seller or exporter controls the supply chain after paying customs
 clearance for export. Seller or Exporter select the carrier and pay the expenses up
to the destination.

Buyer: The risks of goods damages or loss are supported by the buyer as goods
are given by the first carrier. The buyer or importer has to pay importation
customs clearance and the unloading costs.

8. "CIP"- Carriage And  Insurance Paid To

CIP- Carriage and Insurance Paid To: Title and risk pass to buyer when delivered
to carrier by seller who pays transportation and insurance cost to destination.
Used for any mode of transportation.
This term is similar to Carriage Paid To but the seller has to arrange and pay for
the insurance against the risk or loss or damage of the goods during the shipment.

Seller: The seller or buyer has to provide insurance and seller pays the freight and
insurance premium.

Buyer: The buyer or importer supports the risks of damages or loss, as goods are
given to the first carrier. The buyer has to pay customs clearance and unloading
charges.

9. "DAF"- Delivered At Frontier

DAF- Delivered At Frontier: Title, risk and responsibility for import clearance
pass to buyer when delivered to named border point by seller. Used for any mode
of transportation.

This term is used when the goods are to be carried by rail or road.

Seller : The seller is responsible to make the goods available to the buyer by the
carrier till the customs border as defined in sales contract.

Buyer : The buyer takes delivery of the goods at the contract agreed point border
and he is responsible for bearing all customs formalities.

10.DES"- Delivered Ex-Ship

DES- Delivered Ex-Ship: Title, risk, responsibility for vessel discharge and
import clearance pass to buyer when seller delivers goods on board the ship to
destination port. Used for sea or inland waterway transportation.

Seller: The seller is responsible to make the goods available to the buyer up to the
named quay or after crossing the customs border.
 Buyer: The buyer takes delivery of the goods from ship at destination port and
pays the expenses of unloading.

11.DEQ"- Delivered Ex-Quay

DEQ- Delivered Ex-Quay: Title and risk pass to buyer when delivered on board
the ship at the destination point by the seller who delivers goods on dock at
destination point cleared for import. Used for sea or inland waterway
transportation.

12."DDU"- Delivered Duty Unpaid

DDU- Delivered Duty Unpaid: Seller fulfills his obligation when goods have been
made available at the named place in the country of importation.

Seller: The seller is responsible for all transportation cost and accept the customs
duty and taxes as per defined in customs procedures.

Buyer: The buyer is responsible of the importation customs formalities.

13."DDP"- Delivered Duty Paid

DDP- Delivered Duty Paid: Title and risk pass to buyer when seller delivers
goods to the named destination point cleared for import. Used for any mode of
transportation.

Seller: The seller is responsible to make the goods available to the buyer at his
risk and cost as promised by the buyer. All the Taxes and duty on importation is
promised by the buyer to the seller.

Buyer: The buyer is responsible to take delivery at a nominated place and pays the
expenses for unloading of goods.

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 insures the beneficiary that if the required documents are presented and the terms
and conditions are complied with, payment will be made. If a letter of credit is irrevocable it is
referenced on its face.
Transfer and Assignment
The beneficiary has the right to transfer or assign the right to draw, under a credit only when the
credit states that it is transferable or assignable. Credits governed by the Uniform Commercial
Code (Domestic) maybe transferred an unlimited number of times. Under the Uniform Customs
Practice for Documentary Credits (International) the credit may be transferred only once.
However, 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.

Sight and Time Drafts

All letters of credit require the beneficiary to present a draft and specified documents in order to
receive payment. A draft is a written order by which the party creating it, orders another party to
pay money to a third party. A draft is also called a bill of exchange.

There are two types of drafts: sight and time. A sight draft is payable as soon as it is presented
for payment. The bank is allowed a reasonable time to review the documents before making
payment.

A time draft is not payable until the lapse of a particular time period stated on the draft. The bank
is required to accept the draft as soon as the documents comply with credit terms. The issuing
bank has a reasonable time to examine those documents. The issuing bank is obligated to accept
drafts and pay them at maturity.

Standby Letter of Credit

The standby letter of credit serves a different function than the commercial letter of credit. The
commercial letter of credit is the primary payment mechanism for a transaction. The standby
letter of credit serves as a secondary payment mechanism. A bank will issue a standby letter of
credit on behalf of a customer to provide assurances of his ability to perform under the terms of a
contract between the beneficiary. The parties involved with the transaction do not expect that the
letter of credit will ever be drawn upon.

The standby letter of credit assures the beneficiary of the performance of the customer's
obligation. The beneficiary is able to draw under the credit by presenting a draft, copies of
invoices, with evidence that the customer has not performed its obligation. The bank is obligated
to make payment if the documents presented comply with the terms of the letter of credit.

Standby letters of credit are issued by banks to stand behind monetary obligations, to insure the
refund of advance payment, to support performance and bid obligations, and to insure the
completion of a sales contract. The credit has an expiration date.

The standby letter of credit is often used to guarantee performance or to strengthen the credit
worthiness of a customer. In the above example, the letter of credit is issued by the bank and held
by the supplier. The customer is provided open account terms. If payments are made in
accordance with the suppliers' terms, the letter of credit would not be drawn on. The seller
pursues the customer for payment directly. If the customer is unable to pay, the seller presents a
draft and copies of invoices to the bank for payment.
The domestic standby letter of credit is governed by the Uniform Commercial Code. Under these
provisions, the bank is given until the close of the third banking day after receipt of the
documents to honor the draft.

Procedures for Using the Tool

The following procedures include a flow of events that follow the decision to use a Commercial
Letter of Credit. Procedures required to execute a Standby Letter of Credit are less rigorous. The
standby credit is a domestic transaction. It does not require a correspondent bank (advising or
confirming). The documentation requirements are also less tedious.

Step-by-step process:

 Buyer and seller agree to conduct business. The seller wants a letter of credit to guarantee
payment.
 Buyer applies to his bank for a letter of credit in favor of the seller.
 Buyer's bank approves the credit risk of the buyer, issues and forwards the credit to its
correspondent bank (advising or confirming). The correspondent bank is usually located
in the same geographical location as the seller (beneficiary).
 Advising bank will authenticate the credit and forward the original credit to the seller
(beneficiary).
 Seller (beneficiary) ships the goods, then verifies and develops the documentary
requirements to support the letter of credit. Documentary requirements may vary greatly
depending on the perceived risk involved in dealing with a particular company.
 Seller presents the required documents to the advising or confirming bank to be
processed for payment.
 Advising or confirming bank examines the documents for compliance with the terms and
conditions of the letter of credit.
 If the documents are correct, the advising or confirming bank will claim the funds by:
o Debiting the account of the issuing bank.
o Waiting until the issuing bank remits, after receiving the documents.
o Reimburse on another bank as required in the credit.
 Advising or confirming bank will forward the documents to the issuing bank.
 Issuing bank will examine the documents for compliance. If they are in order, the issuing
bank will debit the buyer's account.
 Issuing bank then forwards the documents to the buyer.

Standard Forms of Documentation

When making payment for product on behalf of its customer, the issuing bank must verify that
all documents and drafts conform precisely to the terms and conditions of the letter of credit.
Although the credit can require an array of documents, the most common documents that must
accompany the draft include:

Commercial Invoice
The billing for the goods and services. It includes a description of merchandise, price, FOB
origin, and name and address of buyer and seller. The buyer and seller information must
correspond exactly to the description in the letter of credit. Unless the letter of credit specifically
states otherwise, a generic description of the merchandise is usually acceptable in the other
accompanying documents.

Bill of Lading
A document evidencing the receipt of goods for shipment and issued by a freight carrier engaged
in the business of forwarding or transporting goods. The documents evidence control of goods.
They also serve as a receipt for the merchandise shipped and as evidence of the carrier's
obligation to transport the goods to their proper destination.

Warranty of Title
A warranty given by a seller to a buyer of goods that states that the title being conveyed is good
and that the transfer is rightful. This is a method of certifying clear title to product transfer. It is
generally issued to the purchaser and issuing bank expressing an agreement to indemnify and
hold both parties harmless.

Letter of Indemnity
Specifically indemnifies the purchaser against a certain stated circumstance. Indemnification is
generally used to guaranty that shipping documents will be provided in good order when
available.

Common Defects in Documentation

About half of all drawings presented contain discrepancies. A discrepancy is an irregularity in
the documents that causes them to be in non-compliance to the letter of credit. Requirements set
forth in the letter of credit cannot be waived or altered by the issuing bank without the express
consent of the customer. The beneficiary should prepare and examine all documents carefully
before presentation to the paying bank to avoid any delay in receipt of payment. Commonly
found discrepancies between the letter of credit and supporting documents include:

 Letter of Credit has expired prior to presentation of draft.

 Bill of Lading evidences delivery prior to or after the date range stated in the credit.
 Stale dated documents.
 Changes included in the invoice not authorized in the credit.
 Inconsistent description of goods.
 Insurance document errors.
 Invoice amount not equal to draft amount.
 Ports of loading and destination not as specified in the credit.
 Description of merchandise is not as stated in credit.
 A document required by the credit is not presented.
 Documents are inconsistent as to general information such as volume, quality, etc.
 Names of documents not exact as described in the credit. Beneficiary information must
be exact.
 Invoice or statement is not signed as stipulated in the letter of credit.
When a discrepancy is detected by the negotiating bank, a correction to the document may be
allowed if it can be done quickly while remaining in the control of the bank. If time is not a
factor, the exporter should request that the negotiating bank return the documents for corrections.

If there is not enough time to make corrections, the exporter should request that the negotiating
bank send the documents to the issuing bank on an approval basis or notify the issuing bank by
wire, outline the discrepancies, and request authority to pay. Payment cannot be made until all
parties have agreed to jointly waive the discrepancy.

Tips for Exporters

 Communicate with your customers in detail before they apply for letters of credit.
 Consider whether a confirmed letter of credit is needed.
 Ask for a copy of the application to be fax to you, so you can check for terms or
conditions that may cause you problems in compliance.
 Upon first advice of the letter of credit, check that all its terms and conditions can be
complied with within the prescribed time limits.
 Many presentations of documents run into problems with time-limits. You must be aware
of at least three time constraints - the expiration date of the credit, the latest shipping date
and the maximum time allowed between dispatch and presentation.
 If the letter of credit calls for documents supplied by third parties, make reasonable
allowance for the time this may take to complete.
 After dispatch of the goods, check all the documents both against the terms of the credit
and against each other for internal consistency.

Summary
The use of the letters of credit as a tool to reduce risk has grown substantially over the past
decade. Letters of credit accomplish their purpose by substituting the credit of the bank for that
of the customer, for the purpose of facilitating trade.

The credit professional should be familiar with two types of letters of credit: commercial and
standby. Commercial letters of credit are used primarily to facilitate foreign trade. The
commercial letter of credit is the primary payment mechanism for a transaction.

The standby letter of credit serves a different function. The standby letter of credit serves as a
secondary payment mechanism. The bank will issue the credit on behalf of a customer to provide
assurances of his ability to perform under the terms of a contract.

Upon receipt of the letter of credit, the credit professional should review all items carefully to
insure that what is expected of the seller is fully understood and that he can comply with all the
terms and conditions. When compliance is in question, the buyer should be requested to amend
the credit.