Letter of Credit
Letter of Credit
A Letter of Credit (LC) is a legal document that is issued by the bank that acts as an irrevocable guarantee in making payment to a beneficiary. When an individual fails to perform the required obligations, the bank pays. In this article, we look at the various types of letter of credit available in India.
Types of Letters of Credit
There are four types of Letters of Credit and they are given below.
- A revocable letter of credit
- An irrevocable letter of credit
- A standby letter of credit
- Revolving letter of credit
Revocable Letter of Credit
As the name suggests, letter of credit can be revoked by the issuing bank without the agreement of the beneficiary.
Irrevocable Letter of Credit
If an applicant applies for a duty credit scrip/ discharge of EO against a confirmed irrevocable letter of credit (or bill of exchange that is unconditionally co-accepted/ avalised/ guaranteed by a bank), this is confirmed and certified by exporter’s bank in a relevant Bank Certificate of Export and Realization, payment of export proceeds will be considered to have been realized. For Status Holders, irrevocable letter of credit will be sufficing.
Standby Letter of Credit
Guarantee of Payment: If the beneficiary is not paid from its customer, it can then demand the payment from the Bank by forwarding the copy of the invoice that was not paid and the supporting documentation.
Revolving Letter of Credit
This is implemented when there are regular shipments of the same commodity between the supplier and the customer. The said procedure eliminates the need to issue a Letter of Credit for every individual transaction.
Precautions to be Taken
- The bank that grants the Letter of Credit has to be a regular banker of the opener and should also be known to the beneficiary.
The Overseas Letter of Credit should always be advised through an Indian Bank, preferably it should be confirmed.
- The individual has to check the bank charges, whether to openers account or to the beneficiaries account. Generally, the buyer and the seller has to pay the bank charges in the respective countries that include the LC confirmation charges. The Letter of Credit has to mention the expenses that are on account of the applicant and which on account of the beneficiary.
- The individual has to check if the freight is prepaid or to pay according to the contract.
Parties to Documentary Credit
- Commercial/ trade parties – buyer/ seller, applicant/ beneficiary etc.
- Banks – The banks that issue LC, advising bank, LC confirming bank, reimbursing bank etc.
- Related Parties – Shipping/ Air Lines, Insurance Companies, Forwarders etc.
Buyers/ Importers bankers who transmit the Credit Instructions to the beneficiaries bankers who are the sellers/ exporters bankers.
The advising bank advises the Letter of Credit to the beneficiary. The bank also acts as a correspondent to the issuing bank. In addition to this, the bank may or may not offer to negotiate documents, accept to pay the beneficiary on behalf of the issuing bank.
Often, the Advising and the Confirming bank can be the same. Therefore, the confirming bank adds and provides an undertaking to pay the beneficiary, on behalf of the issuing bank provided the documents are presented for negotiation are in conformity to the Letter of Credit.
The negotiating bank on Negotiation of Export of documents as per the Letter of Credit pays the value immediately with the deduction of interest or at the end of maturity date without the deduction of interest, whichever the case may be.
Sight: The payment will immediately be made effective by presenting the Bill of Exchange.
Usance: The payment will be effected on the Pre-designated day from the date of acceptance of Bill of Exchange.
Deferred Payment: The payment will be effected in instalments according to the contract/ letter of credit at predetermined intervals.
Click here to know more about Deferred Payment.
Acceptance Credit: This is made available by the acceptance of the draft that is drawn by the exporter nominated bank.
If the credit is unconfirmed, the acceptance for payment of such drafts is usually avoided by the banks.
Injunction on Payment
An applicant can stop the payment through LC issuing bank, through Court Injunction and the documents that are negotiated in terms of the Letter of Credit.
There are three types of invoices. They are Commercial Invoice, Customs Invoice and Consular Invoice/ Legalised Invoice.
Commercial Invoice: Invoices that are issued in terms of the contract/ Letter of Credit.
Customs Invoice: This is issued in a specific format for exports to the USA and Canada.
Consular Invoice/ Legalised Invoice: This is issued which is certified by the Consulate of the Importing Country.