What is Documentary Credit (Letters of Credit – LC)? 

• In very simple terms, a LC is an irrevocable undertaking issued by a bank whereby it undertakes to make payment to a named beneficiary, provided that the documents stipulated in the LC are presented, and all of its terms and conditions are complied with.
• LC is an irrevocable undertaking given by the issuing bank to the beneficiary (the seller) to honour a complying presentation. 
• In other words, LC is an undertaking given by the buyer’s bank to the seller that if the seller submits the required documents as per LC terms & conditions, the seller  will receive the payment. This undertaking is irrespective of whether the buyer has sufficient funds in the account or not.
• LC is governed under Uniform Customs and Practices for Documentary Credits (UCPDC) 600.
• A LC is not: 

(a) a contract between the buyer and seller; 

(b) a guarantee that the seller will definitely receive payment; or 

(c) a guarantee that the buyer will receive the goods that it has ordered.

Flow of LC

(1) The contract is agreed between the buyer (‘applicant’) and seller (‘beneficiary’) indicating a LC as the method of settlement. 

(2) The applicant applies to its bank for the issuance of a LC, usually by completing the bank’s standard application form. 

(3) Subject to LC facility being in place and the bank agreeing to the terms and conditions that have been stated in the application form, the bank issues the LC and advises it through a bank in the country of the beneficiary, known as the ‘advising bank’.

(4)The advising bank advises the LC to the beneficiary.

(5) The beneficiary, if in agreement with the terms and conditions of the LC, arranges shipment of the goods. 

(6) Having shipped the goods, the beneficiary issues, collates and presents the documents in the LC to the advising bank, which is also the ‘nominated bank’. 

(7) At the request of the issuing bank, the advising bank may add its confirmation to the LC based on the comfort. Here, we presume that the advising bank has not added its confirmation to the LC. 

(8) If the nominated bank is not a confirming bank, it may or may not examine the documents prior to sending them to the issuing bank. It is also under no obligation to honour or negotiate the beneficiary’s documents. We will assume that the nominated bank has not examined the documents. 

(9) The issuing bank determines that the document is complying and reimburses the presenter of documents (in this case nominated bank). Simultaneously arranges to debit the applicant’s account for the value of the drawing. In return, the documents are handed over to the applicant so that he may take control of the goods. 

(10) The nominated bank, upon receipt of the proceeds from the issuing bank, effects settlement to the beneficiary in the manner requested. 

Under the LC: 

• the applicant was able to indicate the terms and conditions that were to be complied with by the beneficiary before honour or negotiation would occur. 
• The beneficiary knew that if it were to comply with those terms and conditions, it would receive settlement according to the payment terms in the LC and under the  undertaking provided by the issuing bank. 

 Parties of LC

• Parties involved:
• Applicant (Buyer / Importer) - is the party on whose request a LC is issued.
• Issuing Bank - the bank that issues a LC at the request of an applicant or on its own behalf.
• Advising Bank - the bank that advises a LC at the request of the issuing bank.
• Confirming Bank - the bank that adds its confirmation to a LC upon the issuing bank’s authorisation or request.
• Nominated Bank (Negotiating Bank / Paying Bank) - the bank with which a LC is available or any bank in the case it is available with any bank.
• Beneficiary- the party in whose favour a LC is issued and normally the provider of the goods, services or performance. 
• Reimbursing Bank- the bank that, at the request of the issuing bank, is authorized to pay, or accept and pay time draft under a LC.
• Note: In the context of UCP 600, an applicant is not a party to a LC.

 Responsibilities of various parties in LC

 APPLICANT (IMPORTER/ BUYER)

• Should be a customer of the bank
• KYC / IEC verification
• Borrower – should enjoy LC limit facility 
• Non borrower –110-125% cash margin
• Importability of the item / licensing requirement as per FEMA
• Opinion report on supplier
• LC Application request letter

Reimbursing Bank may also be involved

 ISSUING BANK

• Irrevocable undertaking to the beneficiary to honour a complying presentation
• Deals only with documents and not with goods
• Must guide importer in seeking proper documents to safeguard their interests
• Selection of proper advising bank – mostly own FOs / Correspondent bank
• Avoid non documentary conditions
• Avoid ambiguity about issuers of documents
• Scrutiny of documents & notice of refusal within maximum of 5 banking days after the date of presentation
• Honour, if complying presentation has been made

Reimbursing Bank may also be involved

 ADVISING BANK

• Responsible for apparent authenticity of LC
• Responsible that advice accurately reflects the terms and conditions of the LC
• Marketing opportunity for negotiation of documents under LC
• Can guide the exporter on unacceptable LC conditions

Reimbursing Bank may also be involved

 Confirming bank

• Adds confirmation to an LC and stands at par with issuing bank in terms of responsibility. Confirmation means a definite undertaking of the confirming bank, in addition to that of the issuing bank, to honour or negotiate a complying presentation
• Bank exposure limits on issuing bank
• Reserves right not to add confirmation to any amendments
• Scrutiny of docs and notice of refusal within maximum of 5 banking days after the date of presentation
• Must honour or negotiate, a complying presentation

Reimbursing Bank may also be involved

 Nominated bank (Negotiating bank)

• May honour or negotiate a complying presentation
• Negotiation means advancing against a complying presentation on or before reimbursement – usually done with recourse basis
• Done only for customers – limits should be sanctioned (outside ABF).
• Scrutiny of documents and notice of refusal within maximum of 5 banking days after the date of presentation
• Guidance to beneficiary in rectifying discrepancies 

Reimbursing Bank may also be involved

 BENEFICIARY (EXPORTER/ SELLER)

• LC is issued by issuing bank in his favour 
• KYC / IEC code verification
• Must make complying presentation to get the amount
• Usually be a customer of the negotiating bank – “Export Bill Negotiation under LC limits” should have been sanctioned – outside ABF

Reimbursing Bank may also be involved

 Type of Letter of Credit (LC)

1. Security wise:

• • Revocable Credit
  • Irrevocable Credit
  • Confirmed Credit

2. Payment wise (Sight or Usance):

• • Sight Credit
  • Deferred Payment Credit
  • Acceptance Credit

3.          With advance payment:

• • Red Clause Credit
  • Green Clause Credit

4. Involving middlemen:

• • Transferable Credit
  • Back-to-back Credit

5. Others:

• • Revolving Credit
  • Standby LC (SBLC)

The various types of credits listed here may not necessarily be mutually exclusive. The list is also not exhaustive. 

Revocable credit

• A revocable LC may be amended or cancelled by the issuing bank at any time and without prior notice to, or with the consent of, the beneficiary. 
• It should be noted that a revocable LC offers no security of payment to a beneficiary.
• UCP 600 Article 3 presumes that LCs will be issued on an irrevocable basis. Art 3: A credit is irrevocable even if there is no indication to that effect.
• In the unlikely event that a revocable LC is to be issued, it is to state specifically that it is revocable and incorporate the terms and conditions that will apply to the revocability. 
• As a consequence, revocable documentary credits are rarely issued and are not covered in UCP 600.  
• SWIFT MT 700 has also removed it from their ‘message type’(MT). Field 40A (Form of Documentary Credit) only contains ‘irrevocable’ type. 
• Therefore, a revocable LC would have to be sent via a SWIFT MT799 (free format) message or in paper or email format. 
• An issuing bank remains liable to reimburse a nominated bank for any honour or negotiation made before the nominated bank received any notice that the revocable LC had been revoked. This includes a liability to reimburse such bank for any deferred payment undertaking incurred before it received that revocation notice. 
• This type of LC is now only of academic interest. 

 Irrevocable credit

• All LCs issued subject to UCP 600 are irrevocable by definition and by their nature. 
• 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 (Art 2).
• The definition provides that any form of undertaking that is irrevocable and conditioned upon a complying presentation being made to an issuing bank may be issued subject to the application of UCP 600. This would include LCs and SBLC. 
• An irrevocable LC can neither be amended nor cancelled without the agreement of the issuing bank, the confirming bank, if any, and the beneficiary (Art 10.a). 
• The applicant is not a party to the LC.
• An irrevocable LC binds the issuing bank to its irrevocable undertaking from the time it is issued (Art 7.b)
• The irrevocable undertaking is to honour a presentation that comply strictly with the terms of the credit (Art 7.a.i)
• An amendment once issued, binds the issuing bank, if confirmed and advised to the beneficiary, binds the confirming bank.
• For the above reason, once issued, such credit remains a definite undertaking, an irrevocable and a firm commitment on the part of issuing bank to the beneficiary to hounor.

 Unconfirmed credit

• An unconfirmed LC is one that bears no confirmation by advising (another) bank. It has the following features:
  • It is a straight commitment from the issuing bank to the beneficiary. No intermediary bank is involved.
  • The LC reflects the integrity and financial standing of the issuing bank (the one who provide the irrevocable undertaking)
  • Unconfirmed LCs are cheaper than confirmed LCs.
• For a LC that has not been confirmed and is available with a nominated bank by payment, any payment to the beneficiary should be made without recourse unless a recourse agreement has been made with that beneficiary. 
• In the case of an unconfirmed LC, the beneficiary bears the risk of failure of the issuing bank, together with the country risk relating to the country in which that bank is located. 

 Confirmed credit

• Confirmed LC means a definite undertaking of the confirming bank, in addition to that of the issuing bank, to honour or negotiate a complying presentation. A confirmed LC is a LC, which is confirmed by another bank at the authorisation or request of the issuing bank. It provides a beneficiary with an additional irrevocable and independent undertaking that is separate from that of the issuing bank. 
• The LC having been thus confirmed is then advised to the beneficiary. Once the advising bank adds its confirmation, advising bank’s status changes to that of a confirming bank. Art 8 defines the responsibilities of confirming a bank.
• The issuing bank needs to authorise or request the advising bank (another bank) to confirm the LC it issues (Art 2 and Sub Art 8.d). No bank can confirm a LC unless authorised or requested by the issuing bank to do so.
• The bank which is authorised or requested by the issuing bank to confirm the credit is under no obligation or compulsion to add confirmation to a credit advised by it. It may add its confirmation, but solely at its own will or option. This is because confirmation adds to the risk exposure of the confirming bank. Further, confirming bank may qualify its confirmation (i.e. that the availability be restricted to confirming bank).

 Sight Credit

• When a LC is issued available by ‘sight payment’, it means that settlement is due 
  • • once a nominated bank or issuing bank has determined that the documents comply. 
• The draft is not mandatory in case LC is available by sight payment. 
• A sight payment documentary credit may or may not require drafts to be presented. Because drafts may attract stamp duty in some countries, a documentary credit may be issued without a requirement for a draft. In any event, and in most cases, a draft should not be necessary for this type of settlement. 
• Whether or not a draft is required is therefore within the control of each issuing bank. 
• Because settlement by sight payment falls under the definition of ‘honour’, any payment should be effected without recourse to the beneficiary, unless the nominated bank and beneficiary enter into a recourse agreement.
• If sight draft has been stipulated, it must be drawn on the bank with which the LC is said to be available.

 Deferred Payment Credit

• When a LC is issued available by ‘deferred payment’, it means that: 
  • payment is not immediate; 
  • payment is at a time in the future, determinable in accordance with the terms and conditions of the documentary credit; and 
  • presentation of a draft is not required
• The date for payment, as defined in a LC, will usually fall within a specific period after the date of shipment, or a specific period after the date of presentation or another defined event or date. 
• Because settlement by deferred payment falls under the definition of honour, the issuance of a deferred payment undertaking is made without recourse to the beneficiary.
• LCs available by deferred payment provide a means by which the beneficiary may be able to obtain finance by requesting the issuer of the deferred payment undertaking to prepay it.

 Acceptance Credit

• When a documentary credit is issued available by ‘acceptance’, it means that: 
  • payment is not immediate; 
  • payment is at a time in the future, determinable in accordance with the terms and conditions of the documentary credit; and 
  • presentation of a draft is required. 
• The date for payment, as defined in a LC, will usually fall within a specific period after the date of shipment, or a specific period after the date of presentation or another defined event or date. 
• Because settlement by acceptance falls under the definition of honour, the acceptance of a draft is made without recourse to the beneficiary. 
• LCs available by acceptance provide a means by which the beneficiary may be able to obtain finance by discounting the accepted draft with the bank that accepted it, or with any other bank or financial institution of its choice. 

 Red clause credit (Advance Payment Credit)

• At the beneficiary’s request, the applicant may agree to make a part of the purchase price available to the beneficiary as a pre-shipment advance and may further agree that such advance should be made from within the LC when issued. This arrangement provides for the amount of the advance to be deducted from the amount to be paid to the beneficiary upon presentation of complying documents. 
• The issuing bank incorporates a clause in its LC authorising the nominated bank to pay a specific amount, or a percentage of the value of the LC, to the beneficiary in advance of any shipment, or provision of any services or performance. 
• Since the clauses containing the authority given by the issuing bank to the nominated bank to extend the advance used to be written (type) in red ink (in the days of typewriters and black-cum-red typewriter ribbons), LC containing such came to be known as “Red Clause”. The term red clause is still used today by some practitioners to describe a LC that includes a condition allowing for an advance payment. 
• The advance is expected to be squared off against the proceeds of the export bills presented under the LC. 
• A payment guarantee or performance guarantee from the seller’s bank in favour of the issuing bank comes handy to secure these types of advances.

 Green clause credit

• “Green Clause” is an extension of the “Red Clause” in that it envisages granting of additional facilities for storage (warehousing) and insurance at the departure port in addition to pre-shipment payment to the beneficiary by the issuing bank.
• “Green Clause” enables the shipper who cannot get immediate shipping space to warehouse and insure his goods by borrowing further sums for these purposes under similar conditions.
• The risk of the issuing bank and hence, effectively, to the applicant on whose behalf the credit facility is extended to the beneficiary, are the same as for the “Red Clause” LC.
• These LCs also require a greater amount of documentation. In addition, the issuing bank requires title documents in order to advance any payments. These documents are typically proof of warehouse status.
• Advance Percentage:
• In a Red Clause, the percentage of LC value available for an advance is around 20-25%. In contrast, with a Green Clause LC the percentage is far greater – 75-80% the total value of the credit.

 Revolving credit 

• A LC that revolves, in terms of time or value, is generally issued when an applicant and beneficiary have a long-standing repetitive trading relationship and experience in the shipment of the goods described in the LC. 
• The applicant will arrange for a LC to be issued, which allows the amount thereof to revolve, usually without amendment – that is, on an automatic basis. 
• Under this arrangement, the continuing availability of the LC revolves upon shipment or presentation of documents or at a specific time, such as the 1st of each month, and not upon the issuance of a specific amendment.
• Such an arrangement avoids the need for repetitive LCs to be issued on, for example, a monthly or bimonthly basis. 
• A revolving LC depends on three main features: 

(i) the type; 

(ii) whether or not it is to occur on an automatic basis; and 

(iii) whether or not it is to be on a cumulative basis

Type of revolving

(a) If revolvement is dependent upon time, a specific amount is allowed to be drawn within a defined period as stipulated in the LC and during its validity. Example: USD25,000 may be drawn each month during its six-month validity. The revolvement of the amount may occur on an automatic or non-automatic basis and on a cumulative or non-cumulative basis. 

(b) If revolvement is dependent upon value, a revolving LC may indicate that its amount is to revolve upon utilisation within the overall validity of the LC. 

• In the absence of any other indication, such an authorisation allows it to revolve upon each and every utilisation. 
• So, in the above example, the beneficiary could theoretically make a shipment every day for six months – that is, make 180 revolvements of the amount shipped. It is almost impossible to calculate the liability in these circumstances. 
• Whether the revolvement is automatic or not
• If the revolvements are automatic, there is no need for any further amendment from the issuing bank.
• A revolvement is considered non-automatic if it is dependent upon receipt by the nominated bank of the issuing bank’s authorisation for a further revolvement to occur – that is, by way of an amendment revolve. 
• Using the same example, the liability of the issuing bank on the date of issue of the revolving LC will be:
  • USD150,000 if revolvements are automatic; or
  • USD25,000 if it is non-automatic
• Whether the revolvement is cumulative or not
• The LC may indicate that the revolvement is on a cumulative basis. For example, if USD25,000 can be drawn each month during a LC’s six-month validity, any amount not used in a month is available in each following month. Therefore, in the sixth month, the LC could potentially be available for the cumulative total of USD150,000 if no previous drawings have been made.
• If the LC indicates that the revolvement is on a non-cumulative basis, and using the above example, it means that if one month’s shipment of USD25,000 were not made (either completely or partially), the unused amount cannot be carried forward to the succeeding month. If, for example, no shipments had been made for five months, the drawing for the sixth month would be USD25,000 only.

 Transferable LC

• Transferable LC means a LC that specifically states it is "transferable". A transferable LC may be made available in whole or in part to another beneficiary ("second beneficiary") at the request of the beneficiary ("first beneficiary").
• LC is issued in favour of the seller, who ships the goods and claims payment under LC by doing the compliance presentation. It is typically applicable when Seller is the manufacturer of the goods.
• But when the buyer does business with an intermediary trader, who obtains the goods from another source or even several other sources. In this case, the intermediary trader will have to buy the goods before supplying them to the buyer.
• Such intermediary traders operate on a narrow margins: do not carry stocks of goods and have limited Working Capital.  Therefore, they seek a means of finance for their purchase without engaging their own resources. 
• Transferable LC meets the above needs as LC issued in favour of the trader can be used as a means of paying the sources from which the trader obtains goods.
• Under a transferable LC, the final buyer (applicant) instructs its bank to issue a LC in transferable form in favour of the intermediary trader from whom the goods are bought (known as the ‘first beneficiary’).
• This enables the intermediary trader to request the bank at which the LC is available to transfer it in whole or in part to the trader’s supplier (i.e. actual supplier of goods - known as the ‘second beneficiary’). 
• Transferred LC means a LC that has been made available by the transferring bank to a second beneficiary. 
• The value of the parts of the LC transferred to the trader’s suppliers (second beneficiary) represents the price that the trader is paying for the goods. The balance represents the trader’s profit or ‘margin’.
• The Intermediary trader (first beneficiary) could be acting as an agent of the buyer. The agent could be in a better position than the buyer to identify the right source of supply (in terms of integrity of seller, quality of goods adherence to schedule etc.). The agent not only identifies the right sources, but also takes care of the procedures and formalities at the supplier’s end.
• Further a single beneficiary may not be in a position to meet the entire requirement of the buyer, therefore, buyer has to deal with multiple beneficiaries. Transferable LC helps the buyer to avoid the pain of dealing with several beneficiaries as the agent takes care of the same.
• UCP 600 article 38 deals with transferable LC.

 Back-to-Back LC

• A LC used by an agent or trader, when acting as a middleman between the supplier and the final buyer, with the LC issued in its favour serving as part or full security for the issuance of a LC issued in favour of the supplier.
• In some circumstances, a trader may not be able to use or obtain a transferable LC for the purpose of making payment to its supplier. A back-to-back LC is normally issued instead of a transferable LC 
  • when the agent or trader wishes to change more of the details than are permitted in UCP 600 sub-article 38 (g), and/or 
  • when the agent or trader does not want the supplier to see that the LC it receives is a by-product of a transferable LC and/or 
  • when the agent or trader does not want the applicant to know the name of the supplier, and/or 
  • when the payment terms differ between the two contracts agreed by the agent or trader with the buyer and seller.
• In these circumstances, a back-to-back LC operation may provide an acceptable alternative.
• In this type of transaction, two separate LC are issued :
  • the "Master" LC in favour of the trader by the buyer's bank at the request of the actual buyer.
  • the "Back-to-Back" LC in favour of the actual supplier of the goods by the trader’s bank at the request of the trader.
• The primary source of repayment for the issuing bank of the back-to-back LC is often linked to the matching of the payment terms of the Master LC.
• Back-to-back LC is more riskier than transferable LC.
• Master LC is issued in favour of a trader at the request of the ultimate buyer (applicant).
• The trader uses this Master LC as a means by which to request a bank (usually the advising bank or confirming bank of Credit A) to issue a separate LC i.e. back-to-back LC on its behalf in favour of the supplier.
• When trader’s bank issues LC, it is referred to as a ‘back-to-back’ LC as the advising or confirming bank of Master LC issues ‘back-to-back’ LC on ‘the back of’ Master LC. It is also commonly referred to as the ‘baby’ credit.
• The two LCs (Master LC and ‘back-to-back’ LC) are entirely separate, and each issuing bank is liable on its own undertaking. There is therefore, no need for an article in the UCP 600 that refers specifically to the handling of a ‘back-to-back’ LC.
• Documents from ‘back-to-back’ LC will often be used in part to form the presentation under Master LC. The trader is obligated to pay the bank that issued ‘back-to-back’ LC on its behalf, irrespective of whether proceeds are obtained under Master LC or not.
• Master LC does not provide security to the bank that issued ‘back-to-back’ LC; Master LC merely evidences the means of payment that may be forthcoming to meet the payment obligation under ‘back-to-back’ LC. Accordingly, Master LC provides ‘comfort’ to the bank that issued ‘back-to-back’ LC, rather than security.
• However, depending on the assessment of the advising or confirming bank, Master LC may be considered as part or full security for the issuance of ‘back-to-back’ LC. If it forms part of the security, the advising or confirming bank will look for additional security from the trader, such as a cash deposit or bank guarantee, to provide the additional support that it requires for the issuance of the ‘back-to-back’ LC.

 Issuance of LC - Precautions

• Applicant should normally be a customer and whose account has been satisfactorily operated.
• Ascertain means, creditworthiness and standing of the LC applicant.
• Appraisal memorandum to be prepared / limits to be sanctioned and in place.
• LC limit to be commensurate with turnover / CC Limit and should be for genuine trade / manufacturing activity.
• Usance period should ordinarily have relation to WC cycle.
• Level of inventory to be commensurate with industry norms / past trends.
• LCs for purchase of machinery / Capital goods should be backed by borrower’s own funds or sanctioned Term Loan.
• Identification of transactions that fall outside the usual course of business for a customer 
• A suitable margin depending on the applicant’s means, creditworthiness, his other liabilities, etc. may be prescribed.
• If warranted, a lien may be maintained on the unutilised portion of CC Account for the value of bills to be received under the LC.
• In respect of sister concerns or where applicant and beneficiary are otherwise linked, there should ordinarily be no need for LCs. Ensure against ‘kite flying’. Ascertain standing of the beneficiary.
• Before transmitting the LC, ensure that the following particulars are contained in the LC:
  • Particulars of Import Licence, if any
  • Full and correct address of the beneficiary
  • Precise / brief description of goods
  • Price of goods in words and figures
  • Origin of goods
  • Mode of transport – Sea / Air / Land / Rail
  • Last date of shipment of goods, negotiation of documents
  • Port of shipment / destination
  • Whether partial shipment / trans-shipment permitted
  • Value of goods – Incoterms  and its currency
  • Payment terms – Sight or Usance– Tenor of bill
  • Expiry date of LC
  • Instructions regarding negotiation of documents and reimbursement
  • Documents to accompany the LC and how many copies are required: Draft, Invoice, B/L or AWB or R/R or L/R, Packing List, Weigh List, Certificate of Origin, Insurance Policy / Certificate, Quality Certificate, Consumer Certificate, Inspection Certificate etc
• Ensure that the goods to be imported under the LC are covered by valid Import Licence, where required, in the name of the customer. Verify amount, balance available, type of goods permitted, country of origin, validity period, limiting factor (quantity and / or value), any special conditions imposed, etc.
• The terms of payment stipulated in the LC should be as per sanction and fall within the permitted methods of payment as prescribed under FEMA.
• In case Forward Contract has to be arranged, an undertaking to be obtained from the applicant agreeing to accept the rate ruling on that date.
• In case of LCs to be issued  for import of Capital Goods, it would be prudent to ensure that:
  • Beneficiaries of LCs are well reputed as revealed by the Opinion Reports on the beneficiaries.
  • LCs are established in favour of only those beneficiaries who were indicated in the Project Report.
• Bank’s standard clauses to be incorporated in the LCs and onerous responsibility detrimental to the Bank’s interests to be avoided. 
• Need to follow Trade Control / Exchange Control requirements
• Credit norms of RBI
• UCP 600 provisions
• Bank’s internal Credit policies / procedures
• Particular note must be taken of the following aspects: 

• the nature of the goods or type of underlying transaction, for example most banks have policies with regard to the handling of documentary credits covering armaments, explosives, drugs, dual-use goods, etc; 

• the requirement, if any, for import licences and approvals; 

• compliance with other government or central bank requirements, including compliance to any sanction regulation to which the bank is subject; 

• identification of transactions that fall outside the usual course of business for a customer; and 

• the inherent potential for fraud, for example knowledge or lack of knowledge of the proposed beneficiary, particularly when the documentary credit amount is large. 

• Any condition that is not associated with a document to be presented under a LC, should be identified. If such conditions are found, they should be rectified, in liaison with the customer, before the LC is issued, otherwise such conditions will be disregarded considering them as non-documentary conditions.
•  It should not be forgotten that a LC, when issued, carries the name of the issuing bank and bears its irrevocable undertaking to the beneficiary, and is independent of all considerations outside the LC. As a result, all applications should be examined to make sure that they comply with the issuing bank’s internal operational guidelines and applicable regulatory requirements.

 Amendment of LC - Precautions

• As LC constitutes an irrevocable undertaking of the issuing bank, it cannot be amended without the express consent of the beneficiary and confirming bank, if any.
• The fact that a bank previously agreed to issue a LC at the request of its customer does not mean that it is required to amend it as requested by that customer. 
• Issuing bank is irrevocably bound by an amendment as of the time it issues the amendment. An issuing bank must, therefore, ensure that its amendment advice is complete and precise at the time of issuance.
• An amendment should not incorporate any condition that implies that it will be automatically accepted or rejected in the event that the beneficiary does not provide a notification of acceptance or rejection within a specified period. 
• It is normally the beneficiary who will request an amendment to the LC by communicating its requirements to the applicant. If the applicant is in agreement, it should submit a request to the issuing bank to issue an amendment. It should be noted that an amendment might equally be required as the result of a specific requirement of the applicant. 
• Any amendment request should be given to the issuing bank in good time, before the goods are to be shipped or the service or performance is to be provided. If the beneficiary ships goods prior to the receipt of a required amendment, it bears the risk of being unable to make a complying presentation if the issuance of the amendment is delayed or refused.
  • Reviewing the amendment request against an agreed credit facility
  • Reviewing an amendment request against bank policy and regulatory requirements
  • The workability of an amendment. Example: 
  • LC requires -  a full set of bills of lading to be issued to order of the issuing bank; marked ‘notify applicant’ and ‘freight prepaid’; shipment from Bangkok to Shanghai; Incoterms ‘CFR Shanghai Incoterms 2020’; Latest shipment date: 30 June 20XX’.
  • Following some discussions, the applicant and beneficiary agree that the presentation of a full set of bills of lading is not the most appropriate document. Instead, the goods should be collected by the applicant’s freight forwarder and a forwarder’s certificate of receipt issued. 
  • As a consequence, the applicant submits an amendment request in the form DELETE “Full Set Bills of Lading … Prepaid” and ADD “Forwarder’s Certificate of Receipt”, and indicates that all other terms and conditions are to remain unchanged.
  • On its face, the amendment in the example appears to solve the problem of the inappropriate transport document. However, the amendment request does not: 

• delete the routing from Bangkok port to Shanghai port; 

• change the emphasis from a latest shipment date to one of a latest date for receipt of the goods (if a forwarder’s certificate of receipt is issued, there is only a date of receipt of the cargo and not a shipment date); 

• address the issue of the consignee and notify party information (a freight forwarder’s certificate of receipt is not a document that should be issued to order of a named entity); or 

• address whether the Incoterm is still applicable. 

• Without the amendment addressing these issues, the LC will not be issued in a workable form, and leaves the examination of documents open to differing levels of interpretation by the issuing bank, nominated bank and (not least) the beneficiary.

 Advising of LC - Precautions

• An advising bank’s primary role is 
  • establishing the apparent authenticity of the LC or amendment that it receives from the issuing bank. 
  • to ensure that it advises the LC or an amendment substantially in the form in which it was received. 
• LC and any amendment may be advised to a beneficiary through an advising bank and that if the advising bank agrees to advise the documentary credit, or any amendment, it does so without any undertaking to honour or negotiate a complying presentation made by, or on behalf of, the beneficiary. 
• The fact that a bank is not required to advise a credit is made clear in UCP 600 sub-article 9(e). 
• Should a bank decide not to advise a LC or any amendment, it is not required to indicate its reason(s) for not advising the LC or amendment. 
• UCP 600 sub-article 9(f) says if a bank is requested to advise a credit or amendment but cannot satisfy itself as to the apparent authenticity of the credit, the amendment or the advice, it must so inform, without delay, the bank from which the instructions appear to have been received. If the advising bank or second advising bank elects nonetheless to advise the credit or amendment, it must inform the beneficiary or second advising bank that it has not been able to satisfy itself as to the apparent authenticity of the credit, the amendment or the advice. 
  • Because of the significant use of the SWIFT MT700 message type for the issuance of a documentary credit, the occurrence of non-authentication is confined to a very small percentage of transactions that are sent by telex or in letter form. However, in today’s regulatory environment, a bank would be expected not to advise a documentary credit until its apparent authenticity could be determined.
  • Reviewing the documentary credit against an agreed credit facility
  • One of the first items to be reviewed will be whether there is an authorisation or request for confirmation to be added. 
  • Even if the LC does not indicate a request or authorisation for confirmation to be added, there may still be a need to review the main criteria against a credit facility in the name of the issuing bank.
  • If a LC is to be advised to the beneficiary, without confirmation, but it is available with the advising bank and / or second advising bank by deferred payment or acceptance, the bank is being asked to incur a liability against the issuing bank, should it agree to act on the nomination of the issuing bank and incur its deferred payment undertaking or accept a draft drawn on it. Prior to advising such a LC, the bank should check to ensure that the terms and conditions fall within the parameters of the facility, so that if the beneficiary were to ask the bank to act on its nomination, there would be a reasonable chance that it will agree.
  • Reviewing a LC against bank policy and regulatory requirements
  • The terms and conditions of a LC, including the names of entities or countries, should be checked against any regulatory requirements, such as sanction regulations that are applicable to the bank.
  • Bank policy should also be followed in relation to the type and nature of the transaction, including the goods and their description in the LC.
  • If a non-bank financial institution has issued the LC, the advising or second advising bank should make this clear to the beneficiary in its advice. 

 Confirmation of LC - Precautions

• One of the first items to be considered will be whether there is an authorisation or request for confirmation to be added. If the answer is ‘yes’, there is a need to review the main criteria against a credit facility that has been granted in the name of the issuing bank. 
• Reviewing the documentary credit against an agreed credit facility.
• Confirmation mitigates the issuing bank’s risk and issuing bank’s country risk- encountered by the seller 
• Just as an applicant will establish a credit facility with its bank for the issuance of LCs, so will an issuing bank with a number of its correspondent banks in order that confirmation may be added as and when required by the beneficiary and / or the applicant. Details such as the expiry date, amount, payment terms and goods description will be reviewed for compliance with the terms and conditions of the credit facility and the availability thereunder.
• Reviewing the LC against bank policy and regulatory requirements
• The terms and conditions of a LC, including any names of entities or countries appearing thereon, should be checked against any regulatory requirements, such as sanction regulations that are applicable to the bank.
• It is true to say that some banks, when authorised or requested to add confirmation, will insist on the LC being available by payment, acceptance or deferred payment (and not by negotiation), and require that the issuing bank provide a reimbursement instruction that allows the confirming bank to debit the account of the issuing bank or to claim reimbursement from a named reimbursing bank. This is purely a matter of bank policy and not a requirement of UCP 600.
• Reviewing the content of the LC
• A bank that is considering adding its confirmation should review the entire text of the LC to determine that it appears to be in a workable form. If there is any ambiguity with, or clarification needed to, any of its terms and conditions, the issuing bank should be contacted in the first instance. Pending a suitable response from the issuing bank, the LC could be advised to the beneficiary without confirmation being added. Confirmation will then be added when a satisfactory response is received from the issuing bank.
• When adding confirmation to a LC, terms and conditions such as those relating to the place of expiry (which should be the location of the confirming bank), the bank with which the LC is available (which should be the confirming bank or should otherwise allow honour or negotiation with any bank) and the manner in which the bank will be reimbursed are paramount.
• The terms and conditions of the LC may have a bearing on the scope of the confirmation that will be added. 
• The advice of confirmation must clearly reflect the scope of the confirmation and the issuing bank should be similarly informed. It will then be for the beneficiary to determine whether it can operate within the parameters set by the confirming bank. If not, the beneficiary may need to find a bank that will be willing to add confirmation based on the original LC terms. Any new confirming bank would be indicated by way of an amendment to the LC. 
• Preparing the confirmation advice
• The words used in an advice to convey the scope of the confirmation are critical. Such wording will establish the basis under which the confirming bank will be expected to honour, negotiate or reimburse. Any ambiguity can have serious consequences for a bank.
• A number of banks make the mistake of simply stating ‘We confirm the credit’. Such wording can have implications for a confirming bank, especially when there are one or more other nominated banks with which the LC is available.
• UCP 600 sub-articles 8(a)(i)(b)–(e) require a confirming bank to honour or negotiate when another nominated bank fails to act on its nomination to honour or negotiate or, having acted on that nomination, fails to effect settlement on the due date. In either event, a confirming bank that has stated ‘We confirm the credit’ will be obligated to honour or negotiate where a complying presentation was previously made.
• But if confirming bank has added the confirmation using the following wording:
• We hereby add our confirmation to this credit and undertake that we shall [honour or negotiate] all drafts and / or documents that are presented to us, at our address mentioned above, on or before the expiry date mentioned in the credit, provided that they fully comply with the terms and conditions of the credit.
• In this case, the undertaking of the confirming bank is limited to a presentation being made to it and to no other bank. In these circumstances, UCP 600 sub-articles 8(a)(i)(b)–(e) will be modified.

Standby Letters of Credit (SBLC)

• A commercial LC is issued by the issuing bank at the request of the buyer (applicant) in favour of a seller (beneficiary). Its function is to enable the beneficiary to obtain payment due from the applicant once the beneficiary’s part in the commercial contract has been fulfilled. 
• How can beneficiary demonstrate that he has fulfilled his part? By presenting the stipulated documents to a nominated bank for honour or negotiation, or to the issuing bank for honour. They are the primary payment vehicle for the beneficiary. 
• A standby letter of credit (SBLC) acts as a guarantee if there is a failure to perform a contractual undertaking, such as the obligation of a buyer to pay or that of a seller to deliver. 
• It has the same basic form as a commercial LC. However, the intention is often that a beneficiary, in whose favour a SBLC is issued, draws only in case of default on the transaction to which the SBLC relates. 
• When an applicant does not meet its contracted duty, the beneficiary will make a claim against the applicant for payment under the underlying contract. When the applicant fails to honour the request for payment, the beneficiary will make a presentation for payment against the SBLC making it a secondary payment vehicle or payment of last resort for a beneficiary. 
• SBLC can be issued subject to UCP 600 as well as ISP 98.

 SBLC - flow for issuance

(1) The contract is agreed between the buyer and seller, indicating open account terms or a documentary collection as the method of settlement, supported by a SBLC. 

(2) The buyer applies to its bank for the issuance of a SBLC, usually by completing the bank’s standard application form. 

(3) Subject to a credit facility being in place, and the bank agreeing to the terms and conditions that have been stated in the application form, the bank issues the SBLC and advises it through a bank in the country in which the beneficiary is located, known as the ‘advising bank’. 

(4) The advising bank issues its advice of the SBLC and sends it to the beneficiary. 

(5) The beneficiary, if in agreement with the terms and conditions of the SBLC, arranges shipment of the goods. Having shipped the goods, the beneficiary issues, collates and presents its documents directly to the buyer (open account terms) or to the remitting bank (if documentary collection terms) for sending to the collecting bank. 

(6) If the open account transaction, or the documentary collection, is honoured, the SBLC is not utilised. If there is a payment default by the buyer, the seller issues a demand in accordance with the requirements of the SBLC and presents it to the advising bank. 

(7) The advising bank sends the demand to the issuing bank. 

(8) The issuing bank determines that the demand complies and arranges to debit the applicant’s account for the value of the drawing. In return, the demand is handed over to the applicant. At the same time, the issuing bank reimburses the advising bank. 

(9) The advising bank, upon receipt of the proceeds from the issuing bank, effects settlement to the beneficiary in the manner requested.