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Common
Problems with Letters of Credit |
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Common Problems with Letters of
Credit
Most problems result from the seller's
inability to fulfill obligations stated in the letter of credit. The
seller may find these terms difficult or impossible to fulfill and,
either tries to fulfill them and fails, or asks the buyer to amend to
the letter of credit. As most letters of credit are irrevocable,
amendments may at times be difficult since both the buyer and the
seller must agree.
Sellers may have one or more of the
following problems:
- The shipment schedule cannot be met;
- The stipulations concerning freight
costs are unacceptable;
- The price becomes too low due to
exchange rates fluctuations;
- The quantity of product ordered is
not the expected amount;
- The description of product is either
insufficient or too detailed; and,
- The stipulated documents are
difficult or impossible to obtain.
Even when sellers accept the terms of a
letter of credit, problems often arise late in the process. When this
occurs, the buyer's and seller's banks will try to negotiate any
differences. In some cases, the seller can correct the documents and
present them within the time specified in the letter of credit. If the
documents cannot be corrected, the advising bank will ask the issuing
bank to accept the documents despite the discrepancies found. It is
important to note that, if the documents are not in accord with the
specifications of the letter of credit, the buyer's issuing bank is no
longer obligated to pay.
Basic Procedures for Establishing a
Letter of Credit
The letter of credit process has been
standardized by a set of rules published by the International Chamber
of Commerce (ICC). These rules are called the Uniform Customs and
Practice for Documentary Credits (UCP) and are contained in ICC
Publication No. 500. The following is the basic set of steps used in a
letter of credit transaction. Specific letter of credit transactions
follow somewhat different procedures.
1. After the buyer and seller agree on
the terms of a sale, the buyer arranges for his bank to open a letter
of credit in favor of the seller. Note: The buyer will need to have a
line of credit established at the bank or provide cash collateral for
the amount of the letter of credit.
2. The buyer's issuing bank prepares
the letter of credit, including all of the buyer's instructions to the
seller concerning shipment and required documentation.
3. The buyer's bank sends the letter of
credit to the seller's advising bank.
4. The seller's advising bank forwards
the letter of credit to the seller.
5. The seller carefully reviews all
conditions stipulated in the letter of credit. If the seller cannot
comply with any of the provisions, it will ask the buyer to amend the
letter of credit.
6. After final terms are agreed upon,
the seller ships the goods to the appropriate port or location.
7. After shipping the goods, the seller
obtains the required documents. Please note that the seller may have
to obtain some documents prior to shipment.
8. The seller presents the documents to
its advising bank along with a draft for payment.
9. The seller's advising bank reviews
the documents. If they are in order, it will forward them to the
buyer's issuing bank. If a confirmed letter of credit, the advising
bank will pay the seller (cash or a bankers' acceptance).
10. Once the buyer's issuing bank
receives and reviews the documents, it either (1) pays if there are no
discrepancies; or (2) forwards the documents to the buyer if there are
discrepancies for its review and approval.
Opening a Letter of Credit
Level of Detail
The wording in a letter of credit
should be simple, but specific. The more detailed an L/C is, the more
likely the seller will reject it as too difficult to fulfill. At the
same time, the buyer will wish to define in detail what its is paying
for.
Type of Credit
Letters of credit used in trade are
usually either irrevocable unconfirmed credits or irrevocable
confirmed credits. In choosing which type to open both the seller and
the buyer should consider the generally accepted payment processes in
each country, the value and demand for the goods, and the reputation
of the buyer and seller.
Documents
In specifying required documents, it is
very important to include those required for customs and those
reflecting the agreement reached between the buyer and the seller.
Required documents usually include the bill of lading, a commercial
and/or consular invoice, the bill of exchange, the certificate of
origin, and the insurance document. Other documents required may be an
inspection certificate, copies of a cable sent to the buyer with
shipping information, a confirmation from the shipping company of the
state of its ship, and a confirmation from the forwarder that the
goods are accompanied by a certificate of origin. Prices should be
stated in the currency of the letter of credit and documents should in
the same language as the letter of credit.
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The handbook takes you through the practical aspects of exporting essential for both experienced and novice exporters. It covers Export Procedures and Documentation, Customs Export Regulations, Internet Commerce, Banking and Finance, Export Risk and Credit Insurance, Marine Insurance, Shipping and Air Cargo, Freight Forwarding, Export Packaging and Resources for International Trade.
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