BASIC PROCEDURES FOR ESTABLISHING A LETTER OF CREDIT
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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), UCP-600 and eUCP. The following is the basic set of steps used in a Letter of Credit transaction. Specific Letter of Credit transactions may follow somewhat different procedures.
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.
he Buyer's issuing bank prepares the Letter of Credit, including all of the Buyer's instructions to the Seller concerning shipment and required documentation. The Buyer's bank sends the Letter of Credit to the Seller's advising bank. The Seller's advising bank forwards the Letter of Credit to the Seller.
After final terms are agreed upon, the Seller both executes the following steps and is paid upon the goods being loaded and the Buyer obtaining title documents, or the Seller ships the goods to the appropriate port or location.
If payment is expected after shipping the goods, the Seller then obtains the required documents. Please note that the Seller may have to obtain some documents prior to shipment. The Seller presents the documents to its advising bank along with a draft for payment.
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).
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
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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 it 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.
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 a certificate of origin accompanies the goods. Prices should be stated in the currency of the Letter of Credit and documents should in the same language as the Letter of Credit.
The Letter of Credit Application
The Seller should provide to the Buyer its full corporate name and correct address. A simple mistake here may translate to inconsistent or improper documentation at the other end.
he Seller should state the actual amount of the Letter of Credit. One can request a maximum amount when there is doubt as to the actual count or quantity of the goods. Another option is to use words like approximate", "circa", or "about" to indicate an acceptable 10 % plus or minus from the stated amount. For consistency, if one uses this wording it will need to be used also in connection with the quantity.
The Seller will need time to load the goods or ship, and to prepare all the necessary documents. Therefore, the Seller should ensure that the validity and period for document presentation after the loading or shipment of the goods is long enough.
The Seller should list its advising bank as well as a reimbursing bank if applicable. The reimbursing bank is the local bank appointed by the issuing bank as the disbursing bank.
Type of Payment Availability
The Buyer and Seller may agree to use sight drafts, time drafts, or some sort of deferred payment mechanism.
The Buyer specifies the necessary documents. Buyers can list, for example, a bill of lading, a commercial invoice, a certificate of origin, certificates of analysis, etc. The Seller must agree to all documentary requirements or suggest an amendment to the Letter of Credit.