The broad meaning of a ‘Letter of credit (LC)’ is an undertaking letter issued by the importer’s (buyer’s) bank assuring the seller (supplier) of full payment of goods/service sold by him with a condition that the supplier should fulfill his part of the sale contract embodied in Letter of Credit. There are different types of LCs issued by the bank which are distinguishable from each other.
Revocable credit: A credit may be either revocable or irrevocable. Revocable credits can be amended or cancelled by issuing bank at any moment and without prior notice to the beneficiary. The revocable LC is commonly not in use because it offers little security to the supplier.
Irrevocable Credit: Irrevocable LC once opened cannot be revoked without the consent of all the parties. Further, the terms and conditions incorporated in the original LC cannot be unilaterally changed by the issuing bank. An irrevocable credit constitutes a definite undertaking of the issuing bank to the beneficiary of the credit. Beneficiary is assured of full payment of goods/service sold by him on a condition that the supplier fulfills his part of the sale contract embodied in Letter of Credit. In the absence of specific indication that the credit is revocable, the credit will be deemed to be irrevocable.
Irrevocable Credit not confirmed by advising bank: A credit may be advised to the beneficiary without commitment on the part of advising bank. It means advising bank merely advising a credit to the beneficiary without undertaking any obligation to pay, accept or negotiate the bills/drafts drawn there under. However advising bank expected to take reasonable care to check the apparent authenticity of the credit if it elects to advise the credit.
Irrevocable Credit confirmed by advising bank: The advising bank enters into commitment to pay, by confirming the credit, regardless of whether or not the issuing bank is in a position to reimburse it. Hence it is a double guarantee of payment to the beneficiary.
Revolving Credit: In fixed L.C, which remains valid for a specified period, once the credit is fully utilized, a fresh letter of credit to be issued for further drawings. In revolving LC the issuing bank restores the credit to the original amount after it has been utilized, so that there is no need for a fresh LC. The number of utilizations and period of utilizations are specified in revolving letter of credit. Revolving letter of credit is required when the dealings between the importer and the exporters are on continuing or repeat orders basis (multiple delivery contracts).
Transferable Credit: In a transferable letter of Credit, the first beneficiary may instruct the advising/negotiating bank to make it available to a third party (the second beneficiary). The transferable letter of credit is issued when the first beneficiary is a middleman and not the actual supplier of goods. However the second beneficiary cannot transfer it further, except to the first beneficiary. A credit can be transferred only if it is expressly designated as “transferable” by the issuing bank to transfer the credit fully or in part to another beneficiary.
Back-to-back credit: A back to back letter of credits refers to the issuance of an outward letter of credit issued by a bank against the backing of inward letter of credit issued by another bank in favour of intermediary. The intermediary is the middleman or broker. The intermediary is the beneficiary of first credit, who seeks to open a second credit in favour of the actual producer of goods on the strength of first credit. The second credit is separate and distinct from the first. Thus the beneficiary of original letter of credit (intermediary) becomes the applicant for the back to back letter of credit.
Without Recourse letter of Credit: Under ‘without recourse’ letter of credit, the drawer (supplier) is discharged from all liabilities after the bill is negotiated.
Red Clause letter of credit : A ‘Red clause LC’ is a specific clause printed in a LC, whereby the exporter will be permitted to draw a portion or whole of the LC amount from his bank or correspondent bank even before negotiation of the documents. Thus the ‘Red clause LC’ enables the exporter get pre-shipment finance to be exported under said LC. Since the above clause is usually printed in red ink, such a credit is called red clause letter of credit. Banks in India do not issue such LC.
Green Clause LC: Under Green Clause LC, in addition to the credit facilities available in terms of ‘Red clause LC’ the exporter also gets finance for warehousing and insurance charges at the port where the goods are stored pending availability of ship.
Standby LC: A Standby LC is a form of irrevocable guarantee for a payment. Since American Banks are prevented from giving guarantee in that country, the concept of ‘Standby LC’ came into existence. ICC has brought out a set of rules under UCP publication 500 [International Standby Practices 98(ISP 98)], which would govern the issue and other related aspects of ‘Standby LC’. These guidelines set out in 11 articles and they are internationally accepted rules governing Standby LC. Under standby LC, the importer should give an undertaking that he shall not raise any dispute regarding payment made by the bank at any point of time and that the importer will be liable to the bank for the entire amount paid therein. The importer should also indemnify the bank from any loss, claim, counter claim, damage etc which the bank may incur on account of making payment under the stand by LC. Further banks call for credit reports on overseas supplier and issue stand by LC only after getting satisfactory credit report on the supplier. The buyer has the obligation to provide evidence of import (Bill of entry) for all payments made under LC. In view of standby LC is akin to financial guarantee, the commission charged by the banks on standby LCs, are as applicable to financial guarantee and not as applicable to usual import letter of credit.
Related Articles: (i) Things know in Letter of Credit (LC) transactions, (ii) Meaning of Standby LC of different types. (iii) Know the eight parties involved in letter of credit.