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LETTERS OF CREDIT (05/15/2005) I wish I had a dollar for every client that has told me that he “hates” Letters of Credit. It seem that this widely used international finance tool is also widely distrusted and disliked , especially by Americans. HISTORY: When an international seller wants to sell his/her product or service to an international buyer, there are various methods of payment commonly used to seal the transaction a) Direct Payment of Cash (Difficult when currency exchange is involved) b) Open Account (Payment Later), (Requires Trust) c) Documents against Payment Draft- commonly called “Sight Draft” d) Wire Transfer of full payment- Again, requires trust The Letter of Credit seems to be the safest way for a Seller and Buyer who do not know each other or necessarily trust each other, to do business. The L/C does not require any element of trust between the buying and selling parties, only verification that the banks involved are secure and substantial. HOW DOES IT WORK ? A buyer and seller come to an agreement. The seller provides a “pro-forma” invoice to the buyer which outlines the terms and the goods involved and sends this pro-forma invoice to the buyer. The buyer, with “pro-forma’ in hand, now goes to his bank and requests a letter of credit which covers the terms of the transaction , to be sent to the seller. At the originating bank (buyer’s bank), the money covering the letter of credit is either blocked in the buyer’s account or loaned to him/her and the bank then sends the letter to its correspondent in the seller’s country/city advising that the funds will be made available upon completion of certain documentary tasks and presentation of the documents to the correspondent bank in sellers country/city. Once these tasks are completed and the bank in seller’s country has received the documents described in the buyer’s bank’s letter, the local bank can accept or pay the seller’s draft. Now, this may sound very complicated but it’s really not so bad. Banks deal in documents not products. If the seller presents the right documents to the bank, he gets paid. If there are any discrepancies, they must be corrected before the time period allowed expires. Documents must conform exactly. WHAT KIND OF DOCUMENTS ??? Bill of Lading, Invoice, Inspection certificate, etc. Besides the invoice, the Bill of Lading is the most commonly required document under the terms of a Letter of Credit. Most people are not aware that a Bill of Lading can be prepared in such a manner as to become actual title for the goods being transported. Most L/C’s require this. Also, when “Original” Bills of Lading are prepared, no cargo can be released at destination without presentation of an “Original”, properly endorsed. If an “Original” is not available, no cargo can be released and remains in the custody of the carrier or his agent. This means that the buyer cannot get his hands on the products until the correspondent bank in the seller’s country sends the “Original” documents to the buyer’s bank. If the seller’s local bank doesn’t get the documents it needs under the L/C terms, the documents are not sent. In this case, the interests of the buyer are protected. If the buyer’s bank doesn’t get the funds from the buyer or, if the buyer tries to change the terms after the fact, or does not approve any discrepancies in the documents , the documents are not released to the buyer and he can’t pick up the goods. In this case the interests of the seller are protected. So, the system seems to work BUT……… The Seller should READ THE L/C CAREFULLY to insure that he/she understands what needs to be done and within what time frame. REMEMBER, YOU DO NOT HAVE TO ACCEPT ALL THE TERMS OF AN L/C. If you find terms that are not acceptable , or are unreasonable or impossible to perform, GET AN AMENDMENT! It is not unusual for an originating bank to add terms that were not agreed by buyer or seller. KEEP IT AS SIMPLE AS POSSIBLE. There are people that will deliberately insert terms that are difficult or impossible to satisfy. These can create discrepancies and, if the products have been shipped ,as is most often the case, then the buyer may plead for a discount because of “damages, etc” . Now, you can either give him his discount or bring the goods back. THAT’S A GOOD REASON TO GET A DEPOSIT that will cover the two way Transport , just in case this happens. Of course with a good customer, this doesn’t apply. TIME: Allow yourself enough time to produce the goods and ship them. Remember, some carriers may only ship on a monthly basis to some destinations. Allow for the sailing schedule. Allow at least 21 days for presentation of documents at the advising bank. This gives you enough time to fix any possible discrepancies that could occur through clerical error. EXPIRY DATE; An L/C doesn’t last forever. It has a limited life. After the EXPIRY DATE, it’s dead (Unless you’ve gotten an extension) DRAFTS: The method by which the bank pays your invoice. You prepare the draft (looks like a check) and the bank pays it to you or your account. A draft is more than a cool breeze….. SIGHT DRAFT- You’ll get paid as soon as the documents are accepted + about three days to process (if the L/C is CONFIRMED) If the L/C is Not confirmed, you’ll get paid as soon as the bank receives the finds from the opening bank. This is another good reason to insist upon confirmation (have the buyer pay for confirming costs) . TIME DRAFT- Usually stated as: “30 days date” or, “90 days date”. The date could be the date of shipment or the date of presentation or any other date. Essentially, you’ll get paid on that future date (a safe way to give terms with relatively small risk) If you have a CONFIRMED L/C, you can usually discount the draft with the bank and get paid immediately, minus the interest for the time period. Another reason to insist upon confirmation of the L/C. Using this method, you have offered terms and still gotten paid immediately (In some cases, the buyer will pay for discount costs) SO YOU SEE that the Letter of Credit ( L/C ) can be a very useful tool in selling overseas. You don’t have to be afraid of it. Just talk to your forwarder or banker and have them explain it to you . The system works ! Just be sure that your banker and freight forwarder are experienced with L/C’s and let them do the work. You can then concentrate on business and using this tool to increase sales………
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