Plastics : Letter of Credit (LC) - Streamlining your deals -

A Letter of Credit (LC) is a written commitment issued by a bank on behalf of a buyer (importer) to pay a seller (exporter) a specified amount of money upon meeting certain conditions and presenting required documents. 

These documents typically include bills of lading, commercial invoices, insurance certificates, and inspection certificates that prove the seller has shipped the goods as agreed. 

Letters of Credit are particularly vital in international trade as they minimize risks for both parties.

The seller is assured of payment once they fulfill the documented requirements, while the buyer is confident they'll receive the goods as specified before payment is released. 

The bank acts as an intermediary, providing security between parties, especially in cross-border transactions where different legal systems and business practices may apply.

Below is a more detailed explanation on this with more details about how Letters of Credit work:

Types of Letters of Credit:

• Revocable LC (rarely used now): can be modified or canceled without prior notice
• Irrevocable LC: cannot be changed without agreement from all parties
• Confirmed LC: second bank adds its guarantee to the payment
• Standby LC: acts as a guarantee of payment if the buyer defaults
• Revolving LC: can be used multiple times within a specified period

Key Participants:

• Applicant (Buyer/Importer)
• Issuing Bank (Buyer's Bank)
• Beneficiary (Seller/Exporter)
• Advising Bank (Seller's Bank)
• Confirming Bank (if applicable)

Process Flow:

• Step 1: Buyer and seller agree on trade terms
• Step 2: Buyer applies for LC at their bank
• Step 3: Issuing bank sends LC to advising bank
• Step 4: Advising bank verifies and notifies seller
• Step 5: Seller ships goods and prepares documents
• Step 6: Seller presents documents to advising bank
• Step 7: Banks verify documents and process payment
• Step 8: Buyer receives documents and collects goods

Required Documents (Common):

• Commercial Invoice
• Bill of Lading
• Insurance Certificate
• Certificate of Origin
• Inspection Certificate
• Packing List
• Other documents as specified in LC

Bill of Lading (B/L): transport document issued by a shipping company that proves they've received the goods for shipment. It works as a receipt, shipping contract, and title to the goods. Without this document, the buyer cannot claim their goods at the destination port.
Certificate of Origin (CO): An international trade document that confirms where products were made or manufactured. Usually issued by chambers of commerce or government authorities, it's needed for customs clearance and determining import duties. The document helps countries track the true source of imported goods.
Packing List: shipping document that lists all items in a shipment, including quantities, weights, and packaging details. It helps customs officials, warehouse workers, and buyers check what's inside containers or boxes without opening them. Think of it as a detailed inventory of the shipment's contents.

Key Terms and Conditions:

• Expiry Date
• Latest Shipment Date
• Presentation Period
• Partial Shipments (allowed/not allowed)
• Transhipment (allowed/not allowed)
• Description of Goods
• Amount and Currency
• Payment Terms

Latest Shipment Date: final date by which goods must be shipped according to the Letter of Credit terms. If the seller ships after this date, banks may reject the documents and refuse payment. This date is crucial for both logistics planning and LC compliance.
Presentation Period: timeframe within which the seller must present all required documents to the bank after shipment. Typically ranges from 21 to 30 days after the shipping date. If documents are presented after this period, banks may refuse them even if they're otherwise perfect.
Partial Shipments: indicates whether the seller can ship and claim payment for goods in multiple lots or must ship everything at once. When allowed, sellers can split shipments and get paid proportionally upon presenting documents for each shipment. When not allowed, the entire order must be shipped together.
Transhipment: refers to whether goods can be unloaded from one vessel and loaded onto another during transit to the final destination. When not allowed, goods must stay on the same vessel throughout the journey. When allowed, cargo can switch vessels, which might be necessary for certain shipping routes or to optimize logistics.

Advantages For Sellers:

• Payment security
• Risk mitigation
• Bank's obligation to pay
• International trade facilitation

For Buyers:

• Quality assurance through documentation
• Control over payment timing
• Leverage for better terms
• Protection against non-delivery

Common Challenges:

• Document discrepancies
• Strict compliance requirements
• Complex terminology
• Time constraints
• Bank fees and charges
• Different interpretations of terms

Cost Considerations:

• Issuance fees
• Amendment fees
• Document handling charges
• Confirmation fees (if applicable)
• Discrepancy fees
• Bank's commission

Risk Management:

• Document preparation accuracy
• Time management
• Currency fluctuation protection
• Force majeure provisions
• Insurance coverage
• Compliance with regulations

Currency fluctuation protection: safeguard in international trade agreements that protects parties from significant changes in exchange rates between the time of contract signing and payment. This can include hedging instruments, exchange rate clauses, or agreements to use a specific exchange rate, helping both buyers and sellers manage their financial risk if currency values change dramatically.
Force majeure provisions: contract clauses that outline what happens when unforeseeable circumstances prevent parties from fulfilling their obligations. These typically cover events like natural disasters, wars, pandemics, or government actions. The provisions specify whether parties can delay performance, adjust terms, or terminate the contract without penalty when such events occur.

Important Rules and Regulations:

• UCP 600 (Uniform Customs and Practice for Documentary Credits)
• International Standard Banking Practice
• Local banking regulations
• International trade laws
• Foreign exchange regulations
• Sanctions and restrictions

UCP 600 (Uniform Customs and Practice for Documentary Credits): A set of international banking rules developed by the International Chamber of Commerce (ICC) that standardize how banks handle Letters of Credit. These rules define how LCs should be issued, examined, and processed, making international trade more predictable and secure. 

Special Considerations:

• Country-specific requirements
• Industry-specific needs
• Seasonal variations
• Market conditions
• Political risks
• Economic factors

Common Variations:

• Red Clause LC
• Green Clause LC
• Back-to-Back LC
• Transferable LC
• Deferred Payment LC
• Mixed Payment LC

Red Clause LC: A special type of LC that allows the seller (beneficiary) to receive a partial advance payment before shipping the goods. The name comes from the clause traditionally written in red ink. This advance can be used for production or purchasing raw materials. The seller must eventually provide proof that the goods were shipped as agreed.
Green Clause LC: Similar to a Red Clause LC, but with broader advance payment terms. It allows the beneficiary to receive advances not just for pre-shipment expenses, but also for storage of goods at the destination port. The advance is typically granted against warehouse receipts or other storage documents.
Back-to-Back LC: Used when an intermediary (middle party) receives an LC from a buyer and uses it as collateral to open another LC for the actual supplier. Common in trading operations where the middleman doesn't have sufficient funds. The first LC supports the issuance of the second LC.
Transferable LC: Allows the first beneficiary (seller) to transfer all or part of the LC to a second beneficiary (usually the actual supplier). 

Common in trading where the middleman wants to transfer the payment rights to the actual manufacturer or supplier. Can only be transferred once and must be explicitly marked as "transferable."
Deferred Payment LC: Provides for payment to be made to the beneficiary at a specified future date rather than at sight. The bank accepts the documents and agrees to pay at maturity date (e.g., 60, 90, or 180 days after shipment or document presentation).
Mixed Payment LC: Combines different types of payment terms within a single LC. For example, part of the payment might be at sight (immediate), while the remainder could be deferred. This flexibility helps meet both parties' cash flow needs while maintaining the security of an LC.

This comprehensive understanding of Letters of Credit is essential for international trade professionals, banking personnel, and businesses engaged in global commerce. The proper use of LCs can significantly reduce trade risks and facilitate smooth international transactions.