Letter of Credit (L/C) & It's Classifications (Chapter II)

Letter of Credit (L/C) & It's

Classifications

Definition

A Letter of Credit is an irrevocable undertaking of the Issuing Bank, to honour a complying presentation, on behalf of the . importer, in other words, it is a letter of the Issuing Bank to the beneficiary, undertaking to effect payment under some agreed conditions. It is an undertaking of the Issuing Bank to the Beneficiary to make payment or to accept bill of exchange and make payment at maturity

Classification of L/C

In different considerations there are many kinds of L/Cs. Few of them are briefly discussed below:

1. Irrevocable L/C: L/C is always Irrevocable which cannot be amended or cancelled without the consent of the beneficiary or any other interested parties.              

2. Add-Confirmed L/C: When a third Bank provides undertaking to the beneficiary to make payment, if Issuing Bank fail to make payment, the L/C is called confirmed L/C. In case of a confirmed L/C a third Bank adds their confirmation to the beneficiary, to make payment, in addition to that of Issuing Bank. Confirmed L/C gives the beneficiary a double assurance  of payment.

3. Clean Clause LC: It is a normal Clause LC without third Bank confirmation.

4. Revolving L/C: It is an L/C, where the original amount restores after it has been utilized. How many times and how lon^g.., the amount will restore must be specified in the L/C. For example, an L/C opened for USD 10,000,000 and shipment effected for USD 5,000,000, now the L/C restored for full value i.e. there is scope to effect further shipment of USD 10,000,000. Revolving L/C may be opened to avoid difficulties of opining new L/C. This L/C is not allowed in our import policy.

5. Transferable L/C: If the word "Transferable" incorporated in an L/C, then the L/C is transferable. Transferable L/C can be transferred by the 1st beneficiary to the 2nd beneficiary. But 2nd beneficiary can not transfer it further to. another beneficiary. Transfer may be done to more than one beneficiary, partially, if not prohibited in the L/C.

6. Restricted L/C: If advising and/or negotiation of  an L/C_ are restricted to a particular Bank, the L/C is called a Restricted L/C.

 7.    Red Clause L/C: A red Clause L/C is an L/C, where a special Clause is incorporated into it, that authorizes the confirming  or any other nominated Bank to make advances to the beneficiary before presentation of documents. In other words this is an L/C, where the Issuing Bank authorizes the negotiating Bank to provide pre-shipment finance to the beneficiary. The L/C is called red-clause because, the special clause was originally written in red-ink, to draw attention to the unique nature of this documentary credit. Red clause L/C is not allowed in our present import policy.

8.    Green Clause L/C: It is an L/C, where the Issuing Bank authorises the Negotiating Bank to grant storage facilities to the beneficiary. The special clause was  original y written in Green-ink so the L/C is called Green Clause.

        

9.    Clean Letter of Credit: This is a commercial Letter of Credit, wherein the Issuin^g Bank does not ask any documents as evidence of execution of deal under the L/C. Under the said L/C only Bill of Exchange may be negotiated or may be paid without any supporting documents. It is not permissible in our import policy.

10.  Documentary Letter of Credit: All the commercial letter of credits, where export related documents such as invoice. B/L etc are required to present with the Bill of

Difference between L/ & Standby Credit

In consideration of undertaking by the Issuing Bank, to make payment, both letter of credit & stand by credit are alike. But there are some differences between the two as discussed below:

1.  In case of Letter of Credit, Issuing Bank's obligation to make payment, arise when beneficiary perform the credit terms but in case of stand by credit, Issuing Bank's obligation, to make payment, arise when the applicant default.

2.      In case of L/C, beneficiary present export documents for payment but in stand by credit beneficiary claims for payment stating applicant's default.

3..  It is easier for the beneficiary to get payment under stand by credit than that under letter of credit.

Classification of L/C (Considering source of fund)

1. Back to Back L/C:

2. Cash L/C: if client makes payment of LC by buying FC with cash taka is called Cash L/C.

2.     Barter L/C: Where final settlement is being made through commodity Exchange between the nations, the L/C is called Barter L/C.

3.     L/C under Commodity Aid, Loan, Credit or Grant: Where final settlement of import payment are being made through Commodity Aid, Loan, Credit or Grant.

Different Parties to a Documentary Credit:

Normally the following parties are involved to a documentary credit.

a.  The Issuing Bank: This is the Bank, who issues Documentary credit at the request of an applicant or on its own behalf,

b.   The Advising Bank: This is a Bank, acting as Agent of the Issuing Bank, to advise the L/C, to the beneficiary.

c.    the confirming bank: this bank gives the beneficiary a double assurance  to honour or negotiate a complying presentation. This is a third Bank undertaking to honour or negotiate, if the Issuing Bank fail to do so.

d.   Nominated Bank: This Bank purchase drafts or documents under a complying presentation. Usually this is the exporter's Bank who purchases the export documents

           by advancing or agreeing to advance funds to the beneficiary.

e.      Reimbursing Bank: This is a Bank, acting as Agent of ^N the Issuing Bank, authorised to make payment or to honour Reimbursing claim of the Negotiating Bank.

f.    The Transferring Bank: If the L/C is transferable, then the 1st beneficiary of the L/C may transfer the L/C to the 2nd beneficiary, through  a Bank nominated by the Issuing Bank, this Bank is called The Transferring Bank.

g.    Applicant: Applicant means the party on whose request the credit is issued. Importer or buyer is the applicant of a Letter of Credit. Applicant must be the client of the Issuing Bank.

h.   The Beneficiary: Beneficiary means the party in whose favour a credit is issued. Exporter or Seller of the goods is the Beneficiary of a Letter of Credit.

Notify Party: The Party/Bank to whom the arrival of shipl_nent–laz_s_to be notified or to be informed notify party.

Now we can see a sample of LC