September 2006
LETTER OF CREDIT
In international trade, as a consequence of the nature
of business transactions, there are some additional risks
facing the buyer and seller, due to not knowing each other
well. Different foreign exchange regime applications in
both parties’ countries and probable political instability
instances are the risk enhancing factors. Usage of banking
transactions and technology in the international trade
has lead the increasing of import and export figures and
enhancing the risks in the worldwide. Therefore, the letter
of credit is one of the bank warranties aiming to decrease
the risks.
Banks provide
credit to the companies, which are registered in different countries and despite
being almost uninformed about each other, perform mutual business transactions,
by issuing the letter of credit upon answering some specific requirements. By
the courtesy of letter of credit, the exporting costs of the commodities are
paid by the banks. Here, a quadripartite agreement is made. The applicant for
credit, which is the typical buyer (orderer) party of the disposal agreement,
applies to the bank in his/her country and authorizes issuing letter of credit
benefit to exporter. Simultaneously, for the determination of the content of
the letter of credit, the type, the conditions and the documents which are to
be presented at issuing time are also clearly declared.
Beneficiary
of the letter is the party, who makes an agreement with the applicant for credit
and who exports the goods and services. Undoubtedly, the third part of this multilateral
agreement is the issuing bank in the importer’s country. The issuing bank
prepares the agreement text according to the importer’s directions and
delivers it to the advising bank. But in another type of the letter of credit,
it is possible to include a confirming bank, which undertakes the responsibility
of the issuing bank. The duty of the advising bank is announcing the letter of
credit to the orderer. As a matter of fact, the issuing bank and the advising
bank are supposed to be different banks registered in the respective parties’ countries;
but in the practice, the advising bank may be one of the branches of the issuing
bank. Advising bank doesn’t have any responsibilities, unless it adds its
own attachment of confirmation to the notification. If there is a confirming
bank clause in the letter of credit agreement, the confirming bank solemnly undertakes
to pay the cost or to accept the bill of exchange, when the exporter presents
the predetermined documents.
There are
three types of letter of credits in international trade practice, which are classified
as follows:
- Revocable Credit
In
this type, the credit can be cancelled without informing
the beneficiary by the issuing bank. It is not widely used,
because of its inability to provide trust to the beneficiary.
- Irrevocable Credit
This
type has a clause, which states that if all the credit
conditions and documents are provided the credit cannot
be cancelled and the conditions are irreversible. According
to ICC Publication No: 500 Uniform Customs and Practice
for Documentary Credits, a letter of credit is supposed
to be irrevocable, unless specified frankly otherwise.
- Confirmed Credit
The
advising bank, which is responsible to inform the letter
of credit to the beneficiary, undertakes the responsibility
by adding its own confirmation to this information giving.
That is, it might be argued that this type is more beneficial
to the exporter, because of the responsibilities of the
banks in both parties’ countries. But it causes extra
expenses for the importer.
There are
also various kinds of letters of credits, which carry different specifications
according to their usage areas:
- Transferable Letter of Credit
This
type is partly or completely transferable to the third
parties by the beneficiary. Generally, the first beneficiary
is the commission agent of the goods. A credit is assumed
to be transferable, unless otherwise specified.
- Irrevocable Credit
This
type is revolved automatically during the complete or partly
usage, without any specific directions. This version aims
to avoid the need for issuing new letters in all transportation
instances at the long-termed sale contracts.
- Back to Back Letter of Credit
The
beneficiary applies to the advising bank and requests a
second credit for a second beneficiary, by showing a letter
of credit issued for his/her behalf as a warranty. That
is, here two different and independent letter of credit
transactions are carried out.
- Red Clause Letter of Credit
This
type provides complete or partly payment before the presentation
of the documents, which are the essential elements for
issuing a letter of credit to the beneficiary. Therefore,
it is an exception of the general letter of credit type.
- Green Clause Letter of Credit
In
this type, the exporter gains the opportunity to receive
cash payment before transporting the goods. But the goods
must be left to a common store or a warehouse belonging
to a third party.
- Stand By Letter of Credit
This
type is a counter-warranty, which is generally used in
the international contracting business. Here, the issuing
bank ensures its responsibility to the buyer or to employer
of the orderer. American banks aren’t permitted to
issue counter-warranty or stand-by letters, as it is required
by the American legislation, therefore they prefer to issue
this type of the letter of credit.
There
are some crucial points for achieving success and obtaining
problem-free credits in the letter of credit transactions,
which actually have such a major place in the commercial
life. First of all, there is a specific form in the letter
of credit transactions and it has to be executed firmly
and thoroughly to provide the soundness of the letter,
as mentioned in a Turkish Cassation Court’s decision,
dated 1976. Therefore, some clues should be reminded for
the benefit of the both parties, to ensure execution of
these formal requirements to avoid accidental negligence.
First, all
of the necessary documents should be clearly stated before the making of the
agreement. Otherwise, the credit provisions will be invalid due to the lack
of proper documents. Also, the exporter must also be certain about the accuracy
of the name, address and the other relevant information about the importer
party, during the transactions. Besides, the exporter should be informed about
the probability of the acceptance of the partial deliveries or the detailed
facts concerning the loading and shipment of the goods.
The most
extensive conflict reflected to the courts about the letter of the credit is
the matter of confirmation. A lot of disputes have arisen due to the obscurity
about the fact, whether the primary application of the beneficiary should be
to the issuing bank or to the confirming bank. But according to decisions of
the Turkish Cassation Court, the confirming bank has a substantive and fundamental
responsibility and consequently, there must be applied first for the credit.
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