Getting to grips with documentary letters of credit – for fast and secure export payment
By Chamber International documentary credit specialist, Neil Foulder
Letters of Credit: helping exporters get paid
International trade is at the heart of the global economy with new, relatively untapped, markets opening up and presenting new opportunities for business.
Exporters often worry about getting paid promptly and securely from a new customer they may have met only fleetingly or not at all if the order came over the Internet.
One payment method that should not be overlooked is the Letter of Credit (L/C) which is hugely beneficial for importers and exporters, even though some regard them as too expensive, time consuming and complex.
An L/C enables the importer to dictate the terms under which the exporter will get paid and offer a secure and widely-used way of getting paid for goods sold overseas.
An L/C is issued by the importer’s bank and binds them into paying the agreed amount to the exporter when they receive the documents specified in the L/C.
A commercial contract detailing all the terms and conditions of the international transaction should underpin every L/C and identify it as the chosen method of payment.
After the commercial contract is agreed, the importer can arrange for their bank to issue the L/C by completing the bank’s L/C application form.
Completing a Letter of Credit form
The form requires the exporter’s name, a description of the goods and their value, an expiry date, usually determined by when the goods are sent; the latest shipment date, where the goods are being sent from, their destination, and Incoterms, the internationally-recognised rules governing who pays for freight and insurance etc. Finally, the L/C requires a list of documents confirming that its terms have been carried out.
After this, the importer’s bank will issue the L/C electronically to the seller’s bank.
It is important that an L/C should not contain any terms or conditions that the exporter is unaware of and the exporter must scrutinise the L/C on receipt to ensure the terms quoted are as expected. If the exporter thinks terms have been added that they are unable to comply with, they should contact the importer immediately to seek amendments.
I recommend exporters should always obtain a draft copy of the L/C – even one of the importer’s application form would do – before the L/C is issued, to ensure that the document quotes the correct terms and conditions as this will save time and expense if it needs altering.
To get paid under the L/C, the exporter must comply with its terms and conditions by collating and supplying the required documents. These are usually invoices, proof of shipment, such as a Bill of Lading or Air Way Bill; a packing list and certificate of origin although others may be requested depending on the transaction.
It is important that exporters appreciate that, although the L/C is based upon the commercial contract, it is a separate document controlling payment. If an L/C quotes a “latest date for shipment as 31/03/18” shipping goods on the 01/04/18 may jeopardise payment and will certainly delay it, as the L/C terms have not been met precisely by shipping one day later than the L/C stipulated.
Pros and cons of using a letter of credit
Exporters can help the banks by providing clear documentation which can easily be checked against the L/C. Unfortunately, a vast number of documents presented to advising banks for checking are discrepant by not complying with the L/C terms due to errors by the exporter. Most discrepant document presentations are avoidable if exporters read the L/C on receipt and ensure they can comply with the terms and conditions.
L/Cs are sometimes regarded as costly because the time taken by banks to process the transaction, including checking documents against the L/C, can be time consuming and it is wise not to incur additional costs through discrepant or sloppy documentation.
While L/Cs are an excellent method of payment for international trade, their value is reflected in the fees. Certainly, for smaller value international transactions, other methods of payment should be considered first.
Much can be written about Documentary Letters of Credit. This is only a brief introduction to what they are and how they work. Importers and exporters should train staff to understand other aspects of L/Cs such as confirmations, their use in trade finance, acceptances and discounting to remove many of the unnecessary fears associated with them.
Dealing with L/Cs is well within the ability of companies bold enough to export and they are set to become more significant as the UK prepares to fulfil the Government’s aim of becoming an independent global trading nation.