Letters of credit are ... Letters of credit: definition, value, essence, types, forms and payment

Letters of credit are documents, usually issued by the bank and guaranteeing that the seller (beneficiary) will receive payment up to a certain amount only when certain conditions are met. If the applicant is not able to make a purchase, the beneficiary may file a claim. It regulates payment by letter of credit. In this case, the bank considers the application of the recipient. If it meets the conditions of the letter of credit, the request is satisfied.

The letter of credit establishes what documents the beneficiary must submit, what information they should contain. The place and date of expiration is also determined. Buyers who sell goods and use a letter of credit as a payment method have a guarantee from the issuing bank. Therefore, if they submit the relevant documents, the financial institution will satisfy their request for payment. Therefore, letters of credit are often created in banks.

Use of letters of credit

This document is often used in international transactions. It guarantees that payment will be received if the buyer and seller do not know each other and work in different countries. In this case, the seller is exposed to a number of risks, such as credit and legal. Letters of credit are guarantees that he will receive payment until the conditions specified by the parties are met. For this reason, their use has become a very important aspect of international trade.

The bank that issues the letter of credit will act on behalf of the buyer. Previously, he must make sure that all documentary conditions have been met. And only after that he will make a payment to the seller. Most letters of credit are governed by rules published by the International Chamber of Commerce. This act is called “Unified Rules and Customs for Documentary Letters of Credit”. The current version, UCP600, entered into force on July 1, 2007. According to it, letters of credit are used, as a rule, for import and export, and especially for large purchases. And this often negates the need for buyers to pay a deposit immediately before delivery. In addition, there are various types of letters of credit. Depending on them, the purpose of using the document changes.

Origin of the term

The essence of the letter of credit is that the term itself comes from the French word accréditation. It indicates the ability to do something. The term, in turn, was formed from the Latin accreditivus, which is translated into Russian as “trust” or “trust”.

Documents that may be submitted for payment

In order to receive compensation, the exporter or consignor must submit the documents required for the letter of credit. As a rule, the recipient shows papers confirming the goods that were sent, instead of showing the goods themselves. There is also the concept of a “bill of lading”. This is a document that is accepted by banks as evidence that the goods have been shipped. Nevertheless, the list and form of official papers are regulated by agreement of the parties. They may require the submission of documents issued by a neutral third party that has confirmed the quality of the goods. Typical types of securities in such contracts are as follows:

1. Financial documents: bill of exchange (plain or transferable).
2. Commercial papers: invoice, packing list.
3. Shipping documents: transport, insurance, commercial, business or legal.
4. Official papers: licenses, consular legalization, certificate of origin, inspection, phytosanitary certificate.
5. Transport documents: bill of lading, waybill, receipt for heavy / truck, railway receipt.
6. Insurance documents: policy or certificate.
7. If you are importing a machine or other technical device, then a “Test Certificate" (crash test) is required.

Legal principles governing documentary letters of credit

One of the main features of the letter of credit is that the payment obligation does not depend on the main contract of sale or other paper in the transaction. Thus, the bank's obligation is determined by the terms of this document only. Therefore, the contract of sale does not matter. The right to protect one’s interests, which arises from it and which the buyer receives, does not apply to the bank and in no way affects its liability. This principle is established in article 4 (a) of the UCP600 rules.

A letter of credit deals with documents, not goods. This principle is enshrined in article 5 of the UCP600. It expressly states that banks deal with documents and are not related to goods (services). Accordingly, if the documents are submitted by the beneficiary or his agent, then in general the financial institution is obliged to pay the amount without additional reservations. Therefore, the buyer assumes the risk that the unscrupulous seller may submit documents that correspond to the letter of credit. Accordingly, he will receive compensation, while the buyer only later discovers that the papers are fake.

Principle of abstraction

Firstly, if the responsibility for the accuracy of the documents is assigned to banks, then they will also be burdened with a study of the facts underlying each transaction. Naturally, they will be less likely to issue letters of credit due to risk and inconvenience. Secondly, the documents required to make payment possible may, under certain circumstances, differ from those required in the framework of a purchase and sale transaction. This will put banks in a situation of choice in determining which conditions must be met in order to issue the indicated amounts.

Thirdly, the main function of the loan is to provide the seller with a guarantee of payment of documentary duties. This implies that banks must fulfill their obligations, despite the buyer's allegations of abuse of power. The courts emphasize: buyers always have legal remedies under a contract of sale. For business, it can turn into a disaster if the bank has to investigate every violation of the contract. The principle of strict observance of the conditions establishes the obligation of a financial institution to make payments only in accordance with documents and at the same time simple, efficient and quick. Therefore, if spelling mistakes are made in the necessary papers, then they are already invalid.

Types of letters of credit

1. Import / export. A letter of credit can be called import or export, depending on the party that purchases / sells the goods. Everything is pretty simple here.
2. Revocable. The buyer and the bank that issued the letter of credit are able to make corrections to it without informing or obtaining permission from the seller. In accordance with the new rules of UCP 600, all letters of credit are unchanged. Therefore, this type is obsolete.
3. Irrevocable. Any changes (amendments) or cancellation of a letter of credit, with the exception of the validity period, is carried out by the applicant through the issuing bank. They must be certified and approved by the beneficiary.
4. Confirmed. A letter of credit is considered such if the second bank adds a confirmation (or guarantee) that the issuing bank issued the relevant document.
5. Unconfirmed. Accordingly, this type of letter of credit does not receive confirmation from another bank.
6. Limited. This type means that only one bank can purchase a bill from the seller.
7. Unlimited. The exporter has the right to provide a bill of exchange to any bank. He has the right to purchase it.
8. Inexpressible. Letter of credit, which the seller cannot transfer (in whole or in part) to the other party. In international trade, they are all inexpressible.
9. Bearer. The bank can pay the necessary sums of money only if the bearer of the letter of credit is indicated as such in the documentation.
10. "Red clause." Before sending the products, the seller can accept a pre-paid part of the money from the bank (that is, in advance). Terms and conditions are usually written in red ink, thus justifying the name of this type of letter of credit.
11. Compensatory. Two letters of credit, in which one is issued in favor of the seller, which is not able to provide the relevant goods for unknown reasons. In this case, the second document is open to another seller to ensure the transfer of the desired goods. Countervailing letters of credit are issued to facilitate intermediary trade.
12. Reserve. In general, it works as a commercial. Except for the fact that, as a rule, it is retained as a substitute instead of what is needed to directly satisfy the party's claims on the bank.
13. Transferable. Pretty confusing document. A letter of credit may be made available by the exporter to one or more subsequent beneficiaries. This view is more complex, so consider it in a little more detail.

Transferable Letter of Credit

This is done by transferring the original to the recipient, which is an intermediary and does not deliver the goods. But he buys other products from suppliers and organizes them for shipment to the buyer, because he does not want the parties to know each other. The intermediary has the right to replace his own invoice for the supplier and receive the resulting difference in the quality of profit. A letter of credit at the bank may be transferred to the second beneficiary at the request of the first. But only if it expressly states that it is subject to transfer.

A transferable letter of credit can be transferred from one recipient to another as long as the transaction allows partial shipment. The terms and conditions of the initial letter of credit must be reproduced accurately and in accordance with all documentation. However, in order to keep the transferable letter of credit operational, some figures may be reduced or reduced. The transferred loan cannot be transferred again to a third party at the request of the second beneficiary.

Costs

Emission fees covering negotiations, reimbursement of expenses and other fees shall be paid by the applicant or in accordance with the conditions under which the letter of credit is concluded. Sberbank of Russia, as a rule, holds the position that if the document does not determine who should cover the costs, then they are paid by the applicant.

Legal basis

Lawmakers in many countries have not been able to fully regulate this kind of legal document. It is proposed to legalize a bank letter of credit from the standpoint of various theories. However, they are only options for securing such an institution in the legislation. Among them are the following theories: promises, assignments, innovations, dependencies, anticipatory and guarantee, as well as many others. The essence of all of them is quite difficult to reveal. Yes, and this is not worth doing, because of the legal form of the letter of credit, numerous discussions continue.

Letter of credit as an executive document

Some theories are based on the fact that documentary letters of credit are subject to execution as soon as they are transferred to the recipient.In such transactions, the recipient’s obligation to deliver the goods to the applicant is not a sufficient factor to receive the obligation from the bank. This is because the contract of sale is made before the issuance of the letter of credit, which is drawn up on the basis of fait accompli. Nevertheless, the payment of an existing debt under a contract may be a valid factor for a new obligation made by the institution. But only on condition that there are some practical benefits for the bank.

Letter of credit as a pledge agreement

Other theories argue that a completely reasonable way to consolidate is to define a letter of credit as a pledge agreement for third parties, since various entities participate in the transaction: seller, buyer and bank. Due to the fact that letters of credit are dictated by the need of the buyer, the reason for filling out such a document is his release from the obligation to pay the necessary amounts directly to the seller. Thus, by analogy with the pledge, it is proposed to introduce a letter of credit agreement. That is, there are third-party actions in favor of the beneficiary, where the buyer takes part and acts as the one who agrees, and the seller is a kind of drawer.

The term “beneficiary” is not used properly in the letter of credit scheme, since the beneficiary in the broadest sense is an individual or other legal entity that receives money or other benefits. It should be noted that banks are not such in relation to sellers and buyers, while the former do not receive money "just like that." Consequently, letters of credit are those contracts that must be, let’s say, “disguised” in order to conceal the consideration or demand for a common interest.

Legislation Examples

Several countries have created laws in relation to letters of credit. For example, most counties in the United States have ratified Article 5 of the Unified Commercial Code (UCC). This legislative act is designed to work with the rules for the practical implementation of transactions with letters of credit. The rules are included in the transaction by agreement of the parties. Since the UCC is not law, the parties should include them in their contractual relationship as normal conditions.

Payment Methods for International Transactions

Simple documentary letters of credit are a type of payment security that is safer for the seller than for the buyer with a means of payment. According to UCP 600, the bank makes an obligation on behalf of the buyer and, at the request of the applicant, to pay the cost of the goods shipped to the beneficiary. This is if the necessary documents are submitted, and the agreed conditions are strictly observed. The buyer can be sure that the goods that he expects will be received, as this will be confirmed in the form of separate documents used to fulfill these conditions. At the same time, the supplier is convinced that if he agrees with the payment requirements, then the shipment is guaranteed by a bank that is independent of the parties to the contract.

Collection is a safer letter of credit for the buyer, and to a certain extent for the seller. Sberbank of Russia specializes mainly in this type of document under consideration. First, the goods are shipped. Then, the relevant official papers are sent to the financial institution of the buyer by the seller’s bank for the delivery of information regarding the receipt of the goods and the issuance of cash.