International Trade - Exporting and Letters of Credit

If you are thinking about, or have recently begun to export your goods, a key area to consider is how you will ensure that you get paid.  Letters of Credit are frequently used to ensure payment.

A Letter of Credit (LC) is a guarantee by a bank to an exporter stating that they will get paid a specified amount within a certain timeframe, as long as certain conditions are met (evidenced by the bank receiving for example, shipping documentation).

The main advantage of using LCs is that they provide security for both the buyer and seller; the seller is guaranteed payment and the buyer is guaranteed that the seller will honour its obligation to deliver the goods.  Inevitably there are downsides, such as bank arrangement fees, possible delays and bureaucracy.

In deciding whether to insist upon a LC from your customer, establish whether the country you are exporting to, or credit insurer you use, requires an LC to be used.  Consider the costs relative to the value of the export order.  If you cannot pass these costs onto your customer, assess the cost relative to your assessment of their credit worthiness and the value of the order.

Having decided to use an LC, the next decision is what type of LC is most appropriate. LCs often combine a number of the following different characteristics.

Irrevocable
An irrevocable LC cannot be changed or cancelled unless all parties involved agree. A revocable LC can be changed at any time by the issuing bank.

Confirmed
Your customer will normally arrange an LC with its own bank. It is advisable for you to ask your bank to review the LC issued to ensure that it is valid. Depending upon the issuing bank involved and for your additional comfort and security, you could ask your bank to “confirm” (guarantee) the LC in the event of default by the issuing bank; extra security but an additional cost.

Transferable
Transferable LCs can be passed from one party to another and are often used when intermediaries are involved in the transaction.

Standby
This represents an assurance by the issuing bank that your customer is able to pay you. As such, the expectation is that the LC will not be drawn upon.

Revolving
One LC can cover several transactions between you and your customer.

Back –to- back LCs
Used when an intermediary is involved but when a transferable LC may be inappropriate.

Most LCs are drafted under the Uniform Customs and Practice For Documentary Credits (“UCP”) rules issued by the International Chamber of Commerce. Terminology and procedures are standardised, which reduces the risk of misunderstandings.  The current version of rules is UCP 600, issued in July 2007.  As the UCP standards are internationally recognised it is advisable to only accept LCs covered by the UCP rules. 
If you would like to discuss the use of LCs or any aspect of international trade, please contact David Clift on 0161 245 1000 or email dclift@clbcoopers.co.uk