Letter of Credit Types

Revocable and Irrevocable Letters of Credit

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Revocable and Irrevocable Letters of Credit

Revocable Letters of Credit: Revocable letter of credit can be modified or cancelled by the issuing bank after its issuance at any moment without seeking the beneficiary’s consent.

There is one exception regarding the revocation of the credit.

Issuing bank must reimburse any nominated or confirming bank with which the revocable letter of credit has been made available if these banks fulfill their obligations under the documentary credit terms against complying presentation before they receive the amendment or cancellation notice from the issuing bank.

A revocable letter of credit can serve as a limited security payment method to the beneficiaries, because they are subject to amendment or cancellation without their prior knowledge.

As a result revocable letters of credit are not used frequently in international trade.

UCP 500,which is the previous letters of credit rules published by ICC, was indicated that a letter of credit may be either revocable or irrevocable.

UCP 500 assumed that a letter of credit is irrevocable in default of the indication whether it is revocable or irrevocable.

Current letter of credit rules, UCP 600, do not cover revocable letters of credit. This point is made clear in article 3 of UCP 600:

A credit is irrevocable even if there is no indication to that effect.

Irrevocable Letter of Credit: Irrevocable Letter Of Credit (ILOC) is a letter of credit type which can not be cancelled or amended by the issuing bank without the agreement of the parties of the letter of credit transaction.

For example, issuing bank has no power to modify letter of credit terms if beneficiary does not find them acceptable.

In other words, every amendment at least requires beneficiary’s acceptance in order to be effective.

Irrevocable letters of credit give much more payment security to the beneficiaries than revocable letters of credit because of the reasons explained above. As a result, irrevocable letters of credit are the types of LCs that dominantly seen on the market place.

Banks will only add their confirmation to the irrevocable letters of credit. A confirming bank is not obligated to add its confirmation to any amendment. Also, transferable letters of credit should not be issued in a revocable form.

Letters of credits are transmitted through banks via a secure and authenticated system which is called SWIFT.

There are various swift message types for different situations. For example banks use MT700 (Message Type 700) when issuing a letter of credit.

We will examine SWIFT messages in detail later on.

Here we want to explain one section of MT700 swift message (Issue of a Documentary Credit) which contains the information regarding the type of the documentary credit.

In order to understand the letter of credit type we need to check Field 40A in a MT700 swift message. This field contains the necessary information regarding the form of the documentary credit. There are seven possibilities as seen below.

  • IRREVOCABLE : The documentary credit is irrevocable.
  • REVOCABLE: The documentary credit is revocable.
  • IRREVOCABLE TRANSFERABLE: The documentary credit is irrevocable and transferable.
  • REVOCABLE TRANSFERABLE: The documentary credit is revocable and transferable.
  • IRREVOCABLE STANDBY: The standby letter of credit is irrevocable.
  • REVOCABLE STANDBY: The standby letter of credit is revocable.
  • IRREVOC TRANS STANDBY: The standby letter of credit is irrevocable and transferable.

What are the Differences Between MT 700 and MT 760?

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What are the Differences Between MT 700 and MT 760?

MT700 and MT760 swift message types that banks use when issuing documentary credits and guarantees, respectively.

  • Banks use MT700 when issuing a commercial letter of credit or a standby letter of credit.
  • Banks use MT760 when issuing a demand guarantee or a standby letter of credit.

MT700 is used to indicate the terms and conditions of a commercial documentary credit or a standby letter of credit which has been originated by the Sender (issuing bank). This message is sent by the issuing bank to the advising bank.

MT760 is is sent between banks involved in the issuance of a demand guarantee or a standby letter of credit. It is used to issue a guarantee or to request the Receiver to issue a guarantee.

Comparison Between MT700 and MT760

comparison between mt700 and mt760

How to Add a Confirmation to a Letter of Credit?

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How to Add a Confirmation to a Letter of Credit?

Confirmation gives additional payment assurance to the exporters.

When an irrevocable letter of credit is issued, the risk of payment rests with the issuing bank. This type of letter of credit is defined as an unconfirmed letter of credit.

However, in certain circumstances, the exporter may find the issuing bank not fully trustworthy and/or the country where it is located has high political or economic uncertainty.

In this situation, the exporter should consider requesting a confirmed letter of credit.

Confirmation is a security tool for the exporters. Confirmation eliminates country risks and insolvency risk of the issuing bank.

Step by Step Explanation of Letter of Credit Confirmation Process

Figure 1 : Step by step explanation of letter of credit confirmation process

  • Step 1 – Sale Contract: The exporter and importer sign a sale contract. They choose letter of credit as a payment method.
  • Step 2 – Confirmation Request on Sale Contract: On the sales contract, the exporter demands a confirmed letter of credit. The exporter may wish the credit to be confirmed by a bank which is acceptable for the exporter. In order to make sure that the credit is not be confirmed by another bank, which is not suitable for the exporter, the exporter should indicate this on the sales contract with a wording similar stated bellows:

“The documentary letter of credit should be issued in a way so that it can be confirmed by a bank acceptable to the exporter”.

  • Step 3 – Letter of Credit Application: The importer applies to his bank to open the letter of credit.
  • Step 4 – Letter of Credit Issuance: The issuing bank issues the letter of credit. The letter of credit must include “May Add” or “Confirm” codes in field “Field 49: Confirmation Instructions”.
  • Step 5 – Confirmation: Advising bank or another bank that the beneficiary wants to have the letter of credit confirmed discuss the terms and conditions of the confirmation. If both parties agreed on the confirmation conditions, then the letter of credit will be confirmed. Confirming bank should inform to the beneficiary that it has included its confirmation to the letter of credit.

Revolving Letter of Credit

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Revolving Letter of Credit

Revolving letter of credit is a special type of letter of credit, which is not covered under the UCP 600 rules.

Contrary to popular belief, revolving letters of credit are not used frequently.

They may be utilized in limited occasions in international trade, especially when exporters and importers sign a long term commercial sales contract, which covers shipments of the same commodity on a regular basis such as;

  • Shipments of 10.000 mtons of iron ore from Australia to China monthly basis for a 6 months period of time
  • Shipments of textile products monthly basis from China to USA for a 12 months period of time.

An exporter and importer, who have concluded a contract as indicated above and wish to have a letter of credit issued to satisfy their contractual payment obligations, may apply for a revolving letter of credit.

Definition:

A revolving letter of credit is a special letter of credit type, which is structured in a way so that it revolves either in value or in time covering multiple-shipments over a long period of time under a single letter of credit.

Types of Revolving Letters of Credit:

i. Revolvement Based on Time: A fix amount could be drawn under letter of credit within each specific period of time as indicated in the documentary credit until letter of credit expires.

Example: Letter of credit stipulates that 100.000,00 USD can be drawn on monthly basis for a 12 months validity period.

  • Type 1 – Non-Cumulative Revolving Letter of Credit: For a non-cumulative revolving letter of credit, the beneficiary can draw each revolving amount for any given period, and any unused portions cannot be drawn on the subsequent periods.

Example: Using the above example, the shipper could still ship USD 100.000,00 each month and be fully paid. If the shipper shipped USD 90.000,00 in a given month, they would still be paid provided that partial shipment is allowed for each shipments, but they could not get the additional USD 10.000,00 by shipping excessive amount on the upcoming months.

Type 2 – Cumulative Revolving Letter of Credit: Cumulative revolving letter of credit means that the unused sums in the L/C can be added to the upcoming shipments.

Example: Using the above example, the shipper could still ship USD 100.000,00 each month and be fully paid. If the shipper shipped USD 90.000,000 in a given month, they would still be paid, and they could get the additional USD 10.000,00 by shipping extra in the next months until letter of credit reaches to expiry.

ii. Revolvement Based on Value: A fixed amount is replenished every time just after it is utilized by the beneficiary within the overall validity of the revolving letter of credit.

Revolvement dependent upon value could be very risky for the issuing banks as beneficiaries can make excessive presentations if issuing banks fail to specify maximum letter of credit limit.

Confirmed L/C at Sight

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Understanding the benefits of confirmed lc at sight.

Confirmed L/C at sight covers two definitions: Confirmed letter of credit which is payable at sight.

Letters of credit can permit the beneficiary to be paid immediately upon presentation of specified documents (at sight letter of credit), or at a future date as established in the sales contract (term/usance letter of credit). (1)

Confirmation means “a definite undertaking of the confirming bank , in addition to that of the issuing bank, to honour or negotiate a complying presentation” according to latest UCP rules.

By reading this post, you should understand the responsibilities of confirming banks, benefits of confirmed at sight letters of credit and why in some situations at sight confirmed letters of credit mechanism does not work.

Definition of at Sight Letter of Credit:

Latest letter of credit rules, UCP 600, defines four availability options;

A credit must state whether it is available by sight payment, deferred payment, acceptance or negotiation (UCP 600 – Article 6- b).

At sight payment is one of the payment terms in a letter of credit transaction.

At sight letter of credit can be defined as a letter of credit that is payable as soon as the complying documents have been presented to the issuing bank or the confirming bank.

Definition of the Confirmation:

According to latest UCP rules confirmation means,

“a definite undertaking of the confirming bank , in addition to that of the issuing bank, to honour or negotiate a complying presentation”

Confirming Banks’ Responsibilities:

UCP 600 define confirming banks’ responsibilities as follows,

Article 8 – Confirming Bank Undertaking

a. Provided that the stipulated documents are presented to the confirming bank or to any other nominated bank and that they constitute a complying presentation, the confirming bank must:

i. honour, if the credit is available by

a. sight payment, deferred payment or acceptance with the confirming bank;
b. sight payment with another nominated bank and that nominated bank does not pay;
c. deferred payment with another nominated bank and that nominated bank does not incur its deferred payment undertaking or, having incurred its deferred payment undertaking, does not pay at maturity;
d. acceptance with another nominated bank and that nominated bank does not accept a draft drawn on it or, having accepted a draft drawn on it, does not pay at maturity;
e. negotiation with another nominated bank and that nominated bank does not negotiate.

ii. negotiate, without recourse, if the credit is available by negotiation with the confirming bank.

b. A confirming bank is irrevocably bound to honour or negotiate as of the time it adds its confirmation to the credit.

c. A confirming bank undertakes to reimburse another nominated bank that has honoured or negotiated a complying presentation and forwarded the documents to the confirming bank. Reimbursement for the amount of a complying presentation under a credit available by acceptance or deferred payment is due at maturity, whether or not another nominated bank prepaid or purchased before maturity. A confirming bank’s undertaking to reimburse
another nominated bank is independent of the confirming bank’s undertaking to the beneficiary.

d. If a bank is authorized or requested by the issuing bank to confirm a credit but is not prepared to do so, it must inform the issuing bank without delay and may advise the credit without confirmation.

Benefits of At Sight Confirmed Letter of Credit?

Why exporters pay additional fees to have their L/Cs confirmed?

  • First reason is that the exporters would like to eliminate default risk of the issuing bank.
  • Second reason is that they would like to receive their payment sooner by removing the issuing bank out of the equation.

Why in some Situations At Sight Confirmed Letter of Credit Mechanism Does not Work?

The nominated banks, whom added their confirmations and became the confirming banks, keep sending documents to the issuing banks and wait for reimbursement even under confirmed at sight letters of credit.

Unfortunately even the confirmation couldn’t eliminate typical nominated bank action: wait for reimbursement, then pay to the beneficiary!

Confirming banks should pay the credit amount against confirming documents to the beneficiaries under at sight letters of credit as letter of credit rules dictate.

But in practice they are ready to act in this way only if they have determined that the issuing bank is defaulted.

Sources:

  1. Documentary Letters of Credit: A Practical Guide, Scotiabank International Trade Services, Page:2

Red Clause Letter of Credit Sample

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Red Clause Letter of Credit Sample

Letter of credit that carries a provision (traditionally written or typed in red ink) which allows a seller to draw up to a fixed sum from the issuing bank, in advance of the shipment can be defined as a red clause letter of credit.

Red clause letters of credit supply advance payments to the exporters before they actually ship the goods to the importers.

Exporters receive advance payments under red clause letters of credit mostly from the issuing banks inside the letters of credit.

It is also possible that the advance payments are payable outside of the letters of credit from the importers to the exporters.

Normally, the issuing banks make the advance payment under red clause letters of credit against presentation of advance payment guarantees issued by the bankers of the exporters, guaranteeing a refund in the event of failure to ship under the credit.

———————————– Instance Type and Transmission —————————-
Original received from SWIFT
Priority/Delivery : Normal
Message Output Reference : 1225 121016XXXXXXXXX5657939061
Correspondent Input Reference : 1225 121016XXXXXXXXX1178375172

—————————————- Message Header —————————————–
Swift OUTPUT FIN 700 Issue of a Documentary Credit
Sender : ASIATRISXXX
Receiver : PCBCCNBJXXX
————————— Message Text ———————————-
27: Sequence of Total
1/1

40A: Form of Documentary Credit
IRREVOCABLE

20: Documentary Credit Number
ASIAIM00004050

31C: Date of Issue
130722

40E: Applicable Rules
UCP LATEST VERSION

31D: Date and Place of Expiry
131230-TURKEY

50: Applicant
ASIA BANK OF TURKEY TAS
BUYUK HAN MAH. ISMAIL HAKKI BEY
CAD. NO:20 34500
SISLI,ISTANBUL/TURKEY

59: Beneficiary – Name & Address
NINGBO PLASTIC MACHINERY CO., LTD.
PLS SEE FIELD 47A ITEM 7 FOR ADDRESS DETAILS
32B: Currency Code, Amount
Currency : USD (US DOLLAR)
Amount : #327.000,00#

39B: Maximum Credit Amount
NOT EXCEEDING

41A: Available With…By… – BIC
ASIATRISXXX
ASIA BANK OF TURKEY TAS BUYUK HAN MAH. ISMAIL HAKKI BEY CAD. NO:20 34500
SISLI,ISTANBUL/TURKEY
BY MIXED PYMT

43P: Partial Shipments
NOT ALLOWED

43T: Transhipment
ALLOWED

44E: Port of Loading/Airport of Departure
ANY CHINESE PORT

44F: Port of Discharge/Airport of Destination
HAYDARPASA PORT ISTANBUL

44C: Latest Date of Shipment
131209

45A: Description of Goods &/or Services
NEW PLASTIC CUP MAKING LINE QTY:1 SET U/P: USD 327.000 FOR TOTAL AMOUNT: USD 327.000,00 AS PER BENEFICIARY’S PROFORMA INVOICE REF NO: NB130522 DD:04.07.2013
INCOTERMS 2010: CIF HAYDARPASA ISTANBUL TURKEY

46A: Documents Required

  • DULY SIGNED COMMERCIAL INVOICE IN 2 ORIGINALS AND 3 COPIES CERTIFYING IN STRICT CONFORMITY WITH THE BENEFICIARY’S PROFORMA INVOICE REF NO: LL130522 DD:04.07.2013 AND SHOWING QUANTITY, DESCRIPTION , ALSO STATING FOB VALUE OF THE GOODS FREIGHT AND INSURANCE SEPARATELY.
  • CLEAN ON BOARD B/L IN 3/3 ORGS. AND 3 N/N COPIES ISSUED TO THE ORDER OF ISSUING BANK NOTIFY APPLICANT,MARKED: ‘FREIGHT PREPAID’.
  • PACKING LIST IN 2 ORG.S AND 2 COPIES.
  • BENEFICIARY’S CERTIFICATE 1 ORG. STATING THAT SHIPMENT DETAILS INCLUDING DATE AND PLACE OF LOADING,NAME AGE,NATIONALITY,IMO NUMBER OF THE VESSEL,VALUE OF THE GOODS, GROSS AND NET WEIGHTS OF THE GOODS AND THE REF.NO OF THE L/C HAVE BEEN SENT TO OUR BANK’S FAX NO:+90 212 600 50 10 WITHIN 2 DAYS AFTER SHIPMENT DATE FOR INFORMATION PURPOSES.(FAX REPORT AND SHIPMENT DETAILS HAVE BEEN ATTACHED TO THIS DOC.)
  • CERTIFICATE BY BENEFICIARY STATING THAT ‘CE’MARK HAS BEEN LABELLED ON PACKAGES OF THE GOODS AND TECHNICAL DOCUMENTS IN STRICT CONFORMITY CONCERNING LEGISLATION
  • FULL SET INSURANCE POLICY ISSUED TO THE ORDER OF ISSUING BANK FOR FULL CIF VALUE PLUS 10 PERCENT AND STATING THE NAME, PHONE AND FAX NUMBERS OF A CLAIMS SETTLING AGENT IN TURKIYE AND CLAIMS PAYABLE IN TURKIYE COVERING THE FOLLOWING RISKS FROM WAREHOUSE TO WAREHOUSE:
    +INSTITUTE CARGO CLAUSES (A)
    +INSTITUTE WAR CLAUSES (CARGO)
    +INSTITUTE STRIKE CLAUSES (CARGO)
    +RIOTS AND CIVIL COMMOTIONS,
    ALSO INSURANCE TO CERTIFY THAT COVER IS NOT SUBJECT TO A FRANCHISE OR AN EXCESS (DEDUCTIBLE).
  • CERTIFICATE OF ORIGIN IN 1 ORG. AND 1 COPY LEGALIZED BY THE LOCAL CHAMBER OF COMMERCE ATTESTING THAT GOODS ARE CHINA ORIGIN.

47A: Additional Conditions

  • ALL DOCUMENTS MUST BEAR OUR L/C REF.
  • IN CASE OF PRESENTATION OF THE DOCUMENTS WITH DISCREPANCIES, USD 100,00 WILL BE DEDUCTED FROM THE PROCEEDS AS AN ADDITIONAL PROCESS FEE.
  • DOCUMENTS ISSUED BEFORE L/C OPENING DATE NOT ACCEPTABLE.
  • PAYMENTS TO BENEFICIARY UNDER RESERVE AND ANY KIND OF GUARANTEE ARE NOT ACCEPTABLE
  • ALL DOCS MUST BE ISSUED OR FILLED IN ENGLISH
  • BENEFICIARY’S ADDRESS: DEVELOPED AREA OF NINGBO ECONOMIC DEVELOPMENT ZONE NINGBO CITY CHINA

71B: Charges
ALL BANKING CHARGES AND COMMISSIONS OUTSIDE OF TURKEY ARE FOR BENEFICIARY’S ACCOUNT.

48: Period for Presentation
21 DAYS AFTER SHIPMENT DATE BUT WITHIN CREDIT VALIDITY.

49: Confirmation Instructions
WITHOUT

78: Instruction to Paying/Accepting/Negotiating Bank

  • 30 PCT OF L/C AMOUNT SHALL BE PAID IN ADVANCE UPON RECEIVING ADVANCE PAYMENT GUARANTEE,
  • 70 PCT OF L/C AMOUNT SHALL BE PAID UPON RECEIPT OF CREDIT CONFORM DOCS.
  • PLS ADVISE US THE REMITTANCE OF THE DOCS. BY MT 754 MSG. QUOTING OUR REF.

72: Sender To Receiver Information

  • PLS SEND THE DOCS TO FOLLOWING ADDRESS BY DHL IN ONE LOT: ASIA BANK OF TURKEY TAS BUYUK HAN MAH. ISMAIL HAKKI BEY CAD. NO:20 34500 SISLI,ISTANBUL/TURKEY
    ———————– Message Trailer ——————————
    {MAC: 00000000}
    {CHK: XXXXXXXX}

What are the Differences Between Standby Letters of Credit and Commercial Letters of Credit?

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What are the Differences Between Standby Letters of Credit and Commercial Letters of Credit?

Standby letters of credit and commercial letters of credit are two main documentary credit types used in international trade transactions.

A standby letter of credit is a bank’s undertaking of fulfilling the applicant’s obligations.

In case, the applicant can’t fulfill contractual obligations against the beneficiary of the standby letter of credit, then the beneficiary can apply to the issuing bank for full compensation.

A commercial letter of credit means any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation.

Commercial letters of credit are mainly used as a primary payment method in export and import of the tangible goods in international trade.

Table 1: Differences Between Standby Letter of Credit and Commercial Letter of Credit

Differences between standby letter of credit and commercial letter of credit

 

Common Characteristics of Standby Letters of Credit and Commercial Letters of Credit:

Both standby and commercial letters of credit;

  • are irrevocable and conditional payment promises, which is given by a trusted financial institution mostly by a bank.
  • independent payment mechanisms, whatever contracts they may base.
  • are governed by ICC’s rules, ISP 98 and UCP 600, respectively.
  • have a documentary nature.

Types of Standby Letters of Credit

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What are the main types of stand-by letters of credit?

What are the Main Types of Stand-by Letters of Credit?

In this post after giving the standby letter of credit (SBLC) definition, we will have a look at the role and structure of the SBLC.

Later on we explain types of standby letters of credit such as performance standby letter of credit, advance payment standby letter of credit, bid bond / tender bond standby letter of credit, counter standby letter of credit, financial standby letter of credit, insurance standby letter of credit, commercial standby letter of credit.

Definition: A standby letter of credit is a bank’s undertaking of fulfilling the applicant’s obligations.

A standby letter of credit is issued as a collateral and is therefore not intended to be used as a primary payment method unlike a commercial letter of credit.

Standby letters of credit will be liquefied only if the applicant default of its responsibilities under the underlying contract.

Standby letters of credit can be seen as a mixture of “commercial letters of credit” and “demand guarantees”. Standby letters of credit have the same structure as the commercial letters of credit, whereas their role is almost identical to the demand guarantees.

Structure: According to ISP 98, International Standby Practices, “A standby is an irrevocable, independent, documentary, and binding undertaking when issued and need not so state.”.

These are also the main characteristics of the commercial letters of credit.

Usage: The role of a standby letter of credit is that the issuer will “stand by” to perform in the event of the account party’s non-performance or default.

Types of Standby Letters of Credit:

  • A “Performance Standby” supports an obligation to perform other than to pay money, including for the purpose of covering losses arising from a default of the applicant in completion of the underlying transactions.
  • An “Advance Payment Standby” supports an obligation to account for an advance payment made by the beneficiary to the applicant.
  • A “Bid Bond/Tender Bond Standby” supports an obligation of the applicant to execute a contract if the applicant is awarded a bid.
  • A “Counter Standby” supports the issuance of a separate standby or other undertaking by the beneficiary of the counter standby.
  • A “Financial Standby” supports an obligation to pay money, including any instrument evidencing an obligation to repay borrowed money.
  • A “Direct Pay” Standby supports payment when due of an underlying payment obligation typically in connection with a financial standby without regard to a default.
  • An “Insurance Standby” supports an insurance or reinsurance obligation of the applicant.
  • A “Commercial Standby” supports the obligations of an applicant to pay for goods or services in the event of non-payment by other methods.

Sources: ISP 98 preface.

Stand-by Letters of Credit

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Understanding standby letters of credit.

Classification of Letters of Credit

Documentary credits, however named, have certain characteristics in common.

First of all, they are separate transactions by their nature from the underlying contracts on which they may be based.

Secondly, documentary credits deal with the documents only but not with the goods, services and/or other performances to which the documents may relate.

Letters of credit can balance the risks of the parties because the irrevocable payment guarantee is given by an independent and reliable third party, which fulfills its irrevocable payment obligation against the presentation of conforming documents.

These common characteristics have been stated in both of the latest documentary credit rules; UCP 600 and ISP 98.

Documentary credits can be divided into two main categories: Commercial letters of credit and standby letters of credit.

A-) Commercial Letters of Credit:

Commercial letters of credit are mainly used as a primary payment method in export and import of the tangible goods in international trade.

Exporter is the beneficiary of the commercial letter of credit transaction, where importer is the applicant.

Applicant, after negotiating the certain terms of the credit with the beneficiary, applies to his bank in order the letter of credit to be issued.

If issuing bank accepts the applicant’s request and issues the credit, it becomes the institution that gives the irrevocable payment undertaking to the beneficiary.

Issuing bank’s payment obligation under a commercial letter of credit is a separate undertaking from the transaction that occurs between the applicant and the beneficiary.

Beneficiary of the commercial letter of credit can acquire the payment from the issuing bank if he complies with the rules and the stipulations of the credit and be able to supply the required documents without discrepancies.

In all other situations beneficiary will not be paid by the issuing bank unless discrepancies are accepted by the applicant. Even in that case the issuing bank is the sole decider whether or not to pay to the beneficiary the letter of credit amount.

B-) Standby Letters of Credit:

Standby letters of credit can be considered as a slightly modified version of the commercial letters of credit.

Standby letters of credit share the documentary and abstract character of the commercial letters of credit. Also irrevocable payment undertaken is given by an independent reliable institution.

The main difference between the standby and commercial letters of credit is the usage intention.

Generally, a standby letter of credit is used to support the applicant’s position in a contractual relationship, where the applicant is expected to fulfill an obligation.

In case, the applicant can’t fulfill contractual obligations against the beneficiary of the standby letter of credit, then the beneficiary can apply to the issuing bank for full compensation.

It should be stressed once more that standby letters of credit are separate transactions from the underlying contracts on which they may be based.

The standby letter of credit serves as a secondary payment mechanism, which means that as long as the applicant fulfills his contractual obligations, the standby letter of credit will not be utilized.

Standby letters of credit have their own rules since 1999.

ISP 98 – International Standby Practices, ICC Publication No. 590 is published by International Chamber of Commerce to govern the standby letters of credit.

However it is possible to issue standby letters of credit subject to UCP 600.

Standby letters of credit have very similar characteristics with the demand guarantees, which are issued subject to the Uniform Rules for Demand Guarantees, ICC publication No : 758.

Is It Possible to Confirm a Bank Guarantee?

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Is It Possible to Confirm a Bank Guarantee?

In this article following topics will be explained:

  • What is the definition of confirmation in letters of credit?
  • What are the advantages of confirmation?
  • Is possible to confirm a bank guarantee?
  • If confirmation does not exist in bank guarantee transactions, what is the alternative?
  • What are the differences between confirmed letter of credit and counter-guarantee?

What is the Definition of Confirmation in Letters of Credit?

Letter of credit rules define confirmation as a definite undertaking of the confirming bank, in addition to that of the issuing bank, to honour or negotiate a complying presentation.

Honour means either to pay at sight if the credit is available by sight payment, or to incur a deferred payment undertaking and pay at maturity if the credit is available by deferred payment, or to accept a bill of exchange (“draft”) drawn by the beneficiary and pay at maturity if the credit is available by acceptance.

Negotiation means the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents under a complying presentation, by advancing or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank.

We understand from the above definitions that confirming banks and issuing banks are equally responsible for against the beneficiaries under letter of credit rules.

A confirming bank is irrevocably bound to honour or negotiate as of the time it adds its confirmation to the credit.

Even if the issuing bank does not pay the credit amount against the complying presentation, the confirming bank has to pay either to the beneficiary or another nominated bank.

What are the Advantages of Confirmation?

  • By paying a confirmation fee and having the letter of credit confirmed, beneficiary will be able to eliminate insolvency risk of the issuing bank.
  • By the help of the confirmation, beneficiary could avoid country risk of the issuing bank.
  • Beneficiary may be able to receive the reimbursement faster under confirmed letters of credit.

Is Possible to Confirm a Bank Guarantee?

It is not possible to confirm a bank guarantee, because latest version of bank guarantee rules, URDG 758, do not contain any confirmation definition.

If Confirmation Does Not Exist in Bank Guarantee Transactions, What is the Alternative?

  • In bank guarantee transactions, counter-guarantee is an alternative approach to the confirmation.
  • Counter-guarantee defined under bank guarantee rules and confirmation is defined under letter of credit rules.
  • Please keep in mind that confirmation and counter-guarantee are not the same concepts, as there are structural differences exist between a counter-guarantee and a confirmation.

What are the Differences Between Confirmed Letter of Credit and Counter-Guarantee?

  • Original letter of credit and confirmed letter of credit are the same document, covering the same terms and conditions. Confirming banks add their confirmations to the very same credit, which was originally issued by the issuing banks.
  • Counter-guarantee, on the other hand, is issued by the instructed bank, which is usually located in the same country as the principal, in order to persuade guarantor bank, which is usually located in the same country as the beneficiary, to issue a bank guarantee in favor of the beneficiary. As a result counter-guarantee and bank guarantee are two separate and independent facilities.

Conclusion:

It is not possible to confirm a bank guarantee as per URDG 758, which is the latest version of bank guarantee rules. Instead of confirmation, bank guarantee rules define counter-guarantee. But confirmation and counter-guarantee are not the same concepts.