Transferable Letter of Credit

What is a Transferable Letter of Credit?

Ozgur Eker (CDCS) Letter of Credit Types, Transferable Letter of Credit
What is a transferable letter of credit?

Transferable letters of credit are a tool used by trading companies, or other third parties, to facilitate a trade transaction. (1)

Transferable letters of credit are sort of documentary credits which can be used in situations where middlemen are playing a certain role.

How Does a Transferable Letter of Credit Work:

Usually middlemen (first beneficiaries) do not have enough capital establishment to buy the goods from their sources (second beneficiaries) before they re-sell them to their final customers (applicants).

If the final buyer finds it valuable working with a middleman, then he can let the middleman benefit from his credibility by supplying him a transferable letter of credit.

The middleman have the part or all of the transferable letter of credit transferred to his supplier, who has gained considerable payment assurance to ship the goods.

The supplier can receive its payment portion in exchange for the complying documents stated in the letter of credit.

The middleman is entitled to substitute its own invoice for the one that is presented by the supplier and collects the difference as his profit.

Transferable Credits:

  • Transferable letter of credit is a special type of l/c which is suitable for triangle trade.
  • Triangle trade is a type of international business transaction in which a middleman sits between exporter and importer.
  • Middlemen or trade brokers have limited finance facilities. As a result, they have to rely on their buyers’ finance support such as a transferable letter of credit.
  • Process of the transferable lc is as follows in a very simple term. Middleman’s buyer open a transferable letter of credit in favor of the middleman. Then middleman transfers a part of this l/c to his supplier. The difference between two l/cs is the net profit margin of the middleman.
  • Banks play a key role on transferable letters of credit.
  • UCP 600 rules have special articles about transferable letters of credit.

Letter of Credit Rules Regarding Transferable Credits:

According to the latest letter of credit rules, UCP 600 Article 38 which is titled as Transferable Credits

a. A bank is under no obligation to transfer a credit except to the extent and in the manner expressly consented to by that bank.

b. For the purpose of above mentioned article you can find some important definitions of transferable letters of credit as follows:

  • Transferable credit means a credit that specifically states it is “transferable”. A transferable credit may be made available in whole or in part to another beneficiary (“second beneficiary”) at the request of the beneficiary (“first beneficiary”).
  • Transferring bank means a nominated bank that transfers the credit or, in a credit available with any bank, a bank that is specifically authorized by the issuing bank to transfer and that transfers the credit. An issuing bank may be a transferring bank.
  • Transferred credit means a credit that has been made available by the transferring bank to a second beneficiary.

c. Unless otherwise agreed at the time of transfer, all charges (such as commissions, fees, costs or expenses) incurred in respect of a transfer must be paid by the first beneficiary.

d. A credit may be transferred in part to more than one second beneficiary provided partial drawings or shipments are allowed.

A transferred credit cannot be transferred at the request of a second beneficiary to any subsequent beneficiary. The first beneficiary is not considered to be a subsequent beneficiary.

e. Any request for transfer must indicate if and under what conditions amendments may be advised to the second beneficiary. The transferred credit must clearly indicate those conditions.

f. If a credit is transferred to more than one second beneficiary, rejection of an amendment by one or more second beneficiary does not invalidate the acceptance by any other second beneficiary, with respect to which the transferred credit will be amended accordingly. For any second beneficiary that rejected the amendment, the transferred credit will remain unamended.

g. The transferred credit must accurately reflect the terms and conditions of the credit, including confirmation, if any, with the exception of:

– the amount of the credit,
– any unit price stated therein,
– the expiry date,
– the period for presentation, or
– the latest shipment date or given period for shipment,

any or all of which may be reduced or curtailed.

The percentage for which insurance cover must be effected may be increased to provide the amount of cover stipulated in the credit or these articles.

The name of the first beneficiary may be substituted for that of the applicant in the credit.

If the name of the applicant is specifically required by the credit to appear in any document other than the invoice, such requirement must be reflected in the transferred credit.

h. The first beneficiary has the right to substitute its own invoice and draft, if any, for those of a second beneficiary for an amount not in excess of that stipulated in the credit, and upon such substitution the first beneficiary can draw under the credit for the difference, if any, between its invoice and the invoice of a second beneficiary.

i. If the first beneficiary is to present its own invoice and draft, if any, but fails to do so on first demand, or if the invoices presented by the first beneficiary create discrepancies that did not exist in the presentation made by the second beneficiary and the first beneficiary fails to correct them on first demand, the transferring bank has the right to present the documents as received from the second beneficiary to the issuing bank, without further responsibility to the first beneficiary.

j. The first beneficiary may, in its request for transfer, indicate that honour or negotiation is to be effected to a second beneficiary at the place to which the credit has been transferred, up to and including the expiry date of the credit. This is without prejudice to the right of the first beneficiary in accordance with sub-article 38 (h).

k. Presentation of documents by or on behalf of a second beneficiary must be made to the transferring bank.

References:

  1. A guide to doing business abroad, International Trade Procedures, Wells Fargo, P:28

Types of Letters of Credit

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Types of Letters of Credit

Have you ever heard any of the following trade finance terms and wonder their meanings: red clause, confirmed, standby, irrevocable.

These are the terms that are used to describe different types of letters of credit.

On this post, I will discuss the types of letters of credit.

Types of Letters of Credit

Traveler’s letters of credit, which were commonly used in eighteenth and nineteenth century, were the first financial instruments that contain very similar characteristics with the contemporary letters of credit.

From traveler’s letters of credit days to today’s complex global economy, the letters of credit have been performing their duties as a secure and reliable payment method.

Furthermore, in all of these years, the letters of credit provide a very flexible structure that has proven itself to meet the needs of different parties in international trade.

types of letters of creditLetters of credit can be classified under two main categories: Commercial letters of credit and standby letters of credit.

Commercial Letters of Credit

Commercial letters of credit are mainly used as a primary payment tool in international trade.

Commercial letter of credit is the correct type of credit that should be used when an importer pays transaction amount directly to an exporter via letter of credit.

Majority of commercial letters of credit are issued subject to the latest version of UCP (Uniform Customs and Practice for Documentary Credits).

Letter of credit rules are published by a non-governmental international institution called ICC (International Chamber of Commerce).

Standby Letters of Credit

Commercial letters of credit are primary payment tools that need to be utilized when the beneficiary performs its duties and makes a complying presentation.

As an example, let us consider an exporter who ships the goods according to the sales contract and applies to the nominated bank for the payment.

If the nominated bank decides that the presentation is conforming to the terms and conditions of the credit and the UCP rules, then the exporter will be paid.

In standby letters of credit, the opposite scenario is valid.

A payment is made to the beneficiary of a standby letter of credit when the principal can’t fulfill his obligations.

As an example, let us consider a construction company which has been awarded with a tender.

If the construction company can’t fulfill its obligations under the project contract, the beneficiary of the standby letter of credit can apply to the nominated bank for the compensation.

The nominated bank considers only the terms and the conditions of the standby letter of credit and the rules governing the credit when deciding a complying presentation.

One point that needs to be stressed is that standby letters of credit have their own rules, which are called The International Standby Practices 1998 (ISP 98).

These rules are also published by ICC. However, a standby letter of credit can be issued subject to either the UCP or the ISP.

Revocable Letters of Credit

Under a revocable letter of credit, the issuer can either amend or cancel the letter of credit any time without prior notice to the beneficiary.

Since revocable letters of credit do not provide any protection to the beneficiary, they are not used frequently. In addition, UCP 600 has no reference to revocable letters of credit.

All credits issued subject to UCP 600 are irrevocable unless otherwise agreed between the parties.

Irrevocable Letters of Credit

Irrevocable Letters of Credit cannot be amended or cancelled without the agreement of the credit parties.

Unconfirmed irrevocable letters of credit cannot be modified without the written consent of both the issuing bank and the beneficiary.

Confirmed irrevocable letters of credit need also confirming bank’s written consent in order any modification or cancellation to be effective.

Unconfirmed Letters of Credit

Unconfirmed Letters of Credit can be described as a letter of credit, which has not been guaranteed or confirmed by any bank other than the bank that opened it.

In these types of credits, the only bank that undertakes to honor a complying presentation is the issuing bank.

Confirmed Letters of Credit

It would be easier to understand the confirmed letter of credit, if we start from the definition of the confirmation.

Confirmation means a definite undertaking of the confirming bank, in addition to that of the issuing bank, to honor or negotiate a complying presentation.

If a letter of credit’s payment undertaking is guaranteed by a second bank, in addition to the bank originally issuing the credit this kind of credit is called confirmed letter of credit.

The confirming bank agrees to pay or accept drafts against the credit even if the issuer refuses to do so. Only irrevocable credits can be confirmed.

Clean Letters of Credit :

Below, you can find two different definitions of a clean letter of credit.

A letter of credit payable upon presentation of the draft, without any supporting document being required.(www.businessdictionary.com)

L/C that does not require any document other than a written demand for payment by its beneficiary. In effect, a draft. (www.intracen.org)

Clean letters of credit are issued only by the request of the highest credit standing companies.

It is suitable for variety of commercial situations where no movement of goods is expected. Historically these types of credits have been used in traveler’s letters of credit.

Today direct pay standby letter of credit can be given as an example of clean letters of credit.

There are also some other form of letters of credits which deserve special attention.

We will discuss them by one by more in detail, however; you can find short description of each of them below.

Transferable Letters of Credit

Transferable letter of credit is a documentary credit that is issued with the option to allow a trader to transfer its rights and obligations to a new supplier.

Back-to-Back Letters of Credit

Arrangement in which one irrevocable letter of credit serves as the collateral for another; the advising bank of the first letter of credit becomes the issuing bank of the second L/C.

Unlike transferable letters of credit, there are two separate letter of credits exist in back-to-back letter of credit transactions.

Advance Payment (Red Clause) Letters of Credit

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 advising or paying-bank, in advance of the shipment or before presenting the prescribed documents.