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Letters of Credit.

Did you know that the oldest way to get paid in international commerce is via an international commercial letter of credit (L/C)? L/Cs still remain a regular and recommended method of payment for sales to new export customers, larger export orders or those orders requiring progress payments. Larger firms that have been exporting for years have staff well-experienced in documenting letters of credit, but for newer export companies, credit staff needs to have an understanding of how L/Cs work before requiring them to complete a sale.

General Facts About L/Cs

* International L/Cs carry the credit risk of the foreign bank and the country risk where the foreign bank is located.

* These risks can be eliminated by seller's bank confirming the L/C. This means the seller's bank has a correspondent relationship (credit relationship) with the issuing bank and assumes the credit and country risk of the issuing bank. The seller is paid immediately upon presentation of complying documents.

* International L/Cs are irrevocable, meaning they cannot be canceled without the consent of the both the seller and buyer.

* International L/Cs are governed by the UCP 600, Uniform Customs & Practice for Documentary Credits issued by the International Chamber of Commerce (ICC). It's recommended this document be reviewed to get a full, technical understanding of the rules governing international L/Cs.

* L/Cs are typically honored at sight (upon the issuing bank's receipt of complying documents) or based on dated drafts (or term L/Cs) where the L/C is honored at a later date after the issuing bank receives complying documents (30, 60, 90 days, etc.).

Know Your Bank

When a seller is negotiating an export sale, typically cash in advance is the first consideration, but the buyer may feel more comfortable paying by way of an L/C. That way they get evidence of the export and that the seller has performed to their specifications before the seller gets paid. Simply put, an L/C is an exchange of documents between the seller's bank and buyer's bank.

Be sure your bank is prepared to advise an L/C before you require one. Most super regional and money center banks have large, very experienced trade services staff and have relationships with banks globally. Community banks, on the other hand, typically rely on a correspondent relationship with the larger regional banks to handle L/Cs when the need arises. Again, you need to speak with your bank before entertaining the use of L/Cs to be sure it can advise on an export L/C. The commercial lending department would be the first contact for this type of inquiry.

Important note: Obviously, banks charge fees for issuing and advising L/Cs. The fees are usually a percentage of the amount of payment. If fees charged by both the foreign and U.S. banks are to be applied to the buyer's account, this must be explicitly stated in all quotations and in the letter of credit. The exporter usually expects the buyer to pay the L/C charges. If the buyer does not agree to this added cost, you must either absorb the costs of the letter of credit or risk losing the sale. Letters of credit for smaller amounts can be somewhat expensive because fees can be high relative to the sale. Companies should speak to more than one bank about the fees they charge because every bank is different.

Steps of the L/C transaction

* Seller and buyer agree on using an L/C.

* The buyer's bank is the issuing bank which issues the L/C. The seller gets an advance copy so that it's aware of all the required documents needed to evidence the sale. The L/C is based on the specific terms of the sales contract.

* The seller's bank is the advising and/or negotiating bank.

* The seller is the beneficiary of the L/C.

* Once the seller is ready to ship, it produces all the documents required by the L/C (a freight forwarder can do this for you).

* The seller submits the documents to its bank.

* The seller's bank reviews the documents to assure compliance with the L/C (discrepancies are not uncommon, so use a freight forwarder if you're new to exporting).

* If no discrepancies, the seller's bank then overnights the L/C and documents to the buyer's bank (issuing bank).

* If the issuing bank finds no discrepancies, it remits funds to the seller's bank.

* The seller will receive funds in its bank account typically within five to seven business days.

Inconsistency in Documents

Because of the technical elements and attention to detail associated with L/Cs, discrepancies are fairly common. (1)

Summary of common discrepancies (taken from www.linkedin.com/pulse/ what-10-most-frequent-seen-discrepancies-letter-credit-shoaib-amir):

Incorrect data: Information on any one of the documents presented does not comply with the letter of credit terms and conditions.

Late shipment: Goods shipped after the permitted shipment date or period. If the date of the transport document, such as the bill of lading date, falls after the latest date of shipment, then banks raise a late shipment discrepancy.

Late presentation: Documents presented later than 21 days after shipment or after the number of days stipulated in the letter of credit.

Letter of credit expired: Documents presented after the letter of credit has expired. Normally banks should not accept any document that has been presented after the expiry date of the credit. But banks leave the ultimate decision to the applicants in this regard and evaluate late presentation after the expiry date as a discrepancy.

Absence of documents: Documents required by the letters of credit are missing. Missing document discrepancy could also cover the insufficient number of original document presentation, i.e., UCP 600 demands presentation of all original insurance documents if insurance document states that it issued more than one original.

Carrier not defined on the bill of lading or bill of lading signed by improper authority: Name of the carrier is not mentioned on the bill of lading or bill of lading is not signed by the master, the carrier or an agent on behalf of the carrier or master.

Incorrect description of goods: Description of the goods on the invoice and other trade documents differs from the description of goods mentioned on the L/C.

Incorrect endorsement or absence of endorsement: Bill of lading, insurance policy or draft (bill of exchange) not endorsed by the beneficiary of the credit.

Partial shipment or transshipment affected despite L/C terms: Be careful with partial shipments and transshipments. Read credit text to determine if credit allowed the partial shipments and transshipment.

Need Assistance?

This may seem intimidating, particularly for small, new-to-export companies. Companies are encouraged to have the freight forwarder handle the L/C process, including sending documents to the bank. As a source of reference, companies may review the UCP 600. This is the official publication governing international letters of credit that is published by the ICC. The website is a good source for L/C tutorials on the UCP 600 and L/Cs in general, www.letterofcredit.biz.

As a final note, L/Cs are a great source of collateral if you need pre-export working capital to fulfill an export order. The Small Business Administration (SBA) has export working capital loan guarantees that can be used to support your need for pre- or post-export working capital. For more information about SBA's export loan guarantee programs, please feel free to contact me or visit www.sba.gov/international to find one of my colleagues in the U.S. Export Assistance Centers covering your area.

(1.) UCP 600 states "Data in a document, when read in context with the credit, the document itself and international standard banking practice, need not be identical to, but must not conflict with, data in that document, any other stipulated document or the credit." So, if banks find inconsistency between documents, they raise a discrepancy.

Bill Houck has more than 30 years of international trade finance, trade credit insurance and international corporate credit risk management experience. Bill has held management positions with the Export-Import Bank of the United States and private sector concerns specializing in asset-based lending, corporate credit card risk management and global capital market originations. He is currently the regional manager for SBA's Office of International Trade for the Mid-Atlantic region based out of the Northern Virginia Export Assistance Center in Arlington. He can be contacted at 202-557-4063 or at william.houck@sba.gov.

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