Arranging for a Letter of Credit (Importers)
Arranging for a Letter of Credit (Importers)
When negotiating the order or contract with your supplier, you should only be thinking of using a letter of credit if your country’s exchange control regulations require it or if your supplier insists on it as the means of payment. Otherwise, you should try to avoid the procedure, which as mentioned earlier, can quite often cause problems both for you and your supplier.
If a letter of credit is unavoidable, check with your bank that they are prepared to open one for the value of the intended transaction and on the terms of settlement proposed (i.e. payable at sight or later), and whether it is to be confirmed by a bank in the supplier’s country.
Ask the bank to obtain a status report on your supplier, mentioning that a letter of credit will be used.
Make sure that you:
- Have exchange control approval for the importation;
- Will be able to obtain any necessary import licence;
- Can pay import deposits and Customs duty on time;
- Check whether forward exchange cover or a foreign currency account is advisable for letters of credit in a currency other than your own.
Consult other departments in your company
to ensure that the terms of the sales contract and letter of credit meet their requirements.
Obtain a copy of your bank’s application form for opening a letter of credit to see how your supplier’s instructions can best be entered on your bank’s form.
In the absence of pre-arranged instructions, try to discuss the sales contract and any requirements for the credit with your supplier’s representative to agree how your bank’s form should be completed.
However if a representative cannot visit, then read the sales contract very carefully and apply the conditions to your bank’s form as appropriate – consult your bank if you have any doubts whatsoever, as UCP 500 requires that they will open the credit according to your instructions.
Points to agree with your supplier:
- Who pays the charges for opening (and possibly confirming) the credit; for amendments and or extensions, and subsequent payment charges. Unless you specify otherwise, all those charges will be payable by you as the opener, including those in the supplier’s country. If the credit is in a foreign currency, check with your bank on the matter of reimbursing commission.
- The type of letter of credit and its terms. If in doubt discuss them with your bank before you proceed.
Should it be:
- Irrevocable, where your bank gives a binding undertaking to the supplier provided all the credit terms and conditions are fulfilled;
- Irrevocable and confirmed, where a bank usually in the supplier’s country, adds its own undertaking for which it will charge. Once issued, an irrevocable credit can only be amended by joint agreement of your bank and your supplier and, if confirmed, agreement of the confirming bank as well;
When is it to be payable:
- At sight when your supplier presents the correct documents to the paying bank within the time allowed
or
- At a later date, for example, 90 days after the date of the transport document, but only against a correct presentation.
Where it is payable:
- At the bank in the supplier’s country (making it easier for him to deal with any queries over the document)
or
- At your own bank
Are there any special provisions, such as a transferable letter of credit. Make sure you fully understand any special requirements see UCP 500 Article No. 48 regarding transferable credits.
Which documents the letter of credit needs to call for
and which, if any, need to be sent direct to you. The paying bank will ignore vague requirements in the credit where a supporting document is not specified.
What type of transport is available:
Sea, air, road, rail or perhaps a combination of two of more – or possibly post or courier. Include the type of transport document that will be used and who will issue it. Especially check:
- If the goods will be packed in a container;
- If your supplier intends to use a freight forwarders groupage service for small consignments;
- Where the goods will go from and to, and whether there is a direct service;
- If there are any dangerous goods, longs lengths, heavy lifts, or awkward pieces which may have to be shipped on deck;
- If the type of product usually attracts claused bills of lading (for example superficial rust on steel products).
All such contingencies have to be allowed for in the letter of credit.
The expiry date of the letter of credit
must allow time for your supplier as the beneficiary to receive the credit, obtain or manufacture goods, complete arrangements for packaging and transport and to assemble documents prior to presentation. Issuing bank charges are normally levied on a 3 monthly basis, so an expiry date of 3 months from issue or a multiple thereof will be normal in most cases. If the validity proves too short this will likely involve amendments and also lead to delay in despatch. Do not work to the supplier’s “ex works” date, but allow further time for shipment, inspection or consular work, assembling documents and presenting them to the bank.
Check that you have on file the names, full addresses, telephone, email and fax numbers
of the people responsible in both the supplier’s company and your company for the day to day handling of letter of credit operations.
When the letter of credit is to be opened.
If it is to be opened after you have placed your order, ensure your supplier knows as soon as possible what the letter of credit will call for. Possibly by a copy of your application to the bank (although that is no authorisation for him to proceed with manufacture/supply) or by a copy of the actual credit when you receive it from your bank, sent to him directly by you.
When applying to your bank for a letter of credit
Give your bank clear and precise instructions and avoid unnecessary requirements. If a latest shipment/despatch date is to be quoted, this should precede the expiry date by the number of days allowed for presentation of documents. If no latest shipment/despatch date is indicated it will be taken to be the same as the expiry date, which can cause problems for the supplier in presenting documents. (Note UCP 500 Article 42).
State clearly:
- What type of letter of credit has been agreed;
- Who pays what charges, commissions and any other costs;
- The correct value. Ensure that it covers the value as laid down in the sales contract, including any agreed variations in quantity, price, or other costs such as freight and insurance, inspection fees etc. (“About” and similar expressions used in conjunction with the credit amount or the quantity of goods or the unit price allows a difference of up to 10% more or 10% less).
- The delivery terms for example $50,000 CFR Singapore (Incoterms 2000). Remember to match documents to delivery terms, e.g.
- Stipulate “freight paid” on transport document where appropriate
- Do not call for a certificate of insurance for CFR (C&F) or CPT purchases.
- It is essential to refer to the appropriate Incoterms 2000 in all sales contracts to establish without doubt the responsibilities of the seller and the buyer during the transit of the goods.
- The beneficiary’s (supplier’s) name and address. Check the spelling, company title (whether Limited, plc and Inc, GMbH etc), and address, exactly as on the supplier’s letterhead or proforma.
Points to check carefully
- Describe the goods simply, briefly and accurately. You only need enough detail for basic identification, no more.
- Do not state “part shipments prohibited” or “transhipment prohibited” unless you have agreed this with your supplier. Note UCP 500 Articles 23(d), 24(d), 26(b) and 27(c) for transhipments and article 40(a) for partial shipment.
- Ensure the expiry date allows time for shipment and presentation of documents to the bank.
- Do not use expiry dates as a way of putting pressure on your supplier to improve delivery times.
- Call for the agreed minimum documentation only. The bank’s application form for letters of credit may have a pre-printed list of documents – this is only a guide. Be sure to delete what is not necessary and amend it as appropriate to meet your requirements, as items left on the form may cause problems for your supplier. Banks should in any event discourage excessive detail, in accordance with UCP 500.
- Avoid asking for the same information twice. For example, packing list details are often included in the commercial invoice and weight certificates can be included as stamps on transport documents. The credit must nevertheless be specific as to what is required.
- Call for a certificate of insurance not a policy, where the supplier is effecting insurance on your behalf i.e. on CIF or CIP terms. State which risks are to be covered. If “all risks” is stipulated, banks will accept any “all risks” notation or clause on the document and in the UK, the London Institute Clauses “A” will be applied unless requested otherwise. If you wish for more specific cover, give details.
- Avoid stating “photocopies are not acceptable”. UCP 500 provides for documents produced by copier or computer methods, and banks will accept them if marked as originals and, where necessary, authenticated. This should be an adequate safeguard.
- Transport Document. The following points on transport documents should be checked carefully and, if necessary, discussed with your bank. They refer to transport documentation practices as recognised in the UCP 500 (Section D. Documents), which may indicate loading on board, despatch or taking in charge.
Call for the type of transport document you need.
This may not be a “traditional” ocean or marine bill of lading, especially with through container transport. UCP 500 provides the flexibility which you, the carrier and your supplier need. It clearly defines what banks will accept as meeting the requirements of the transport document you call for.
- Determine if a freight forwarder’s or a ‘house’ transport document is to be used for the particular method of transport selected – state that this is acceptable.
- Do not state “Short form transport documents are not acceptable”, if your import regulations permit them.
- If you require an “on board” notation to be properly authenticated, stipulate this in the credit.
- Permit “on deck” shipment for dangerous, heavy or awkward sized goods.
- State that “claused” transport documents are acceptable if they are usual in your trade, and say what type of clauses are acceptable.
Especially with through container transport:
- Specify the place of despatch and the place of delivery, without specifying ports of loading or discharge.
- Do not prohibit transhipment when the goods are being shipped in container or by air.
Other points:
- State how the letter of credit has to be sent to your supplier’s country: by airmail or, if urgent, by courier service (fast but usually more expensive), or by electronic transmission. If sent electronically, state who pays any extra cost and whether the transmission itself is to be the effective letter of credit.
- To help control interest cost within your facilities with your bank, ask them to instruct the overseas bank to confirm on the day they pay your supplier. In the knowledge that the overseas bank has checked and found documents to be in order, you can then decide whether to pay your bank before it receives them.
- Request all documents to be sent from the bank overseas by fastest means, preferably registered express mail or courier service. Even if this costs more, it can be much less than demurrage and other costs caused by delayed documents.
- Ask your bank to telephone you on the day they receive the documents. Give your bank the name of the right person to contact, and if possible arrange to collect the documents rather than having them posted to you.
- If there is still doubt about any terms or documents, contact your supplier and refer to your bank for advice before you ask them to open the letter of credit.
- If the checks and suggestions on this Checklist mean that you decide to change some of the practices you have operated with your bank previously, discuss them with the bank first.
- As soon as you receive your copy of the letter of credit from your bank, check it carefully and in particular watch for any additions or omissions to your original instructions, which may not be workable for your supplier. If anything is in doubt, contact your bank immediately.
- If it is correct, send a clear photocopy of it and of any covering instructions from your bank, direct to your supplier. That may give him advance information possibly several days before getting the formal letter of credit through the banking system. It may also enable him to identify points with which he cannot comply and to advise you immediately thus avoiding problems later.