Documentary Letter of Credit

The Documentary Letter of Credit, abbreviated L/C, is a written undertaking of a bank made at the request of a buyer, to honor drafts or other demands for payment (presented by the Seller) upon compliance with the conditions specified in the L/C. Beneficiary of the L/C is the Seller!

Essentially, Letter of Credit is a declaration by a bank that it will make certain payments on behalf of the Buyer (you) under specified conditions!

Let’s say, you are in Bombay, India and you want to buy 100 dining room tables. The manufacturer/seller informs you that the order will take two months to complete and nearly three months to deliver to the United States and that he wants to be paid only by an Irrevocable Letter of Credit issued in his favor. He stipulates that he wants you to set up the Letter of Credit with an expiration date three months from the day of your order.

You will need to contact your bank and ask them to issue the Irrevocable Letter of Credit as the seller specified.

Request a quote for financing your import product order, cost of Letter of Credit, alternative terms of payment

Your bank here in the United States will issue such a L/C per your instructions, to contain a set of conditions you specify, but will do so only once you either give them the funds, say $25,000, a sum the Seller indicated/you agreed to pay the Seller as purchase price.
 
In other words, your bank will not enter into a contractual obligation with the Seller’s bank - and L/C is in essence a contractual agreement between the Seller’s and Buyer’s banks - unless your bank will either collect the money from you up front or puts lock on it in your account.
 
For that simple reason, it’s best that you will keep an account in a bank that does import/export financing as oppose to having to give up the funds for the entire course of the contract - until your order arrives and your bank will have to pay the draft.
 
In such a case, you may open a special CD account in your bank where your money will at least keep earning interest all the while your bank has got a hold on it as oppose to parting from your money and having your bank use it any which way they may and you earn no interest.
 
Letter of Credit issued by your bank will clearly show the amount to be paid on delivery and compliance, date of expiration and list of conditions you demand to be fulfilled by the Seller. Customarily, an L/C will ask for specific documents to accompany the shipment, or for all the necessary documents for the Buyer/you to clear the US Customs.
 
In any case, however, Letter of Credit does not guarantee the quantity and quality of goods shipped!
 
Special Conditions would be those that can guarantee count, quality, and packing! This is covered in depth in the Letter of Credit publication and the course on tapes.
 

When your order arrives at your destination, the documents come to your bank for so called negotiation, a process whereby your bank reviews the documents and makes sure that all of your conditions you specified were met.
 
Once again, beware: when Documents arrive to your bank, bank will examine the Documents, but does not itself guarantee the quality and quantity of goods shipped!
 
To guarantee yourself not only the quantity but also the quality of the goods shipped, you should employ the use of a document called Certificate of Inspection.
 
Without this document, your bank could pay the draft, release the documents to you, you would take them to your Customhouse Broker to clear US Customs only to find out thereafter that your order is short on count and instead of blue you received green!
 
Certificate of Inspection is an instrument where you ask for an inspection of the shipment to guarantee yourself quantity and quality of goods shipped.
 
This inspection is typically done just prior to shipment from the country of origin.
 
If you asked for such a document and the document is not enclosed with the rest of the documents upon arrival, your bank isn’t obligated to pay the draft and the L/C contract becomes void.
 
Naturally, a seller would probably negotiate with you a discount on the shipment so that he would not have to pay for the goods to be shipped back to the point of origin at his cost, a most likely loss for the Seller.
 
Once again, if a Draft is presented for payment after expiration of the L/C, the Documents arrive late, the L/C would not be paid, Documents would be returned to the shipper and the Seller would have to provide for the return of his goods back at his expense. At this point, Seller and Buyer may negotiate a discount on the existing L/C. If an agreement is reached, the existing L/C must be amended, Buyer will be purchasing discounted goods, and his bank pays the discounted draft.
 
The other scenario, when your bank would not be obligated to pay the draft, is if both the shipment and the documents would arrive at the Buyer’s bank after the expiration of the L/C. Typically, sellers will ask, however, for date of expiration to be well past their estimated date of delivery so that such a case would not happen.
 
The Draft is called Documentary Draft because it is to be accompanied by Documents to be delivered to the Drawee/you/the Buyer on Payment, or on Acceptance of the Draft.
 
-L/C may involve either Sight or Time Drafts:
-Sight Draft are payable on presentation
-Time Drafts are payable at some specified future date
 
Letter of Credit is either Revocable or Irrevocable.
 
-Revocable: may be amended or canceled at any time, without approval by the Beneficiary
 
-Irrevocable: cannot be amended or canceled without the consent of all parties
 
In closing, it is necessary to point out that Letter of Credit, no matter how secure the transaction, is today an expensive method of payment. The banks charge upwards of $500-$600 to issue and negotiate a letter of credit plus a percentage to pay the draft and wire the money to the Seller’s bank.
 
In other words, it’s not in your favor, the Buyer, to pay for your goods by a Letter of Credit unless you are buying at least $5-$6,000 worth of goods, otherwise your inherent costs entailed in the L/C will constitute too high a percentage of your invoiced value of purchases.
 
On the other hand, if a secure transaction and time is of essence, then payment by an L/C is recommended, regardless of the high costs.
 
Let’s say that you want your order to arrive no later than December 1 because you intend to market the goods only before Christmas. The date of expiration on the Letter of Credit will assure you that you’ll either have the goods on time and sell them before Christmas or you don’t have to take the goods if the shipment should be late. 
 
 
Documentary Draft for Collection

 
Documentary Draft for Collection is also referred to as D/P, commonly known also as Documents against Payment.
 
A Draft is an unconditional order in writing, signed by the Seller, the Drawer, addressed to the Buyer, the Drawee, ordering him to pay on presentation - Sight Draft, or at future date, Time Draft.
 
A Draft is "documentary" because it is accompanied by documents delivered to the drawee on payment (or acceptance) of the draft. Hence it is known also as "bill of exchange."
 
A Draft indicates payment is to be made usually to the Seller's bank which handles the collection on behalf of the Seller. Thus Seller keeps control of the merchandise through the Collecting Bank until the Buyer has paid. Here lies the difference as compared to the Letter of Credit.
 
Under the L/C, the Seller is not looking to you, the Buyer, for the payment but directly to your bank. Under the D/P, the Seller is looking directly to you, the Buyer, for the Payment.
 
Thus under L/C, the Seller has the maximum protection that he gets paid whereas under the D/P he does not. If your bank can’t collect money from you, the Seller won’t get paid and will have to provide for the return of his goods at his expense.
 
Under the L/C, there was a contractual agreement between two banks. Under the D/P there is none. Seller’s bank merely uses the Buyer’s bank to collect the money but the collecting bank is under no contractual liability to the Seller’s bank.
 
Under the international guidelines for the collection of documentary credits (see publication, Letter of Credit), the collecting bank is merely to exercise caution and act to the best of their ability. To use the exact words: under the D/P, “banks are only to act in good faith and exercise reasonable care” (as governed by Documentary Credit Collection guidelines issued by the International Chamber of Commerce).
 
In other words, the difference between selling against an Irrevocable L/C and selling against a Documentary Draft for Collection lies in the degree of protection that these methods give to the Seller/the Exporter!
 
-Under the L/C banks have committed themselves to pay.
-Under the Drafts for Collection banks merely act as “collecting agents” on behalf of the Seller, who must look to the Drawee/the Buyer for the actual payment of his Drafts!
 
Under the D/P, the collecting bank is not obligated to check if all Documents are present, nor whether any Special Conditions are fulfilled (as is the case under L/C) for there were none specified to begin with!
 
In summary, Documentary Draft for Collection is the best instrument for you, the Buyer, for it does not tie up your available credit!
 
Because it is not a 100% secure instrument for the Seller to get paid, no seller will sell you goods using the D/P alone but typically will ask for a sizeable deposit up front to assure himself that you, the Buyer, will come up with the rest of the money when the goods arrive to your destination and the documents to your bank with the draft for your bank to collect on.

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