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Raghu Palat
Chong Wong from Hong Kong wishes to buy tea from Mr Madan Menon. They discuss terms and arrive at an agreement. This is the first stage - the sale contract. Mr Menon in order to be certain of payment on schedule asks Mr Wong to confirm the sale contract by sending him a letter of credit (LC).The LC is "any arrangement however named or described, whereby a bank ("the issuing bank") acting at the request and on the instructions of a customer ("the applicant") or on its own behalf:
(i)Is to make a payment to or to the order of a third party (the "beneficiary") or to accept and pay bills of exchange drafts drawn by the beneficiary, or
(ii)Authorises another bank to make such payment, or to accept and pay such bills of exchang, or
(iii)Authorises another bank to negotiate against stipulated document(s) provided that the terms and conditions of the credit are complied with. The LC is therefore issued on the instructions of the buyer. The bank follows the instructions and issues the credit. It does not makeany assurance on the buyer's credit worthiness or honesty nor does the bank give any guarantee on the goods. It merely concerns itself with documents.
Therefore, the seller must check the antecedents and reputation of the buyer before the purchase contract is entered into. The undertaking given to the seller is only conditional. The bank undertakes to pay only if he meets all the requirements of the LC.
Credit Application
The applicant (buyer) must, before a LC is actually issued, make an application. This is known as an application for a LC or a documentary credit application.
The instructions which will be addressed to the issuing bank will normally detail:
1. The seller's full name and address. It is important that this is stated as this would ensure that the seller will receive the LC.
2. The date of application. The date is detailed to check and ensure that the LC is issued within a reasonable time. Often time is of the essence and delays could result in the transactionfalling through. Many banks, as a measure of quality, take pride in the fact that they issue LC within hours of receiving the application.
3. The amount of credit. The amount is the figure upto which the issuing bank agrees to pay and it is imperative that the amount be specified. In fact no bank would agree to issuing a credit without specifying an amount as that would expose the bank to an unlimited commitment.
4. The type of credit. An LC can be either revocable or irrevocable. These are discussed in detail in a subsequent chapter but are briefly:
5. The manner the credit or payment is to be available. This is of primary importance to the seller. He needs to know how and where he will be paid. This may be on the presentation of documents, on acceptance or bynegotiation.
6. The draft to be drawn. Payment is always made on the presentation of a draft which is essentially a bill of exchange. The draft would normally state whether it is payable on sight or at a future date. The draft would also clearly state to whom it is payable.
7. The goods. The application will always detail the goods that are being bought including the price at which it is being purchased. It may even specify markings and type if these factors are very important.
8. Freight. Freight can be expensive and the contract price is usually agreed after it has been decided on who (seller or buyer) is to bear the cost of freight. This is why the cost is stated as CIF (Cost Insurance Freight), FOB (Free on board),C & F (Carriage & Freight), C & I (Carriage and Insurance) and the like.
9. Documents to be submitted. Banks deal with documents and the issuing and confirming bank undertake to pay the seller on the submission of certain documents.
10. Shipment. Theapplication normally states where the shipment is to take place and by when. It also specifies where the goods are to be shipped to. This is crucial as the goods would need to be procured by the buyer by a particular date.
11. Transhipment. Many buyers are concerned about transhipment and may state that transhipment are not allowed. Transhipment occurs when the goods are transferred from one ship to another. There could be breakages or losses for some other reasons.
12. Partial Shipments. The application normally specifies whether partial shipments are allowed. Partial shipments are acceptable if a large quantity of goods are being purchased and are required over a period of time.
13. The period within which the documents must be presented. The applicant would normally want to take possession of the goods as early as possible (especially if they are perishables or in great demand). Consequently, he may stipulate the time within which the documents must be presented for payment,acceptance or negotiation. The usual wording is "documents to be presented within 7 days after the date of issuance of the transport documents but within the validity of the credit".
14. Date and place of expiry of credit. The LC is never issued for an indefinite period. It requires the seller to ship the documents and comply with the requirements on schedule. The undertaking therefore given by the bank is that payment will be made if the requirements are completed on or by a specific date. A place is also usually specified and it is usually the place where the beneficiary resides.
15. Whether transferable. The applicant can permit the credit to be transferable either in part or whole to another. If the credit is transferable the beneficiary can transfer his rights by endorsement and signature to another supplier and this new supplier will be entitled to claim upon the issuing bank payment under the credit. This facility is prevalent in certain industries. In order for the credit to betransferable the applicant must specifically state that it be so. Otherwise the credit issued would be non transferable.
16. Manner credit is to be advised. This could be done by post, telex, fax (facsimile) or telegram. The applicant must clearly stipulate the manner the credit is to be advised.
17. Authorisation. The application must be signed by individuals authorised to sign the application and instruct the bank.
18. Permission. In certain countries free imports are not permitted and for certain items the permission of a governmental body or a license is required. If there is such a requirement the application will contain a notification to that effect and a copy of the permission/license.
When the bank receives an application, it initially checks if the application has been signed properly by those authorised to instruct the bank. After this has been satisfactorily ascertained, the bank has to check if the applicant has a LC facility and sufficient bank balance available forthe credit tobe issued.
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
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This story was printed from Net Express located at http://www.expressindia.com. Net Express provides a portal to India, with news from The Indian Express and The Financial Express along with sites on travel and tourism, the entertainment industry, the power sector, the environment and much more.
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