Understanding and Using Letters of Credit, Part I

Letters of credit accomplish their purpose by substituting the credit of the bank for that of
the customer, for the purpose of facilitating trade. There are basically two types:
commercial and standby. The commercial letter of credit is the primary payment
mechanism for a transaction, whereas the standby letter of credit is a secondary payment
mechanism.

Commercial Letter of Credit

Commercial letters of credit have been used for centuries to facilitate payment in
international trade. Their use will continue to increase as the global economy evolves.

Letters of credit used in international transactions are governed by the International

Chamber of Commerce Uniform Customs and Practice for Documentary Credits. The
general provisions and definitions of the International Chamber of Commerce are binding
on all parties. Domestic collections in the United States are governed by the Uniform
Commercial Code.

A commercial letter of credit is a contractual agreement between a bank, known as the

issuing bank, on behalf of one of its customers, authorizing another bank, known as the
advising or confirming bank, to make payment to the beneficiary. The issuing bank, on
the request of its customer, opens the letter of credit. The issuing bank makes a
commitment to honor drawings made under the credit. The beneficiary is normally the
provider of goods and/or services. Essentially, the issuing bank replaces the bank's
customer as the payee.

Elements of a Letter of Credit

• A payment undertaking given by a bank (issuing bank)

• On behalf of a buyer (applicant)
• To pay a seller (beneficiary) for a given amount of money
• On presentation of specified documents representing the supply of goods
• Within specified time limits
• Documents must conform to terms and conditions set out in the letter of credit
• Documents to be presented at a specified place

Beneficiary
The beneficiary is entitled to payment as long as he can provide the documentary
evidence required by the letter of credit. The letter of credit is a distinct and separate
transaction from the contract on which it is based. All parties deal in documents and not
in goods. The issuing bank is not liable for performance of the underlying contract
between the customer and beneficiary. The issuing bank's obligation to the buyer, is to
examine all documents to insure that they meet all the terms and conditions of the credit.
Upon requesting demand for payment the beneficiary warrants that all conditions of the
agreement have been complied with. If the beneficiary (seller) conforms to the letter of
credit, the seller must be paid by the bank.

Issuing Bank
The issuing bank's liability to pay and to be reimbursed from its customer becomes
absolute upon the completion of the terms and conditions of the letter of credit. Under the
provisions of the Uniform Customs and Practice for Documentary Credits, the bank is
given a reasonable amount of time after receipt of the documents to honor the draft.

The issuing banks' role is to provide a guarantee to the seller that if compliant documents
are presented, the bank will pay the seller the amount due and to examine the documents,
and only pay if these documents comply with the terms and conditions set out in the letter
of credit.

Typically the documents requested will include a commercial invoice, a transport

document such as a bill of lading or airway bill and an insurance document; but there are
many others. Letters of credit deal in documents, not goods.

Advising Bank
An advising bank, usually a foreign correspondent bank of the issuing bank will advise
the beneficiary. Generally, the beneficiary would want to use a local bank to insure that
the letter of credit is valid. In addition, the advising bank would be responsible for
sending the documents to the issuing bank. The advising bank has no other obligation
under the letter of credit. If the issuing bank does not pay the beneficiary, the advising
bank is not obligated to pay.

Confirming Bank
The correspondent bank may confirm the letter of credit for the beneficiary. At the
request of the issuing bank, the correspondent obligates itself to insure payment under the
letter of credit. The confirming bank would not confirm the credit until it evaluated the
country and bank where the letter of credit originates. The confirming bank is usually the
advising bank.

Letter of Credit Characteristics

Negotiability
Letters of credit are usually negotiable. The issuing bank is obligated to pay not only the
beneficiary, but also any bank nominated by the beneficiary. Negotiable instruments are
passed freely from one party to another almost in the same way as money. To be
negotiable, the letter of credit must include an unconditional promise to pay, on demand
or at a definite time. The nominated bank becomes a holder in due course. As a holder in
due course, the holder takes the letter of credit for value, in good faith, without notice of
any claims against it. A holder in due course is treated favorably under the UCC.

The transaction is considered a straight negotiation if the issuing bank's payment

obligation extends only to the beneficiary of the credit. If a letter of credit is a straight
negotiation it is referenced on its face by "we engage with you" or "available with
ourselves". Under these conditions the promise does not pass to a purchaser of the draft
as a holder in due course.

Revocability
Letters of credit may be either revocable or irrevocable. A revocable letter of credit may
be revoked or modified for any reason, at any time by the issuing bank without
notification. A revocable letter of credit cannot be confirmed. If a correspondent bank is
engaged in a transaction that involves a revocable letter of credit, it serves as the advising
bank.

Once the documents have been presented and meet the terms and conditions in the letter
of credit, and the draft is honored, the letter of credit cannot be revoked. The revocable
letter of credit is not a commonly used instrument. It is generally used to provide
guidelines for shipment. If a letter of credit is revocable it would be referenced on its
face.

The irrevocable letter of credit may not be revoked or amended without the agreement of
the issuing bank, the confirming bank, and the beneficiary. An irrevocable letter of credit
from the issuing bank insures the beneficiary that if the required documents are presented
and the terms and conditions are complied with, payment will be made. If a letter of
credit is irrevocable it is referenced on its face.

Transfer and Assignment

The beneficiary has the right to transfer or assign the right to draw, under a credit only
when the credit states that it is transferable or assignable. Credits governed by the
Uniform Commercial Code (Domestic) maybe transferred an unlimited number of times.
Under the Uniform Customs Practice for Documentary Credits (International) the credit
may be transferred only once. However, even if the credit specifies that it is
nontransferable or nonassignable, the beneficiary may transfer their rights prior to
performance of conditions of the credit.

Sight and Time Drafts

All letters of credit require the beneficiary to present a draft and specified documents in
order to receive payment. A draft is a written order by which the party creating it, orders
another party to pay money to a third party. A draft is also called a bill of exchange.

There are two types of drafts: sight and time. A sight draft is payable as soon as it is
presented for payment. The bank is allowed a reasonable time to review the documents
before making payment.

A time draft is not payable until the lapse of a particular time period stated on the draft.
The bank is required to accept the draft as soon as the documents comply with credit
terms. The issuing bank has a reasonable time to examine those documents. The issuing
bank is obligated to accept drafts and pay them at maturity.
Standby Letter of Credit
The standby letter of credit serves a different function than the commercial letter of
credit. The commercial letter of credit is the primary payment mechanism for a
transaction. The standby letter of credit serves as a secondary payment mechanism. A
bank will issue a standby letter of credit on behalf of a customer to provide assurances of
his ability to perform under the terms of a contract between the beneficiary. The parties
involved with the transaction do not expect that the letter of credit will ever be drawn
upon.

The standby letter of credit assures the beneficiary of the performance of the customer's
obligation. The beneficiary is able to draw under the credit by presenting a draft, copies
of invoices, with evidence that the customer has not performed its obligation. The bank is
obligated to make payment if the documents presented comply with the terms of the letter
of credit.

Standby letters of credit are issued by banks to stand behind monetary obligations, to
insure the refund of advance payment, to support performance and bid obligations, and to
insure the completion of a sales contract. The credit has an expiration date.

The standby letter of credit is often used to guarantee performance or to strengthen the
credit worthiness of a customer. In the above example, the letter of credit is issued by the
bank and held by the supplier. The customer is provided open account terms. If payments
are made in accordance with the suppliers' terms, the letter of credit would not be drawn
on. The seller pursues the customer for payment directly. If the customer is unable to pay,
the seller presents a draft and copies of invoices to the bank for payment.

The domestic standby letter of credit is governed by the Uniform Commercial Code.
Under these provisions, the bank is given until the close of the third banking day after
receipt of the documents to honor the draft.

Procedures for Using the Tool

The following procedures include a flow of events that follow the decision to use a
Commercial Letter of Credit. Procedures required to execute a Standby Letter of Credit
are less rigorous. The standby credit is a domestic transaction. It does not require a
correspondent bank (advising or confirming). The documentation requirements are also
less tedious.

Step-by-step process:

• Buyer and seller agree to conduct business. The seller wants a letter of credit to
guarantee payment.
• Buyer applies to his bank for a letter of credit in favor of the seller.
• Buyer's bank approves the credit risk of the buyer, issues and forwards the credit
to its correspondent bank (advising or confirming). The correspondent bank is
usually located in the same geographical location as the seller (beneficiary).
 • Advising bank will authenticate the credit and forward the original credit to the
seller (beneficiary).
• Seller (beneficiary) ships the goods, then verifies and develops the documentary
requirements to support the letter of credit. Documentary requirements may vary
greatly depending on the perceived risk involved in dealing with a particular
company.
• Seller presents the required documents to the advising or confirming bank to be
processed for payment.
• Advising or confirming bank examines the documents for compliance with the
terms and conditions of the letter of credit.
• If the documents are correct, the advising or confirming bank will claim the funds
by:
o Debiting the account of the issuing bank.
o Waiting until the issuing bank remits, after receiving the documents.
o Reimburse on another bank as required in the credit.
• Advising or confirming bank will forward the documents to the issuing bank.
• Issuing bank will examine the documents for compliance. If they are in order, the
issuing bank will debit the buyer's account.
• Issuing bank then forwards the documents to the buyer.

Standard Forms of Documentation

When making payment for product on behalf of its customer, the issuing bank must
verify that all documents and drafts conform precisely to the terms and conditions of the
letter of credit. Although the credit can require an array of documents, the most common
documents that must accompany the draft include:

Commercial Invoice
The billing for the goods and services. It includes a description of merchandise, price,
FOB origin, and name and address of buyer and seller. The buyer and seller information
must correspond exactly to the description in the letter of credit. Unless the letter of credit
specifically states otherwise, a generic description of the merchandise is usually
acceptable in the other accompanying documents.

Bill of Lading
A document evidencing the receipt of goods for shipment and issued by a freight carrier
engaged in the business of forwarding or transporting goods. The documents evidence
control of goods. They also serve as a receipt for the merchandise shipped and as
evidence of the carrier's obligation to transport the goods to their proper destination.

Warranty of Title
A warranty given by a seller to a buyer of goods that states that the title being conveyed
is good and that the transfer is rightful. This is a method of certifying clear title to product
transfer. It is generally issued to the purchaser and issuing bank expressing an agreement
to indemnify and hold both parties harmless.
Letter of Indemnity
Specifically indemnifies the purchaser against a certain stated circumstance.
Indemnification is generally used to guaranty that shipping documents will be provided in
good order when available.

Common Defects in Documentation

About half of all drawings presented contain discrepancies. A discrepancy is an
irregularity in the documents that causes them to be in non-compliance to the letter of
credit. Requirements set forth in the letter of credit cannot be waived or altered by the
issuing bank without the express consent of the customer. The beneficiary should prepare
and examine all documents carefully before presentation to the paying bank to avoid any
delay in receipt of payment. Commonly found discrepancies between the letter of credit
and supporting documents include:

• Letter of Credit has expired prior to presentation of draft.

• Bill of Lading evidences delivery prior to or after the date range stated in the
credit.
• Stale dated documents.
• Changes included in the invoice not authorized in the credit.
• Inconsistent description of goods.
• Insurance document errors.
• Invoice amount not equal to draft amount.
• Ports of loading and destination not as specified in the credit.
• Description of merchandise is not as stated in credit.
• A document required by the credit is not presented.
• Documents are inconsistent as to general information such as volume, quality, etc.
• Names of documents not exact as described in the credit. Beneficiary information
must be exact.
• Invoice or statement is not signed as stipulated in the letter of credit.

When a discrepancy is detected by the negotiating bank, a correction to the document

may be allowed if it can be done quickly while remaining in the control of the bank. If
time is not a factor, the exporter should request that the negotiating bank return the
documents for corrections.

If there is not enough time to make corrections, the exporter should request that the
negotiating bank send the documents to the issuing bank on an approval basis or notify
the issuing bank by wire, outline the discrepancies, and request authority to pay. Payment
cannot be made until all parties have agreed to jointly waive the discrepancy.

Tips for Exporters

• Communicate with your customers in detail before they apply for letters of credit.
• Consider whether a confirmed letter of credit is needed.
• Ask for a copy of the application to be fax to you, so you can check for terms or
conditions that may cause you problems in compliance.
 • Upon first advice of the letter of credit, check that all its terms and conditions can
be complied with within the prescribed time limits.
• Many presentations of documents run into problems with time-limits. You must
be aware of at least three time constraints - the expiration date of the credit, the
latest shipping date and the maximum time allowed between dispatch and
presentation.
• If the letter of credit calls for documents supplied by third parties, make
reasonable allowance for the time this may take to complete.
• After dispatch of the goods, check all the documents both against the terms of the
credit and against each other for internal consistency.

Summary
The use of the letters of credit as a tool to reduce risk has grown substantially over the
past decade. Letters of credit accomplish their purpose by substituting the credit of the
bank for that of the customer, for the purpose of facilitating trade.

The credit professional should be familiar with two types of letters of credit: commercial
and standby. Commercial letters of credit are used primarily to facilitate foreign trade.
The commercial letter of credit is the primary payment mechanism for a transaction.

The standby letter of credit serves a different function. The standby letter of credit serves
as a secondary payment mechanism. The bank will issue the credit on behalf of a
customer to provide assurances of his ability to perform under the terms of a contract.

Upon receipt of the letter of credit, the credit professional should review all items
carefully to insure that what is expected of the seller is fully understood and that he can
comply with all the terms and conditions. When compliance is in question, the buyer
should be requested to amend the credit.

Understanding and Using Letters of Credit, Part II

CRF thanks Ron Borcky for his development of this section

Purpose
The purpose of this document is to provide a general understanding of letters of credit,
their use and application. The topics covered are the following:

• General background information;

• Types of letters of credit;
• Common problems with letters of credit;
• Procedures for establishing letters of credit;
• Amendments; and
• General tips to both buyers and sellers.
In addition, attachments to this document detail a step-by-step letter of credit procedures.

Definition
Letters of credit are commonly used to reduce credit risk to sellers in both domestic and
international sales arrangements. By having a bank issue a letter of credit, in essence, one
is substituting the bank's credit worthiness for that of the customer.

Types
There are two basic forms of letters of credit: Standby and Documentary. Documentary
letters of credit can be either Revocable or Irrevocable, although the first is extremely
rare. Irrevocable letters of credit can be Confirmed or Not Confirmed. Each type of credit
has advantages and disadvantages for the buyer and for the seller, which this information
will review below. Charges for each type will also vary. However, the more the banks
assume risk by guaranteeing payment, the more they will charge for providing the
service.

Documentary Revocable Letter of Credit

Revocable credits may be modified or even canceled by the buyer without notice to the
seller. Therefore, they are generally unacceptable to the seller.

Documentary Irrevocable Letter of Credit

This is the most common form of credit used in international trade. Irrevocable credits
may not be modified or canceled by the buyer. The buyer's issuing bank must follow
through with payment to the seller so long as the seller complies with the conditions
listed in the letter of credit. Changes in the credit must be approved by both the buyer and
the seller. If the documentary letter of credit does not mention whether it is revocable or
irrevocable, it automatically defaults to irrevocable. See Credit Administration, Sample
Procedure for Administration of a Documentary Irrevocable Letters of Credit for a
systematic procedure for establishing an irrevocable letter of credit.

There are two forms of irrevocable credits:

Unconfirmed credit (the irrevocable credit not confirmed by the advising bank)
In an unconfirmed credit, the buyer's bank issuing the credit is the only party responsible
for payment to the seller. The seller's advising bank pays only after receiving payment
from the issuing bank. The seller's advising bank merely acts on behalf of the issuing
bank and, therefore, incurs no risk.

Confirmed credit (the irrevocable confirmed credit)

In a confirmed credit, the advising bank adds its guarantee to pay the seller to that of the
buyer's issuing bank. Once the advising bank reviews and confirms that all documentary
requirements are met, it will pay the seller. The advising bank will then look to the
issuing bank for payment. Confirmed Irrevocable letters of credit are used when trading
in a high-risk area where war or social, political, or financial instability are real threats.
Also common when the seller is unfamiliar with the bank issuing the letter of credit or
when the seller needs to use the confirmed letter of credit to obtain financing its bank to
fill the order. A confirmed credit is more expensive because the bank has added liability.
Standby Letter of Credit
This credit is a payment or performance guarantee used primarily in the United States.
They are often called non-performing letters of credit because they are only used as a
backup should the buyer fail to pay as agreed. Thus, a stand-by letter of credit allows the
customer to establish a rapport with the seller by showing that it can fulfill its payment
commitments. Standby letters of credit are used, for example, to guarantee repayment of
loans, to ensure fulfillment of a contract, and to secure payment for goods delivered by
third parties. The beneficiary to a standby letter of credit can cash it on demand. Stand-by
letters of credit are generally less complicated and involve far less documentation
requirements than irrevocable letters of credit. See Credit Administration, Sample
Procedure for Administration of a Standby Letter of Credit for a systematic procedure for
establishing a standby letter of credit.

Special Letters of Credit

The following is a brief description of some special letters of credit.

Back-to-Back Letter of Credit

This is a new letter of credit opened based on an already existing, nontransferable credit
used as collateral. Traders often use back-to-back arrangements to pay the ultimate
supplier. A trader receives a letter of credit from the buyer and then opens another letter
of credit in favor of the supplier. The first letter of credit serves as collateral for the
second credit.

Deferred Payment (Usance) Letter of Credit

In Deferred Payment Letters of Credit, the buyer accepts the documents related to the
letter of credit and agrees to pay the issuing bank after a fixed period. This credit gives
the buyer a grace period for payment.

Red Clause Letter of Credit

Red Clause Letters of Credit provide the seller with cash prior to shipment to finance
production of the goods. The buyer's issuing bank may advance some or all of the funds.
The buyer, in essence, extends financing to the seller and incurs the risk for all advanced
credits.

Revolving Letter of Credit

With a Revolving Letter of Credit, the issuing bank restores the credit to its original
amount once it has been used or drawn down. Usually, these arrangements limit the
number of times the buyer may draw down its line over a predetermined period.

Transferable Letter of Credit

This type of credit allows the seller to transfer all or part of the proceeds of the original
letter of credit to a second beneficiary, usually the ultimate supplier of the goods. The
letter of credit must clearly state that it is transferable for its to be considered as such.
This is a common financing tactic for middlemen and is common in East Asia.
Assignment of Proceeds
The beneficiary of a letter of credit may assign all or part of the proceeds under a credit to
a third party (the assignee). However, unlike a transferred credit, the beneficiary
maintains sole rights to the credit and is solely responsible for complying with its terms
and conditions. For the assignee, an assignment only means that the paying bank, once it
receives notice of the assignment, undertakes to follow the assignment instructions, if and
when payment is made. The assignee is dependent upon the beneficiary for compliance,
and thus this arrangement is riskier than a transferred credit. Before agreeing to an
assignment of proceeds arrangement, the assignee should carefully review the original
letter of credit.

Common Problems with Letters of Credit

Most problems result from the seller's inability to fulfill obligations stated in the letter of
credit. The seller may find these terms difficult or impossible to fulfill and, either tries to
fulfill them and fails, or asks the buyer to amend to the letter of credit. As most letters of
credit are irrevocable, amendments may at times be difficult since both the buyer and the
seller must agree.

Sellers may have one or more of the following problems:

• The shipment schedule cannot be met;

• The stipulations concerning freight costs are unacceptable;
• The price becomes too low due to exchange rates fluctuations;
• The quantity of product ordered is not the expected amount;
• The description of product is either insufficient or too detailed; and,
• The stipulated documents are difficult or impossible to obtain.

Even when sellers accept the terms of a letter of credit, problems often arise late in the
process. When this occurs, the buyer's and seller's banks will try to negotiate any
differences. In some cases, the seller can correct the documents and present them within
the time specified in the letter of credit. If the documents cannot be corrected, the
advising bank will ask the issuing bank to accept the documents despite the discrepancies
found. It is important to note that, if the documents are not in accord with the
specifications of the letter of credit, the buyer's issuing bank is no longer obligated to pay.

Basic Procedures for Establishing a Letter of Credit

The letter of credit process has been standardized by a set of rules published by the
International Chamber of Commerce (ICC). These rules are called the Uniform Customs
and Practice for Documentary Credits (UCP) and are contained in ICC Publication No.
500. The following is the basic set of steps used in a letter of credit transaction. Specific
letter of credit transactions follow somewhat different procedures.

1. After the buyer and seller agree on the terms of a sale, the buyer arranges for his bank
to open a letter of credit in favor of the seller. Note: The buyer will need to have a line of
credit established at the bank or provide cash collateral for the amount of the letter of
credit.
2. The buyer's issuing bank prepares the letter of credit, including all of the buyer's
instructions to the seller concerning shipment and required documentation.

3. The buyer's bank sends the letter of credit to the seller's advising bank.

4. The seller's advising bank forwards the letter of credit to the seller.

5. The seller carefully reviews all conditions stipulated in the letter of credit. If the seller
cannot comply with any of the provisions, it will ask the buyer to amend the letter of
credit.

6. After final terms are agreed upon, the seller ships the goods to the appropriate port or
location.

7. After shipping the goods, the seller obtains the required documents. Please note that
the seller may have to obtain some documents prior to shipment.

8. The seller presents the documents to its advising bank along with a draft for payment.

9. The seller's advising bank reviews the documents. If they are in order, it will forward
them to the buyer's issuing bank. If a confirmed letter of credit, the advising bank will
pay the seller (cash or a bankers' acceptance).

10. Once the buyer's issuing bank receives and reviews the documents, it either (1) pays
if there are no discrepancies; or (2) forwards the documents to the buyer if there are
discrepancies for its review and approval.

Opening a Letter of Credit

Level of Detail
The wording in a letter of credit should be simple, but specific. The more detailed an L/C
is, the more likely the seller will reject it as too difficult to fulfill. At the same time, the
buyer will wish to define in detail what its is paying for.

Type of Credit
Letters of credit used in trade are usually either irrevocable unconfirmed credits or
irrevocable confirmed credits. In choosing which type to open both the seller and the
buyer should consider the generally accepted payment processes in each country, the
value and demand for the goods, and the reputation of the buyer and seller.

Documents
In specifying required documents, it is very important to include those required for
customs and those reflecting the agreement reached between the buyer and the seller.
Required documents usually include the bill of lading, a commercial and/or consular
invoice, the bill of exchange, the certificate of origin, and the insurance document. Other
documents required may be an inspection certificate, copies of a cable sent to the buyer
with shipping information, a confirmation from the shipping company of the state of its
ship, and a confirmation from the forwarder that the goods are accompanied by a
certificate of origin. Prices should be stated in the currency of the letter of credit and
documents should in the same language as the letter of credit.

The Letter of Credit Application

The following information should be addressed when establishing a letter of credit.

1. Beneficiary
The seller should provide to the buyer its full corporate name and correct address. A
simple mistake here may translate to inconsistent or improper documentation at the other
end.

2. Amount
The seller should state the actual amount of the letter of credit. One can request a
maximum amount when there is doubt as to the actual count or quantity of the goods.
Another option is to use words like "approximate", "circa", or "about" to indicate an
acceptable 10 % plus or minus from the stated amount. For consistency, if you use this
wording you will need to use it also in connection with the quantity.

3. Validity
The seller will need time to ship and to prepare all the necessary documents. Therefore,
the seller should ensure that the validity and period for document presentation after the
shipment of the goods is long enough.

4. Seller's Bank
The seller should list its advising bank as well as a reimbursing bank if applicable. The
reimbursing bank is the local bank appointed by the issuing bank as the disbursing bank.

5. Type of Payment Availability

The buyer and seller may agree to use sight drafts, time drafts, or some sort of deferred
payment mechanism.

6. Desired Documents
The buyer specifies the necessary documents. Buyers can list, for example, a bill of
lading, a commercial invoice, a certificate of origin, certificates of analysis, etc. The
seller must agree to all documentary requirements or suggest an amendment to the letter
of credit.

7. Notify Address
This is the address to notify upon the imminent arrival of goods at the port or airport of
destination. A notification listing damaged goods is also sent to this address, if
applicable.

8. Description of Goods
The seller should provide a short and precise description of the goods as well as the
quantity involved. Note the comments in step #2 above concerning approximate amounts.
9. Confirmation Order
With international arrangements, the seller may wish to confirm the letter of credit with a
bank in its country.

Amendment of a Letter of Credit

For the seller to change the terms noted on an irrevocable letter of credit, it must request
an amendment from the buyer. The amendment process is as follows:

1. The seller requests a modification or amendment of questionable terms in the

letter of credit;
2. If the buyer and issuing bank agree to the changes, the issuing bank will change
the letter of credit;
3. The buyer's issuing bank notifies the seller's advising bank of the amendment; and
4. The seller's advising bank notifies the seller of the amendment. Tips for Buyers
and Sellers

Seller
1. Before signing a sales contract, the seller should make inquiries about the buyer's
creditworthiness and business practices. The seller's bank will generally assist in this
investigation.

2. In many cases, the issuing bank will specify the advising and/or confirming bank.
These designations are usually based on the issuing bank's established correspondent
relationships. The seller should ensure that the advising/confirming bank is a financially
sound institution.

3. The seller should confirm the good standing of the buyer's issuing bank if the letter of
credit is unconfirmed.

4. For confirmed letters of credit, the seller's advising bank should be willing to confirm
the letter of credit issued by the buyer's bank. If the advising bank refuses to do so, the
seller should request another issuing bank as the current bank may be or is in the process
of becoming insolvent.

5. The seller should carefully review the letter of credit to ensure its conditions can be
met. All documents must conform to the terms of the letter of credit. The seller must
comply with every detail of the letter of credit specifications; otherwise the security given
by the credit is lost.

6. The seller should ensure that the letter of credit is irrevocable.

7. If amendments are necessary, the seller should contact the buyer immediately so that
the buyer can instruct the issuing bank to make the necessary changes quickly. The seller
should keep the letter of credit's expiration date in mind throughout the amendment
process.
8. The seller should confirm with the insurance company that it can provide the coverage
specified in the letter of credit and that insurance charges listed in the letter of credit are
correct. Typical insurance coverage is for CIF (cost, insurance and freight) often the
value of the goods plus about 10 percent.

9. The seller must ensure that the goods match the description in the letter of credit and
the invoice description.

10. The seller should be familiar with foreign exchange limitations in the buyer's country
that could hinder payment procedures.

Buyer
1. When choosing the type of letter of credit, the buyer should consider the standard
payment methods in the seller's country.

2. The buyer should keep the details of the purchase short and concise.

3. The buyer should be prepared to amend or re-negotiate terms of the letter of credit with
the seller. This is a common procedure in international trade. With irrevocable letters of
credit, the most common type, all parties must agree to amend the document.

4. The buyer can reduce the foreign exchange risk by buying forward currency contracts.

5. The buyer should use a bank experienced in foreign trade as its issuing bank.

6. The validation time stated on the letter of credit should give the seller ample time to
produce the goods or to pull them out of stock.

7. A letter of credit is not fail-safe. Banks are only responsible for the documents
exchanged and not the goods shipped. Documents in conformity with the letter of credit
specifications cannot be rejected on grounds that the goods were not delivered as
specified in the contract. The goods shipped may not in fact be the goods ordered and
paid for.

8. Purchase contracts and other agreements pertaining to the sale between the buyer and
seller are not the concern of the issuing bank. Only the letter of credit terms are binding
on the bank.

9. Documents specified in the letter of credit should include those the buyer requires for
customs clearance.