Letter of Credit vs. Bank Gaurantee

Letter of Credit vs. Bank Gaurantee
A letter of credit differs from a bank guarantee. An issuing or confirming bank's obligation is independent of, and unqualified by, the contract of sale under the transaction. A commercial credit is neither a performance bond, nor it is a guarantee of the quantity or quality of the goods shipped.
Letters of Credit are Separate Transactions

A contract for sale of goods between the seller and the buyer incorporates mode of settlement. Letters of credit by their nature are separate from the sale contract, and banks are not concerned or bound by such sale contracts even if the credits bear reference to them.

The credits stipulate documents which have to be tendered for payment and it, therefore, follows that in credits parties deal with documents and not with goods, services or performances to which the documents relate.

It is, therefore, in the interest of all the parties concerned that the conditions and terms of credit are complete and precise and barefit of excessive details.

Payment under a letter of credit does not depend on the performance obligation on the part of the exporter except those which the credit imposes. Banks accept documents under letters of credit for what those document purport to be on their face. Contract between the buyer and the seller is obligatory between themselves. The seller(beneficiary) cannot take advantage of any contractual terms in between the buyer and the opening bank and between the opening bank and the advising/confirming bank.

Uniform Customs and Practice for Documentary Credit

In the course of time, a number of practices, expressions and terms have evolved between banks dealing with documentary credits. To ensure uniformity of interpretation in international trade, the International Chambers of Commerce in Paris has worked out the "Uniform Customs and Practice for Documentary Credit". These have been revised and brought up to date several times in the past. The latest in the line of revisions is the UCP 500 (w.e.f. January 1, 1994) which updates and consolidates the previous UCP 400. They are now applied by the banks in nearly all countries including India.

Parties to a Letter of Credit:

Following persons are generally parties, to a letter of Credit:

Benificiary : The exporter of goods in whose favour the L/C has been established. Customer/importer : The person we intends to import the goods and instructs bank to established Letter of Credit.

Issuing Bank: The Banker in the importers Country who opened the L/C. Correspondent Bank or Advising Bank: The banker in the exporters country, who is authorised by the issuing bank to advise the beneficiary of the Credit and to effect such payment or to accept and pay such bills of exchange or to negotiate against Stipulated documents and on Compliance of Stipulated terms and condition specified by the importer on the exporter.

Confirming Bank: The banker in the exporters(beneficiary) country, who at the desire of the beneficiary adds confirmation to the letter of Credit so that beneficiary can get payment without recourse from the Confirming bank. The Confirming bank may be correspondent bank itself or some other bank.

Generally following types of Letter of Credit are in operation.

Revocable or Irrevocable Letters of Credit
Confirmed Credit
Transferable Credit
With or without Recourse Credit
Revolving Letter of Credit
Transit Credit
Back to Back Credit
The Sight Credit
The Credit available against Time Draft (Usance Credit)
The Deferred payment Credit.

Precautions to be taken at the time of establishing Letter of Credit

Letter of credit offers almost complete protection to the seller but the buyer is put to many disadvantages and has to make payments against documents only. Before agreeing to open a letter of credit in favour of the seller, the opener must be satisfied with the creditworthiness and general reputation of the seller. Entire success of an L/C transaction depends on proper conduct of the seller.

Confidential report on the seller must be obtained at the time of first transaction with him.

Letter of credit also does not offer any protection for the quality/quantity of goods supplied under the L/C. It would, therefore be necessary to know the nature of goods and specify submission of quality reports/inspection reports from an independent agency to ensure receipt of goods of proper quality. This is particularly important in case of import of chemicals and such other goods. The opener has to submit an L/C application to the opening bank. The instructions contained in the L/C application is the mandate for the issuing bank and letter of credit will be issued in accordance with this application. It is, therefore, necessary that complete and precise information must be given in the L/C application form specifying therein the description, unit rate and quantity of the goods covered under L/C and details of documents required in absolute clear and unambiguous terms. The reference to underlying sale contract must be avoided as far as possible. The L/C application must nevertheless contain all the required/information based on which L/C could be opened by the bank.

After the L/C has been issued by the bank, a copy thereof must be obtained immediately. The L/C must be scrutinized to ensure that it has been properly issued and is in conformity with L/C application. Discrepancy, if any, must be brought to the notice of opening bank immediately.

Import contact may be concluded either in terms of INR or in foreign currency. Where the contracts are in INR, the related documents are also prepared in INR and no conversion is involved. However, where the bill is drawn in foreign currency, the payment is made in Indian rupees equivalent to the foreign currency. The equivalent rupee value is arrived at by applying suitable exchange rate. These rates are applied by banks to standardise the foreign exchange-rupee conversion process.

When the price of foreign currency is quoted in terms of home or local currency it is called direct quotation basis. This has been in application since 02.08.1993. However, there is a difference between inter-bank exchange rates and merchant rates.

Merchant rates are the exchange rates applied by the bankers for transaction with their customers for various purposes, including imports and exports. These rates are calculated by the banks as per the guidelines issued by the Foreign Exchange Dealers Association of India (FEDAI). Inter-bank rates are the rate for transactions amongst the authorised dealers in foreign exchange and depend on the market conditions.

Since exchange rates are volatile, documents delivered by the bank at the time of a favourable exchange rate will enable the Indian purchaser to pay less of Indian rupees. Forex rates are always quoted as two way price i.e. at a rate at which the bank is willing to sell foreign currency(buying rate) and at a rate at which the bank is willing to buy foreign currency(selling rate). There is always some difference in buying and selling rates. However, the maximum spread available to bank is restricted in terms of celling imposed by RBI. All exchange rates by authorised dealers are quoted in terms of their capacity as buyer or seller.

under L/C))

Checklist for Document (received under L/C) scrutiny:

General-check whether all documents in full sets as per L/C terms have been received
Documents had been presented before the expiry date
All the documents are dated subsequent to the date of issue of the L/C
Cancellation/overwriting in all documents are authenticated
Bills of Exchange-check whether
Drawn on the person indicated in the L/C and duly signed up by the beneficiary of the credit
Drawing is within L/C amount and in the same currency as per the L/C
The amounts in words and figures are the same and identical with the amount stated in the invoice

Superscription, regarding drawing under L/C has been made and the Bill must have been issued stamped.

Invoice- check whether invoice:
Is made out in the name of the person who had opened the L/C
Quantity, unit price and value are quoted as per L/C
Whether unit price and value are quoted as per L/C
The description of the merchandise corresponds to the description in the L/C
The arithmetical calculations are correct
Import license/OGL/Contract No./Order No./Indent No. mentioned as per L/C
No charge other than stipulated in L/C in included
Additional copy for Exchange Control purposes is submitted
The date and no. of the License/OGL indicated

Bill of lading is submitted within 21days from the date of shipment, if no specific time is between the date of issue and expiry of L/C

The date of shipment is between the date of issue and expiry of L/C
Full quantity of goods is shipped, if part shipment is not allowed
Full set is submitted
Freight is shown as prepaid/payable at destination, as per L/C
Bill of lading shows 'on board shipment'
Parties are notified as per L/C terms
Carrying vessel's name has been mentioned in Bill of Lading
The beneficiary's name is shown as consignor, unless L/C terms permits third party bill of lading
The consignee's name is as per L/C
The B/L is manually signed

The description of goods is consistent with L/C
The ports of loading/destination are mentioned as per L/C
Marks, numbers, quantity and weight agree with the invoice
The carrying vessel belongs to any particular line as per L/C
Adequately stamped
Properly endorsed
If AWB, whether flight number and date of departure mentioned
If freight has been added separately in invoice and no separate freight certificate of shipping company is submitted. B/L shows freight amount.

Scrutiny for Insurance documents-check whether the policy is taken out in the name of the shipper

Certificate/policy is according to Letter of Credit terms
Risk commences w.e.f. date of B/L
Amount of insurance as per L/C terms
Whether drawn in the same currency as the L/C
Description of goods agree with B/L
Risks as per L/C are covered
The place where claims are payable is as per L/C terms
Adequately stamped
Details such as name of carrying vessel, ports of loading/destination, marks, agree with the B/L
Certificate of analysis, weighment,etc.
The certificates are issued by the authority stipulated in L/C
Name of the shipper is properly shown
The samples drawn relate to the goods actually shipped
Date of sample verification is within the date of shipment

Certificate of origin
It is issued by the authority stipulated in the L/C
The description of goods agrees with that in the invoice

Checking other documents
All other documents stipulated in the L/C are verified

They are issued by the authorities specified in the L/C

They contain the details as required by the L/C

For matter relating to Documentary Collections and Commercial terms, the importers are likely to be conversant with the brochures issued by the International Chamber of Commerce(ICC), Paris.

Following are the brochures:
Uniform Customs and Practice for Documentary Collection and Commercial Terms
Uniform Rules of Collections (ICC522)
Uniform Rules for a Combined Transport Document (ICC298)
INCO Terms 1990
RBI regulations for Making Payments by importers