Letters of credit

Documentary Letter of credit

A documentary Letter of credit is an obligation of the bank to pay the value of the goods (services) to the beneficiary (seller) subject to the seller submitting to the bank documents drawn in full conformity with the conditions of the Letter of credit.

Irrevocable and revocable Letter of credit

An irrevocable Letter of credit can be modified or cancelled by the issuing bank (the bank which opened the Letter of credit) at the order of the applicant for the Letter of credit only with the consent of the beneficiary (the company in favour of which the Letter of credit is opened) to the Letter of credit modification or cancellation.

A revocable Letter of credit can be modified or cancelled at any time by the issuing bank at the order of the applicant for the Letter of credit with no prior notification of the beneficiary.

However, if documents properly made out are presented to the bank prior to the Letter of credit revocation the issuing bank shall be obliged to pay under the Letter of credit.

In international practice only irrevocable letters of credit are used.

Unconfirmed and confirmed letters of credit

An unconfirmed Letter of credit presumes the obligation of payment of the issuing bank. Confirmation of the Letter of credit by a third party bank means that along with the obligation of the bank having opened the Letter of credit the beneficiary obtains an equally valid independent obligation of the confirming bank to make the relevant payment.

Transferable Letter of credit

A Letter of credit is transferable if the beneficiary has the right to authorize the designated bank to transfer the whole Letter of credit or any part thereof to one or more other persons (second beneficiaries).

Red clause Letter of credit

A Red clause Letter of credit allows the exporter to receive a part of assets under the Letter of credit as advance payment before all documents of title are presented. This is basically intended to finance production and consumption of the goods delivered under the Letter of credit, as well as, possibly, for the purchase and payment for the goods intended for export (before their shipment to the buyer).

Letter of credit payable at sight

Payment under the Letter of credit is carried out right after the documents issued in full conformity with the conditions of the Letter of credit are presented to the bank, and the bank verifies them.

Letter of credit with payment extension

Payment is effected not right after the bank receives and verifies the documents, but after a certain period of time indicated in the Letter of credit. Such Letter of credit allows an extension of payment for the buyer, and guarantees to the seller that the money will be received at a certain moment.

Revolving (renewable) Letter of credit

A revolving (renewable) letter of credit is opened for a part of the contract value providing for restoration of the initial sum of the Letter of credit or another agreed amount after a certain period of time or after each use of the Letter of credit. There may be cumulative and non-cumulative revolving letters of credit. Cumulative letters of credit provide addition of the unused balance to the sum renewed, non-cumulative letters of credit are renewed only to the initial sum.

Revolving letters of credit are employed at settlements under contracts for large amounts with regular shipment of certain consignments (for example, at shipment of petroleum by tankers) to minimize costs.

Stand-by Letter of credit

Stand-by letters of credit are used to guarantee the contracting parties’ performance of their contractual obligations. I.e. this kind of the Letter of credit is used not as a settlement instrument, but as a tool for securing the obligations of the principal (applicant). Payment under the stand-by Letter of credit is always made against presentation of the documents indicated in the Letter of credit (usually these are the documents confirming the counterparty’s default under the contact). Provided that the beneficiary can take advantage of the Letter of credit at the principal’s defaulting under the contract. Such letters of credit are widely used in the USA and replace the guarantees common in Russia which according to the jurisdiction of most states of the USA cannot be issued by the banks. Canadian legislation also forbids the use of guarantees in the course of foreign trade activity.