International documentary business

,

Documentary letters of credit

Documentary letters of credit offer the highest level of protection when payments are made in international trade. When applied correctly, documentary letters of credit protect importers and exporters from risk and balance the interests of both parties. This is particularly true when it comes to new business contacts. Behind every documentary letter of credit stands a bank (or several banks), promising to make payment to an exporter as soon as that exporter has fulfilled obligations that have previously been meticulously agreed on in a contract. Documentary letters of credit not only provide protection, they also fulfil a financing function as exporters can grant their customers generous terms of credit without having to wait too long for their money – by turning their claim into liquidity before the letter of credit is due.

Documentary letters of credit are important tools for processing, protecting and financing international trade. They eliminate certain risks for the parties to a trade: a bank (the "issuing bank" or "opening bank") contractually agrees to pay the seller ("exporter") a certain amount in a certain currency on a certain date on behalf of, for account of and in accordance with the instructions from the buyer ("importer"), in return for the delivery of certain documents matching the specifications set out in the letter of credit. Buyers often use the term "import letter of credit", reflecting their point of view, while sellers refer to these instruments as "export letters of credit".

• Importer and exporter agree on the delivery of machinery. Because it is the first time the two parties are doing business together, they agree on the following terms of payment: the importer is to open a letter of credit with their principal bank – the "issuing" or "opening" bank – for the benefit of the exporter and available by sight payment with Commerzbank. With the opening of the letter of credit, the issuing bank makes a non-accessory undertaking to pay.
• The exporter reviews the letter of credit and then ships the machinery to the importer.
• The exporter presents the documents required as per the letter of credit to their advising bank – Commerzbank – that checks these documents for compliance with the terms and conditions of the letter of credit.
• Commerzbank provides the complying documents to the issuing bank.
• The issuing bank checks the documents and informs the importer.
• Once the issuing bank has obtained payment from the importer, it releases the documents to the importer, who is then able to dispose of the machinery.
• The issuing bank passes the payment on to Commerzbank.
• The exporter receives payment from Commerzbank.

In the case of unconfirmed letters of credit, the buyer's issuing bank assumes the obligation to make the payment, while the seller's advising bank does not incur any obligation. In the case of confirmed letters of credit, the advising bank enters into a payment obligation of its own on behalf of – or on authorisation by – the issuing bank, providing the seller with extra protection. Yet another type is a letter of credit with a silent confirmation. This means that the advising bank enters into an irrevocable payment obligation on the request of the buyer, but without the issuing bank or the issuing bank's principal being aware of this commitment.

Every letter of credit must specify the conditions that must be fulfilled for the letter of credit to become available (meaning that it can be drawn upon). There are various options:

• Sight letter of credit
  The bank releases payment to the seller as soon as the complying documents are presented, i.e. without delay.
• Usance letter of credit
  Usance letters of credit, also known as deferred payment letters of credit, differ from sight letters of credit in that the seller does not receive the equivalent of the complying documents presented without delay, but at a later, specified date (e.g. 60 days after bill of lading date).
• Acceptance letter of credit
  The issuing bank is required to accept a bill of exchange, drawn by the beneficiary, when the complying documents are presented. The buyer acknowledges the payment request with their signature; this acknowledgement is binding. The seller receives payment on the due date of the bill of exchange.
• Negotiation
  Negotiation means the purchase of drafts and/or documents under a complying presentation. If a letter of credit becomes available by negotiation, the negotiating bank – acting on behalf of the issuing bank – can pay the seller before reimbursement is due.