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Five points to consider for a workable Letter of credit

Published on January 17, 2023 by Mansi Thakur

Banks often get complaints from clients that letters of credit (LC) are not workable, or their clauses are ambiguous, making it difficult to understand requirements fully or meet all the requirements; this has resulted in loss of USD50-100 as discrepancy charges each time documents are presented under LC.

This not only leads to further amendments and delay, but also affects the relationship between the parties concerned, and clients start looking for banks that can understand their pain and resolve these issues.

The LC- issuing bank is responsible for issuing workable LCs to ensure execution of smooth trade cycle and client satisfaction. A workable LC refers to one where the beneficiary is paid on presentation of complying documents that do not depend on other requirements being met.

Example: The LC should not contain incorrect international commercial terms (incoterms), and the documents called for under the LC should correspond to the incoterms incorporated in the LC.

Points to keep in mind when issuing LCs:

1. Non-documentary conditions:

The LC must refer/be linked to all documents required for meeting conditions stated under LC Field 46A. Otherwise, the applicant would have to bear the risk of the ambiguity.

UCP 600 states that, “If a credit contains a condition without stipulating the document to indicate compliance with the condition, banks will deem such condition as not stated and will disregard it.”

Example:  Field 46A states that the clause “CERTIFICATE OF ORIGIN (A-K FORMS) SHOULD BE SENT DIRECTLY TO THE NOTIFY PARTY BY EXPRESS COURIER MAIL” is a non-documentary condition and does not refer to a document that needs to be presented under F.46A. Banks would disregard this condition, in line with UCP 600 sub-article 14 (h).

2. Clear definitions, plain structure, non-ambiguous clauses:

Ambiguity, abbreviations and an unstructured LC lead to misunderstanding and disagreement between the parties concerned. Issuing banks should, therefore, avoid including terms and conditions that are ambiguous in nature and could mean different things, They should also discourage clients from including excessive details in LCs. LCs must be precise and should not contain nested clauses.

Example: Virgules [i.e., slash marks (/)] may have different meanings and should not be used as a substitute for a word. If, however, a virgule is used and no context is apparent, this would enable the use of one or more of the options. For example, a condition in an LC that states “pink/brown/green” with no further clarification could mean only pink, only brown, only green or any combination of these colours.

3. Unnecessary administrative steps:

LCs mentioning detailing administrative steps does not hold any importance in the trade cycle and would have no impact on the underlying transaction. Such clauses should not be incorporated in LC. Example: LC under Field 46A called for a shipping advice (a document containing specific shipping details) to be faxed to the applicant within X number of days after shipment. However, LC often omit to indicate the fax number.

4. Joker clauses

: Clauses where the applicant has control over the presentation of a document are called joker clauses. Banks must avoid incorporating clauses that require documents to be issued, signed, or countersigned by the applicant; certificates to be issued by a representative or agent of the applicant; and certificates to be issued and/or signed by the applicant.

Example: Documents providing evidence that goods have cleared customs at the port of destination and a confirmation from the applicant that the goods have been received in good condition

5. Inoperative clauses:

Incorporating clauses that make the LC depend on other variables or instruments results in losing the essence and individual functionality of LC. Example: “This LC will be operative in the event the performance bond (bank guarantee) issued by the beneficiary bank covers at least 2% of the credit amount.". This condition makes the LC inoperative, as the performance bond needs to be issued to make the LC effective.

How Acuity Knowledge Partners can help

1.Our subject-matter experts prepare workable and well-structured LCs. They hit the ground running and concentrate on risk management and strategic decision making. 2.We provide clients with a robust hybrid model, helping them reduce costs, increase productivity, and improve end-client experience. 3.Our flexible engagement model helps clients streamline existing functions.

4.Risk management and governance – we operate in a controlled environment that guarantees the appropriate segregation of duties and delegation of authority. 5.Stringent service-level agreements for all key operations these ensure both efficiency and effectiveness, helping augment the client experience.



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About the Author

Mansi Thakur has pursued Post Graduation in International Business & Finance from IIFT, Delhi.She is a CDCS-certified professional with 12 years of rich experience in the Trade Finance domain, customer service & relationship management.She has rich experience of working with both Indian & MNC banks and handling all Trade finance products for Wholesale & Corporate customers.

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