Letters of Credit have been a cornerstone of international trade dating back to the early 1900s. They continue to play a critical role in world trade today. For any company entering the exporting market, Letters of Credit are an important payment mechanism to understand.
TD's Crash Course in International Trade offers more information, including the mechanics of a Letter of Credit.
What is a Letter of Credit?
A Letter of Credit, simply defined, is a written instrument issued by a bank at the request of its customer, the Importer (Applicant), whereby the bank promises to pay the Exporter (Beneficiary) for goods or services provided that the Exporter presents all documents called for, exactly as stipulated in the Letter of Credit, and meets all other terms and conditions set out in the Letter of Credit. A Letter of Credit is also commonly referred to as a Documentary Credit.
Parties to a Letter of Credit
Accepting Bank: The bank named in a term Letter of Credit on which drafts are drawn that has agreed to accept the draft. By accepting the draft, the Drawee Bank signifies its commitment to pay the face amount at maturity. After accepting the draft, the Drawee Bank becomes the Accepting Bank.
Advising Bank: The bank to which the Issuing Bank sends the Letter of Credit, with instructions to notify the Exporter (Beneficiary).
"Available with" Bank: The Bank authorized in the Letter of Credit to effect payment under, accept or negotiate the Letter of Credit.
Confirming Bank: The bank which, at the request of the Issuing Bank, adds its confirmation to the Letter of Credit. In doing so, the Bank undertakes to make payment to the Exporter upon presentation of documents under the Letter of Credit assuming all terms and conditions of the Letter of Credit have been met.
Drawee Bank: The bank named in the Letter of Credit on which the drafts are to be drawn.
Exporter/ Beneficiary/ Seller: The party that has contracted to sell goods.
Importer/ Applicant/ Buyer: The party that has contracted to buy goods.
Issuing Bank: The bank issuing the Letter of Credit at the request of its customer the Importer (Applicant) in favour of the Exporter (Beneficiary.
Reimbursing Bank: The bank designated in the Letter of Credit to reimburse the "available with" Bank which submits payment claims under the Letter of Credit.
Must-Know Facts About Letters of Credit
Can a Letter of Credit be amended or revoked without your consent?
Some Letters of Credit can be amended or revoked without the Exporter's consent. It depends on whether the credit is Revocable or Irrevocable. A Revocable Letter of Credit can be revoked without the consent of the Exporter, meaning that it may be canceled or changed up to the time the documents are presented. As a Revocable Letter of Credit affords the Exporter little protection, it is rarely used. On the other hand, an Irrevocable Letter of Credit cannot be canceled or changed without the consent of all parties, including the Exporter. Unless otherwise stipulated, all Letters of Credit are Irrevocable.
Does a Letter of Credit protect you from country risks (e.g. war, embargo) and/or Issuing Bank risks (e.g. bank failure, bank fraud)?
When a Letter of Credit is issued, the risk of payment has shifted from the Importer to the Issuing Bank. However, you still assume both Issuing Bank and country risks. In the case where the Issuing Bank is not considered an acceptable risk and/or the country where it is located has high political or economic uncertainty, you should consider requesting a Confirmed Letter of Credit. With a Confirmed Letter of Credit, another bank, known as the Confirming Bank, usually located in your country, will add its "confirmation" to the Letter of Credit. By adding its confirmation, the Confirming Bank undertakes to honour your claim under the Letter of Credit, assuming all terms and conditions of the Letter of Credit are met. The risk of payment is now assumed by the Confirming Bank, as well as the Issuing Bank, thereby providing you more protection.
How to get a Letter of Credit Confirmed
An Exporter who decides to have a Letter of Credit confirmed should inform the Importer to instruct the Issuing Bank to issue an Irrevocable Letter of Credit requesting a confirmation. For a bank to add its confirmation, the Letter of Credit must state that a confirmation be added. It is recommended that you check with your own bank prior to the issuance of the Letter of Credit as to whether it is prepared to add its confirmation, should it be requested to do so by the Issuing Bank. To make this decision, the bank will need preliminary information about the Letter of Credit such as the name of the Issuing Bank, country of issuance, expiry date and amount.
Are there agreed-upon, international standards for transactions involving Letters of Credit?
The International Chamber of Commerce (ICC) publishes internationally agreed-upon rules, definitions and practices governing Letters of Credit, called "Uniform Customs and Practice for Documentary Credits" (UCP). The UCP facilitates standardization of Letters of Credit among all banks in the world that subscribe to it. These rules are updated from time to time; the last revision became effective January 1, 1994, and is referred to as the UCP 500. Copies of the UCP 500 are available from your TD branch or your nearest TD International Trade Services office.
Step-by-Step Process for the Exporter
The following is a detailed explanation of the process you, as an Exporter, follow when named as a Beneficiary under a Letter of Credit. In this explanation, TD is acting as the Advising Bank and Confirming Bank.
- There are several different ways to notify you that a Letter of Credit has been issued in your favour. TD's Export Letter of Credit Department will call you directly and obtain instructions as to how you would like to receive the Letter of Credit. The choices include:
- Faxing a copy of the Letter of Credit.
- Sending the original Letter of Credit by courier or mail.
- Electronically downloading the content of the Letter of Credit via our Facilitrade software to your PC, allowing you to print your own copy of the Letter of Credit. Our Facilitrade software even allows you to electronically forward the contents of the Letter of Credit to your Freight Forwarder. Click here for more information on Facilitrade.
Please note that an Exporter does not have to be a TD Bank customer to be advised of a Letter of Credit through the TD Bank.
- Upon receipt of the Letter of Credit, you should read it carefully paying close attention to all terms and conditions to ensure they can be met. Accompanying the Letter of Credit is a covering letter which includes the address of TD's International Trade Services office and the appropriate phone numbers to call with any questions regarding the Letter of Credit. Click here for a sample Letter of Credit in SWIFT format.
- If any of the terms and conditions in the Letter of Credit differ from the sales contract between you and the Importer, you should ask the Importer for an amendment to the Letter of Credit. It is recommended that shipments not be made against the Letter of Credit until all amendments have been received.
- Once the terms and conditions of the Letter of Credit meet your satisfaction and shipment is made, all documents requested in the Letter of Credit must be prepared or obtained. You forward these documents, along with the draft (if required) and the original Letter of Credit, to TD's International Trade Services office listed in the covering letter.
- TD checks these documents to ensure they meet the terms and conditions outlined in the Letter of Credit. If the documents contain discrepancies, TD will discuss how they may be corrected as well as what other options are available.
- When the documents are in order, payment under the Letter of Credit is made to any bank account you designate. In the case of a term Letter of Credit, payment will be made on the maturity date of the accepted draft, although TD would be willing to discuss with you discounting such a term payment.
What an Exporter Should Look for when Reviewing a Letter of Credit
- Which Bank issued the Letter of Credit? (Letter of Credit Header under "Received From:") Is this bank a reputable one that can be relied on for payment? (Contact TD's local International Trade Services office if unsure). Does the country in which the Issuing Bank is located have a stable economic and political environment? If not, does the Letter of Credit allow for confirmation by another bank in another country? (SWIFT FORMAT, Field 49)
- Is the L/C irrevocable? (Field 40A) If it is not stated, the Letter of Credit is irrevocable.
- Are the Importer's (Applicant's) name and address spelled correctly? (Field 50)
- Are your name and address spelled correctly? (Field 59)
- Are the dollar amount and currency of the Letter of Credit correct? (Field 32B)
- Does the payment term agree with the sales contract? (Field 42C)
- If necessary, are partial shipments allowed? (Field 43P)
- Are the points of shipment (Field 44A) and destination (Field 44B) as agreed?
- Is it possible for you to meet the latest shipping date? Are enough days allowed to present documents? (Field 48) You may need to check with the Freight Forwarder handling the shipment and preparing the documents for you.
- Is the merchandise description correct and if needed, does it include unit price, weight and quantities? (Field 45A) If necessary, does the Letter of Credit allow for any leeway on the quantity and/or dollar amount?
- Are the terms of the sale regarding insurance and freight charges as agreed? (Field 45A)
- Can all documents listed in the Letter of Credit be obtained? (Field 46A) See Document Preparation Checklists for further information.
- Which party is responsible for the Letter of Credit banking charges? (Field 71B)
- Where is the Letter of Credit payable? (Field 41D) Note, this will affect the length of time required to receive your funds.
- Is the Letter of Credit confirmed? (Field 49)
After reviewing the Letter of Credit, if you find any terms and conditions that are not to your satisfaction, you must ask the Importer (Applicant) to instruct the Issuing Bank to make the necessary amendments to the Letter of Credit. It is recommended that you do not proceed with shipment until such amendments are received.
Document Preparation Checklists
The following checklists are intended to provide you with simple guidelines for document preparation. Note that in addition to checking the documents for inconsistencies with the Letter of Credit, the "available with" Bank checks for inconsistencies between documents.
It is recommended that Exporters unfamiliar with such documents use or consult with a reputable freight forwarder. Since payment to you depends on the documents being in exact accordance with the Letter of Credit, the preparation of these documents is an extremely important part of the Letter of Credit process.
Draft
A Draft, also known as a Bill of Exchange, is a legally enforceable instrument, which is regarded as the formal evidence of debt under a Letter of Credit. An academic definition is an unconditional order in writing addressed by one person to another, signed by the person giving it, and requiring the addressee to pay at a fixed or determinable time a certain sum of money to the order of a specified party. A draft must be presented with all other documents requested in the Letter of Credit, unless stipulated otherwise. Drafts may be obtained from any of TD's International Trade Services offices.
How to Complete a Draft
1. If a specific date of payment is in the Letter of Credit, it must be entered here.
2. Payment term e.g. "at sight", "30 days after sight", "60 days after Bill of Lading Date" (Field 42C).
3. Date you present documents to the "available with" Bank.
4. Dollar amount of the Draft written out in words along with the currency.
5. Dollar amount of the Draft in figures along with the currency
6. Letter of Credit number assigned by the Issuing Bank. (Field 20)
7. Date the Letter of Credit was issued. (Field 31c)
8. Name and address of the Issuing Bank. (Listed in the Header under "Received From")
9. Name and address of the bank on which the Drafts are to be drawn. (Field 42D) If it states "yourselves", it is drawn on whichever of TD's International Trade Service offices that advised the Letter of Credit.
10. Signature of an authorized signing officer of the Company. The Beneficiary's name as shown on the Letter of Credit must be spelled out below the line.
Commercial Invoice
The Commercial Invoice is the accounting document through which you charge the importer for goods and services purchased. The Invoice gives details about the goods and/ or services (size, quantity etc.) as well as the trade terms (C.I.F., F.O.B. etc.).
- Does the merchandise description -- including weight, quantity and price --conform exactly with the Letter of Credit and other documents?
- Are the name and address of you and the Importer exactly as shown in the Letter of Credit?
- Have the correct number of copies been presented and signed if required?
- Is it made out in the same currency as the Letter of Credit?
- Is the trade term listed, e.g. C.I.F.? Click here for a list of commonly used trade terms/incoterms.
Transport Document
(commonly referred to as a "Bill of Lading") A Transport Document (e.g. Bill of Lading, Airway Bill, Railway Consignment Note) is a document issued by the carrier that describes the goods that have been accepted for carriage. In some forms, the Bill of Lading may also act as a document of title to the goods.
- Has it been submitted with all the required originals?
- Is the merchandise description consistent with the Letter of Credit?
- Are the points of loading and discharge consistent with the Letter of Credit?
- Is the Bill of Lading consigned to the order of the party specified in the Letter of Credit?
- Is it dated on or before the latest shipment date stipulated in the Letter of Credit?
- Is the Bill of Lading endorsed correctly?
- If the Letter of Credit states freight is to be prepaid, is this clearly indicated on the Bill of Lading?
Insurance Document
Under the Insurance Document, the shipment of goods is guaranteed in part or in whole -- depending on the terms and conditions -- by an insurance company. The Insurance Document will specify the goods shipped on a named vessel, will briefly indicate the applicable coverage, and show to whom loss is payable.
- Is the Insurance Document a certificate or policy, as called for in the Letter of Credit?
- Does the Insurance Document cover all risks specified in the Letter of Credit?
- Is a sufficient amount insured to meet the percentage requirement of the Letter of Credit, and is it in the currency of the Letter of Credit?
- Is the issue date of the Insurance Document prior to the shipment date of the goods?
- Is the Insurance Document signed by or endorsed in blank by the insured or endorsed to the order of the party designated in credit?
- Is the Insurance Document signed by the insurance company, underwriter or agent?
- Is the merchandise described as per the Letter of Credit?
Certificates of Origin and Inspection
The Certificate of Origin notes the country where the goods were produced. The Certificate of Inspection offers an opinion that specified, quality and quantity related conditions have been met.
- Are the documents dated on or before the Bill of Lading date? Make sure they are!
Packing and Weight Lists
A Packing List is usually supplied by the exporting shipper in cases where a diversified shipment is packed in several packages. The list will show the contents of each box or case identified by a specific number. A Weight Certificate is supplied by you, the Exporter, at the request of the Importer. It certifies the weight of each large unit in a shipment or the net and gross weights of packages containing smaller units. It is of particular value when the price of the goods is based on weight and, also, is often used by the carrier in arriving at the weight to be recorded on the Bill of Lading as a basis for the freight charges.
- Does the quantity of units/weights match that which is indicated in the Commercial Invoice?
- Is the breakdown of merchandise/weight per carton shown if requested in the Letter of Credit?
Advantages & Disadvantages of a Letter of Credit
Advantages to the Exporter
- Shifts credit risk from the Importer to the Importer's Bank (Issuing Bank).
- An undertaking from the Issuing Bank that payment will be made under the Letter of Credit, provided that you meet all terms and conditions of the Letter of Credit.
- If the Letter of Credit is not issued as agreed, you are not obligated to ship against it.
Disadvantages to the Exporter
- Documents must be prepared in strict compliance with the requirements stipulated in the Letter of Credit. Non-compliance leaves you exposed to risk of non-payment and removes the protection afforded by the Issuing Bank since the final decision on the documents then rests with the Importer.
Questions Exporters Commonly Ask About Letters of Credit
Amendments
Q: I have received a Letter of Credit, but it does not meet the sale terms agreed upon. What should I do?
A:If the Letter of Credit is not acceptable to you, you should request an amendment to the Letter of Credit from the Importer. If the Importer does not agree to the request for amendment, you may refuse to ship against the Letter of Credit and simply let it expire unused.
Reimbursing Bank Charges
Q: I just received a list of charges for a Letter of Credit that I presented documents under. What are Reimbursing Bank charges?
A: A Reimbursing Bank is one authorized by the Issuing Bank to effect the transfer of funds between TD and the Issuing Bank. It may be necessary to have a Reimbursing Bank involved because reimbursement is in a foreign currency or because the Issuing Bank and TD do not share settlement accounts. The Reimbursing Bank will charge a fee to facilitate the payment. This fee is your responsibility if the Letter of Credit states that all charges outside of the Importer's country will be paid by the Exporter.
Advising & Negotiating the Letter of Credit
Q: I received a Letter of Credit advised by a Canadian bank other than TD. Can I still negotiate my documents with TD?
A:If the Letter of Credit states that it is "negotiable with any bank", then you may negotiate your documents with TD. This information is found in the Letter of Credit SWIFT format in field 41D "Available with...". In order to do so, you must have a copy of the original Letter of Credit.
The Uniform Customs and Practice for Documentary Credits (UCP 500)
Q: How do I get a copy of the Uniform Customs and Practice for Documentary Credits (UCP) 500, (1993 revision)?
A:You can obtain a copy from your local TD branch or from a TD International Trade Services office.
Avoiding Discrepancies
Q: Because Letters of Credit can be so complicated, discrepancies seem almost unavoidable. Is there a way to convey my Letter of Credit requirements to the Importer simply and clearly?
A:As an Exporter, you can be proactive and tell your customer (the Importer) exactly what terms and conditions you require in a Letter of Credit. You can communicate these terms and conditions by using a TD Letter of Credit Issuance Instructions form. While this will not guarantee the Letter of Credit will arrive exactly as you specified, it can help avoid misunderstandings between you and the Importer. Click here for a copy of the Letter of Credit Issuance Instructions form (p. 22 of TD's L/C Guide book, available at branches or your nearest TD Trade Service Office).
Dealing with Non-Correctable Discrepancies
Q: Due to unavoidable circumstances, the shipment was delayed. Having violated the terms of the Letter of Credit (late shipment), is there any chance I might get paid under the Letter of Credit?
A: Late shipment is known as a non-correctable discrepancy. However, there is still a chance that you might be paid. As the Exporter, you can follow one of three routes:
Option 1. Forward Documents on Approval -- TD sends the documents to the Issuing Bank at your risk, noting the relevant discrepancies. When the documents are received by the Issuing Bank, they will be checked and the discrepancies referred to the Importer for acceptance. Meanwhile, the documents will not be released to the Importer until the Issuing Bank receives the Importer's approval of the discrepancies. Once this occurs, payment will be made under the Letter of Credit.
This route is often chosen when it is expected that the Importer will approve the discrepancies. It may also be that the shipment has already arrived or is about to arrive and you do not want the shipment to incur a demurrage charge.
Option 2. Cable for Approval -- TD sends a telex or SWIFT message to the Issuing Bank requesting authority to negotiate the documents, noting the discrepancies found. The Issuing Bank, in turn, will notify the Importer of these discrepancies. The Importer will then indicate to the Issuing Bank whether the documents are acceptable with the discrepancies noted. If authorization to waive the discrepancies is received by TD from the Issuing Bank, TD will send the documents to the Issuing Bank and payment will be made according to the Letter of Credit terms assuming there are no additional discrepancies.
Option 3. Indemnity -- In certain situations you may provide TD with an acceptable Indemnity Agreement for the discrepancies. Such indemnity enables TD to effect payment immediately, even though there are discrepancies in the documents. If documents are not accepted by the Importer, TD has the right to claim the funds back from you under the Indemnity Agreement.
In any case, it is advantageous for you to advise the Importer directly of the discrepancies to ensure a quick response when the Importer is contacted by the Issuing Bank.
Dealing with Correctable Discrepancies
Q: The TD trade professionals noticed a discrepancy in my invoice. Does this mean I won't get paid?
A: There are certain discrepancies that you or the freight forwarder may correct, either by amending the original documents or by replacing them with new ones. The Commercial Invoice falls in this category. If there is a discrepancy in a document issued by a third party -- such as the Certificate of Origin -- then the document must be returned to the issuing party for correction.
Discounting Acceptances
Q: My Letter of Credit matures in 90 days. Is there a way to collect payment under the Letter of Credit sooner than the maturity date?
A: Instead of waiting until the maturity date of an Acceptance to obtain your funds, you may approach TD to have the accepted draft "discounted" at prevailing discount rates. This allows you, the Exporter, to collect your funds, net of discount charges, as soon as the draft has been accepted. To discount an Acceptance, a formal request is made to the TD Bank or any other bank. This request can be made at any time prior to the maturity of the Acceptance.
In addition to receiving funds prior to the maturity date, another advantage to discounting is that the discount rate is based on the risk of the Accepting Bank and, therefore, may be lower than the your borrowing rate.
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