Letter of Credit have been a cornerstone of international trade for many years. They continue to play a critical role in world trade today. For any company entering the international market, Letters of Credit are an important payment mechanism to understand.
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 to anyone who presents it 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 Confirming Bank undertakes to make payment to the Exporter 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
What is the difference between Revocable and Irrevocable Letters of Credit?
A Revocable Letter of Credit may 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.
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 amongst 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 Importer
The following is a guide to the process you, as an Importer, follow when acting as the Applicant for a Letter of Credit. In this explanation, TD is the Issuing Bank.
- Once TD has established a line of credit for you to issue a Letter of Credit, you must complete an "Application for Irrevocable Documentary Credit" and deliver it to TD either manually or using TD's automated Facilitrade system. Click here for Instructions for Completing an Import Letter of Credit Application Form. (Click here to download TD's application form)
- To ensure a smooth transaction, be sure that you and the Exporter are in agreement with the terms of the Letter of Credit before you complete the Letter of Credit Application. If you are unfamiliar with any of the documents mentioned in the Application (see sample of Application) and require further explanation than provided here, contact a TD Trade Services specialist. Also, it is advisable to consult a customs broker for specific information on what documents are necessary in order to clear your goods through Canada customs.
- Your next step depends on whether the Exporter agrees to ship against the Letter of Credit as issued or requests an amendment to it. If the Exporter is satisfied with the terms of the Letter of Credit, shipment should be effected against the Letter of Credit.
If, on the other hand, the Exporter doesn't agree with the terms of the Letter of Credit, you will likely receive a request for an amendment. Any change to an issued Letter of Credit is known as an amendment. In order to issue an amendment, you, as the Importer, must obtain the "Application for Amendment to Documentary Credit" form from a TD branch. It is on this form that any changes required to the Letter of Credit are listed. More than one change can be accommodated in one amendment. Once completed, the form must be forwarded to the same branch from which you requested the original Letter of Credit. Once processed, the TD International Trade Services office will send the amendment through the Advising Bank for delivery to the Exporter.
Please note that any amendments to the Letter of Credit must be accepted by the Exporter. If more than one item in the Letter of Credit is amended, e.g. the amount and shipping date are changed, all must be accepted as opposed to accepting or rejecting individual items within the amendment.
The amendment process can be carried out electronically through Facilitrade. Ask a TD International Trade specialist about Facilitrade!
Instructions for Completing an Import Letter of Credit Application
Detailed instructions follow for the completion of the Application.(click here to download TD's application form). If you are interested in obtaining instructions for using TD's automated system Facilitrade, click here.
- Branch. Complete address of the TD Branch of Account for your line of credit.
- Enter date of the Application.
- Expiry date. Enter the expiry date of the Letter of Credit.
Note: In determining the expiry date of a Letter of Credit, you must allow enough time for the Exporter (Beneficiary) to effect the shipment and present the documents required in the L/C. The general rule is to take the Latest Shipping Date (K) and add the number of days the Exporter is allowed to present the documents (Q). Example: If the Latest Shipping Date is November 1 and 10 days are allowed to present documents, then the Expiry Date of the Letter of Credit would be November 11.
- Applicant. Enter your name and address exactly as they appear on your line of credit.
- Beneficiary. Enter the name and address of the Exporter.
- Indicate the method by which TD should send the Letter of Credit to the Advising Bank. It may be sent at your option by mail or teletransmission depending on the urgency of the situation. For a small cost, teletransmission enables your Letter of Credit to be received faster by the Beneficiary and is the method most commonly used.
- Currency & Amount. Enter the currency and maximum amount that can be drawn under the Letter of Credit.
Note: Writing the words "about", "approximately" or "circa" before the amount indicates that the amount may vary within 10% more or less of the specified amount. Variance is not restricted only to the percentages indicated above; you may choose any other variances, e.g. +/- 15%. Further information regarding variances is detailed under Goods (M).
- Partial Shipments. Check the appropriate box to indicate if you will allow partial shipments to take place under the Letter of Credit.
Transhipment. Indicate whether transhipment is allowed. Your choice depends on the method of shipment/transport document used. Generally, transhipment means that during the course of voyage merchandise is unloaded and reloaded from one vessel to another vessel or from one mode of transportation to another. Transhipment must be allowed for multimodal and air transport documents.
Examples of Transhipment: 1. A shipment is destined for the Philippines but there is no carrier available to go directly to the Philippines. It must first stop in Japan and be transferred to another carrier destined for the Philippines. 2. A shipment is destined from the port of Hong Kong to Calgary, Alberta. First it travels by ocean carrier from Hong Kong to Vancouver, B.C. and then must be transferred onto a truck destined for Calgary.
- Transferable Credit. Indicate if the Letter of Credit may be transferred to another party.
- Available against Documents detailed herein:
If a draft is required, check the box "and the Beneficiary's draft". The majority of Letters of Credit do require a draft.
And Beneficiary's Draft: The document that represents the demand for payment that the Exporter (Beneficiary) makes on the bank. Generally, a Beneficiary's draft is always required as evidence that a drawing has been made by the Beneficiary under the L/C.
The use of drafts is not common in all countries. Sometimes a draft is avoided due to the excise stamp duty that may apply. While the absence of a draft does not change anything in the case of sight payments under Letters of Credit, the situation is slightly different when a term payment is used. In this case, settlement is defined as a "Deferred Payment".
Indicate which one of the following payment terms applies to the L/C.
At sight. Payment is made upon presentation of stipulated documents. This payment term is very commonly used.
__ Days After Sight or __ Days after Date of __. The Exporter may agree to provide extended payment terms such as "payable 60 days after sight" or "30 days after Date of Bill of Lading". This is referred to as a term payment, in this case, payment will be made on the maturity date of the accepted draft.
- Shipment From. Indicate the name of the place/port from which the goods will be shipped.
For Transportation to: Name of the place/port to which the goods will be shipped.
Not Earlier Than: If specified, goods cannot be shipped earlier than this date.
Not Later Than: The latest mutually acceptable date for the shipment to be made. Commonly known as the "Latest Shipping Date".
- Insurance. Indicate whether you, the Applicant, or the Shipper (Exporter/Beneficiary) is responsible for insuring the goods. Keep in mind, this must coincide with the trade term (N).
- Goods. Enter a brief description of the merchandise. The common practice is to use a Purchase Order or Proforma Invoice number. Example: Men's shoes as per Purchase Order #23456. Including excessive detail does not give you more protection against inferior or defective goods shipped since, as mentioned earlier, banks deal in documents and not in goods.
Variances: A variance of 5% more or 5% less will be allowed as long as:
- the merchandise description is not stated in number of packing units or individuals items;
- the amount of the L/C is not exceeded; and
- the L/C does not stipulate that the quantity of goods specified must not be exceeded or reduced.
Variance is not restricted to 5%; you may specify another variance, e.g. +/- 15%.
- Trade Terms. Indicate the trade terms that apply. These trade terms are commonly referred to as Incoterms. They determine the obligations of the Exporter and Importer with respect to freight costs, insurance, taxes, duties, etc. These terms are issued by the International Chamber of Commerce.
Example: If the trade term is F.O.B. (Free on Board) Kaoshiung, Taiwan, it will be marked "Freight Collect" on the transport document, since the Importer (Applicant) is responsible for paying all freight charges and insurance from Kaoshiung, Taiwan to the point of destination.
Click here for definitions of commonly used Incoterms, or contact the International Chamber of Commerce directly and ask for the "Guide to Incoterms" publication.
- Documents Required. The documents you choose will be determined in the contract between you and the Exporter and will largely depend on how the goods will be transported -by sea, by truck, by rail, by airplane or a combination thereof. Once you have identified the relevant transport documents, you may be asked to fill in one or more of the following details depending on the type of transport document selected:
Issued by: You may specify who is to issue the transport documents.
Marked Freight Prepaid or Collect: Check the appropriate box as to whether the freight charges will be prepaid by the Exporter or if they are your responsibility and are therefore collect. This should be consistent with the trade term used in Section (N).
Notify: Name the party to be notified once the goods arrive at the destination point.
Click here for a Guide to Commonly Requested Documents.
- Special Conditions
Indicate whether any special conditions apply.
Transport Documents issued by Freight Forwarders acceptable. Exporters sometimes use the services of a freight forwarder to transport the goods and, therefore, prepare the documents related to the shipment. Indicate here whether documents prepared by a freight forwarder are acceptable to you.
Please Advise Beneficiary by Phone or Fax. If it is urgent that the Beneficiary be notified immediately of this L/C, please include instructions as to whom the Advising Bank must call or fax upon receipt of the L/C.
- Documents to be presented within... Indicate the number of days after shipment in which the Exporter is allowed to present documents to the "available with" Bank. The shortest presentation time possible is recommended to ensure your receipt of the documents prior to the arrival of goods at their destination.
- Banking Charges. Indicate who will pay the Exporter's banking charges, along with the charges of any other bank outside of Canada that is used in the transaction, such as the Reimbursing Bank, etc. It not uncommon for all banking charges outside Canada to be for the Beneficiary's account. Note that the Issuing Bank charges are often the responsibility of you, the Applicant.
- Your TD branch must insert the date that you signed the Continuing Documentary Credit Agreement. Two authorized TD officers must also sign.
- Your company name must be typed/printed in full, and, if the applicant is a company, the company's signing officers must sign the Application.
Once your TD branch has received the Application, it will be forwarded to the nearest TD International Trade Services office. You can feel secure knowing that the Application will be closely reviewed, and any clarifications will be discussed with you.
Guide to Commonly Requested Documents
Commercial Invoice
The Commercial Invoice is an accounting document through which the Exporter claims payment from you, the Importer, for goods and services purchased. It provides details about the goods and/ or services (size, quantity etc.) as well as the trade terms (CIF, FOB etc.). The Commercial Invoice is normally required for any transaction. On the Application, indicate whether you require original signed copies of the commercial invoice or simply copies of the original. You must also stipulate the number of copies that are required.
TRANSPORT DOCUMENTS
The following are simple guidelines to assist you in making your selection. It is advisable that you refer to the UCP 500, Articles 23-33 for more detailed information. This document is available on request at the nearest TD International Trade Services office.
In general, a transport document provides evidence the carrier has received the goods it is responsible to ship. Some transport documents, such as a Marine/Ocean Bill of Lading, also carry title to the goods. A transport document is negotiable if it transfers title to the goods.
Marine & Multimodal Transport
If the method of transportation includes an ocean vessel, place a check mark in the box labeled "Full set of" referenced in Section O of the Instructions for Completing an Import Letter of Credit Application, and indicate which of the following two documents is required:
- Multimodal Transport Document: For shipments using more than one mode of transportation, e.g. ocean vessel and truck.
- On Board Marine/Ocean Bill of Lading. Used for ocean shipments from one ocean port to another. For a city to be considered a port, it must be accessible by ocean vessel year round.
Air Transport
An Air Transport Document is used when the shipment is by air. This is a non-negotiable document; therefore, it does not carry title to the goods. You must indicate to whom the goods are being consigned, e.g. yourself(Applicant) or TD.
Land Transport
If the goods are transported either by truck or rail or both, check the box marked "Trucking/Rail Bill of Lading consigned to __" referenced in Section O of the Instructions for Completing an Import Letter of Credit Application. These bills of lading are non-negotiable and are usually consigned to you, the Applicant, but may be consigned to another named party.
Insurance Documents
Policy/Certificate. This document must be requested if the Exporter is responsible for arranging for the insurance on the shipment. It is recommended that the minimum amount of insurance be for 110% of the invoice value. You must also state what risks the insurance policy is covering. A standard insurance policy will cover "all risks". The term "all risks", however, does not mean that all risks are covered. Certain risks such as war, strikes and riots are not included and must be specifically requested. Refer to the UCP 500, Articles 34-36 for detailed information regarding insurance. Contact the nearest TD International Trade Services office for a copy. It is also recommended that you seek professional advice from your insurance broker or agent.
OTHER DOCUMENTS
You may request documents other than those listed above. For all documents in this category, you must stipulate which party will issue the document as well as the wording of the document, otherwise it will be accepted as it is presented. The following is a list of commonly used documents that fall into this category.
Generalized System of Preference Certificate of Origin Form "A". This document certifies the country of origin of the goods being shipped and may provide you with a preferential duty rate. Indicate how many copies are required. You should contact Canada Customs or your Customs broker for information regarding whether this document is required.
Packing List. A Packing List is usually supplied by the Exporter in cases where a diversified shipment is packed in several packages. The list will show the contents of each box or case, which will assist you in the inventory and distribution of the merchandise.
Canada Customs Invoice. Imports into Canada require that a Canada Customs invoice be presented to customs. This invoice may be prepared by you; however, it may be called for in an L/C for the Exporter to prepare. If this document is being requested, you must indicate how many copies you require.
Inspection Certificate. An Inspection Certificate may be requested to be issued from a third party or your agent located in the country of dispatch, to verify the quality of the goods. Specify the issuer of such a Certificate under the heading "Inspection Certificate issued by__". You may also wish to include the content or wording of the Certificate or banks will accept the document as presented.
Weight List. A Weight List 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.
Advantages and Disadvantages of a Letter of Credit to the Importer
Advantages:
- You are assured that, for the Exporter to be paid, all terms and conditions of the Letter of Credit must be met.
- You may have the ability to negotiate more favourable terms with the Exporter when payment by Letter of Credit is offered.
Disadvantages:
- A Letter of Credit assures correct documents but does not guarantee correct goods. Consequently, it is important that you perform the appropriate due diligence to assess the reputation of the Exporter. If the Exporter acts fraudulently and does not ship the goods agreed upon, the only recourse available to you is through legal proceedings. Note: Added protection may be provided by requesting additional documentation in the Letter of Credit, e.g. a Certificate of Inspection.
Questions Importers Commonly Ask About Letters of Credit
Expiry Date
Q: When the Letter of Credit expiry date is set, should enough time be allowed for the goods to reach me or for payment to be made when extended payment terms have been negotiated (e.g. 60 days after sight)?
A: No. The expiry date should simply allow the Exporter sufficient time, after the latest shipping date, to present documents to the "available with" Bank. In a Letter of Credit, you are not allowed the opportunity to inspect the goods prior to paying for them. Keep in mind that banks deal only in documents and not in goods.
Quality of Goods
Q: Is there any way that I can protect myself from receiving inferior quality goods by using a Letter of Credit?
A: Yes. This can be done by requesting appropriate third party documents to be submitted under the Letter of Credit that would evidence shipment of the proper goods, e.g. Inspection Certificate, Health Certificate, Agent's Certificate, etc.
SWIFT Transmission of the Letter of Credit
Q: How quickly will the Exporter receive my Letter of Credit?
A: Once the Letter of Credit Application form is received by TD's International Trade Services office, usually the Letter of Credit will be issued within 24 hours. If it is sent by teletransmission as requested in the Application, the Advising Bank will receive advice the same or next business day depending on time zones. The Advising Bank then controls how quickly the Letter of Credit is sent to the Exporter. If it is urgent that the Exporter (Beneficiary) receive advice of the Letter of Credit immediately, we recommend that you include instructions in the Application to notify the Beneficiary by phone or fax. Make sure you include the relevant contact numbers.
Cost
Q: What is the cost to issue a Letter of Credit?
A: The fees vary based on the dollar amount of your Letter of Credit and the length of time it is outstanding. You should contact your TD branch for a Schedule of Fees and Charges.
Recourse In Case of Non-Fulfillment of Contract
Q: Under the Letter of Credit, what recourse is available to me if the goods arrive and they are not the quantity or quality agreed upon?
A: Since banks deal only in documents and not in goods, all disputes of this nature may either be referred to International Chamber of Commerce Arbitration or handled through legal proceedings.
Goods Preceding Documents
Q: What happens if my ocean shipment arrives before my transport documents?
A: You have two options. You can either wait for the transport documents and pay for storage of the goods or you can request TD to issue on your behalf a Bond of Indemnity under your line of credit in favour of the carrier. The Bond of Indemnity allows you to obtain the goods without producing the transport documents. When the transport documents do arrive, you must forward them to the carrier in order to have your Bond of Indemnity returned to you and you, in turn, must deliver it back to the TD branch.
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