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Here we will discuss the Documentary Letter of
Credit. |
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Many attempts have been made to replace the
Letter of Credit but not with much success. The
reason Letter of Credits are still here is because via the
Letter of Credit a third party bank irrevocably
guarantees payment to the Seller if the Seller
performs with the terms that the Buyer and
Seller have agreed on. This irrevocable nature
of this ‘guaranty’ issued by a bank, allows the
Exporter’s bank to provide pre-export
(pre-shipment) financing. Letter of Credit is
one of the main means of financing international
and domestic trade. |
Letter of
Credits are unique financial instruments that
connects the movement of physical goods that are
being bought and sold with the funding of these
goods as they move through the channels of
trade. Over the years, certain terms and
modality has been established which are
reflected through specific Incoterms through
which the Buyer, Seller and the transporting
company know when the responsibility for the
goods move from one party to another and when
title to the underlying goods transfers from one
party to another.
Generally a Letter of Credit will be irrevocable
and at sight. This means that the Letter of
Credit issuing bank is irrevocably committing to
pay the Seller once the seller meets the terms
of the Letter of Credit. ‘At Sight” means that
when the Letter of Credit issuing bank receives
the documents from the Seller and ‘sees’ them
the issuing bank is obligated to pay if all the
Letter of Credit documents are in order. |
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It is important to note that Letter of Credits
deal with documents not with goods. In other
words the Letter Credit requires that to be paid
the seller has to provide certain documents such
as an Invoice, Packing List and Bill of Lading
showing the goods have been taken over by the
shipping company. If these documents are
correct, then issuing bank will pay. The issuing
bank will not physical verify that the goods
have actually been shipped but do reasonable due
diligence to make sure that the documents are
authentic. For this reason, it is important to
have the goods inspected by reliable third
parties and the shipping company, the freight
forwarders are reputable established credit
worthy companies so that if something goes wrong
the buyer will have redress to financially
strong companies.
Other than 'at
sight’ Letter of Credits, there are Letter of
Credits where the payment is made after a
certain period of time. The staring point should be
from the date on the Bill of Lading, or the date
the draft was accepted by the issuing bank, etc. |
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Letter of Credits use “Incoterms” which are
abbreviations of International Commercial Terms
that are key elements of international contracts
of sale. In a trade transaction there are
generally three parties involved: the Seller,
the Buyer and the Transporting Company moving
the goods from the seller to the buyer. The
Incoterms explain the distribution of function,
costs, risks and title to the goods relating to
the transfer of goods from seller to buyer |
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Some common Incoterms: |
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FOB (Free on Board)
a) Transportation or carriage is to be arranged
by the Buyer.
b) Risk transfer from the Seller to the Buyer
when the goods pass the ship’s rails.
c) Cost transfer from the Seller to the Buyer
when the goods pass the ship’s rails. Here
Buyer’s costs are the cost of the goods, freight
and insurance. |
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CIF (Cost, Insurance and Freight)
a) Freight and insurance to be arranged by the
Seller.
b) Risks transfer from the Seller to the Buyer
when the goods pass the ship’s rails.
c) Costs transfer at port of destination, Buyer
pays the costs of the goods but not the freight
and insurance. In essence the Buyer pays for all
the costs when the goods arrive at port of
destination and takes delivery. |
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CFR (Cost and Freight)
Same as CIF except the insurance is the
responsibility of the Buyer. |
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FAS (Free Alongside Ship)
a) Transportation to be arranged by the Buyer.
b) Risks transfers from the Seller to the Buyer
when the goods have been placed alongside the
ship.
c) Costs transfers from the Seller to the Buyer
when the goods have been placed alongside the
ship. |
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EXW (Ex Works)
a) Transportation to be arranged by the Buyer
who is responsible to pick up the goods from the
Seller’s warehouse.
b) Risks transfers from the Seller to the Buyer
when the goods are delivered at the warehouse
and are at the disposal of the Buyer.
c) Costs transfers from the Seller to the Buyer
when the goods are at the disposal of the Buyer
at the warehouse. |
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DDP (Delivered Duty Paid)
a) Transportation to be arranged by the Seller.
b) Risks transfers form the Seller to the Buyer
when the goods have been put at the disposal of
or delivered to the Seller.
c) Costs transfers from the Seller to the Buyer
when the goods have been put at the disposal of
or delivered to the Seller. The Seller pays for
the transportation of the goods, any duties, and
insurance. |
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