International Trade Law - Case Study Example

INTERNATIONAL TRADE LAW Definition: A letter of credit is an instrument issued by the bank promising that the buyer’s payment to the seller will be received on time. A letter credit promises that if the buyer denies payment, the buyer’s bank will make obligatory measures for payment. Letters of credit instruments are widely used in international transactions for guaranteeing the safe receipt of payments. Letters of credit have now become so vital because of factors like distance, unfamiliarity between parties, different laws etc (Letter of credit. 2009) letters of credit instruments are sales requests made to the seller to conduct the sales (Harvard law school 1922. p570) . A letter of credit instrument is generally issued by a bank against two types of bills, they are demand bills and usance bills (Massood, A. 2008).To decrease the credit risk to sellers in both domestic as well as foreign trade practice is the most important purpose of letter of credit.. When a bank issues a letter of credit in favor of a customer, it surrogates its creditworthiness for that customer (Borcky. R. 1999). Types: There are two types of letter of credit; they are standby letter of credit and documentary letter of credit. Documentary letter of credits can again be categorized into revocable and irrevocable. The revocable letter of credit is particularly rare in usage. Irrevocable letter of credit can be confirmed or unconfirmed letter of credit. Every type of letter of credits has its advantages as well as its disadvantages for the buyers and sellers. The charges of each type of letter of credit may vary according to its characteristics. The more the bank assures payment, higher will be the charges of it (Borcky. R. 1999). Without an agreement between the concerned parties, an irrevocable letter of credit cannot be cancelled before a particular date. A revocable letter of credit can be changed anytime without previous discussions by the bank which issues it. A confirmed letter of credit includes backing by the issuing bank and its correspondents promising payments of all drafts. At the same time an unconfirmed letter of credit will not have any guarantee that the bank will make payments on drafts in case of non payment from the buyer. A stand by letter of credit is a conditional obligation by the issuing bank that it will make payment to the chosen beneficiary if the banks client fails to execute as per the terms of the contract (Letter of credit. 2009). Nature of security problems: Letters of credit are more or less separate transactions. They are totally different from bank guarantees. The issuing banks responsibility is totally independent. It is not a performance bond as well as a promise for the excellence of goods shipped. Payment assurance by the issuing bank does not depend on the performance commitment of the seller except in those situations which the credit forces. The contract between the buyer and the seller is between themselves and the recipient of the letter of credit cannot take any sort of advantage of any contractual terms in between the buyer and the opening bank and between the opening bank and the confirming bank (Singh, GA. 2009). The parties of a letter of credit are the recipient who is the exporter of goods. The customer or the importer who instructs his bank to issue a letter of credit, and the issuing bank who is the importers bank in his home country. There is also the confirming bank which is the bank of the exporter who gives authentication to the letter of credit so that the beneficiary or the exporter can get payment without alternatives from the confirming bank (Singh, GA. 2009). A letter of credit is believed to offer identical security for both the seller and the buyer (Hinkelman,EG. 2007). Even though letter of credit instruments offer absolute safety to the parties involved, it has a few drawbacks. One among them is that the buyer has to make payments against documents only. Moreover before issuing to issue a letter of credit in favor of the seller, the bank usually stresses the creditworthiness of the seller. The whole success of the letter of credit depends on the proper conduct from the part of the seller. For this purpose the issuing bank demands a secret report on the seller. A letter of credit will not offer any protection on the eminence of the goods that are sending abroad under the letter of credit transactions. Therefore it becomes essential to obtain a report from a sovereign agency regarding the guarantee of quality of goods exported. This report is of at most importance when hazardous goods like chemicals and other similar goods are exported. Unpredictability in exchange rates may sometimes create problems for the seller. Such problems cannot be prohibited through the use of letter of credit (Singh, GA. 2009). A letter of credit is considered one of the safest means of attaining payments in international trade. But the fact is that people who are exporting are never in total control of the process of payment. The documents necessary in the process are prepared by people other than the parties to the deal and may not strictly comply with the standards prescribed by the issuing bank. This may result in the refusal of payment. Some banks even reject payments to sellers on the basis of constricted letter of credit principles. Moreover many courts have frequently upheld that banks actions and denying payments are correct on the ground that the seller has not sternly complied or followed proper documentations. As per information published by the Midland bank international of Britain and the Simplification of international trade procedures board, it is very hard to obtain information from banks on how frequently letters of credit are made wrong. Banks are unwilling to share its information with the public regarding failure of letter of credit instruments because it’s their own product. According to the report of National council on trade documentation, there was almost 63% failure of letter of credit instruments on an average in US. For maximizing the chances of payment under a letter of credit, it is advisable that the buyer and seller should know the rules set by the International chamber of commerce called the Uniform customs and practice for documentary credits (UCP). These rules are framed with a view to shield the interests of the banking community. The interests of the parties are given less priority under this rule. Interests of the bank alone are protected from getting caught up in disagreement between the parties to the contract. The issuing bank is not worried with the terms of the contract between the buyer and the seller. It is only concerned with the consistency of documents presented by the seller as well as the time periods of presentation. In order to avoid problems related to payment, support should be given to clients to control the process of payment from the beginning. The seller should induce the buyer to use a bank suggested by the seller. The selected bank should have a good global presence and reputation. While doing this the payment process can be made less complex and transparent. If the selected bank itself is fragile the purpose of the letter of credit may not be fulfilled at all. If the seller does not have any confidence with the bank of the buyer or if there is any political unsteadiness in the country where the bank is located, it is better to get the letter of credit confirmed by another creditable bank most likely a United States bank. If the letter of credit is confirmed by the United States bank, it has payment obligation. Increase in the number of documents, complications may rise. Non production of documents also reduces the protection given by the instrument. Problems also occur if proper signatures are not obtained from correct persons. For almost every letter of credits issued by banks requires commercial invoice and a transport bill of lading as supportive credentials. On the basis of commercial invoice, the letter of credit gives the explanation of goods that must be found in the invoice. If there is difference regarding the description, the seller may not get payment. In some cases, even if there is inconsistency in documents, the buyer will agree to relinquish any discrepancies with the consent of the bank. However, if the buyer becomes insolvent, the bank may reject payments to the seller because of the bankruptcy. Another problem detected in letter of credit transactions is regarding date of documents. Article 43 of the UCP 500 states that if no time period after shipment is given for presentation of documents, bank will never accept documents presented to them after 21 days after the shipment. An exporter who is unaware of this rule is most sure to miss the deadline (Moses, ML. 2005). Another risk factor seen in letter of credit transactions is that the financial institution who is the maker of the letter of credit has no direct association in the sale transaction between the buyer and the seller. When the correct documents are deposited with the bank, payment is made by the bank to the seller and the job of the bank ends. But some difficulties can arise if there is breach of conditions of the terms of contract by both the buyer and seller (Blodget, MS & Wilson, JW. 1993). As per statistical records, there is an average rejection of around 50% cases related to documentation. This can create aggravation for both the buyer and the seller. In Great Britain the estimated loss of business due to rejection of letter of credit amounts to 5 billion pounds every year. Due to delays in payments many suppliers can go insolvent, can drop profit and ends up in awful relations with the buyer. The banks have a very restricted role in this problematic situation. They simply act as unbiased parties who are not involved in trading and dealings of goods. They have very limited discretion in matching the terms and conditions of credit against the documents that are presented. There is absolutely less scope for judgment. Letter of credit instruments sometimes fail to foresee some aspects of the transactions, this also creates tribulations. For example, a common required document during the process is the Clean on board bill of lading. It is a document that is prepared by the shipping company clarifying that the goods are received in good condition and were loaded onto the hold of the ship. But if the goods are ignitable, they will be loaded onto the deck instead of the hold. The bill of lading will be marked as On deck. This cannot be an On board bill of lading and the bank will certainly reject it (Letters of credit. 2009). Most of the problems associated with letter of credit arise from the seller’s failure to execute obligations revealed in the letter of credit. The seller may find the terms and conditions difficult to accomplish and asks the buyer to alter these. Most of the letters of credit are irrevocable hence modifications are not that much easy. Problems associated with the seller are difficulty in meeting the shipping timetable, unacceptability regarding conditions of freight costs, drop in price due to exchange fluctuations, difference in the quantity ordered and expected amount or value. Insufficient details related to the product and difficulty in obtainment of specific documents. Problems related to letter of credit also occur late in the process of trade. This can happen even if the seller has accepted all terms of a letter of credit. In such situation, either the differences are negotiated through or most likely the payment gets cancelled and the exporter incurs a loss. When there are late differences of opinion; the buyer’s bank has no commitment to pay the undertaken amount to the exporter (Borcky. R. 1999). Since the parties involved in a letter of credit are dealing with documents and not goods, there is a chance of risk that the goods will not be shipped by the exporter as directed in the letter of credit instrument. Moreover letter of credit is a costlier payment guarantee method. It is costlier than other methods of payment like open account or the collection method. Moreover the beneficiary or the seller is out in the open to the economic as well as political risks along with risks associated with foreign exchange fluctuations in the home country of the importer (Letter of Credit. 2008). CONCLUSION Every body knows that the letter of credit is a specialized commercial instrument. The law related to letter of credit is complex. Even specialists in this field are too often confused or perplexed by the complicated nature and relationship of the instrument (Gao, X.2002 P57). Use of letter of credit lessens the exporter’s credit risks. Therefore the exporter is able to propose a better price (Westering, G. 2009).In order to reduce risks and problems associated with letter of credit transactions, the parties concerned with the contract are advised to learn the rules associated with it. They should use good care while going on. Moreover all kinds of mistakes should be avoided (Moses, ML. 2005). Reference list: Borcky. R. Understanding and Using Letters of Credit, Part II. 1999. Available: . Accessed on 8 December, 2009. Blodget, MS & Wilson, JW. The impact of transaction fraud: strategies for the international letter of credit. 1993. Available: Accessed on 8 December, 2009. Hinkelman,EG. Illustrated Guide to Letters of Credit. 2007. Available: Accessed on 8 December, 2009. Harvard law school. Harvard law review, Volume 35. Harvard: Harvard law review association. 1922. P570.   Gao. X. The fraud rule in the law of letters of credit: a comparative study. Hague: Kluver law international. 2002. P57   Letter of Credit: information; types; advantages and limitations. 2008. Available: Accessed on 8 December, 2009. Letters of credit. 2009. Available: Accessed on 8 December, 2009. Letter of credit. 2009. Available: Accessed on 8 December, 2009. Moses, ML. Controlling The Letter of Credit Transaction. 2005. Available: Accessed on 8 December, 2009. Massood, A. What is letter of credit 90days (dp basis) and how it works ????. 2008. Available: Accessed on 8 December, 2009. Singh, GA. Letter of Credit Vs. Bank Guarantee. 2009. Available: Accessed on 8 December, 2009. Westering, G. Excerpts from ‘international procurement’. 2009. Available: Accessed on 8 December, 2009. Read More