A reader asked me a question about letter of credit and trade finance timelines..
With a letter of credit. What sort of timings are usually connected to when the payment between banks occurs? Does the shipment sail prior to the LC being satisfied?
This is actually is a very good question – and the answer usually is: “it depends..” Kim Sindberg provides below comprehensive response on what it actually depends on and the relevant rules applicable..
The roles of the involved banks
First of all it is important to understand that there are usually 2 banks involved in the LC transaction:
1) The LC is issued by the buyer’s bank. That bank is termed “issuing bank”.
2) The LC is advised to the seller by another bank. That bank may have different roles and responsibilities – all depending on what the bank has agreed to do i.e.:
The bank may act as an Advising bank: Not obligated under the LC to pay.
The bank may also act as a Nominated bank: Nominated under the LC (e.g.) to pay, but any obligation under the LC depends on the agreement made with the seller.
The bank may also act as a Confirming bank: Has given an undertaking to pay when a complying presentation has been made.
This means that
- When a complying presentation is made to the issuing bank, then it must pay (according to the terms of the LC).
- When a complying presentation is made to the
- Advising bank, it will normally not pay until funds has been received from the issuing bank.
- Nominated bank, its payment will depend on the agreement made with the seller.
- Confirming bank, it must pay when a complying presentation is made to it.
How the LC is available
Also important in this respect is the “availability” of the LC. In general LCs are issued either at “sight LCs” or “Usance LCs.”
For the first payment is made “at sight” i.e. right after presentation of the documents.
For the latter payment is made after a specified number of days (as determined by the LC) – e.g. “90 days after shipment.”
The timelines given by the rules
Practically every LC is governed by the UCP 600. Those rules include the following provisions:
- The banks (issuing, confirming, nominated) have “a maximum of 5 banking days following the day of presentation” to determine if a presentation is complying.
- This means that if the issuing / confirming bank has not refused the presentation within that timeline then they are obligated to pay (according to the terms of the LC).
- Also important is the rule that dictates what the bank must do when it determines that the presentation is complying:
- When the issuing bank determines that a presentation is complying it must pay (according to the terms of the LC).
- When a confirming bank determines that a presentation is complying, it must pay (according to the terms of the LC) and forward the documents to the issuing bank.
- When” is not defined in the rules, but it is practice that the issuing / confirming bank must start the payment process right after they determine that it is a complying presentation.
The LC in practice
The above may seem a bit abstract, so let us look at two realistic scenarios:
Scenario 1: A confirmed LC
On 1 October the seller received an LC from their bankers. The bank has indicated that they have confirmed the LC. The LC is available “at sight” with the confirming bank.
On 15 October the seller ships the goods covered by the LC. (From that day the seller has 21 days to present the document to the bank).
On 20 October the seller presents the documents to the confirming bank. (From that day the confirming bank has 5 banking days to examine the documents).
On 23 October the confirming bank revert to the seller informing that the documents comply with the terms and conditions of the LC, and that they will effect payment value 26 October.
On the same day the confirming bank forwards the documents to the issuing bank.
On 26 October the payment is made to the seller.
On 28 October the documents arrive at the issuing bank. (From that day the issuing bank has 5 banking days to examine the documents).
On 2 November the issuing bank accepts the documents, pays the confirming bank, and draws the funds from the buyer.
Scenario 2: An unconfirmed LC
On 1 October the seller received an LC from their bankers. The bank has indicated that they have NOT confirmed the LC. The LC is available “at sight” with the issuing bank.
On 15 October the seller ships the goods covered by the LC. (From that day the seller has 21 days to present the document to the issuing bank).
On 20 October the seller presents the documents to the advising bank.
On 23 October the advising bank revert to the seller informing that the documents comply with the terms and conditions of the LC, and that they have forwarded the documents to the issuing bank awaiting payment.
On the same day the advising bank forwards the documents to the issuing bank.
On 28 October the documents arrive at the issuing bank. (From that day the issuing bank has 5 banking days to examine the documents).
On 2 November the issuing bank accepts the documents, pays the advising bank, and draws the funds from the buyer.
On 4 November the advising bank receives the finds from the issuing bank, and pays the seller.
As can be seen from the above:
- It is the documents from the seller (including the transport document) that trigger the payment; i.e. shipment is made before payment.
- When the payment is made to the seller depends highly on the structure of the LC.
It should be added also, that in the two above examples the documents did comply with the terms and conditions of the LC. If that is not the case, the confirming and issuing banks may refuse the documents, and payment is only made when approved by the buyer.
I trust the Letter of Credit and trade finance timeline is clear.. You can find more information about bridging the transport industry with the banking industry in Kim’s book “UCP 600 Transport Documents 2nd Edition” which also includes a chapter that offers a brief overview of the documentary credit..
For more information you can contact Kim Sindberg by email..
What are the implications of shipping material 2 days after latest shipment date, once a confirmed LC was received from the customer?
So nice.and thanks a lot
Dear Readers,
My LC stated as follows (just for some important clause)
1. At sight
2. Available with my Bank by negotiation
3. Latest shipment 15 November
4. LC expiry : 25 November in Indonesia
5. LC confirmation : Without (also my Bank no need confirmation because my bank has correspondence line with issuing bank)
6. Incoterms 2010 and UCP 600 applied.
I have shipped the cargo on 5 November, due to some of shipping documents need to legalized to Applicant’s Embassy so I just submitted the all shipping documents as per LC on 20 November.
On 23 November my Bank Officer told me that my documents 100% Complying the LC, BUT his Branch Manager would not to negotiate my LC because he wonder about expiry of the LC. His arguments : If all shipping documents couriered to issuing Bank on 23 Nov, the docs will reach issuing bank on 26 November (LC expired already).
I insists to ask him to negotiate my LC. I said to him “Please refer to UCP 600 for this circumtances”. After involving his District Manager finally the bank has negotiated my LC.
I wonder I will facing again this circumstances in the future. Exactly, WHAT UCP 600 SAID REGARDING PRESENTATION DOCUMENTS CLOSE TO LC EXPIRY ?
Please kindly help.
thank you,
Another important point is that an ‘advising’ bank only receives and forwards the shipping documents; it does not check or validate them. A ‘confirming’ bank does check and validate the documentation so in case there is any discrepancy, it can be handled locally. This is significant when time is of the essence but should become less relevant as you gain experience in handling LCs and learn the pitfalls to avoid.
Another point of relevance is partial shipments. In case you are shipping more than one container, it is prudent that the LC includes allowance for partial shipments. This allows the seller to start collecting right after the first shipment and not have to wait until all the order has been shipped to start the collections process.
Hi Everybody,
I wonder if the carrier should compy with specific standards or not? I mean it is one thing when the carrier is a big international company like Maersk, the other when it is a relatively small NVOCC (or maybe just a forwarding company) issuing HBLs.
I have experienced with LC from USA for frozen fish or frozen foods.
Seller do not accept the LC with clause ” PAYMENT after passed USFDA Approval” or anything wording like this. But seller can accept for clause ” Beneficiary’s Certificate stating that “If goods rejected by USFDA, beneficiary will reimburse to applicant all fund that already drawn plus any additional cost occured…… …… ….. ” “
Re: the letter of credit (LC) article. You left out one of the most important steps, i.e., the seller’s instructions to the buyer detailing the specific terms/wording to be included in the letter of credit. These instructions should be sent to the buyer BEFORE the buyer’s bank draws up the actual LC. The seller’s documentation must be EXACTLY identical to the terms/wording of the LC or the bank will declare the documentation differences as “discrepancies” and refuse payment until after the seller OKs the differences. This could possibly defeat the original purpose (protection) of the LC and/or add expenses (charged by the bank) to make the changes. In other words, once the buyer/seller agree to conduct the sale with an LC, they must then agree to the terms, especially its various dates. If not, the buyer may receive the copy of the LC and then realize he cannot comply with it and then must go back to the issuing bank for (additional) costly changes.