Tips Given For Managing Letters Of Credit

Letters of credit (LCs), Sprague noted, are used primarily in import/export transactions although they are sometimes used for domestic shipments. She said there are commercial and documentary letters of credit, where payment is initiated by the presentation of documents relating to a successful shipment of appropriate goods. There are also standby letters of credit, which are default mechanisms that trigger payment when the buyer for goods does not make payment. These are used primarily for sales made on open terms. "Standby LCs are designed to not get paid, because we all want the open account to be paid."

Sprague pointed out that when a bank issues a letter of credit it is "putting itself on the hook and putting its credit in the place of the buyer." A letter of credit is a bank instrument that is payable upon presentation of the appropriate supporting documents related to the sales transaction. The important thing to get right about the process, Sprague noted, was to make sure any pertinent documents related to the letter of credit are correct. The biggest hurdle in a seller getting paid on a letter of credit is when there is a discrepancy; documents presented to the bank that don’t match what is specified in the letter of credit. "For companies who do not manage the process well, they have an 80-85 percent discrepancy rate," Sprague said.

When selling internationally, Sprague recommends having two banks involved—one bank in the buyer’s country and one in the seller’s country. The bank in the seller’s country would be the advising bank, which reviews the letter of credit and authenticates it. "Choose a bank in the U.S. that can help you with your LC. Find someone you can trust and that can meet your needs." "Make sure the letter of credit matches the terms in the sales contract," she added. "It is the seller’s responsibility to read the LC." When listing the products to be sold in the LC Sprague said, "The merchandise description should be short and sweet. The more detail you put in, the more chance for discrepancies."

The regulations relating to LCs are the ICC (International Chamber of Commerce) Uniform Customs and Practices Publication 500 or UCP 500. This is scheduled for updating to UCP 600 in July, 2007. There is also the Uniform Commercial Codes (UCC 5), Federal Reserve Bank regulations, ICC uniform rules for bank-to-bank reimbursements (URR 525, the International Standards for Banking Practices (ISBP) and ISP 98 for standby LCs.

Sprague added that some of the common documents related to commercial LCs are the invoice, transportation document, packing/weight list, certificate of origin, section or quality certifications and other certifications.

Charges for an LC are determined by the customer’s creditworthiness Sprague said. She mentioned the average fee is between 1-1.5 percent per year.
Source: NACM and Madeline Sprague

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