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 A standard, commercial letter of credit is a document issued mostly
by a financial institution, used primarily in trade finance, which usually provides an irrevocable payment undertaking.
The LC can also be source of payment for a transaction, meaning
that redeeming the letter of credit will pay an exporter. Letters of credit are used primarily in international trade transactions of significant value, for deals between a supplier in one country and a
customer in another. They are also used in the land development process to ensure that approved public facilities (streets, sidewalks, stormwater ponds, etc.) will be built. The parties to a letter of credit
are usually a beneficiary who is to receive the money, the issuing bank of whom the applicant is a client, and the advising bank of whom the beneficiary is a client. Almost all letters of credit are
irrevocable, i.e., cannot be amended or cancelled without prior agreement of the beneficiary, the issuing bank and the confirming bank, if any. In executing a transaction, letters of credit incorporate
functions common to giros and Traveler's cheques. Typically, the documents a beneficiary has to present in order to receive
payment include a commercial invoice, bill of lading, and documents proving the shipment was insured against loss or
damage in transit. However, the list and form of documents is open to imagination and negotiation and might contain
requirements to present documents issued by a neutral third party evidencing the quality of the goods shipped, or their place of origin.
Terminology
 The English name “letter of credit” derives from the French word
“accreditation”, a power to do something, which in turn is derivative of the Latin word “accreditivus”, meaning trust. S.‘The Application any defence relating to the underlying contract of sale. This is as long
as the seller performs their duties to an extent that meets the requirements contained in the LC.
How it works
A business called the InCosmetika from time to time imports goods from a business called ACME, which banks with the ABC Bank.
InCosmetika holds an account at the Commonwealth Bank. InCosmetika wants to buy $500,000 worth of merchandise from ACME, who agrees to sell the goods and give InCosmetika 60 days
to pay for them, on the condition that they are provided with a 90-day letter of credit for the full amount. The steps to get the letter of credit would be as follows:
 - InCosmetika goes to The Commonwealth Bank and requests a $500,000 letter of credit, with ACME as the beneficiary.
- The Commonwealth Bank can issue an LC either on approval of a standard loan underwriting process or by InCosmetika funding it directly with a deposit of $500,000 plus fees which are typically
between 1% and 8% of the face value of the LC.
- The Commonwealth Bank sends a copy of the LC to the ABC Bank, which notifies ACME that payment is available and they can
ship the merchandise InCosmetika has ordered with the full assurance of payment to them.
- On presentation of the stipulated documents in the letter of credit
and compliance with the terms and conditions of the letter of credit, the Commonwealth Bank transfers the $500,000 to the ABC Bank, which then credits the account of ACME for that amount.
- Note that banks deal only with documents required in the letter of credit and not the underlying transaction.
- Many exporters have mistakenly assumed that the payment is
guaranteed after receiving the LC. The issuing bank is obligated to pay under the letter of credit only when the stipulated documents are presented and the terms and conditions of the letter of credit have been met.
Availability
 LC being an irrevocable undertaking of the issuing bank makes
available the Proceeds, to the Beneficiary of the Credit provided, stipulated documents strictly complying with the provisions of the LC, UCP 600 and other international standard banking practices,
are presented to the issuing bank, then:
- i.if the Credit provides for sight payment – by payment at sight against compliant presentation
- ii.if the Credit provides for deferred payment – by payment on the maturity date(s) determinable in accordance with the stipulations of the Credit; and of course undertaking to pay on due date and
confirming maturity date at the time of compliant presentation
- iii.a.if the Credit provides for acceptance by the Issuing Bank – by acceptance of Draft(s) drawn by the Beneficiary on the Issuing Bank
and payment at maturity of such tenor draft, or
- iii.b. if the Credit provides for acceptance by another drawee bank – by acceptance and payment at maturity Draft(s)drawn by the
Beneficiary on the Issuing Bank in the event the drawee bank stipulated in the Credit does not accept Draft(s) drawn on it,
or by payment of Draft(s) accepted but not paid by such drawee bank at maturity;
- iv. if the Credit provides for negotiation by another bank – by payment without recourse to drawers and/or bona fide
holders, Draft(s) drawn by the Beneficiary and/or document(s) presented under the Credit, (and so negotiated by the nominated bank )
- Negotiation means the giving of value for Draft(s) and/or document(s) by the bank authorized to negotiate, viz the
nominated bank. Mere examination of the documents and forwarding the same to LC issuing bank for reimbursement, without giving of value / agreed to give, does not constitute a negotiation.
Legal principles governing documentary credits
 One of the primary peculiarities of the documentary credit is that the payment obligation is abstract
and independent from the underlying contract of sale or any other contract in the transaction. Thus the bank’s obligation is defined by the terms of the credit alone, and the sale contract is irrelevant.
The defences of the buyer arising out of the sale contract do not concern the bank and in no way affect its liability. Article 4(a) UCP states this principle clearly. Article 5 the UCP further states that
banks deal with documents only, they are not concerned with the goods (facts). Accordingly, if the documents tendered by the beneficiary, or his or her agent, appear to be in order, then in general
the bank is obliged to pay without further qualifications.
The policies behind adopting the abstraction principle are purely commercial and reflect a party’s
expectations: firstly, if the responsibility for the validity of documents was thrown onto banks, they
would be burdened with investigating the underlying facts of each transaction and would thus be less inclined to issue
documentary credits as the transaction would involve great risk and inconvenience. Secondly, documents required under the
credit could in certain circumstances be different from those required under the sale transaction; banks would then be placed
in a dilemma in deciding which terms to follow if required to look behind the credit agreement. Thirdly, the fact that the basic
function of the credit is to provide the seller with the certainty of receiving payment, as long as he performs his documentary
duties, suggests that banks should honour their obligation notwithstanding allegations of misfeasance by the buyer. Finally,
courts have emphasised that buyers always have a remedy for an action upon the contract of sale, and that it would be a
calamity for the business world if, for every breach of contract between the seller and buyer, a bank were required to investigate said breach.
The “principle of strict compliance” also aims to make the bank’s duty of effecting payment against documents easy, efficient
and quick. Hence, if the documents tendered under the credit deviate from the language of the credit the bank is entitled to
withhold payment even if the deviation is purely terminological. The general legal maxim de minimis non curat lex has no place in the field of documentary credits.
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