Documentary Letters of Credit

Documentary letters of credit are commonly used to settle obli­gations between buyers and sellers. The majority of these instru­ments are used to settle international obligations, but some are em­ployed in domestic trade.

Typically these letters of credit are used when buyers and sell­ers are unknown to each other and alternative methods of settle­ment, such as open account or collections, are unsatisfactory to one or both parties. Additionally, in some countries government regu­lations mandate the use of letters of credit for settlement of inter­national trade obligations.

Under a letter of credit a bank (rather than the buyer) promises to pay the seller a designated sum of money, provided the seller presents certain documents that purport to evidence a shipment has taken place. The letter of credit specifies the latest date on which these documents can be presented and may also specify the latest date for shipment. The seller is assured that he will receive payment if he properly presents the documents described in the credit to a desig­nated bank on or prior to the expiration date. Thus he is afforded much more protection under a letter of credit than under an open-account transaction or a collection, where he must rely on the buyer's ability and willingness to pay the draft. The buyer, on the other hand, is assured that payment will not be made unless the documents pre­sented conform on their face to the credit's requirements.

The nature of commercial letters of credit is best described by illustration. Suppose that ImportCo, a Brazilian mining corpora­tion, agrees to purchase a piece of heavy equipment from Ex­portCo, a German manufacturer. The terms of sale specify that the equipment is lo be shipped by ocean freight, insured by the ship­per, within four months. The purchase price of one million euros is payable on delivery of the equipment in Brazil.

ExportCo, in order to protect itself against non-payment, requires ImportCo to provide an irrevocable letter of credit. ImportCo ar­ranges for the issuance of the letter through Banco do Brasil, where it does the bulk of its banking business. Banco do Brasil obtains a commitment from ImportCo that it will make payment upon receipt of the equipment, collects a fee, and issues its irrevocable letter of credit to Deutsche Bank, ExportCo's bank in Germany. In doing so, Banco do Brasil accepts a credit exposure to ImportCo. Its exposure is reduced if it obtains a lien on the equipment which ImportCo is purchasing (a common practice) and is eliminated if it requires pre­payment of the purchase price (a less common practice).

Deutsche Bank, upon receipt of the letter of credit, notifies Ex­portCo with full details of the terms of the letter. As long as those terms agree with its understanding of the transaction, ExportCo will now proceed to complete the equipment to ImportCo's specifi­cations and to ship it. Having done so, it will present Deutsche Bank with the documentary evidence supporting shipment (in­voices, bills of lading, certificates of inspection and of origin, title

FINANCIAL DOCUMENTS

BILL OF EXCHANGE

A bill of exchange (also called a bill) is a written order, addressed by one person to another, to pay on demand or at a specified date a stated sum to a specified person or to his order, or to bearer. English and American law give the following definition of a bill of exchange:

A bill of exchange is an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at a fixed or determinable future time, a sum certain in money to or to the order of a specified person, or to bearer.

Bills are either inland or foreign.

An inland bill is one which is drawn by a person in one country upon another person resident in the same country as a bill drawn in London upon a person in Sheffield.

A foreign bill is one which is drawn by a person resident in one country upon another person resident in some other country, as a bill drawn in New York upon a firm in London.

SETTLEMENT OF CLAIMS

It often happens that one of the parties to the contract considers that the other party has infringed the terms of the contract. In such cases the dissatisfied party may think it necessary to send the other party a letter of
complaint which often contains a claim, a demand for something to which the sender of the letter, in has opinion, has a right as, for instance,a claim for damages or for a reduction in the price etc. Сlaims may arise in connection with inferior quality of the goods, late delivery or non-delivery of the goods, transportation, insurance and storage of the goods and in many other cases.

The Sellers, for example, may hold the Buyers responsible for omitting to give transport instructions in time, and the Buyers may make a claim on (against) the Sellers for damage to the goods caused by insufficient packing.

Disputes between Russian organizations and foreign firms arising out of foreign trade transactions are very often settled by the Foreign Trade Arbitration Commission at the Russian Chamber of Commerce*.