Letters of credit (LCs) allow businesses to protect themselves against the possibility of payment delays or defaults in the context of international trade relations.
When it comes to international transactions, businesses have to contend with a number of risks, such as payment delays, non-payment, and supply difficulties. One way of ensuring against these sorts of risks, notes commercial law firm and international trade law experts MTR Legal Rechtsanwälte, is letters of credit.
It is not uncommon with international transactions for some time to pass between delivery and payment of the goods, and this exposes the exporter to various risks, from geopolitical changes and economic troubles, through to the possibility of their importing business partner going bankrupt. If the importer has made upfront payments, they may be affected by supply delays or even non-deliveries. Letters of credit are a means of mitigating these risks by involving a bank in the transaction.
What this means in practice is that the importing company’s bank assumes an abstract payment obligation vis-à-vis the exporter, i.e., the bank assumes the importer’s obligation to render payment(s) to the exporter. The bank undertakes to transfer the amount due within an agreed timeframe as soon as it has received the agreed documents in an error-free state, including the commercial invoice, consignment note, insurance certificate, certificate of origin, packing list, and the document certifying that the goods have been inspected.
The letter of credit needs to be included in the purchase agreement as a payment arrangement, and the importer must then issue a letter of credit to its bank and deposit the relevant amount. The bank can release the money as soon as it receives the agreed documents. The issuing bank discloses the terms and conditions of the letter of credit to the exporter’s bank and guarantees to pay out the sum of money once these terms and conditions have been met.
Both parties can benefit from a letter of credit. Exporters are able to protect themselves against non-payment, whereas importers will not have had to pay upfront in the event of non-deliveries.
It is essential to set out clearly in the purchase agreement which documents need to be submitted in order to satisfy the terms and conditions of the letter of credit. To prevent legal disputes from arising, the terms and conditions in the purchase agreement ought to line up with those contained in the letter of credit.
Lawyers versed in international trade law can advise on how best to draft agreements.
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