There are more and more people using documentary letters of credit agreement. Simply put, this makes it possible for the sellers who don’t want to rely only on the promise of the buyers that they will pay to have some assurance that once the shipped goods are unloaded, they will receive their payment.
How does it work?
The seller can go to a bank and present the letter of credit. This bank would pay the seller the given amount of money even if it didn’t have any previous contact with him whatsoever. In fact this letter is a part of the three party relationship that represents the commercial transaction.
The letter represents a contract between two parties, the seller and the buyer, in which the buyer promises to pay the goods at a given moment. It is also a contract between the seller and a bank or other financial institution that actually makes the payment and in the end it is a contract between the buyer and the bank, because the buyer will pay the amount of money written on the letter to the bank.
Why is it special?
The most interesting thing about this letter is that it has an independence from the transaction between the beneficiary and the applicant. This letter of credit can be either a standby or documentary credit. It is common for all credits for the issuer to give a given item or pay something against a specific document that accompany the request for payment.
The payment can happen at the moment of presentation, and this is known as at sight or at a later moment and this is called deferred payment. The issuer can present an item of value to the bank, like bills of exchange(1) that can be payable at sight or at a later moment.
This document must specify the documents that have to accompany the presentation, such as the invoice, insurance certificate or bill of landing. In case of the standby credit the presentation can mean the request on its own, without any additional documents. In case of the standby payment the seller has the possibility to request the payment in advance. This is not possible in case of the documentary credit.
There are a lot of similarities between the standby credit agreement and documentary credit and the truth is that officially the distinction between them wasn’t noted because there was no need.