Documentary credits, collections and bank guarantees

Documentary credits, collections and bank guarantees

Documentary credits, collections and bank guarantees This book is aimed primarily at import or export companies purchase department employees, CFOs, logistics specialists or people who draft sales contracts and conduct related negotiations. It is also useful reading for those wanting to reduce risks in any financial relationship (e.g. lease contracts, purchase or sale of various rights). The book gives an overview of documentary credits, documentary collections and bank guarantees, describes their types, advantages, disadvantages and possibilities of use. Therefore it is suitable for all those who want to get acquainted with the basics of documentary payments and guarantees. Since the topic is very broad we have attempted to introduce the most important aspects that you must be aware of when using documentary payments and guarantees. On the issues not touched upon in this publication our Documentary Payments and Guarantees Department is always ready to assist you. Enjoy the book! Your Swedbank 3

Methods of payment In trade transactions goods move from the seller to the buyer, while money moves from the buyer to the seller. At the time of entering into the contract of sales it is decided how the settlements must be arranged between the buyer and the seller. Each method of payment has its advantages and disadvantages, depending on which party you are, the buyer or the seller. The most common methods of payment are: Advance payment Open account The goods are first paid for; thereafter, the goods are shipped The buyer has to take into account the possibility that the seller does not ship (the right kind of) goods the seller fails to meet the agreed deadlines the seller goes bankrupt The goods are first shipped; thereafter, the goods are paid for The seller has to take into account the possibility that the buyer does not pay the buyer fails to pay as agreed Regardless of which of the aforementioned payment methods is used, one of the business partners is inevitably the weaker side i.e. exposed to certain risks. If the described risks are acceptable for the parties, everything is fine. If not, a bank as a neutral intermediary can step in with the following methods of payment which can help better balance the risks between the parties. Collection Documentary credit The goods are first shipped; thereafter, a collection order along with the documents is submitted to the buyer s bank the buyer decides whether it wants the goods and is willing to pay for them, but the buyer will not receive the documents giving evidence of shipment of goods before the buyer has agreed to pay for the goods Documentary credit (= letter of credit or LC) is first issued in favour of the seller; thereafter, the goods are shipped the letter of credit cannot be cancelled or amended without the seller s approval, i.e. the buyer cannot stop the trade or refuse to pay the seller has to submit to the bank only the documents required by LC, but the money is not paid if the documents do not comply with the terms and conditions of the LC 4

Regardless of which method of payment to use there is always the risk that cannot be hedged entirely for instance, the risk of not receiving money upon settlements with an open account, the risk of the goods not being shipped in the case of using documentary credit, etc. With a bank guarantee the bank covers urgently and following a simple procedure expenses arising from non-performance with breach of contracts. Guarantee The bank will be called upon only if the parties run into problems in the course of performance of the contract and the party receiving the guarantee wants financial compensation. 5

Collections

Description of collection In a collection transaction the buyer s bank delivers the documents evidencing the shipment of goods (commercial documents) to the buyer in accordance with the collection instructions either against payment or against acceptance. The terms and conditions of collection are established by the seller and reflected in the collection instructions. The role of the bank as a neutral intermediary is to introduce the terms and conditions of release of commercial documents and payment of money. Since the buyer needs the commercial documents in order to receive and use the goods and the seller does not want to hand them over to the buyer before the buyer has agreed to pay, the bank as an intermediary assumes the obligation to strictly follow the seller s instructions regarding how and when to release the documents to the buyer. The bank s obligations upon handling collection are confined to following the terms and conditions of collection, intermediation of collection to the buyer and secure holding of commercial documents. The bank does not assume any payment obligation the buyer must pay for the goods. If the buyer refuses to pay because of lack of funds, or if he does not consent to collection, the seller will not be paid under the collection process. For the purpose of regulation and harmonisation of handling collections the International Chamber of Commerce (ICC) has issued Publication No. 522, ICC Uniform Rules for Collections (URC 522). 7

Collection process 1 2 5 6 7 3 9 4 8 1. The buyer and the seller agree on the terms and conditions of the trade and that goods are paid for using collection. 2. The seller ships the goods to the buyer. 3. The seller gives the documents relating to the goods to its bank (= remitting bank) for collection along with the instruction specifying the terms and conditions of release of the documents to the buyer. 4. The remitting bank sends the documents by a courier to the buyer s bank (= collecting bank). 5. The collecting bank notifies the buyer of the received collection and the terms and conditions thereof. 6. The buyer consents to the terms and conditions of collection. 7. The collecting bank hands over the documents to the buyer in accordance with the collection instructions either against payment or acceptance. 8. Depending on the terms and conditions of collection, the collecting bank debits the sum from the buyer s account either immediately (payment at sight) or on the due date (deferred payment) and makes the payment to the remitting bank. 9. The remitting bank pays the money to the seller. 8

Collection from the exporter s viewpoint Collection is a reasonable option for the seller if: the seller trusts the country where the buyer is located (the country is economically and politically stable); the seller trusts the buyer; the seller trusts the buyer s solvency. NB! The buyer can always refuse the collection order, whereas the goods have usually been shipped to the buyer by the time of submission of the documents for collection. If the goods are shipped by train, airplane, truck or post the goods will usually be delivered to the buyer without the need to present the transport document (provided the goods are consigned to the buyer). In such cases the buyer therefore does not need the document sent for collection. Only where the goods are shipped using marine transport and the originals of the negotiable bill of lading are sent for collection, the buyer will not get the goods right away but will need to present the original bill of lading. If the buyer refuses collection, the seller may face a situation where the goods have to be stored at the destination for a long time; the seller has to start looking for a new buyer for the goods; the goods have to be sold at an auction; the goods have to be returned to the place of departure; the goods have to be destroyed (e.g. highly perishable goods). Some of the risks listed can be prevented by using documentary credit instead of collection. If the buyer sends collection documents for payment, the banks retain control over the documents until the buyer has paid the collection amount. If the documents are sent for acceptance, the buyer s bank releases them to the buyer against an undertaking to pay at maturity or acceptance of a bill of exchange and the actual payment on the required due date depends solely on the buyer s solvency. To exert pressure on the buyer the seller may demand that the collecting bank protest the refusal to pay or accept, which is the prerequisite for claiming payment of the money in a court in most countries and which results in the disclosure of the party who refused to pay or accept. A protest can be filed if a bill of exchange has been submitted to the buyer along with the collection documents (see the chapter titled Bill of Exchange ). In Estonia the procedure for protesting bills of exchange is regulated by the Law of Obligations Act. If the sums are big and the seller does not completely trust the buyer, the seller may prefer to use documentary credit. 9

Collection from the importer s viewpoint For an importer, i.e. the buyer collection involves relatively little risk and constitutes a convenient method of settlement. In the case of collection the buyer is the one who decides over the documents compliance or non-compliance with the contract and assumption of the payment obligation. When refusing the collection documents the buyer can always refuse payment of the service fees relating to the collection order. The buyer has an opportunity to see collection documents in the bank before making a decision regarding payment. The bank however does not have the right to hand over the collection documents or copies made of them to the buyer before the buyer has consented to the terms and conditions of collection. NB! After consenting to collection the buyer must under no circumstances pay the collection sum to the seller by a payment order! In that case the transfer would take place outside the collection order and the bank would be unable to release the documents to the buyer without the approval of the consignor s bank The submitted bill of exchange can be accepted, i.e. signed in the presence of a bank employee only by a person authorised by the buyer. Authorised persons can be people who have been specified as members of the management board of the company in part B of the commercial register. The seller of the goods may demand that the buyer s bank provide an aval for the bill of exchange to guarantee the payment on due date. If the buyer s bank does not agree to provide an aval for the bill of exchange, the buyer will not have the right to receive the collection documents. For further information on provision of bill of exchange an aval see the Classification of guarantees by purpose section in the chapter titled Bank guarantees. 10

Documentary credits

Description and cornerstones of the documentary credit A documentary credit is often named credit, but also known as Letter of Credit or just LC. In the following the term LC will be used. A bank that issues an LC (= the issuing bank) is obligated to pay the LC amount to the seller of the goods (= the beneficiary) if he submits to the issuing bank the documents listed in the LC in compliance with the terms and conditions stated in the LC. The regulatory background for LC is defined and regulated by Publication No. 600 of the International Chamber of Commerce (2007 edition), the Uniform Customs and Practice for Documentary Credits (UCP 600). The uniqueness of LC lies in the fact that not the buyer, but a neutral party (a bank) that assumes the obligation to pay the seller for the goods. Banks are obligated by law to be transparent in their activities and not to take too high risks, as a result of which the creditworthiness and liquidity of banks is considered to be higher than that of other companies. Upon using the LC service, the buyer can improve its creditworthiness and increase the seller s certainty regarding receipt of the money. A letter of credit is irrevocable. It cannot be amended or cancelled without the seller s consent. It gives the seller the certainty that the buyer cannot change its mind with regard to the transaction or unilaterally amend the terms and conditions to make them more suitable for itself. The irrevocable nature of LC influences the buyer and the issuing bank to issue such LC that does not need to be changed or cancelled. Although LC is usually based on a sales or another contract, it is an independent transaction and no obligations derive from the contract to the bank which issued the LC (as well as to other banks involved in handling the LC) even if the text of the credit refers to the contract (Article 4 of the UCP 600). The seller certifies compliance with the terms and conditions of the LC, submitting the documents listed in the LC to the bank. The issuing bank must honour the documents complying with the terms and conditions, i.e. pay their value to the seller by the due date specified in the LC. Thus, banks only examine the compliance of the documents against the terms and conditions of the LC, but they are not liable for the goods (services) relating to the documents (Article 5 of the UCP 600). Banks are not liable for the effectiveness of the documents either. Only the issuer of the document is liable for it (Article 34 of UCP 600). The buyer (= the applicant) determines the terms and conditions of the LC. The issuing bank interferes with the establishment of the terms and conditions only if the buyer s instructions are confusing or ambiguous or do not comply with international rules and practice or if the bank is involved in financing the transactions associated with the LC. Thus, the buyer and the seller play the greatest role in smooth progress of the LC transaction before issuing the LC the terms and conditions of the LC have to be negotiated thoroughly. 12

LC is a precisely regulated and harmonised banking service used throughout the world most of the banks understand the obligations, examination of documents and other principles of LCs in the same way. Such commercial LCs, which are not handled in accordance with the UCP rules are extremely rare in practice. LC process 2 8 9 1 5 10 7 3 11 6 4 1. The buyer and the seller agree on the terms and conditions of the trade and that goods are paid for using LC. 2. The buyer contacts its bank and applies for opening an LC in favour of the seller. The bank may, but not have to accept the application. If the bank approves the application the buyer must give the bank collateral acceptable to the latter. 3. The issuing bank drafts the LC on the basis of the instructions received from the buyer and sends it electronically (SWIFT message) to the seller s bank (= the advising bank). SWIFT (= The Society for Worldwide Interbank Financial Telecommunication) is a member-owned cooperative through which the financial world conducts its business operations. 4. The advising bank verifies the authenticity of the LC and advises the seller of the received LC. 5. The seller examines the text of the LC and makes certain that it complies with the agreement made with the buyer of the goods. Thereafter the seller ships the goods to the buyer. 6. The seller presents the documents requested in the LC, which certify that the seller has fulfilled all the terms and conditions of the LC to its bank. The seller s bank may guide the seller in interpretation of the terms and conditions and issuance of the documents. 7. The seller s bank forwards the documents to the issuing bank. Thereafter the issuing bank examines the documents within five working days and decides if they comply with the terms and conditions of the LC. 8. If the documents comply with the terms and conditions of the LC, the issuing bank will confirm acceptance of the documents to the seller s bank and release the documents to the buyer. With an LC payable at sight the issuing bank pays the amount of the LC to the seller (through the seller s bank) immediately. The buyer s consent to the given operations is not required. 9. The buyer pays the issuing bank the amount paid. 10. The advising bank pays the seller the money after the payment has accrued. 13

Why use LC and when? Being a very flexible payment instrument, LC offers various opportunities for reduction of risk and spreading it between partners. LC can be compared to the work of a tailor: the parties get the result that fits their needs. LC can be used if: the buyer and the seller do not know each other well enough the other party is unfamiliar, the cooperation experience is short-term and the trust is little; one party or both parties are located in an economically or politically unstable country (region); the legislation of one or another country requires the use of the LC; the goods constitute a special order or are very specific; the goods are price-sensitive; if the buyer or intermediary has no money of its own it can carry out the transaction only by using the LC; in the case of deferred payment transactions the LC is suitable for reducing the payment risk and, where necessary, quicker receipt of the money. In international business transactions you need to take into account different laws and customs, foreign exchange risks, foreign government or central bank regulations and decrees, trade embargos and black lists. Many of these risks can be prevented or reduced by using LCs. If necessary, LC can be combined with guarantees, invoice discounting, factoring, etc. If you have little or no experience in using LCs it is wise to consult a bank before entering into a trade agreement. 14

LC payment methods LC must specify how it is available: by sight payment, deferred payment, acceptance or negotiation. In the LC the issuing bank may authorise another bank (= the nominated bank) to act under the LC, e.g. to evaluate compliance of the documents submitted by the beneficiary with the terms and conditions of the LC and to pay the amount of the LC to the beneficiary. This bank may be the advising bank and, in the case of freely negotiable LCs, a bank chosen by the beneficiary. The issuing bank may choose not to give such a nomination to other banks. Payment at sight The value of the documents is paid to the beneficiary immediately after the documents have been submitted to the nominated bank and the nominated bank has determined that the documents comply with the terms and conditions of the LC. Example: The nominated bank receives the documents Monday, May 2. On May 5 the bank decides, after examining the documents, that they comply with the terms and conditions of the LC and makes the payment value date Monday, May 9. Usually, the issuing bank pays the nominated bank before having the possibility to examine documents compliance with the terms and conditions of the LC. Therefore the issuing bank must trust the nominated bank and its ability to evaluate the compliance of the documents with the terms and conditions of the LC as well as its ability to return the funds should the documents be refused due to valid discrepancies. Deferred payment The value of the documents is not paid to the beneficiary immediately after presentation of the documents, but on the date calculated pursuant to the formula specified in the LC. One of the most common methods of calculation of the due date is the one whereby the agreed period in days is added to the date of shipment of the goods or to the date of presentation of the documents to the bank. This way the applicant can defer payment for the goods purchased by the LC until the money from the resale of the goods is received. Example: The LC is payable 60 days after loading the goods on board the ship. The nominated bank receives the documents on May 2. On May 5 the bank decides, after examining the documents, that they comply with the terms and conditions of the LC. According to the bill of lading the goods were loaded on board April 12. The bank is obligated to pay the beneficiary on June 11. 15

Negotiation In the case of negotiation the nominated bank pays (or promises to pay) the beneficiary the value of the documents (or the bill of exchange) before it receives money from the issuing bank. Example: The LC is payable by negotiation at sight in the seller s bank. The seller s bank receives the documents on May 2. On May 5 the bank decides, after examining the documents, that they comply with the terms and conditions of the LC. The bank agrees to negotiate and pays the money to the beneficiary on the same date. By mutual agreement the negotiating bank pays the beneficiary the document amount less interest charged for two weeks. The money accrues from the issuing bank to the negotiating bank on May 16. The nominated bank is not obligated to negotiate. Its activities depend on how certain it is in the issuing bank and the beneficiary. If the nominated bank negotiates the documents, it does so with the right to claim the money back (right of recourse), i.e. the bank which negotiated the documents can reclaim the paid sums from the beneficiary if the issuing bank does not pay for some reason. The issuing or confirming bank does not have the right of recourse (see the chapter titled Confirmed LCs ). Unlike other methods of payment, in case of freely negotiable LCs any bank may be chosen by the beneficiary (except the issuing bank) as a nominated bank to negotiate. Obviously, the circle of banks nominated to negotiate can be limited in the terms and conditions of the LC, e.g. to the banks of the country of location of the beneficiary or a specific bank. In the case of negotiation the banks usually charge interest on the period that remains between negotiation and the receipt of money from the issuing bank. Acceptance It is a traditional form of deferred payment LCs whereby the beneficiary must, along with other documents specified in the LC, submit a bill of exchange whose due date is calculated pursuant to the terms and conditions of the LC. If the documents presented by the beneficiary are in compliance with the terms and conditions of the LC, the issuing bank or the nominated bank accepts the bill of exchange, thus undertaking to pay the amount of the bill of exchange on the due date. If the beneficiary wants to receive money right away, it can sell the bill of exchange with a discount. NB! Banks make the LC available in the other bank if a) the applicant or the beneficiary has requested it; b) the LC has to be confirmed by the other bank; c) the LC has to be transferable in another bank; d) the issuing bank trusts the nominated bank; e) in the region or country where the seller of the goods is located it is common practice to use freely negotiable LCs for the purpose of financing.. 16

Types of LC Confirmed LC If the LC has been confirmed, the confirming bank undertakes, in addition to the issuing bank, to pay for the complying documents. Sellers who want to avoid the possible political or other risks of the issuing bank or its country of location should always ask for the confirmation of the LC. Confirmation of the LC also helps to obtain settlements faster and more conveniently after receiving the payment from the confirming bank the transaction is over for the seller. Possible disputes between the issuing and confirming bank are no longer its concern. NB! The bank is not obligated to confirm the LC. Before asking the buyer for a confirmed LC the seller should always ask the bank about the possibility of confirmation. Transferable LC A transferable LC gives the intermediary the opportunity to apply to the nominated bank for the transfer of the LC for the benefit of its supplier. Thus, the intermediary buys the goods using the same LC that it resells to the buyer. NB! The seller of the goods (supplier) knows that it deals with an intermediary! The transferable LC allows for intermediating major goods transactions without making any investments. The supplier (= the second beneficiary) has to fulfil the terms and conditions of the LC and submit the documents. The intermediary (= the first beneficiary) replaces only the invoice and bill of exchange of the second beneficiary (higher by its commission/profit) upon the arrival of the documents at the transferring bank. If the terms and conditions of the LC allow for partial consignments, the LC can be transferred to several second beneficiaries (to the extent of the initial amount or quantity of goods). If the intermediary would like to build up a transaction using a transferable LC, it must keep in mind that upon transfer of the LC the terms and conditions of the LC must not be changed, except the latest shipment date, the validity and the period for presentation of documents (all may be curtailed) and the amount and the unit price (both may be reduced); all the documents listed in the letter of credit (incl. transport documents) must be submitted by the second beneficiary (the first beneficiary may only substitute its own invoice and bill of exchange for those of the second beneficiary). Therefore, the terms and conditions of the LC must specify the shipment of the goods directly from the supplier to the buyer. NB! The LC may be transferred only if it specifically states to be transferable. This will normally be based on an indication to this effect in the LC application issued by the buyer. 17

In the transfer application the intermediary should shorten the period of submission of the documents and the validity of the LC in such a manner that upon arrival of the documents to the transferring bank the intermediary would be able to replace the invoice and the bill of exchange submitted by the supplier. The use of transferable LCs is regulated by an article 38 in the UCP 600. Back-to-back LC The bank opens a back-to-back LC at the request of the intermediary in favour of the supplier. This form of LC is based on and secured by another LC (= the master credit) opened by the buyer in favour of the intermediary. Unlike the transferable LC, the master credit and the back-to-back LC are two legally independent LCs, although both are meant for the same transaction. To reduce the risks banks usually demand that the intermediary provide additional collateral for issuing such LC. Since the back-to-back LC formally are two legally independent LCs the back-to-back LC is not mentioned in the UCP 600. Revolving LC In the case of a revolving LC the conditions of the LC are renewed periodically or after a certain event and the seller of goods can ship another consignment in the amount and on the terms and conditions of the LC. Since the terms and conditions of the LC are exactly the same in the case of each consignment, the revolving LC is suitable only in the case of regular consignments which have exactly the same terms. Red clause LC LCs of this type allow the seller to receive advance payment before fulfilment of all the terms and conditions (for acquisition or production of goods, coverage of transportation expenses, etc.). Usually, to receive such an advance payment some document, for instance, a certificate stating that the goods complying with the terms and conditions of the LC are in the port or at the storage site (if the advance payment is necessary for financing transportation) must be submitted. In such an event the seller receives the remaining amount after shipping the goods to the buyer and submitting all the documents listed in the LC, including the transport document. Standby letter of credit A standby letter of credit is, in essence, a guarantee. This means that the beneficiary demands money only if the applicant fails to perform its obligation, e.g. does not pay for the goods if the applicant is the buyer. The list of documents of such a letter of credit usually contains only a copy of the invoice unpaid by the buyer and the seller s claim to the bank for payment of the amount of the letter of credit. Transport documents are rarely requested. 18 More information on standby letters of credit can be found in the section on guarantees.

Trade agreement between the buyer and the seller To make the transaction a success and to avoid wasting time and money on amendment of the terms and conditions the buyer and the seller should agree on the terms and conditions of the LC in as great detail as possible before issuance of the LC and preferably set them out in a trade agreement binding upon both of them. The recommended list of terms and conditions that are important from the point of view of the LC is as follows: description of the goods as long as necessary, but as short as possible (e.g. blue men s socks as specified in Order No. 123); quantity of the goods either exact (e.g. 1,250) or more vague (e.g. 1,000 kg +/ 5%); price of the goods; other essential parameters of the goods, which have to be specified in the LC (e.g. highly perishable goods must be transported in a refrigerated container); deadlines for shipping the goods and other activities; means of transport and places of loading and unloading; delivery terms (e.g. CIF Tallinn, Incoterms 2000); time of payment for the goods, i.e. whether the documents of the LC are paid for immediately after their presentation to the bank or the seller gives the buyer some time to make the payment (e.g. the due date is 90 days after the date of invoicing); list of the documents of the LC, i.e. these documents that certify the fulfilment of the terms and conditions of the agreement those needed by the buyer in order to obtain and clear the goods; special type of the LC, i.e. whether the LC has to be confirmed or transferable; the bank to advise the seller of the LC once issued usually the seller s bank; the bank (if any) to be nominated to act under the LC, e.g. to pay the beneficiary. Depending on the characteristics of the specific trade it may be necessary to specify other terms and conditions in the agreement. If you have little or no experience in using LC-s and/or transaction complex, it is strongly advisable to consult a bank before enetring into the trade agreement. 19

LC from the buyer s viewpoint In LC settlements the bank pays the LC amount to the seller only if the seller submits to the bank the document required in the LC and these documents are in full compliance with the terms and conditions of the LC. The buyer determines the terms and conditions of the LC. Thus, the LC allows the buyer to dictate what goods have to be shipped, in what quantity they have to be, and when and where they have to be shipped. If the terms and conditions (e.g. the price, quantities) have been fixed once they cannot be amended unilaterally and the beneficiary interested in the sale must fulfil them exactly in order to get the money. NB! The seller does not have to use LC! If the seller does not agree with the terms and conditions and does not ship the goods, the buyer s expenses on the LC may prove to be worthless. The usage of LC may give the buyer the opportunity to negotiate a lower price, because the closure of the transaction and receipt of the money are guaranteed to the seller by the issuing bank. LC also allows the buyer to manage cash flow more flexibly, because upon agreement with the bank the buyer can postpone its obligation to pay the amount of the LC to the bank to a time that is more suitable for the buyer. However, the buyer must take into account that the bank s approval of LC application takes time and requires collateral the buyer cannot unilaterally cancel the LC or amend the terms and conditions thereof the LC service is expensive and in any event the buyer is (ultimately) responsible for payment of all service fees If the banks involved in the LC settlements do not receive their service fees from the seller for some reasons regardless of the fact that the terms and conditions of the LC so demand, the issuing bank (and thereby the buyer) will be liable for payment of all the respective service fees (Article 37(c)). the payment is made on the basis of the right documents, not the goods It is important to remember that if the seller submits the documents complying with the terms and conditions of the LC, the issuing bank will be obligated to pay the amount of the LC to the seller. Thus, the buyer is obligated to compensate the issuing bank for such payment regardless of whether the goods shipped or the service provided by the seller complies with the agreement or the expectations of the applicant or whether the goods have been shipped in compliance with the submitted documents. upon making the payment decision, the bank will not take into account the terms and conditions which have not been stipulated in the LC 20

The bank verifies the fulfilment of only those terms and conditions which have been stipulated in the LC and the fulfilment of which has been certified by the required documents. The bank does not take into account the fulfilment or non-fulfilment of other terms and conditions (e.g. the terms and conditions of the trade agreement) and/or other documents. shipped goods may not comply with the documents submitted NB! Bank employees cannot be experts in a single chapter of goods or branch of industry, but are merely LC specialists. Banks verify the compliance of the documents based on the terms and conditions of the LC, not the compliance of the goods against the agreement, the standards of the industry, etc. It is the issuers of the documents (not the banks) that are liable for the correctness of the data contained in the documents. If the goods do not meet the expectations, they are not shipped or they are shipped later or otherwise in conflict with the transport documents, complaints should not be addressed to the bank but the seller and/or the carrier who has issued the documents. fraud cannot be precluded entirely The banks are not liable if the documents which seem to comply with the terms and conditions of the LC prove to be forged later on. The buyer of the goods itself has to learn to know the other party to the agreement before it trusts the party! LC from the seller s viewpoint For the seller LC gives clarity and certainty about the activities required for receiving the money and the time of payment: if the seller fulfils the LC terms and conditions, the issuing bank must pay the money in accordance with the LC terms. The main advantage for the seller is the replacement of the buyer s payment risk with the bank s payment obligation. Banks better liquidity and the need to retain their international reputation ensure that they usually perform their obligations accurately. Secondly, LC is an irrevocable payment obligation of the bank. If the buyer changes its mind after LC is issued, the buyer and the issuing bank cannot unilaterally amend or cancel the fixed terms and conditions (e.g. deadlines, quantities) without the seller s consent. 21