International Trade (Intl Trade) 101: Payment Methods LC Process Application Issuance Amendment Presentation Examination Honour Reimbursement

What This Is

The Letter of Credit (LC) process is a critical component of international trade finance, enabling buyers and sellers to conduct transactions with reduced risk. An LC is a payment guarantee issued by a bank on behalf of a buyer, which the seller can use to draw funds from the buyer's bank. The LC process involves several steps, from application to reimbursement, and requires a thorough understanding of key terms, rules, and procedures. For instance, consider a shipment of electronics from China to the US, where the buyer requests an LC to secure payment for the goods. The seller must comply with the LC terms to receive payment, while the buyer's bank verifies the documents to ensure compliance.

Key Terms & Rules

• UCP 600 (Uniform Customs and Practice for Documentary Credits): Governed by the International Chamber of Commerce (ICC), UCP 600 outlines the rules and guidelines for LC transactions globally.
• Incoterms: A set of international trade terms that define the responsibilities of buyers and sellers, including EXW (Ex Works), FOB (Free on Board), and CIF (Cost, Insurance, and Freight).
• LC Application: The process of requesting an LC from a bank, which involves providing details about the transaction, including the buyer, seller, goods, and payment terms.
• LC Issuance: The bank's approval and issuance of the LC, which includes the terms and conditions of the transaction.
• LC Amendment: Changes made to the original LC, which can be requested by either the buyer or seller.
• LC Presentation: The process of presenting the documents required by the LC to the buyer's bank for verification.
• LC Examination: The buyer's bank verifies the documents to ensure compliance with the LC terms.
• LC Honour: The buyer's bank pays the seller in accordance with the LC terms.
• LC Reimbursement: The buyer reimburses the buyer's bank for the payment made under the LC.

Step-by-Step Process

1. LC Application: The buyer requests an LC from their bank, providing details about the transaction, including the buyer, seller, goods, and payment terms.
2. LC Issuance: The bank approves and issues the LC, which includes the terms and conditions of the transaction.
3. LC Presentation: The seller presents the documents required by the LC to the buyer's bank for verification.
4. LC Examination: The buyer's bank verifies the documents to ensure compliance with the LC terms.
5. LC Honour: The buyer's bank pays the seller in accordance with the LC terms.
6. LC Reimbursement: The buyer reimburses the buyer's bank for the payment made under the LC.

Common Mistakes

• Mistake: Confusing CIF and CIP.
• Correction: CIF (Cost, Insurance, and Freight) includes the cost of goods, insurance, and freight, while CIP (Carriage and Insurance Paid To) includes only the cost of goods and insurance, with the seller responsible for carriage.
• Example: A seller ships goods under CIF terms, but the buyer's bank claims that the seller is responsible for carriage, resulting in a dispute.
• Mistake: Assuming "open account" is risk-free.
• Correction: Open account transactions do not involve a letter of credit or other payment guarantee, leaving the seller exposed to the risk of non-payment.
• Example: A seller ships goods under open account terms, but the buyer fails to pay, resulting in a loss for the seller.
• Mistake: Misusing "free on board" with air freight.
• Correction: FOB (Free on Board) is typically used with sea or inland waterway transportation, while for air freight, the correct term is "free at airport" or "free at carrier".
• Example: A seller ships goods under FOB terms, but the buyer's bank claims that the seller is responsible for carriage, resulting in a dispute.

Exam / Certification Tips

• Tricky distinction: FOB vs FCA (Free Carrier).
• Memory aid: FOB is like "free to board" a ship, while FCA is like "free to carrier" at a designated point.
• Common question pattern: LC honour vs LC dishonour.
• Tricky distinction: Confirmed vs unconfirmed LC.
• Memory aid: Confirmed LC is like a "guaranteed payment", while unconfirmed LC is like a "best efforts" payment.

Quick Practice Scenario

Scenario: A Chinese exporter sells goods under FOB Shanghai terms to a US importer. Who pays for the main carriage?

Answer: The buyer pays for the main carriage under FOB terms.

Explanation: Under FOB terms, the seller is responsible for delivering the goods to the buyer at the named port of shipment, in this case, Shanghai. The buyer is responsible for the main carriage from the port of shipment to their destination.

Last-Minute Cram Sheet

• UCP 600 governs LC transactions globally.
• Incoterms define the responsibilities of buyers and sellers.
• LC application involves providing details about the transaction.
• LC issuance includes the terms and conditions of the transaction.
• LC presentation requires the seller to present documents to the buyer's bank.
• LC examination involves verifying documents to ensure compliance.
• LC honour involves the buyer's bank paying the seller in accordance with the LC terms.
• LC reimbursement involves the buyer reimbursing the buyer's bank for the payment made under the LC.
• CIF includes the cost of goods, insurance, and freight.
• CIP includes only the cost of goods and insurance, with the seller responsible for carriage.
• FOB is typically used with sea or inland waterway transportation.
• FCA is like "free to carrier" at a designated point.
• Confirmed LC is like a "guaranteed payment".
• Unconfirmed LC is like a "best efforts" payment.
• ⚠️ Under FOB, risk transfers when goods are on board the vessel – not at the port gate or on the dock.
• ⚠️ LC honour involves the buyer's bank paying the seller in accordance with the LC terms.