Transferable Letter of Credit: A Smart Way to Extend Your Credit Protection
In international transactions, a letter of credit issued in your favor by your buyer's bank is one of the best ways to get paid quickly and surely. It provides you with credit protection and allows you to get paid locally--by your own bank-- although your client may be overseas.
What you may not know is that the letter of credit can get even better. It can allow you to extend your credit to your supplier, if you get a transferable letter of credit. Kim Lester, trade service officer at Fleet Bank (Boston), explains the key points of a typical transferable letter of credit, and how to avoid many of the pitfalls that are common occurrences in handling transferable letters of credit. How It Works
"If you receive a letter of credit in your favor but you are not the manufacturer of the goods," says Lester, "you must first purchase the goods from a third party or a supplier. However, the supplier will want some type of protection that it will get paid. You have three options:
- Use your own funds to purchase the goods.
- Utilize your credit line to arrange for a letter of credit to be issued in your favor.
- Transfer your rights--either in full or in part--under your existing letter of credit to your supplier under a transferrable letter of credit.
"A transferable letter of credit has many advantages," says Lester. "It allows you to extend credit to your buyer without tying up your most valuable resource--your own credit line. You are essentially using the credibility of the issuing bank. It allows you to get paid quicker." But in order to successfully complete the transaction, here are some of the key points to keep in mind. Begin at the Beginning
As soon as you receive the letter of credit, make sure it allows you to transfer the credit. Under UCP 500 (Uniform Customs and Practice), all letters of credit are not transferable. Therefore, unless this provision is specifically mentioned, you will not be able to transfer the credit to your buyer. Examine Your Letter of Credit
Read the letter of credit very carefully. As you may have heard thousands of times, banks only deal in documents, not in goods. Make sure the invoice asks for the description that you can submit. Keep in mind that you are allowed to replace only two documents; namely, invoice and draft. Find out what kind of shipping document is required and whether the supplier can produce the right one. "If there are other concerns, your bank is a great resource," says Lester. "Talk to your banker, but keep in mind that you should do your homework in choosing your supplier. "Under a transferable letter of credit, the beneficiary is totally at the mercy of the supplier. So knowing who you are dealing with is of utmost importance." Act Swiftly
"In a transferable letter of credit, time is of the essence, since you need additional processing time," Lester says. "The process includes the second beneficiary presenting documents to its bank, who then sends the documents to the transferring bank, which is often in a different country." Prepare your documents so that you can make presentation as soon as the documents from your supplier have arrived. Amendments
"As a first beneficiary, you have two options. You can either allow for the automatic transfer of amendments or keep the right to refuse the amendment before it gets transferred," says Lester. Regardless of which option you choose, the UCP 500 requires the transferring bank to convey the decison to the second beneficiary. "In the interest of the beneficiary," says Lester, "I suggest that they always refuse to allow for the automatic transfer of amendments. This will allow them to maintain control over the requirements in the letter of credit." Protecting Identity
Although you are essentially passing on the same papers--except the invoice and draft--it is possible to protect the identity of your supplier or your buyer under a transferable letter of credit. However, you must be careful.
"As soon as you know that you will be the beneficiary of a transferable letter of credit, contact your bank to find out how you can structure the letter of credit to protect all necessary parties and eliminate potential pitfalls," says Lester. "For example, if you do not want to expose the name of the buyer to the supplier, make sure that the transport document is cosigned to the bank or freight forwarder." Although a transferable letter of credit is a very useful instrument and will work in most transactions, you should keep in mind that there are some instances when it just would not work. "For example, if your supplier wants to be paid up front," notes Lester, "a transferred letter of credit is not a good idea, since it will allow payment only after shipment is made and not before."
The goods news is that once you master the ways a transferable letter of credit works, you can reap a bundle of benefits by using it to your advantage. Editor's Note: The above article originally appeared in the Credit & Collection Manager's Letter, a newsletter purchased by Credit Today in 2006. This article originally appeared prior to 2000.
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