In international trade, as a consequence of the nature of business transactions, there are some additional risks facing the buyer and seller, due to not knowing each other well. Different foreign exchange regime applications in both parties’ countries and probable political instability instances are the risk enhancing factors. Usage of banking transactions and technology in the international trade has lead the increasing of import and export figures and enhancing the risks in the worldwide. Therefore, the letter of credit is one of the bank warranties aiming to decrease the risks.
Banks provide credit to the companies, which are registered in different countries and despite being almost uninformed about each other, perform mutual business transactions, by issuing the letter of credit upon answering some specific requirements. By the courtesy of letter of credit, the exporting costs of the commodities are paid by the banks. Here, a quadripartite agreement is made. The applicant for credit, which is the typical buyer (orderer) party of the disposal agreement, applies to the bank in his/her country and authorizes issuing letter of credit benefit to exporter. Simultaneously, for the determination of the content of the letter of credit, the type, the conditions and the documents which are to be presented at issuing time are also clearly declared.
Beneficiary of the letter is the party, who makes an agreement with the applicant for credit and who exports the goods and services. Undoubtedly, the third part of this multilateral agreement is the issuing bank in the importer’s country. The issuing bank prepares the agreement text according to the importer’s directions and delivers it to the advising bank. But in another type of the letter of credit, it is possible to include a confirming bank, which undertakes the responsibility of the issuing bank. The duty of the advising bank is announcing the letter of credit to the orderer. As a matter of fact, the issuing bank and the advising bank are supposed to be different banks registered in the respective parties’ countries; but in the practice, the advising bank may be one of the branches of the issuing bank. Advising bank doesn’t have any responsibilities, unless it adds its own attachment of confirmation to the notification. If there is a confirming bank clause in the letter of credit agreement, the confirming bank solemnly undertakes to pay the cost or to accept the bill of exchange, when the exporter presents the predetermined documents.
There are three types of letter of credits in international trade practice, which are classified as follows:
- Revocable Credit
In this type, the credit can be cancelled without informing the beneficiary by the issuing bank. It is not widely used, because of its inability to provide trust to the beneficiary.
- Irrevocable Credit
This type has a clause, which states that if all the credit conditions and documents are provided the credit cannot be cancelled and the conditions are irreversible. According to ICC Publication No: 500 Uniform Customs and Practice for Documentary Credits, a letter of credit is supposed to be irrevocable, unless specified frankly otherwise.
- Confirmed Credit
The advising bank, which is responsible to inform the letter of credit to the beneficiary, undertakes the responsibility by adding its own confirmation to this information giving. That is, it might be argued that this type is more beneficial to the exporter, because of the responsibilities of the banks in both parties’ countries. But it causes extra expenses for the importer.
There are also various kinds of letters of credits, which carry different specifications according to their usage areas:
- Transferable Letter of Credit
This type is partly or completely transferable to the third parties by the beneficiary. Generally, the first beneficiary is the commission agent of the goods. A credit is assumed to be transferable, unless otherwise specified.
- Irrevocable Credit
This type is revolved automatically during the complete or partly usage, without any specific directions. This version aims to avoid the need for issuing new letters in all transportation instances at the long-termed sale contracts.
- Back to Back Letter of Credit
The beneficiary applies to the advising bank and requests a second credit for a second beneficiary, by showing a letter of credit issued for his/her behalf as a warranty. That is, here two different and independent letter of credit transactions are carried out.
- Red Clause Letter of Credit
This type provides complete or partly payment before the presentation of the documents, which are the essential elements for issuing a letter of credit to the beneficiary. Therefore, it is an exception of the general letter of credit type.
- Green Clause Letter of Credit
In this type, the exporter gains the opportunity to receive cash payment before transporting the goods. But the goods must be left to a common store or a warehouse belonging to a third party.
- Stand By Letter of Credit
This type is a counter-warranty, which is generally used in the international contracting business. Here, the issuing bank ensures its responsibility to the buyer or to employer of the orderer. American banks aren’t permitted to issue counter-warranty or stand-by letters, as it is required by the American legislation, therefore they prefer to issue this type of the letter of credit.
There are some crucial points for achieving success and obtaining problem-free credits in the letter of credit transactions, which actually have such a major place in the commercial life. First of all, there is a specific form in the letter of credit transactions and it has to be executed firmly and thoroughly to provide the soundness of the letter, as mentioned in a Turkish Cassation Court’s decision, dated 1976. Therefore, some clues should be reminded for the benefit of the both parties, to ensure execution of these formal requirements to avoid accidental negligence.
First, all of the necessary documents should be clearly stated before the making of the agreement. Otherwise, the credit provisions will be invalid due to the lack of proper documents. Also, the exporter must also be certain about the accuracy of the name, address and the other relevant information about the importer party, during the transactions. Besides, the exporter should be informed about the probability of the acceptance of the partial deliveries or the detailed facts concerning the loading and shipment of the goods.
The most extensive conflict reflected to the courts about the letter of the credit is the matter of confirmation. A lot of disputes have arisen due to the obscurity about the fact, whether the primary application of the beneficiary should be to the issuing bank or to the confirming bank. But according to decisions of the Turkish Cassation Court, the confirming bank has a substantive and fundamental responsibility and consequently, there must be applied first for the credit.