6 Ways to reduce unworkable letters of credit

by | Apr 29, 2016 | Uncategorized

Credit managers are often faced with the task of getting paid when they have a letter of credit that contains conflicting issues. Compounding this problem is the fact that banks have no incentive to change their practices regarding fee-generating services since the “fees and interest banks can collect on trade finance transactions are directly proportional to the confusion and complexity of the issued credit,” says John W. Dunlop, president of AVG Trade Group.

This results in what Dunlop calls unworkable letters of credit. He says that sellers (not the credit manager of course) contribute to the problem because they would rather take the risk of a bad letter of credit then lose the sale. The problem ends up on the desk of the credit manager, who must figure out how to get paid – without the letter of credit.

Unworkable Terms
“An unworkable letter of credit,” says Dunlop, “is one that contains conditions that the beneficiary cannot comply with. The result is a discrepant submittal of negotiable documents and the loss of protection.”

Dunlop is quick to point out that unworkable letters of credit are different from unfavorable ones. Though there maybe conditions in the latter that are not to the beneficiary’s liking, these conditions can be met. With an unworkable letter of credit, meeting the conditions – either because two conditions contradict each other or because of insufficient timing or other impracticalities – becomes physically impossible.

To help credit professionals, Dunlop has prepared a list of the most common unworkable terms in tellers of credit. They are as follows:

  • Performance conditions. Since the buyer does not wish to tie up its credit for any longer then the minimum amount of time, the latest shipping date, the expiry date, or the presentation date are apt to be inadequate.
  • Document requirements. This might include a requirement for documents that the beneficiary cannot produce or procure before shipment – for example, a signed inspection certificate detailing the origin or each component in an assembled product. Even if this information were known, American chambers of commerce will only certify American products, so any product with a foreign component would not be given a certificate, and this requirement would not be met.
  • Additional conditions which the beneficiary cannot meet. Dunlop gives the example of a requirement where the applicant asks the beneficiary to supply a copy of the carrier’s insurance policy instead of a certificate of insurance. Such policies are typically umbrella policies to cover the ongoing operations of the carrier and are not available to freight forwarders or their customers.
  • Ambiguities. When two contradictory requirements are included in a letter of credit, the beneficiary has no way of complying. Dunlop cites the example of the INCOTERM FOB being used in one place and then a requirement that freight be prepaid to the destination. Other vague terms such as “an original copy” or a “certified fax” make it impossible for the beneficiary to comply.

 

Minimizing Unworkable Conditions
While completely eliminating these unworkable items is probably impossible, the international credit professional can do many things to make sure these issues are either eliminated or dealt with in a timely fashion. Here’s what you can do:

  1. Identify the unworkable issues. Start with Dunlop’s list of common items and add it to ones that recur in your shop.
  2. Work with the buyer. Often the buyer is not aware that these conditions exist in the letter of credit. Once the buyer understands the seller’s issues with the letter of credit, it can negotiate with the bank to have them stricken from the letter of credit.
  3. Communicate with the buyer about these conditions in writing. In this manner, the new wording can be included, and the buyer can five it directly to the bank. The change will come in the form of an amendment that should reflect the seller’s recommended wording. Dunlop suggests that the letter sent to the buyer should, if at all possible, include references to the letter of credit not conforming to UCP 500. This information will be useful to the buyer if its bank insists on its own language.
  4. Provide the buyer with letter-of-credit instructions that spell out the terms and conditions that should be included. If at all possible, make this a standard document that the sales force gives to all customers that are required to provide letters of credit.
  5. Review the amendment as soon as it is received from the bank. If is does not conform to what was requested of the buyer, make an assessment of whether accepting the amendment as is or requesting another amendment is worthwhile. Remember in all likelihood, time will be running out.
  6. Get your staff up the letter-of-credit learning curve. Not all the letter-of-credit problems originate with the customer. Occasionally those in the credit department make mistakes. Dunlop has put up a letter-of -credit tutorial on his Web site. Anyone can use it at no cost. Insist that your staff go through the various modules. It is available in several languages.

Credit professionals who follow Dunlop’s advice will reduce the number of unworkable conditions that they encounter in letters of credit. John W. Dunlop can be reached at 619-692-9648 or johnwdunlop@avgtsg.com. For more information about letters of credit or handling letters of credit over the Internet, visit AVG Trade Group’s Web site, http://www.avgtsg.com.