We have many clients utilize letters of credit to expedite payment and minimizing risk of nonpayment by having their customers issue a letter of credit in the client’s favor. A letter of credit (LC) is a document from a bank guaranteeing that a seller will receive payment in full as long as certain delivery conditions have been met. In the event that the buyer is unable to make payment on the purchase, the bank will cover the outstanding amount.
While LCs are among the most secure of payment methods for sellers, utilizing them successfully requires strict attention to detail. LCs are notoriously subject to discrepancies that can slow or even prevent payment. However, by diligently following the best practices outlined below, credit and AR pros can ensure this instrument works the way it’s supposed to, rather than generating a whole new set of headaches.
It is amazing how companies don’t take the time to really understand what documents are required to be paid under an LC. An LC is very black and white, easy to understand and will not pay if there are discrepancies. The following are examples of common discrepancies that are easy to avoid,
- Match incoming LCs against POs and sales orders.
- Send copies of the LC to both the sales and shipping department for review. This will help ensure it agrees with the order given, and delivery dates in the document can be met. Check that the shipping terms specified in the LC agree with those actually used.
- As soon as any discrepancies are found, ask your customer to have the changes made. In most cases, your customer will have a better relationship with the issuing bank and will be better able to get the required changes made. Also, by not waiting until the last minute, you will be in a better negotiating position.
- Fill out a sample LC application and give it to your customer. Most banks’ applications are the same, and your sample should work well in most instances. By using such a document you will have steered your customer in the right direction.
- If you do not like the terms and conditions, send the LC back immediately. It is much easier to get documentation fixed before the goods have left your facility. Once the product is on its way to your customer, you will have lost your negotiating advantage.
Partner with the Right Banks
An LC is only as good as the issuing bank standing behind it. Here are some tips to help you evaluate the issuing bank.
- Run a copy of the LC by your banker. This can help avoid obvious banking errors.
- Deal with a large local bank. This will provide the level of sophistication you need while simultaneously delivering the personal attention you’ll require when things go awry, as they often can with LCs.
- If an LC comes directly to you from a foreign bank, there is a good chance it is phony. It should usually come from an American bank.
- Ask for a confirmed LC only if the confirmation is truly needed. Ask your bank to confirm the bank that is issuing an LC that you will be receiving. If the dollar amount is large, you should definitely get a confirmation, as confirmed LCs are generally paid faster. If you are dealing with a country where one is required, you may have to get the confirmation.
- A bank that confirms an LC is not required to confirm amendments. This is another reason to check your LCs quickly. If the political situation should change rapidly, such confirmations may be withheld.
Follow LC Rules to the Letter
As stated before, LCs are very specific and it the customer does not meet ALL of the LC requirements, the issuing bank will not pay.
- Be aware of rules: A full set of documents means three originals and three copies unless the shipping line issues it. A deck bill of lading is not usually acceptable if a clean bill of lading is required.
- Present your papers in exactly the manner required by your LC. Don’t make any assumptions and don’t take any shortcuts. Remember, an LC is not a contract between you and the bank, but a financial obligation based on your ability to present perfect documentation.
- Never ship prior to receiving the LC. Once the goods are gone, you’ve lost all negotiating strength to get your documents fixed. In fact, if the LC never shows up, there is little you can do and you run the risk of having to convert the sale to open account with unlimited terms.