Letters of credit, which are frequently used in international trade relations come with a double-sided guarantee for both the importer and the exporter. However, these credit letters also have a downside in terms of their limiting nature, as they are hard to transfer. Even though one may easily transfer a transferable letter of credit, the transfer of many of the other types, which do not carry this phrase in particular, can only take place in a few limited ways. This article discusses the alternative ways to transfer non-transferable letters of credit.
Each suggestion in this article should be interpreted within the context of each particular letter of credit on a case by case basis, taking into account the specific terms and the general characteristics of that type of letter of credit in question.
There are a few different types of letters of credit depending
on the payment method to be used and other characteristics. The
transfer of a letter of credit is possible if it carries the term
"transferable". Letters of credit can only be transferred
in a few other limited ways, even though they are frequently used
due to the conditional guarantees they provide.
If the transfer of a letter of credit is desired, in most cases this should be foreseen or determined beforehand. Yet, under certain conditions, it may still be possible to transfer a letter of credit that is not classified as transferable with alternative transactions. This article provides an insight into transferable letters of credit and how alternative solutions can be used to transfer non-transferable letters of credit.
Types and Characteristics of Letters of Credit
Letters of credit rest on conditional commitments and are prepared by banks upon the request of importers. The document guarantees that the importing party will pay the cost of goods to the exporter when the conditions are met and the required documents on the letter of credit are delivered correctly.
Letters of credit are frequently used in myriad sectors that take part in international trade, as it provides some basic guarantees for both the importer and the exporter and protects both sides. For the exporter, the letter of credit provides a guarantee that the price of the goods sold will be paid to that party. The exporter has the payment guarantee of the bank. It further provides assurances against political risk factors. For the importer, it provides the guarantee that the requested goods will be shipped and that the bank will not pay before the exporter submits the documents proving that conforming goods have been delivered to the importer. Also, as the bank examines whether the conditions in the letter of credit are fulfilled, the importer is relieved of this burden.
As aforementioned, banks are the main institutions that form the basis of the letter of credit procedure. Usually, there are two banks that coordinate within the process; the issuing bank which is the bank of the importer and corresponding bank which is the bank of the exporter. Other than the issuing and corresponding banks, the exporter may request a third financial institution to confirm the requested loan to provide an extra guarantee. In this case, the third bank is the confirming bank. The confirming bank provides a type of insurance in terms of the commitments of the issuing bank. The issuing bank provides the letter of credit and is obliged to make the payment when the exporter makes the payment within the period stated on the letter of credit.
The letter of credit procedure begins when the importer issues a letter of credit document and the corresponding bank sends the exporter a notice after the parties enter into a sales agreement that states letter of credit to be the payment method. The goods must be shipped within the determined period on the document. Then, the documents proving the shipment are sent to the issuing bank and the payment must be initiated following the conditions on the document when the receiving party confirms that the conditions are met by reference to the letter of credit.
It is very important to ascertain which letter of credit type is used in the transaction to be able to determine the terms of the procedure and the rights and disposals of the parties. The reason behind such structure is that the letter of credit is a very strict and normative document compared to an agreement entered into by the parties.
The following types are the most commonly used letters of credit, the types usually differ in terms of payment methods and certain other characteristics like transferability and revocability. Even though there are certain other types of letters of credit, it is possible to list the most common ones as follows:
Sight Payment Letter of Credit,
Deferred Payment Letter of Credit,
Acceptance Credit Letter of Credit,
Negotiation Letter of Credit,
Revocable Letter of Credit,
Irrevocable Letter of Credit,
Confirmed Letter of Credit,
Unconfirmed Letter of Credit and
Transferable Letter of Credit
Transferable Letters of Credits and the Transfer Procedure
The general rule is that in order for a letter of credit to be transferred, it should specifically be stated on the document with the phrase "transferable" and the letter of credit should be issued as transferable in the beginning. A transferable letter of credit is one that the beneficiary can freely transfer to a second beneficiary. Transferable letter of credits allow exporters to transfer the letter of credit issued in their favor to another beneficiary of their choice.
Transferable letters of credit are regulated under Article 38 of UCP 600 – The Uniform Customs and Practice for Documentary Credits, a set of rules on the issuance and use of letters of credit, drafted by the International Chamber of Commerce (ICC) and is utilized by bankers and commercial parties over 175 countries. Under UCP's Article 38, a letter of credit which is issued as "transferable" can be transferred in whole or in part to a second beneficiary different from the one specified on the document upon request of the exporter (first beneficiary). It is commonly agreed that a letter of credit which has been transferred once cannot be transferred a second time unless otherwise stated on it specifically. However, if the letter of credit allows partial shipments the consensus is that it can be transferred more than once.
In case of transferable letters of credit, a transfer bank may be included in the letter of credit scheme as a third bank. In this scenario, the issuing bank notifies the transfer bank. The transferred letter of credit must meet the terms of the original letter of credit.
Unless agreed otherwise, transfer fees are usually paid by the first beneficiary.
Is it possible to transfer a letter of credit unless the document specifically states that it is "transferable"?
As aforementioned, the rule is that it is not possible to transfer a letter of credit unless the document specifically states it is "transferable" with the exact phrase. However, even non-transferable letters of credit may be transferred by using an alternative method.
Article 39 of the UCP 600 allows the transfer of rights and funds deriving from a certain letter of credit, even when a document is not issued as 'transferable'. This way, the rights and funds arising out of a given letter of credit may be transferred instead of the document itself when the party to the document changes. This is an alternative resolution as the new actor in this case does not become a party to the original transaction but rather receives the right to collect either the goods or the funds.
Parties, however, should always keep in mind that these provisions are not imperative before they base their actions on UCP 600 provisions. Thus the alternative way Article 39 provides would not be possible unless parties agree otherwise in an agreement. Therefore one should initially examine the letter of credit contract. According to the leading opinion on the subject, unless otherwise agreed upon in the main contract and if the paying bank is a Turkish bank, the transaction will be subject to Turkish Law. Pursuant to Article 184 of the Turkish Law of Obligations (which contains the local law pertaining to contracts) a written transfer of rights arising out of the letter of credit will be deemed valid by courts. Additionally, it is important that one of the parties notifies the paying bank and the issuing bank of the transfer.
Furthermore, for the transfer of rights arising out of a letter to be possible, one should determine whether the credit is due or not. If the bank decides that submission is proper when the letter of credit is submitted, the beneficiary's credit will be regarded as due. However, if the first beneficiary does not submit the necessary documents, only a mere possibility of transfer claim may arise. In the latter scenario, the risk would be higher comparatively, because unless the transferor beneficiary submits the documents in due time, the transferee (second) beneficiary might have difficulties in claiming the payment.
To conclude, when a letter of credit is not issued as transferable, parties may resort to this alternative procedure to transfer the rights arising from the letter of credit in order to achieve the result.
If a party chooses this alternative way, the first beneficiary should submit the documents before the transfer and the credit should be due. In addition, both banks should be notified and the agreement for the transfer of rights should be in writing. This procedure is crucial to minimize the risks that might arise in the case of transfer of rights claim.
It should be reiterated that when a party resorts to this alternative procedure, merely the right of claim arising from the letter of credit is being transferred, not the letter of credit itself. It is not possible to directly transfer a letter of credit unless the document prepared by the issuing bank specifically states it is "transferable".
Even though there exists an alternative resolution discussed in this article for transferring letters of credit, if the possibility of transfer is present from the beginning or is considered by one of the parties, it will always be preferable to have the letter of credit be issued as "transferable" by the bank itself.
This way, it is possible to prevent possible disputes and risks that might occur in the future.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.