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Letter of credit
Definition:
A letter from a bank guaranteeing that buyer's payment to seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase. Nature

The seller would prefer to be paid as early as possible and the buyer would wish to delay the payment. In practice, contracting parties use a letter of credit (documentary credit or banker’s credit or commercial credit). Under a documentary credit, the buyer (applicant) agrees to pay the seller (beneficiary) using a reliable paymaster- generally, a reputable bank in the seller’s country- who pays against the presentation of stipulated documents that comply with the terms of credit. Letter of credit advantages for the seller

The seller has the guarantee from the buyer's bank to pay for the shipped goods Reducing the risk of the buyer cancels or changes his order The seller is able to calculate the payment date for the goods The buyer cannot refuse to pay

Letter of credit advantages for the buyer
The bank will pay for the goods
The buyer can control the time period for shipping
By a letter of credit, the buyer demonstrates his solvency
The seller grants a credit to the buyer in the case of letter of credit Buyer can avoid or reduce pre-payment.
Characteristics of letters of credit
The autonomy of letters of credit
According to the principle of autonomy, the undertaking of the issuing bank or confirming bank to pay against the documents is seen as a primary obligation. The obligation of the banks (issuing bank and confirming bank) are in respect of the documents, not in respect of the goods. As long as the documents are in order, the banks cannot get out of their obligations by pointing to incidents such as shipment of defective goods. Buyers often seek an injunction to stop the bank from paying where goods do not match the contract description...
Letter of credit
Definition:
A letter from a bank guaranteeing that buyer's payment to seller will be received on time and for the
correct amount. In the event that the buyer is unable to make payment on the purchase, the bank
will be required to cover the full or remaining amount of the purchase.
Nature
The seller would prefer to be paid as early as possible and the buyer would wish to delay the
payment.
In practice, contracting parties use a letter of credit (documentary credit or banker’s credit or
commercial credit).
Under a documentary credit, the buyer (applicant) agrees to pay the seller (beneficiary) using a
reliable paymaster- generally, a reputable bank in the seller’s country- who pays against the
presentation of stipulated documents that comply with the terms of credit.
Letter of credit advantages for the seller
The seller has the guarantee from the buyer's bank to pay for the shipped goods
Reducing the risk of the buyer cancels or changes his order
The seller is able to calculate the payment date for the goods
The buyer cannot refuse to pay
Letter of credit advantages for the buyer
The bank will pay for the goods
The buyer can control the time period for shipping
By a letter of credit, the buyer demonstrates his solvency
The seller grants a credit to the buyer in the case of letter of credit
Buyer can avoid or reduce pre-payment.
Characteristics of letters of credit
The autonomy of letters of credit
According to the principle of autonomy, the undertaking of the issuing bank or confirming bank to
pay against the documents is seen as a primary obligation.
The obligation of the banks (issuing bank and confirming bank) are in respect of the documents, not
in respect of the goods.
As long as the documents are in order, the banks cannot get out of their obligations by pointing to
incidents such as shipment of defective goods.
Buyers often seek an injunction to stop the bank from paying where goods do not match the contract
description but court are unwilling to grant such injunction.
Case: Discount Records v Barclays Bank (1975)
On delivery of the cargo, the buyer discovered that some of the boxes which should have contained
records were empty or contained cassettes instead.
The buyer wanted to stop the bank from paying the seller but was refused by the court.
Held that the buyer obligation to pay under the credit was separate from the contract of sale, and the
court could intervene only if a sufficient cause was shown.
Payment by the bank, however, does not affect the buyer’s rights under the contract of sale. The
buyer can always sue the seller for breach of contract in the event of receiving no goods, or
substandard goods.
The principle of autonomy favours the banks and the seller. Banks are not responsible for ensuring
the cargo match with the contract description.
The principle of autonomy is affected in the event of illegality in the underlying transaction or fraud,
which means that no oblications on a letter of credit is contrary to exchange regulations.
Case: United City Merchants v Royal Bank of Canada (1983)
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