What is a Letters of Credit?

Letters of credit are a payment method used for the sale of goods between exporters and importers.

A letter of credit is an undertaking given by a bank that they will pay the exporter. The exporter must fulfil all of the terms and conditions of the letter of credit to ensure the issuing bank will pay.

The Advantages of a Letter of Credit

Letters of credit (LCs) are one of the most versatile and secure instruments available to international traders. An LC is a commitment by a bank on behalf of the importer (foreign buyer) that payment will be made to the beneficiary (exporter) provided that the terms and conditions stated in the LC have been met, as evidenced by the presentation of specified documents.

Since LCs are credit instruments, the importer’s credit with their bank is used to obtain an LC. The importer pays the bank a fee to render this service.

An LC is useful when reliable credit information about a foreign buyer is difficult to obtain or if the foreign buyer’s credit is unacceptable, but the exporter is satisfied with the creditworthiness of the importer’s bank.

The Letter of Credit Process

There are typically seven steps that occur in order to get paid using a letter of credit:

1. The importer arranges for the issuing bank to open an LC in favor of the exporter.
2. The issuing bank transmits the LC to the nominated bank, which forwards it to the exporter.
3. The exporter forwards the goods and documents to a freight forwarder.
4. The freight forwarder dispatches the goods and either the dispatcher or the exporter submits documents to the nominated bank.
5. The nominated bank checks documents for compliance with the LC and collects payments from the issuing bank for the exporter.
6. The importer’s account at the issuing bank is debited.
7. The issuing bank releases documents to the importer to claim the goods from the carrier and to clear them at customs.

Why use a Letter of Credit in International Trade Transactions

Seller Concerns:

• Contract risk: Having a well-crafted sales agreement with proper terms of sale and payment.
• Production risk: What if the buyer cancels the order?
• Legal risk: What are the foreign laws and jurisdiction in case of disputes and/or defaults?
• Currency Risk: Doing business in hard currency. i.e. currency widely accepted around the world as a form of payment for goods and services.
• Export regulations.
• Risk of misunderstanding: Using terms of sale and payment terms that has common interpretation in the buyer’s and seller’s countries.
• Title Retention: Risk of losing title to goods in a foreign country.
• Insolvency risk: What if the buyer goes bankrupt? Knowing the credit worthiness of the buyer.
• Control on logistics of shipping the goods.
• Control on transfer of risk from seller to buyer during transit of goods.
• Risk of non-acceptance: Goods may not be accepted by the buyer upon arrival in buyer’s country.
• Payment Risk: Payment may not be made on time or as per terms of the sale.
• Country Risk: The risk factors associated with the country of import: Geographical, Economic and Political.
• Financing: Opportunity of getting financed for the job.

Buyer Concerns:

• Contract risk: Having a well-crafted sales agreement with proper terms of sale and payment. Accurate description of goods; pricing; invoicing; origin etc.
• Import Regulations.
• If pre-paid, what if the seller takes the money and does not ship?
• What if the seller sends substandard goods or goods not as per description in the contract?
• Legal risk: Knowing the local laws and jurisdiction in case of disputes and/or defaults.
• Risk of misunderstanding: Using terms of sale and payment terms that has common interpretation in the buyer’s and seller’s countries.
• Control on the timing for shipment of goods.
• Control on logistics of shipping the goods.
• Control on transfer of risk from buyer to seller during transit of goods.
• Negotiating credit terms from the seller for payment: Net 30, Net 60 etc.

See our article Commonly Used Export And Import Documents In 2022 for more information.

Documents Required for International Shipping

There are many documents involved in international trade, such as commercial documents, financial documents, transport documents, insurance documents and other international trade related documents.

In processing the export consignment, documentation may be executed in up to four contracts: the export sales contract, the contract of carriage, the contract of finance and the contract of cargo insurance.

It is therefore important to understand the role of each document and its requirements in international trade.

List of Documents required for Exports Customs Clearance

• ProForma Invoice
• Customs Packing List
• Country of Origin or COO Certificate
• Commercial Invoice
• Shipping Bill
• Bill of Lading or Airway Bill
• Bill of Sight
• Letter of Credit
• Bill of Exchange
• Export License
• Warehouse Receipt
• Health Certificates

List of Documents required for Imports Customs Clearance

• Bill of Entry
• Commercial Invoice
• Bill of Lading or Airway Bill
• Import License
• Certificate of Insurance
• Letter of Credit or LC
• Technical Write-up or Literature (Only required for specific goods)
• Industrial License (for specific goods)
• Test Report (If any)
• RCMC Registration cum Membership Certificate
• GATT/DGFT declaration
• DEEC/DEPB/ECGC License for duty benefits

Pro Forma Invoice 

A pro forma invoice is an important  document used as a negotiating tool between the seller and the buyer prior to an export shipment. This document should be used  by the seller to quote  at the beginning of an export transaction and it will eventually become the  final  commercial invoice  used when goods are cleared through customs in the  importing  country. The document  contains a description of goods (e.g., quantity, price, weight, kind and other specifications)  and  is a declaration by the seller to provide the products and services to the buyer  at  the specified date and price.

Commercial Invoice 

The commercial invoice is a legal document between the  exporter  and the  buyer (in this case, the foreign buyer)  that clearly  states the  goods  being sold and the amount  the customer is to pay. The commercial invoice is one of the main documents used by customs in determining customs duties.  A commercial invoice is a bill for the goods from the seller to the buyer. These  documents are often used by governments to determine the true value of goods when assessing customs duties. Governments that use the commercial invoice to control imports will often specify its form, content, number of copies, language to be used and other characteristics.

Packing List  

Considerably more detailed and informative than a standard domestic packing list, an export packing list lists seller, buyer, shipper, invoice number, date of shipment, mode of transport, carrier, and itemizes quantity, description, the type of package, such as a box, crate, drum, or carton, the quantity of packages, total net and gross weight (in kilograms), package marks and dimensions, if appropriate. Both commercial stationers and freight forwarders carry packing list forms. A packing list may serve as conforming document. It is not a substitute for a commercial invoice. In addition, U.S. and foreign customs officials may use the packing list to check the cargo  so  the commercial invoice  should  reflect the information shown on the packing list.

Transportation Documents  

Air Waybill

Air freight shipments require airway bills.  An air way bill accompanies goods shipped by an international air carrier. The document  provides  detailed information about the shipment and allows it to be tracked.  Air waybills are shipper-specific  and are not negotiable documents (as opposed to “order” bills of lading used for vessel shipments).

Bill of Lading  

A bill of lading is a contract between the owner of the goods and the carrier (as with domestic shipments). For ocean shipments, there are two common types: a straight bill of lading, which is non-negotiable, and a negotiable, or shipper’s order bill of lading. The latter can be used to  buy, sell or trade the goods  while  in transit. The customer usually needs an original  bill of lading  as proof of ownership to take possession of the goods  from the ocean carrier.

Country of Origin or COO Certificate

The Country of Origin Certificate is a declaration issued by the exporter that certifies that the goods being shipped have been completely acquired, produced, manufactured or processed in a particular country.

Letter of Credit

Letter of credit is shared by the importer’s bank, stating that the importer will honour payment to the exporter of the sum specified to complete the transaction.

Depending on the terms of payment between the exporter and importer, the order is dispatched only after the exporter has this letter of credit.

Bill of Exchange

Bill of Exchange is an alternative payment option where the importer is to clear payments for goods received from the exporter either on-demand or at a fixed or determinable future.

It is similar to promissory notes that can be drawn by banks or individuals. You can even transfer a Bill of Exchange by endorsement.

Export License

Businesses must have an export license that they can provide to customs in order to export or forward any products. This only needs to be produced when the shipper is exporting goods to an international destination for the very first time. This type of license may vary depending on the type of export you intend to make.

This can be done by applying with the licensing authority, and the permit is eventually issued by the Chief Controller of Exports and Imports.

Warehouse Receipt

Warehouse Receipt receipt is generated once the exporter has cleared all relevant export duties and freight charges post customs clearance. This is needed only when an ICD in involved.

Health Certificates

Health Certificate is applicable only when there are food products that are of animal or non-animal origin involved in international trade.

The document certifies that the food contained in the shipment is fit for consumption by humans and has been vetted to meet all standards of safety, rules and regulations prior to exporting. This certificate is issued by authorised governmental organisations from where the shipment originates.

Bill of Entry

A bill of entry is a legal document to be filled & duly signed by an importer/CHA/carrier. After filing a bill of entry along with the other necessary documents, assessment and examination of goods are carried out by concerned authorities. Once the process is completed, an importer can avail for ITC claim on goods.

Import License

There are certain items that cannot be freely imported in India, an import license is a permission granted by the government to undertake import activities for restricted goods. In order to avail the benefits, one must file an application to the licensing authority.

Insurance certificate

An Insurance Certificate is a document required for import customs clearance. This certificate helps the authorities to verify the shipment, in terms of whether the selling price contains the insurance or not. Also, it helps determine the precise value which eventually decides the import duty aggregate.

What Is A Packing List (PL) in Import and Export ?

A packing list is a shipping document that is widely used in international trade. As its name suggests, it contains information about the contents of the exported goods. It is glued on the exterior of the shipment.

The foreign trade policy of the Government of India requires a commercial invoice-cum-packing list, or a separate invoice and packing list, to accompany all shipments. As a measure to reduce the number of mandatory documents, Indian customs accepts a combined commercial invoice and packing list.

A packing list is generally attached to the shipment in a waterproof pouch.

Contents in the Format for Export Packing List

Let us look at the contents of this all-important list:

• Details of the exporter/consignor of the goods, including their name and complete address.
• Details of the consignee, i.e., the party to whom the consignment is shipped (generally, the overseas buyer). However, in cases where a letter of credit is used, write the name of the bank with the words ‘To the order of…’ If the contents of the shipment are to be resold at the destination to a third party, mention the words ‘To order’. If the actual buyer and the consignee are different, specify their details.
• The invoice number, which is a serial number of the sale transaction, along with the date.
• The purchase order number of the overseas buyer, along with the date. If the shipment is under a letter of credit, mention the LC number and date as well.
• Any other reference number related to the shipment.
• The country of origin is the country where the goods were originally manufactured. This information is especially relevant if goods are imported into a country and exported after repackaging.
• The country of final destination is the country where the goods will finally reach.
• Name of the vessel/flight, along with the voyage number in case of vessels.
• Pre-carriage mode, which refers to the movement of the cargo to the port of loading.
• Place of receipt is the location where the goods are received by the carrier after completing export customs procedures.
• Port of loading can be the same as the place of receipt unless the loading is done somewhere other than the place of customs clearing.
• Port of discharge is the port where the shipped goods are to be unloaded from the carrier for delivery at the buyer’s place.
• Place of delivery will be the same as the port of discharge unless the buyer is located far from the latter. The carrier has to deliver the goods up to this point; this is where the buyer files customs documents for import and takes delivery of the cargo.
• Terms of delivery and terms of payment indicate whether the goods shipped are ex-works, free on board (FOB), C&F, C&I, CIF, DDU, DDP, etc. and terms of payment like LC, DA, DP, etc. as per the agreement between the exporter and the importer.
• For Marking and Numbering, refer to the details made on the on parcels to be exported. Proper marking and labeling are particularly important in case of less than container load (LCL) shipping.
• The number and kind of packages show the total amount and type of cargo. Goods can be in the shape of a wooden box, drums, corrugated carton boxes, pallets, etc.
• Description of goods is self-explanatory; however, if the shipment is under the letter of credit, the description of the goods in the LC should exactly match the words mentioned in the LC.
• Physical information of the shipment; this includes its dimensions, net weight, and gross weight.
• A declaration to the effect that all information given in the packing list is true.
• Any Other Remarks as applicable.
• Finally, the Authorized Signatory, dated and stamped, affixes a stamp of authenticity to the packing list.

Additional Details For Packing List

Considerably more detailed and informative than a standard domestic packing list, an export packing list lists seller, buyer, shipper, invoice number, date of shipment, mode of transport, carrier, and itemizes quantity, description, the type of package, such as a box, crate, drum, or carton, the quantity of packages, total net and gross weight (in kilograms), package marks and dimensions, if appropriate.

Both commercial stationers and freight forwarders carry packing list forms. A packing list may serve as conforming document. It is not a substitute for a commercial invoice.

In addition, U.S. and foreign customs officials may use the packing list to check the cargo  so  the commercial invoice  should  reflect the information shown on the packing list.

Check out our instruction to how to write a Commercial invoice, Pro-Forma invoice  and Bill of Lading for more  details.