Letter Of Credit

Letter of Credit is a financial document that is used in international trade. It is a payment guarantee offered by the bank to the supplier of the goods. A “Credit Letter” that is issued by the bank will be a kind of promise to the seller of the goods if the buyer fails to make the payment of the purchased goods. We at Dhanguard offers assistance for obtaining Letter of Credit in UAE.

Before proceeding further, let’s understand what is meant by Letter of Credit. In simple word, Letter of Credit can be referred to as ‘Lifeblood of any International Commerce’. It is governed by Federal Law No. 18 of 1993 of the Commercial Transactions Law.

Letter of Credit can be stated as a contract in which the issuing bank approves to provide a substantial amount of finance at a precise period when the applicant requests for the payment. The financed amount will be provided in the name of the seller of the goods who is also known as the beneficiary. This financial assistance is secured by document that represents goods are being shipped or being prepared for the shipment.

The components of Letter of Credit are as follows-

components of Letter of Credit

Issuing Bank

The Name and details of the banks that offers you the credit should be mentioned.

Applicant

The name and details of the applicant who arranges for payment.

Beneficiary

The name and details of the beneficiary who is going to receive the payment from issuing bank.

Specified Time Limit

The time limit for the Payment has to be mentioned.

Agreement

The parties to the Letter of Credit should agree up on the Terms and Conditions listed in the letter.

Specified Place

The document has to be presented at a specified place, and that place should be mentioned in the document.

In Letter of credit, the credit provided has to be mentioned with respect to the agreement of Sale that is agreed by the buyer as well as the seller. If the credit stated in the Letter of Credit and the agreement are not same, the seller has the right to reject it.

Once the bank has confirmed the credit amount, the beneficiary will be informed directly or any other communicator bank in the place of the beneficiary about the credit. The communicator bank will then contact the beneficiary and get authorization from them. Henceforth the communicator bank will be accountable to make payment to the beneficiary. 

As per the Commercial transactions law, there are two types of letter of credits available. They are as follows-

Types of Letter of Credit

Revocable Letter of credit

In this type of letter of credit, the credit can be annulled or modified at any time. Lastly, it should not hold any liability with regards to the beneficiary. 

Once the terms and conditions with the required documents are met, the letter of credit will be honored. It is mostly used to offer guidelines for the consignment.

Irrevocable Letter of credit

An irrevocable letter of credit cannot be cancelled without the agreement of the beneficiary with the issuing bank as well as the confirming bank. It offers a fine relationship between the bank and the beneficiary. Consequently this kind of Letter of Credit guarantees security to the beneficiary concerning the payments.

Letter of Credit is more significant in trade in the UAE because the country has commercial deals all across the globe. A documented credit transaction or letter of credit transaction, demands trust towards the issuing banks. Both the buyer and seller must have assurance that the bank will justify the payment commitments. A letter of credit builds up confidence for both the performing parties. 

What is ‘margin amount’ while opening Letter of Credit?

Bank guarantee the beneficiary with the payment but what is the guarantee provided by the beneficiary against the amount of the Letter of Credit. So, in this case a margin amount is blocked in the bank account of the seller to make the payment under the said document. Undoubtedly you also wants to know what margin amount bank blocks. This amount can be determined purely based on your financial relationship with your bank.

What are the fundamental Principles for governing Letter of Credit in UAE?

There are various principles that governs the Letter of Credit under the UAE laws-

Principle of Autonomy

Under Principle of Autonomy, documentary credit can be considered as separate contract than the underlying sales contract. The autonomy of Letter of Credit can be considered as an advantage in the international sales as it serves as a corporate assurance to the parties involved in the international market in various countries. If the banks were allowed to refuse the payment afterwards under Letter of Credit in a situation where dispute has arouse between the trading parties then the significant flow of the international trade has been blocked.

Doctrine of Strict Compliance

The second important principle for Documents Credit is the Doctrine of the Strict Compliance. It is the requirement that the issues documents are complied with the terms and conditions. The Letter of Credit will be considered as compliant to the terms laid down in the document and free of any defects.

What is the obligation of the Bank in terms of Letter of Credit?

Once the documents are presented, according to the Article 435, the bank is under the obligation to make sure the required documents are in accordance with the terms & conditions laid down in the letter, and should agrees with each other. Once the bank is satisfied with the above mentioned details, it can proceed to make the payment.

If the presented documents does not comply with the Letter then the issuing bank has the right to reject them. The issuing bank can even send the documents to the buyers for their approval to make the payment. Or else, the issuing bank will be deemed to accept it, and has to make the payment accordingly.

Letter Of Credit Related FAQ

Frequently Asked Questions