CDCS study materials-Transferable credits, back-to-back credits and assignment of proceeds
19.1 Transferable documentary credits
Transferable documentary credits are one of the more common types of documentary credit. There are a number of similarities with (and differences to) back-to-back documentary credits, which are reviewed in section 19.2.
In its simplest form, a documentary credit is issued in favour of the seller (beneficiary), which ships the goods, presents the stipulated documents and claims payment. This scenario is particularly applicable if the beneficiary is the manufacturer or producer of the goods. In some cases, however, an applicant will conduct business with an intermediary trader, agent or middleman (referred to hereafter as trader) who obtains the goods from one or more other sources. In this event, the trader will need to buy the goods or make arrangements for their purchase before supplying them to the applicant.
Typically, a trader will operate on narrow margins. It does not carry a stock of goods and often has limited working capital. A trader will therefore seek a means of financing the purchases in a manner that does not place a burden on its own resources.
In the context of a standby letter of credit, the underlying debt obligation is often sold, necessitating the transfer of the documentary credit to the new owner of the debt.
Transferable documentary credits were devised as a response to these needs. The basic idea underlying this feature is that the documentary credit issued in favour of the trader can be used as a means of paying the supplier(s) from which the goods are obtained and can act as security for payment for such goods. It also allows for the transfer of the undertaking in the documentary credit to the actual seller of the goods.
19.1.1 The basic features of a transferable documentary credit
To arrange the issuance of a transferable documentary credit, the final buyer (applicant) instructs its bank to issue a documentary credit in favour of the trader from which the goods are to be bought (who will become known as the ‘first beneficiary’), stating that it is transferable. This allows the trader to request the nominated bank with which the documentary credit is available for honour or negotiation to transfer it in whole or in part to the trader’s supplier(s) (who will become known as the ‘second beneficiary’). When a documentary credit is available with any bank, it must indicate the name of the bank that is authorised to transfer it.
If an application for the issuance of a documentary credit calls for it to be issued as ‘divisible’, ‘fractionable’, ‘assignable’ or ‘transmissible’, the issuing bank should check with the applicant that it simply requires the documentary credit to be issued as transferable. The bank should explain that the other terminology used has no meaning in the context of UCP 600. The definition of transferable credit is contained in UCP 600, sub-article 38(b).
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Transferable credit means a credit that specifically states it is “transferable”. A transferable credit may be made available in whole or in part to another beneficiary (“second beneficiary”) at the request of the beneficiary (“first beneficiary”).
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If the trader is buying from several suppliers, the bank may be requested to transfer parts of the documentary credit to each such supplier. The value of the parts of the documentary credit transferred to each supplier represents the price that the trader is paying for the goods. The balance represents the trader’s profit or margin.
This arrangement provides a trader’s supplier(s) with security for payment because part of the documentary credit itself is transferred to the supplier(s). In this way, each supplier obtains the right to claim payment direct from the bank at which its portion of the documentary credit is available (against presentation of complying documents). This means that a supplier obtains a large measure of control over the payment process, because it is able to ensure that the stipulated documents are presented within the time limits established in the transferred documentary credit.
A transferable documentary credit is also a convenient solution for a trader. It allows a trader to provide its supplier(s) with the security of a documentary credit without having to use any part of its own banking facilities.
19.1.2 The risks and costs of transferable documentary credits
A transferable documentary credit can involve extra risks and costs for the original applicant (the buyer for which the goods are destined). In particular, it accepts the risk of receiving goods from a third party, whom it may not know and with whom there may have been no previous business dealings.
Moreover, once a documentary credit is transferred, more parties are involved. This means that the documents have to be examined and, possibly, mailed twice before they reach the issuing bank. This increases the risk of delay, loss and error along the way.
The greater difficulties involved in controlling the operation under a transferable documentary credit may also increase the risk of fraud. A large part of this risk ultimately falls on the original applicant, which undertakes to reimburse the issuing bank provided that a complying presentation has been made.
Additional costs arise because of the difference between the price paid by the trader and the price that the trader charges to the applicant.
18.104.22.168 Managing the transferable documentary credit process
Transferable documentary credits will involve:
◆◆ a first beneficiary (trader) and one or more second beneficiaries (supplier(s));
◆◆ more than one set of documents;
◆◆ dealings in possibly more than one country;
◆◆ more than one reimbursement; and
◆◆ a longer chain of banks than are involved in a non-transferable documentary credit.
As a consequence of these features, a number of challenges may arise, and a transferring bank and issuing bank should have in place detailed procedures to manage them.
◆◆ It can prove difficult to monitor advices of amendments to the transferable documentary credit and the transferred documentary credit through the chain of the applicant, first beneficiary and one or more second beneficiaries. The monitoring of the necessary consents might also cause concern. However, it should be noted that UCP 600, sub-article 38(f), allows for each transferred credit to be amended individually and that the acceptance or rejection of an amendment by one-second beneficiary does not bind any other second beneficiary to the same course of action.
f. If a credit is transferred to more than one second beneficiary, rejection of an amendment by one or more second beneficiary does not invalidate the acceptance by any other second beneficiary, with respect to which the transferred credit will be amended accordingly. For any second beneficiary that rejected the amendment, the transferred credit will remain unamended.
◆◆ The bank of the second beneficiary might dispatch documents directly to the issuing bank, causing problems for the transferring bank and first beneficiary.
◆◆ If there are discrepancies in the documents, it may prove difficult to obtain the second beneficiary’s and first beneficiary’s agreement to an agreed course of action.
The following steps can be taken to address some of these risks or problems.
◆◆ The issuing bank can restrict honour or negotiation and transfer to a single nominated bank. While a beneficiary and applicant may be reluctant to agree to such an arrangement, the question that the issuing bank should ask itself is whether it wishes to be exposed to the greater risk inherent in any alternative arrangement and to what extent, if any, the applicant would agree to indemnify the bank for doing so…..
Source: Guide to Documentary Credits By Gary Coller
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