Factoring Companies Guidebook

This is a financial statement used by overseas suppliers to obtain a guarantee of payment from the buyer. It is raised by the buyer and drawn on their bank using part or all of a pre-arranged facility.

Alternatively:- "A written undertaking by the issuing bank given to the beneficiary (usually the supplier) at the request and in accordance with the instructions given by the applicant (the buyer) to make payment up to the stated sum of money, within a prescribed time limit and against stipulated documents".

See also: - Trust Receipts

Concerns

Purchasing by Letter of Credit - The letter of credit does not cause concern in itself, however it may be possible for the Client to have received the goods and sold them on to their customers prior to the obtaining good title to them. This is particularly the case where the documents are released to the Client, entitling them to the goods under a Trust Receipt. In this instance the Client cannot pass good title of the debts on to us.

The issuing bank may also cover their LC exposure by removing it from the overdraft facility, thus potentially restricting the Client's cash flow.

Sales by Letter of Credit - While generally sales by LC provide a higher level of security for the exporter, it may weaken their competitive position as they involve significant bank costs for both the exporter and the buyer. Of greater direct concern to us is that generally, we cannot be named as beneficiary under the LC. If the debts were funded, we would be reliant upon the Client transferring the proceeds of the LC across to us upon receipt, thus weakening our security and controls. Traditionally c70% of all presentations of documents to the advising bank are faulty in some way, therefore negating the security aspect.

The most common form of Letter of Credit is an Irrevocable LC, which can be amended only with the agreement of all parties; however the exporter remains dependant upon the undertaking of the foreign bank.

Identification

Enquiries should be made as to how export sales and purchases are paid for. If a Letter of Credit is used then the following questions should be asked:-

• Which bank is used?
• What are the terms of the Letter of Credit?
• Are Trust Receipts used?

Does the supplier or the bank hold title to the goods?

Bear in mind the likelihood of invoices being assigned prior to payment (maturity) of the Letter of Credit.

Treatment

Where the Client is purchasing by Letter of Credit, the amounts are material and the terms prevent good title passing to us, a reserve should be set up.

Mechanics

1. The exporter and buyer conclude a sales contract providing for payment by Letter of Credit

2. The buyer instructs its bank (the issuing bank) to open a Letter of Credit in favour of the supplier (exporter)

3. The issuing bank asks a bank in the supplier's country to advise or confirm the Letter of Credit to the supplier

4. The supplier ships the goods and submits all required documents to the advising bank

5. The advising bank checks the documents and either pays at sight or on some future date stipulated in the terms of the Letter of Credit

6. If the advising bank has added its 'confirmation' then regardless of any other consideration, it must pay, accept or negotiate without recourse to neither the supplier nor the issuing bank, provided the terms of the Letter of Credit have been fulfilled.

Note: - Neither bank sees any goods; they are only concerned with the documentation. Hence the buyer could find that all the goods received are faulty but is unable to stop payment.