Letter of credit

The letter of credit is a certified (documented) instrument of international payment which is subject to the rules of UCP 600 (Uniform Customs and Practice for Documentary Credits) provided that the parties refer to these set of rules in the document of the letter of credit.

In the letter of credit, all transactions are carried out through the bank: the documents requested by the importer from the exporter are examined via the bank and the amount requested by the exporter from the importer is paid by the bank as well. Therefore, after it is accredited, all transactions are carried out by the bank with the bank's assurance.

The Operation of the Letter of Credit

In the letter of credit, first of all, a sales agreement is concluded between the buyer (importer) and the seller (exporter), in which it is decided that the payment will be performed via the letter of credit. The buyer (applicant for the credit) applies to his bank (issuing bank, bank of the letter of credit) with a request to open a letter of credit. The bank prepares the letter of credit (letter of credit opening), and sends it to the seller's bank (correspondent bank, advising bank) and this text is transmitted by this bank to the seller (beneficiary). When the seller loads the goods and gives the documents specified by the buyer in the letter of credit to his/her own bank, these documents are sent to the issuing bank and the issuing bank informs the buyer about the situation. In order for the buyer to obtain the goods with the documents, either the sale amount must have been blocked from the account of the buyer, or the buyer must have paid the amount to the bank before receiving the documents. While the buyer obtains the goods with the documents in his/her possession, the issuing bank transfers the said price to the seller through the correspondent bank.

Principles governing the letter of credit

One of the main characteristics of a letter of credit is that it is completely separate and independent from the agreement concluded between the credit applicant and the beneficiary which constitutes the basis of the letter of credit. In accordance with "The principle of the independence / abstractness of the letter of credit", the bank will not be interested in whether the sales contract between the buyer and the seller has been fulfilled duly, this relationship will not affect the letter of credit in any way. Accordingly, the bank's burden of inspection will be limited solely to the documents submitted to its part, and payment will have to be performed to the bank together with the seller's performance of the appropriate presentation.

Thanks to the mechanism of the letter of credit functioning in this way, the seller assures that the seller will accept the price of the goods in exchange for the submission of the documents specified in the letter of credit to the bank assigned by the buyer; the buyer also has the assurance that the payment will be presented only in exchange for the documents specified by the buyer (UCP 600/5). This is one of the other main characteristics of the letter of credit, which is the principle that banks are bound by documents.

In accordance with the principle of adherence to documents, the issuing bank will check whether there is any incompatibility in the documents submitted to its part as a result of its inspection according to the text of the letter of credit and the current letter of credit rules; if there is no incompatibility, the bank will pay the exporter, if there is a mismatch, the bank will refrain from paying if there is a reserve, as it is known in international trade. The issuing bank will decide whether the presentation made to its part is with a reserve or not only by looking at the documents that are presented.

Advising Bank

The advising bank is the bank that notifies the letter of credit or amendments in the letter of credit upon the request of the issuing bank.

The notification of the letters of credit and amendments

According to UCP 600/9, the procedure for notifying letters of credit and amendments is as follows;

  1. A letter of credit and any amendment can be notified to the beneficiary through an advising bank. An advising bank that is not a confirmation bank notifies the letter of credit and any amendments without any obligation to submit or participate.
  2. Through notifying the letter of credit or the amendment, the advising bank states that the letter of credit or the amendment is specified adequately on its part and that the notification reflects the conditions of the letter of credit or the amendment accurately.
  3. An advising bank may benefit from the services of another bank (a second advising bank) for the notification of the letter of credit or any sort of amendment to the beneficiary, through notifying the letter of credit or the amendment, the second advising bank states that the apparent authenticity of the notification is adequate based on its evaluation and that the notification reflects the conditions of the letter of credit or the amendment accurately.
  4. A bank that uses the services of an advising bank or a second advising bank to notify a letter of credit must use the same bank to notify any amendments related to that letter of credit.
  5. If a bank that is asked to notify a letter of credit or amendment chooses to not perform the notification, the bank must notify the bank that receives the letter of credit, amendment, or notification in this regard without delay.
  6. If a bank that is asked to notify a letter of credit or amendment cannot adequately determine the apparent authenticity of the letter of credit, amendment, or notification, the bank must inform the bank from which this instruction appears to have come from regarding the situation without delay. However, if the advising bank or the second advising bank chooses to notify the letter of credit or amendment, the bank must inform the beneficiary or the second advising bank that it cannot adequately determine the apparent authenticity of the letter of credit, amendment, or notification.2

Therefore, according to UCP 600/9; after the issuing bank has made the bank notification through the advising bank and the notification bank has accepted the obligation to perform the notification, the advising bank is obliged to notify the letter of credit and the amendment.

As it is clearly understood from UCP 600/10-c, these letter of credit amendments must be performed through the notification bank. As a matter of fact, in the text of the specified article, it is stated that "The terms of the original letter of credit (or a letter of credit containing previously accepted amendments) will remain in force for the beneficiary until the beneficiary notifies the bank which notified the amendment that the beneficiary has accepted this amendment. The beneficiary must provide a declaration of acceptance or rejection of an amendment. If the beneficiary does not provide such a declaration, a submission in accordance with the letter of credit and any amendments that have not yet been accepted will be considered as a declaration that the beneficiary has accepted that amendment. The letter of credit will be amended as of that moment."

In other words, even if it is known by the beneficiary that amendments have been made to the letter of credit (since a contractual relationship is already present between the applicant and the beneficiary, the amendments are known by the beneficiaries in any case, as the parties of the agreement reached a consensus before notifying the banks), in order for the notification to be valid in accordance with UCP 600, a notification to be made by the advising bank is required.

Also, according to UCP 600/10-d, it is stipulated that a bank notifying the amendment will have to inform the bank receiving the amendment about any notification it receives regarding the acceptance or rejection of the amendment.

Responsibility of the advising bank

Although there is no contractual relationship between the beneficiary of the letter of credit and the advising bank in the relationship of the letter of credit, the notification bank is responsible to the issuing bank for accurately transmitting all the information the bank receives from the issuing bank which should be transmitted to the beneficiary in a timely manner, without delay. Even though the advising bank does not hold any contractual responsibility to the beneficiary, the bank will be liable as per the tort provisions within the framework of the rules of good faith, expressed in art.2 of the Turkish Civil Code (Prof.Dr.Vahit Dogan, Akreditif, p. 226; Prof.Dr.Arslan Kaya, Belgeli Akreditifte Lehtarin Hukuki Durumu, p. 83, 84). Therefore, due to the failure to fulfill the obligation to notify as required, it may be possible for the notification bank to cover the loss incurred by the beneficiary.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.