Discuss the rationale behind letters of credit with emphasis on the Essay

Discuss the rationale behind letters of credit with emphasis on the fundamental principles underlying these instruments. Critica - Essay Example Credit letters are used in cross border business transactions to make sure that payment will be received. The adoption of letters of credit has become extremely essential in cross border trade due to the nature of international dealings such as varying laws and difficulty in knowing each trade party personally. Additionally, the bank acts on buyer’s behalf by making sure that a seller will not receive payment pending the bank’s verification that goods have been dispatched. The parties to a letter of credit comprise of three or more persons. These are; the account party (importer/ applicant/ buyer), the issuing bank (the applicant bank) and the beneficiary (exporter/seller) (Gilles & Moens, 1998, p 395; DiMatteo, 2009, p 100). There exist contractual associations while using letters of credit in global business among the most essential parties, that is the issuing bank (one making payment of the applicant’s behalf), to the beneficiary, and the paying bank (in situ ations where there is a correspondent), the advising bank, as well as the confirming bank. Ideally, they are same bank but given different terms. As such, several contractual relationships are distinguishable. One is the contract between the applicant and the beneficiary. Two is the relationship between the applicant and the issuing bank. ... This is usually a letter drafted and signed by bank acting on the applicant’s behalf, addressed to the beneficiary. The applicant bank will agree to drafts under credit simply if the beneficially adheres to conditions set forth in the credit letter. The beneficiary is also requested to hand in certain deeds like commercial invoices and insurance papers in addition to the draft and other documents that may be specifically needed. The issuing banks acts on behalf of the buyer (applicant) in paying the beneficiary provided that all terms stipulated in the letter are adhered to (Ramlogan & Persadie, 2004, p 14). Source: Michigan law review, p 406 Documentary credit letters can be classified into: Transferable or non-transferable A beneficiary in the credit letter often maintains on an express term in the contract clarifying that the credit is â€Å"transferable†. The main upshot of a transferable letter of credit is that the seller (beneficiary) may request the designated b ank to transfer credit to the beneficiary’s supplier. However, the designated bank is under no legal obligation to transfer credit. The UCP affirms that a credit letter is transferable only if the contacts states so, the absence of which the beneficiary cannot insist that the designated bank to transfer credit (Moens & Jones, 2008, p 39). Revocable and irrevocable A revocable letter can be rescinded by the bank responsible for issuing at any time without preceding notice to the seller. The contract has to specifically state that a credit letter is revocable; otherwise it will be considered unalterable. A beneficiary seller in cross border transaction needs payment security, apparently not prepared to accept revocable letter of credit, since this would result