Understanding Transferable Letters of Credit
In international trade transactions, a letter of credit(LC) is a formal mechanism to ensure payment and fulfilment of obligations on the parts of both exporter and importer. While a standard LC has only one beneficiary, a transferable LC allows the first (primary) beneficiary to transfer some or all of the credit guaranteed by the LC to a second (secondary) beneficiary. In simple terms, think of it as a “shareable” LC.
How It Works
In addition to the usual terms of an LC, a transferable LC will also include a provision for transferability, allowing the primary beneficiary to allocate some or all of the credit to a secondary beneficiary. When this happens, the secondary beneficiary will be granted rights to the payment amount as stipulated by the primary beneficiary, along with the necessary obligations that go along with the transaction as laid out in the LC. This then allows the second beneficiary to use their portion of the LC to access credit, in the same way as a normal LC would allow a single beneficiary.
Why transferable LCs Are Useful
In many international trade transactions, the entity contracted to supply the goods to the buyer may not be the original producer of the goods, or a very large portion of the manufacturing process or back-end services in the case of a service, may be provided by a 3rd party.
The entity contracted to supply the goods or services may also simply be a middleman and, in such cases, the actual supplier of the goods may require some form of guarantee of payment. It is also possible that two suppliers may be acting together in partnership to supply goods or services to a buyer. In these instances, a transferable LC provides an ideal and fair solution to all parties involved.
transferable LCs may also be used as an alternative mechanism for advance payments and are often a much simpler option for buyers than confirmed LCs as the buyer will only need to deal with a single bank, rather than two separate banks.
Making It Easier to Do Business
Ultimately all forms of LCs make it easier to do international business, particularly when the parties involved do not know each other well enough to work purely on trust. Furthermore, an LC, whether transferable or not, insulates both buyer and seller from the inherent risks involved in international trade.