Common Mistakes To Avoid While Writing A Letter Of Credit
More & more importers-exporters endeavor to expand their business globally to better profits, grow services & sustain in the competitive market. However, not all business owners have the proper funds to do so. This is where trade finance service acts as a savior for them.
As of now, there are several types of trade finance instruments available for both buyers & sellers including Cash Advances, Bank guarantees, Documentary collections, Open Accounts and letters of credit, etc. Among all, the most common, safe, and preferred option for global traders is an international letter of credit.
It is a most popular type of trade finance that mitigates the risks of payment failure and assures exporters of being paid on time by the importer. However, if the importer defaults, the issuing bank will compensate the exporter.
However, there are cases when parties to a transaction often make mistakes while writing an LC, leading to affecting their trade finance.
In this blog, we will discuss some of the most common Letter of Credit mistakes that require to be paid attention. Here they are as follows:
Check Out Letters Of Credit Discrepancies In Detail And Know How To Avoid ThemA letter of payment guarantee has been issued to mitigate payment failure in a trade transaction. Now, it is up to you to ensure the potential discrepancies of this international trade payment method to avoid future complexities. Check it out:
Mistake 1 - Ignoring the real purpose of a letter of creditOne of the most common letter of credit mistakes that business owners make is to get an LC issued without knowing what it is all about, how it helps you meet their requirements, etc. Though finance experts can help you, it is vital for the parties to understand the real purpose of this method. Do thorough research, and take your time to understand what a letter of credit is and how it works.
Mistake 2 - Not negotiating/paying attention to the T&C of a letter of credit during the LC contractWhen will the goods be available to ship? What is the country of origin of goods? Who pays for banking charges? If you don’t negotiate these terms upfront, you’re unintentionally pushing yourself into potential legal complexities. When creating an international letter of credit, you need to negotiate to get the best out of the agreement.
Mistake 3 - Not reviewing Letters of Credit when they’re receivedYou’ve negotiated & approved the Terms & Conditions of the LC contract thoroughly but neglected to review it after you received it. This simple negligence can invite unwanted arguments/disputes among parties especially if some crucial points aren’t mentioned in the agreement. Always check the LC once you receive it to make sure there aren’t any unfavorable surprises for you. Check the Letter of Credit Issuance Process here.
Mistake 4 - Not being able to meet all the terms & conditions mentioned within a letter of creditEven if you’ve reviewed the terms of the LC prior to it being issued, you also need to make sure that these terms are capable of being fulfilled by you. Negotiate with your bank to make sure that the document you’re reviewing is beneficial to you & doesn’t contain any detrimental to your interest. Bank can help you review it to make sure that you can go with it.
Mistake 5 - Get the letter of credit drawn by someone inexperiencedYou can’t trust anyone who isn’t professional, qualified, or experienced to tackle your finances, handle your legalities or prepare a letter of credit. Make sure that your letter of credit service providers who are preparing the documentation under the LC contract has all of the background information, expertise, and resources available to do the task correctly.
Mistake 6 - Not considering the cost of writing a letter of creditOnce you have locked a deal with an exporter/supplier, you aren’t supposed to ask them to make any changes in the terms & conditions of an LC later. Thus, it is important for you to consider the cost or fees charged by letter of credit service providers.
Mistake 7 - Not asking for a draft LC to be made available for review & change before the final issuanceThere are times when you might require to check, review or change the mentioned terms & conditions that seem unfavorable to you in an LC contract. You can do so by asking for a draft LC where any kind of changes to the content of the LC is far easier to implement compared to the final issuance.
Mistake 8 - Shipping Goods before receiving an approved & workable Letter of creditThis is the biggest mistake an exporter can make. Since an international letter of credit provides a timely & full-payment security to the suppliers, shipping goods without receiving a legal LC is digging your own grave. What if you receive a letter of credit later containing unfavorable terms or conditions you weren't agreed on? Avoid this risk by receiving an LC upfront.
Recommended Read: Check out the most common letter of credit FAQs now.
These are a few common letter of credit mistakes that business owners need to be aware of while drawing it. Letter of credit is one of the safe, reliable & popular trade finance services that provide a payment guarantee to the exporters and avoids several risks associated with a global trade transaction. Taking care of these mistakes can save you from potential legal or trade complexities.