Top Most Common Mistakes While Preparing Letters Of Credit

Letters of credit are one of the most popular forms of payment in international trade & transactions. Issued by a bank on its customer’s behalf ie. (buyer/importer), a payment guarantee letter” or a “documentary credit letter assures that the beneficiary ie. (seller/exporter) will be paid on time for his shipped goods & services. In case if the buyer defaults, the issuing bank will reimburse the payment to the seller.

Here, the “Payment Security” in LCs makes them one of the most used trade finance instruments among importers & exporters while executing international trade deals. But there are many Letter of Credit errors or submission mistakes that can lead to delayed or failed transactions. Regardless of being an importer or exporter, if any global party is being paid by using an LC, it’s time to pay attention to the fact that it is issued correctly.

In this blog, we will help learn about the top most common LC mistakes that an international trader should be aware of. Here they are as follows:

Mistake 1 — Not being aware of the significance of a letter of credit

Most importers or exporters who are involved in international trade deals typically approach their banks and get a payment guarantee letter issued without knowing its real purpose. For example, what it is, how they are going to get benefitted by it or how it works etc. This lack of knowledge ends with a failed transaction. To avoid failure, take the proper time to understand its significance and then apply for it.

Mistake 2 — Failing to negotiate T&C of an LC

Not negotiating all the terms & conditions upfront can expose global traders to potential legal issues. Who will be liable for paying banking charges, time & date of shipped goods, country of origin, etc. are some of the examples that both the importers & exporters should be aware of while deciding on the T&C of an LC agreement. Discuss these terms with the involved parties.

Mistake 3 — Choosing documentary credit letters over another preferred method

Though letters of credit are one of the most frequently used trade finance instruments in overseas transactions, there are several other payment methods available for import/export transactions that deserve a look. For example, Bank guarantees, or Documentary Collection, etc. Gather information about all of them and figure out the most appropriate one following the transaction.

Mistake 4 — Not getting a draft LC to be made available for review

Getting a draft of a Letter of Credit is an opportunity for importers or exporters to check & address any unwanted clauses or T&C that are inconsistent or unworkable with a transaction. Grab the opportunity and avoid trade transaction fraud.

Mistake 5 — Not checking the original Letters of Credit

Checking only the draft of a documentary credit doesn’t demonstrate its complete reliability throughout the trade deal. The involved importers & exporters should also pay attention to checking the original LC also. Sometimes, the issuing bank adds a few of its T&C that the other party is not aware of.

Mistake 6 — Delivery of goods before getting a reliable issuance of Letter of Credit

This can be one of the big LC mistakes to avoid on the part of exporters while shipment takes place. Until they receive a clean and original payment guarantee letter, they lack payment security. In this scenario, shipping the goods to the buyer can bring them risks of being presented with unworkable LCs or the buyer’s denial to make the payment. So, never allow the shipment until receiving an LC.

Mistake 7 — Not being capable of fulfilling all the terms & conditions of the LC contract

While accepting a Letter of Credit, the global traders need to ensure that it includes all the T&C that they were agreed on earlier. In addition to this, they are also required to figure out whether they are capable of fulfilling those conditions.

Mistake 8 — Letter of Credit is prepared by an inexperienced professional

While executing any type of international trade & transactions, the parties need to make sure that the person who is handling the tasks ie. preparing Letters of Credit is a professional and has proficient experience in his field. Conduct a thorough background check and gather all the information.

Mistake 9 — Not checking discrepancies if they are believed to be invalid

If an LC agreement contains any type of discrepancy, the bank would highlight it and both the parties tend to accept it. However, if any of the parties to the transaction believes that the highlighted error is invalid or unjustified, a Discrepancy Notice can be challenged.

Mistake 10 — Entering into a contract with an importer without having information about him

This is also one of the big Letter of Credit mistakes to avoid by exporters. An exporter should gain all the necessary information about the importer or his counterparty before starting any type of transaction. A lack of information about the counterparty can lead to a fraudulent transaction.

Mistake 11 — Not paying attention to the associated risk factors with the transaction

Running a business on an international level brings a lot of associated risks for global traders. For example, political risks, foreign currency risks, legal limitations, etc. Regardless of an importer or exporter, the parties to the contract should be aware of these associated overseas risks.

Mistake 12 — Not understand how a Letter of Credit works

To ensure a successful overseas trade transaction, both the parties ie. an importer & exporter should have proper knowledge of its working. On one hand, where the bank is required to watch the entire process right from the beginning to make sure everything goes as planned. While, on the other hand, the exporter should provide evidential documents to the issuing bank to get the payment from the buyer.

Mistake 13 — Typos mistakes or inconsistent information

A Letter of Credit with spelling mistakes, or missing out on important information, or inconsistent spellings can cause a delayed or failed transaction. These types of mistakes can be mostly seen in applicant’s names or addresses etc. Make sure to check these mistakes and determine an LC with correct information.

Mistake 14 — Delay in Submitting the documents

Finally, there are some issues with submitting the documents on time to the bank. All Letters of Credit have a “Submission Period” in which the exporters are required to present the LC documents to the applicant’s issuing bank. Many times when the bank doesn’t receive the instrument within the stipulated period, there can be additional issues.

These are some of the most common LC mistakes that every global trader should be aware of while executing an international transaction. This can help mitigate the associated overseas trade deal risks.