Green Clause Letter of Credit
Definition: A Green Clause Letter of Credit is a special type of letter of credit that includes a provision allowing the seller to receive an advance payment before the shipment of goods. This advance is typically made against the presentation of documents such as a warehouse receipt, which confirms that the goods are stored and ready for shipment. The term “green” comes from the historical practice of typing this clause in green ink to distinguish it from other terms.
Usage: Green Clause LCs are especially useful when the seller needs funds to cover pre-shipment storage costs. For instance, if goods must be stored in a warehouse before they are shipped, this type of LC can provide the necessary funds to the seller during this period.
Example: Imagine a spice exporter in India who has received an order from a buyer in the USA. The spices need to be stored in a warehouse before they can be shipped. With a Green Clause LC, the exporter can obtain an advance payment by presenting a warehouse receipt, ensuring they have the funds to cover storage costs until the spices are shipped.
Red Clause Letter of Credit
Definition: A Red Clause Letter of Credit is another type of LC that allows the seller to receive an advance payment before the shipment of goods. Unlike the Green Clause LC, the advance under a Red Clause LC is typically made against a simple receipt or draft. The name “red” originates from the practice of writing this clause in red ink.
Usage: Red Clause LCs are often used when the seller needs funds to purchase raw materials or cover production costs. It provides the seller with the necessary working capital to fulfill the order.
Example: Consider a textile manufacturer in Bangladesh who has received an order from a retailer in Europe. The manufacturer needs to purchase raw materials such as fabric and threads. With a Red Clause LC, the manufacturer can get an advance payment by presenting a simple receipt, which helps finance the production of the textiles.
Why Named Green and Red?
The names “green” and “red” come from the old practice of typing these specific clauses in green and red ink, respectively, to make them stand out in the letter of credit document. The red ink indicated more immediate, unsecured advance payments, while green ink was used for advances against more secure documents like warehouse receipts.
Differences Between Green Clause and Red Clause LCs
| Aspect | Green Clause LC | Red Clause LC |
|---|---|---|
| Advance Payment | Provided against warehouse receipts or storage documents | Provided against simple receipts or drafts |
| Security | More secure due to storage documents | Less secure, typically unsecured |
| Usage | Covers storage costs and pre-shipment expenses | Covers production or procurement costs |
| Documentation | Requires proof of storage (e.g., warehouse receipt) | Requires minimal documentation (simple receipt) |
| Risk Level | Comparatively lower risk due to secured advance | Higher risk due to unsecured advance |
When They Are Used
- Green Clause LC:
- Used when the goods require storage before shipment.
- Commonly used for commodities or goods that are stored in warehouses.
- Suitable for exporters who need funds to cover storage costs.
- Red Clause LC:
- Used when the seller needs working capital to produce or procure goods.
- Suitable for exporters who need advance funds for production or raw material purchase.
- Common in industries where immediate cash flow is required to fulfill orders.
Example Scenario Illustrating Both Types
Scenario: An electronics manufacturer in China receives an order from a retailer in Australia.
- Red Clause LC:
- The manufacturer needs funds to purchase electronic components.
- The retailer in Australia issues a Red Clause LC allowing the manufacturer to receive an advance payment upon presenting a simple receipt.
- The manufacturer uses the advance funds to buy the necessary components and starts production.
- Green Clause LC:
- After production, the electronics need to be stored in a warehouse before shipment.
- The manufacturer requests another advance to cover the storage costs.
- The retailer issues a Green Clause LC allowing the manufacturer to receive funds upon presenting a warehouse receipt.
- The manufacturer uses the advance to pay for the storage, and the goods are shipped once ready.
By using both Red Clause and Green Clause LCs, the manufacturer can manage the cash flow required for both production and storage before shipping the goods to the buyer.