Understanding Transferable Letters of Credit: Key Benefits, Parties Involved, and Practical Examples

Definition: A Transferable Letter of Credit (LC) is a special type of LC that allows the initial beneficiary (often a middleman or trading company) to transfer part or all of the credit to one or more second beneficiaries (usually the actual suppliers). This is particularly useful in international trade, where intermediaries may not have the capital to buy the goods upfront but can facilitate the transaction as traders or intermediaries.

Why It Is Used in International Trade

In international trade, Transferable LCs are valuable because they provide a secure payment method for all parties involved. They help intermediaries or trading companies manage their cash flow and financing needs without requiring large amounts of upfront capital. This arrangement ensures that suppliers get paid, even if the intermediaries don’t have sufficient funds immediately.

Parties Involved

1. Applicant: The buyer who initiates the request for the LC.
2. Issuing Bank: The bank that issues the LC on behalf of the buyer.
3. First Beneficiary: The intermediary or trading company receiving the original LC.
4. Transferring Bank: The bank responsible for transferring the LC to the second beneficiary.
5. Second Beneficiary: The supplier of the goods who receives the transferred LC.

Role of the Transferring Bank

The transferring bank’s role includes:

• Confirming the LC is transferable.
• Processing the request to transfer the credit to the second beneficiary.
• Ensuring that the second beneficiary meets the terms and conditions of the LC.
• Handling the substitution of documents if necessary.

Document Substitution

The first beneficiary can replace their own invoices and draft with those of the second beneficiary. This substitution keeps the profit margin of the first beneficiary confidential. Other documents, such as the bill of lading and insurance documents, are usually transferred as is.

Document Presentation

The second beneficiary submits their documents to the transferring bank. The transferring bank then checks these documents and forwards them to the first beneficiary. The first beneficiary may replace their invoices and draft before the documents are sent to the issuing bank.

Conditions That Can Be Curtailed in a Transferable LC

Certain conditions in the LC can be altered or curtailed when transferring the LC, such as:

• The total amount of the credit.
• The unit price of the goods.
• The expiry date of the LC.
• The latest shipping date.
• The period allowed for presenting documents.

Calculation of Insurance Percentage

The insurance percentage typically covers the value of the goods plus an additional amount (often 10%) to protect against unforeseen events. Here’s how it works:

For the first beneficiary:

• LC Value: $100,000
• Insurance Coverage: 110% of $100,000 = $110,000

For the second beneficiary:

• Transferred LC Value: $80,000
• Insurance Coverage: 110% of $80,000 = $88,000

Relevant UCP 600 Article

The relevant article in the UCP 600 (Uniform Customs and Practice for Documentary Credits) that covers Transferable LCs is Article 38.

Example Scenario

Scenario: A retailer in the USA orders electronics from a supplier in China, but uses a trading company in Hong Kong as an intermediary.

1. Applicant: Retailer in the USA.
2. Issuing Bank: Bank in the USA.
3. First Beneficiary: Trading company in Hong Kong.
4. Transferring Bank: Bank in Hong Kong.
5. Second Beneficiary: Supplier in China.

Here’s how the process unfolds:

1. The retailer’s bank issues a transferable LC to the trading company.
2. The trading company instructs the transferring bank to transfer part of the credit to the supplier in China.
3. The supplier ships the goods and presents the documents to the transferring bank.
4. The transferring bank forwards these documents to the trading company.
5. The trading company substitutes their invoices and draft with those of the supplier and then sends the documents to the issuing bank.
6. The issuing bank pays the trading company, who in turn pays the supplier, completing the transaction.

This arrangement ensures that the supplier gets paid promptly, the trading company can operate without large amounts of capital, and the retailer receives the goods as per the agreement.

You can also check out below explanation video in Youtube –