Documentary Credit
Documentary Credit/Letter of Credit represents the most common form of a documentary financing.
A letter of credit is a document through which a bank substitutes its credit for that of another obligor. The basic structure of a letter of credit is a legally enforceable commitment by the “issuing bank” to pay money to a second party (known as the “beneficiary”) on behalf of a third party (known as the “account party” or “opener”).
The account party is the initiator of the transaction. Terms and conditions, upon which the bank’s obligation will be invoked, are specified in the letter of credit.
A letter of credit transaction involves three agreements:
· The Agreement between the account party and the beneficiary which gives rise to the use of a letter of credit;
· The Agreement between the account party and the issuing bank which spells out their mutual obligations, including that of the account party to reimburse the issuing bank when payments are made to the beneficiary in accordance with the terms of the letter of credit;
· The Agreement between the issuing bank and the beneficiary (in the body of the letter of credit) which specified the conditions that must be met before the payments will be made.