The Concept Of Letter Of Credit And Bill Of Exchange

            Both the letter of credit and the bill of exchange are useful documents in expressing the buyer’s interest in undergoing a contractual relationship in the international trade. However, rationality should be employed in internalizing which between the two pronounces better terms in such interest.  Letter of Credit (LC) refers the declaration of the financial commitment and soundness by a particular bank on behalf of its client on a monetary value which is stated in that particular LC and addressed to another party who is the perceived beneficiary named on the LC. It can either be endorse-able or not. In the event of any payment default by the one obliged to make the payment, its issuing bank is governed in honoring such payment either conditionally or not. Usually, LCs may be drawn with or without some conditions. Additionally, some Bills of Exchange may be drawn on and above the preferential limits held by a LC in significance of authenticating specific amount within the LC to be made at a later date.

 (http://www.wisegeek.com/what-is-a-letter-of-credit.htm)

            A bill of exchange refers to a set legally held negotiable instrument that is used in settling payment in the future. It is usually drawn by the drawer and addressed to the drawee in reference of the drawee’s acceptance of the particular payment liability within the scope of a later date as stated in it. The drawer draws it and sends it to the particular drawee for the acceptance of the same. In the event of such an acceptance, the bill of exchange thereon becomes a legitimately negotiable instrument within the proximities of financial market terms and thus a legal debt against him/her (drawee). Upon its acceptance, the drawer can choose the discounting of the bill of exchange from his account so as to get immediate funds as working capital. When the payment date is due, it is presented for the accepted payment by the drawee as it could be stated. (http://www.wisegeek.com/what-is-a-bill-of-exchange.htm)

            Rationally therefore, a letter of credit posits greater interest for the buyer than a bill of exchange. This is because LC shows a greater commitment to making payment than a bill of exchange. Otherwise the transacting bank to the LC is governed by the legal execution of making the payments stated to it either conditionally or elsewhere unconditionally. However, a Bill if Exchange is only shielded with some substantial capacity of its payment and that the choice of payment is solely held by the drawer. Cases like bankruptcy can revoke its payment (Mark, Jerry, 1993, p.46) Since the drawee is the sole person allied to making the transfer of its payment at such a stated date, his personal opinion whether irrevocable or not may entail and result to lack of payment. Conventionally, LC is governed by the legal bound that its client should pay the debt. Any possible revoke to this payment is waged by the bank’s commitment of payment transfer to the beneficiary. As a measure to curb any possible bankruptcy, the bank keeps on monitoring the credit level of the client to ensure that a controlled level always exists which can help settle the debt. However, any state of such bankruptcy requires full consent in making such payment by the bank (Susan, 2007, p. 93)

            In the international business, LC refers to the document which is written under the request of his bank to give a guarantee on the possible payment for particular goods that are to be transferred by the seller. This is a reassurance and affirmation of possible state of receiving the payment for specific goods so received. The validity of payment requires that the seller should provide the buyers bank all necessary documents involved in the shipping transaction   so that the bank can transfer the aforementioned payment. It is a document used within the international trade for the elimination of various risks such as ambiguities in customs, foreign country unfamiliarity or possible states of political instability (Susan, 2007, p.71) Letter of credit entails its purpose through credit substitution of the customer’s bank to enable trade facilitation. They are adequate in facilitating payment within the scores of international trade. The beneficiary to letter of credit has a legal entitlement of the payment as long as the provisions of the documentation process into the transactions are provided. It is a separate and distinct transaction than the contractual terms which forms its basis. The parties into it are involved in transaction documents but not the goods. However, the bank in concern has no liability in the trade performance of whatever contract existing between the beneficiary and the customer. Upon the request of documents into the transaction for revealing the conditions and terms held in the contract, the bank is legally entitled to make the payment (Mark, Jerry, 1993, p. 89)

            Contrary to this however, a bill of exchange is only unconditional order that is issued by a business or a person directing its recipient to make payment of a fixed amount of money to another party in the future. The contractual relationship in a bill of exchange may not warranty a legal transfer of the payment. The third party may due to different factors revoke its payment (Kenneth, 2007, p. 102)

            Generally therefore, a letter of credit is a better document at showing the buyer’s interest in international trade than a bill of exchange. This is because a letter of credit reveals assured commitment in fulfilling the debt transactions involved in business transactions. However, a bill of exchange may not adequately serve to imply this commitment since it is transfer of debt to a third party whom by reasons may not facilitate its payment.

Bibliography

Mark, S & Jerry, W (1993) The Impact of Transaction Fraud: Strategies for the International Letter of Trade: Review of Business, Vol. 43

Susan, W (2007) The Letter of Credit, London, Lighting House Inc.

Kenneth, D (2007) Building an Import/Export Business, New York, John Wiley and Sons

What is a Bill of Exchange? Retrieved on 24^th August 2008 http://www.wisegeek.com/what-is-a-bill-of-exchange.htm

What is a Letter of Credit? Retrieved on 24^th August 2008 http://www.wisegeek.com/what-is-a-letter-of-credit.htm