A deferred payment, usance, or time letter of credit is a time-bound form of a letter of credit.
It works similarly to other LCs apart that it can releases funds after a specified time. It offers another flexible payment option for international buyers and sellers.
Deferred Payment Letter of Credit – Working Mechanism
The applicant of the deferred payment LC adds a clause of time specification in the letter of credit.
The applicant defers the release of funds to a specific event or calendar date to achieve certain objectives.
This deferral can work as:
- A later calendar date until the buyer receives the goods or for any other reason.
- Added days after the goods supply, purchase order, or bill of lading date.
- Added days after the sight of a letter of credit.
- Any specific trade event, such as completion of the manufacturing order, or shipment of goods date, etc.
Commonly a buyer adds a few calendar days after the completion of goods manufacturing. That ensures the timely delivery of the goods.
Trade deals with new sellers are always risky, it mitigates the trust deficit between both parties. The seller, on the other hand, feels the comfort of a payment guarantee in the form of an LC.
The seller can present the letter of credit after receiving a copy from the buyer. The clearance of the LC cannot take place until the specific deferred clause is fulfilled. In a sense, a usance LC works like a sight LC but with a delayed clearance mechanism.
Importance of a Deferred Payment Letter of Credit
Considering the advantages a documentary credit brings, it can bring additional benefits with modifications. Several types of letters of credit bring different benefits for both parties in the trade.
A deferred LC confirms the payment for the seller (exporter), yet it offers additional time to the buyer (importer) to confirm the receipt of goods. Like other types of LC, its main importance lies in reducing the trust deficit between both parties.
Deferred payment LC can practically save time for both parties if used wisely. Once both parties agree upon a schedule of goods order, manufacturing, shipping, and receiving the goods, the dates on a deferred LC can be adjusted accordingly.
The seller can present the deferred payment LC to its bank before it is cleared on a specific date.
The bank can authenticate or demand other documentary requirements from the seller or buyer meanwhile.
An importer in country X orders electric components from an exporter in-country Y. both parties confirm the order placement and trade terms.
The payment is decided to be in the form of documentary credit. The buyer wishes to issue a deferred payment LC.
Let say the importer adds a clause of 90 days deferred payment after the bill of lading. The exporter can receive the payment through the LC only 90 days after the bill of lading is issued by the shipping company.
The bill of lading will confirm the shipping of the goods. Additional 90 days will ensure the buyer receives the goods and inspects them by the time payment is cleared.
Important Considerations with a Deferred Payment Letter of Credit
A deferred payment LC can embed other documentary clauses as well. Depending on the type, it can work as a revocable or irrevocable LC too.
By default, all LCs are irrevocable unless specified by the issuer otherwise. However, like any other type of documentary credit, it is legally different from the trade contract between the two parties.
This implies that a deferred payment LC cannot guarantee that both parties will fulfill their trade obligations. The risk for both parties still exists to some extent.
Advantages of Deferred Payment Letter of Credit
It offers certain benefits to both parties in the trade. New trade partners in international trade can use the deferred payment LC to their advantage.
- It offers flexible trade payment terms for both parties in the trade.
- The buyer can add any deferment clause in the LC to ensure the receipt of goods in good conditions.
- The seller can confirm the purchase of goods and manufacture the goods with confirmation of a deferred LC.
- The buyer can add other clauses or features in the deferred LC such as a performance clause, confirmation clause, or red clause, etc.
Limitations of Deferred Payment Letter of Credit
Like other documentary credit instruments, a deferred payment LC has some limitations too:
- It is a separate documentary contract from the trade agreement between both parties.
- It legally does not guarantee the trade terms for both parties.
- It can increase the costs of goods as the seller may charge for the time value of money with delayed terms.
- It does not fully mitigate the payment risk.