A transferable letter of credit provides the option of transferring the credit to a second beneficiary. The first beneficiary of a letter of credit is the seller (exporter). A transferrable LC allows the transfer of approved credit partially or in full to another party.
A transferrable documentary credit is used often in agreements where the sellers need to outsource the raw materials from suppliers. The suppliers or the middlemen in the trade become the first party and the credit is transferred to them.
How Does It Work?
Practically, the supplier becomes a second beneficiary in a transferrable letter of credit once approved. The applicant of an LC is the buyer, and the issuer bank issues the LC in favor of the seller usually. However, in the transferrable letter of credit, the middleman or the supplier becomes the first beneficiary.
This arrangement is made to facilitate the trade agreement. The buyer (or importer) of products still remains the applicant for LC to the bank.
Usually, the buyer sends a letter of credit to its seller to guarantee the payment on the specified date. In a transferrable LC, the buyer further facilitates the sellers to transfer part of the payment to their suppliers as well.
The manufacturers often face a shortage with working capital cash requirements. The transferrable credit provides an opportunity for them to smoothly complete the buyer’s order. They can fully outsource the production to a third-party as well.
Approval Criteria for Transferrable Letter of Credit
As with any documentary credit, the issuing bank will appraise the applicant’s creditworthiness. The bank after evaluation of the credit profile may issue a transferrable letter of credit to the applicant. The additional clause of transferring the credit may incur additional charges by the bank.
Once approved, the seller can request the approved credit limit from the bank at the time of trade completion. The release of LC will depend upon the conditions specified. However, with the approved limit of credit transfer, the original beneficiary can transfer that amount to the second beneficiary.
Features of a Transferrable Letter of Credit
Certain rules apply to all documentary credits. The additional feature of credit transfer further applies some limitations.
There are certain features associated with a transferrable letter of credit.
- The LC agreement must explicitly state that it holds a provision of “transferrable Credit”.
- The credit transfer may be approved in part or full.
- The transferrable credit can be approved for one or more beneficiaries.
- The credit transfer can take place with specifies terms and dates as on the LC agreement.
- The beneficiary cannot request the provision of credit transfer, only the applicant of LC (buyer) can.
- Issuer banks can only transfer the credit up to the approved limit as specified in the LC agreement.
- Any additional charges of credit transfer, insurance, etc. are paid by the applicant of the LC.
The applicant can include a clause of amendments in the LC as well. For clarity, any objections from one beneficiary on amendments in the LC or credit transfer terms do not affect the payment rights of the other beneficiaries.
Pros and Cons of Using a Transferable Letter of Credit
Transferrable credit provides flexible terms for all parties involved in the trade agreement. The sellers of the goods usually lack cash for payments to their suppliers.
With a transferrable credit, they can use it as a loan to utilize the funds and pay the suppliers. The buyers may find the trade contract beneficial with transferrable credit terms.
Some key benefits of using a transferrable letter of credit:
- It can help the buyer to negotiate better prices in the trade contract.
- The seller can utilize the approved credit for transferring funds to their suppliers of raw materials.
- It facilitates the sellers working as a middleman in modern trading to smoothly complete the buyer orders.
- There is only one bank involved in a transferrable LC contract.
- It ensures the payment terms as with any other LC.
- The buyer holds the control with credit transfer stating the terms and dates of credit transfer.
Likewise, the transferrable letter of credit still holds some limitations.
- Although it provides the flexibility of advance payment, the second beneficiary becomes liable for the delivery of goods.
- A transferrable LC may offer strict payment schedules and conditions than other forms of documentary credit.
- The approval of transferrable LC requires endorsement from the buyer, which may put the seller in a defensive position in trade negotiations.
- The buyer bears all costs associated with additional arrangements of partial or full credit transfer.