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Monday, September 22, 2014

Learning basics - Marine Cargo Insurance - Letter of Credit (LC)

Marine Cargo Insurance is insurance of goods in transit from one place to another …. International trade is exposed to financial losses due to different set of risks – physical loss or damage to cargo caused by various perils (some insurable and some not) and non-payment of goods. After all a transaction is made for commercial purpose of making money and when not paid for, it is of no use.  Goods can be bought and sold with payment of price in various forms – cash(currency); credit; cash against documents (negotiation through a bank); telegraphic transfer; barter and more.  There will be no conclusion to a commercial transaction : if the Seller insists that he will send goods only when he receives payment in advance and buyer insists that they will pay only when the goods are delivered at their doorstep.

The potential non-payment could arise due to various factors – political, commercial risks and could be due to condition of cargo too.  Marine Cargo insurance offers financial protection against the incidence of loss or damage to goods arising out of insured perils, is not the subject matter of this post, as I venture something on the financial side and more specifically on ‘Letter of Credit’ (LC). Again, who is obliged to insure – whether it is Seller or Buyer or both – and that it is categorically determined by the ‘Sale contract’ – the Inco terms is not also the objective of this post.

The Policy of Insurance covers financial loss arising out of physical loss or damage to the subject matter insured but does not cover pure financial losses.  Even in this global era of advanced communication, there could be financial default arising out of – insolvency of the buyer, failure of the buyer to make the payment, buyer’s failure to accept the goods and more. In normal circumstances – there could be different terms of payment – Advance payment (which is most beneficial to seller and could harm the buyer, if goods are not sent after receipt of payment); payment upon receipt of consignment; payment upon receipt of documents (documentary collection); documentary credit and the like.  ….. can there be something which will make both Seller and Buyer happy and serve both the interests in a proper way …. Can there be somebody (who is credible and trustworthy) who can guarantee payment – more so, if that body can make payment and collect it from the buyer later. 

Other than ‘cash’ transactions, there are ‘credit’ transactions – where the buyer is allowed to make payment after receipt of consignment (documents) within stipulated time of 30/60/90/180 days.  So here is an attempt to peep into the financial World by someone who has no finance background…  In the Credit front, there can be Guarantee and Undertaking.  In the former, the parties will be : Principal Creditor, Principal Debtor and Guarantor.  In the latter, there is the Indemnifier and Indemnified (not to confuse with Insurance Indemnity here).  We are to read of an Undertaking by a reputed Institution.  It is the “letter of Credit’ (LC) – where a Bank agrees to effect payment on behalf of buyer, subject of course to compliance of certain stipulations – receives the documents, pays for and then collects from the buyer. LC is an undertaking of the Issuing Bank to the Beneficiary (who will the Seller) for payment against compliance of set terms (documents). 

Often this transaction is International in nature.  There would be two banks – the bank which issues the LC on behalf of the importer (buyer) and the bank of the Seller (exporter) called the accepting bank / negotiating bank.  The LC issuing bank does not directly deal with the goods but more to do with the compliance of documentation called ‘doctrine of strict compliance’.  Technically, a  letter of credit guarantees payment of a specified sum in a specified currency, provided the seller meets precisely-defined conditions and submits the prescribed documents  within a fixed timeframe.

The Sale contract between the Buyer and Seller would mention that payment shall be documentary credit.  The buyer (Applicant) would apply to the bank in his Country (Issuing Bank) to open and issue in favour of the Seller (beneficiary) an LC and to pay the Beneficiary such amount on the fulfilment of terms and conditions specified in Letter of Credit.  Once this is done, the Seller is assured of the price (by the bank) upon fulfilment of terms as contained therein in the LC, the buyer gets credit from the bank, the Issuing bank would collect commission and charges of security.  The seller, thus assured of payment – ships the goods, makes available the necessary documents and sends them to the LC issuing bank, who processes the documents, effects payment as agreed and then collects it from the buyer (applicant)

These documents that are required would include: Commercial  Invoice in Original, Packing List, Certificate of Origin, Clean bill of lading / air waybill and Policy / Certificate of Insurance……… that there would be stringent specifications for each of these documents is another lengthy topic.  More on the types of letter of Credit; on Uniform Customs and practice of documentary credit and ….in the posts to be continued.

With regards – S. Sampathkumar

22nd Sept. 2014.

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