The example involves a grain merchant in Minnesota who purchases a shipment of grain from a producer and then plans to resell the same grain to a buyer in the Middle East. Using what is called the “warehouse receipt financing” method, the Minnesota merchant purchases the grain and “deposits” it into a recognized public warehouse and, in return, receives a warehouse receipt, identifying, among other things, the type of grain, its quality, quantity and the date it was received in the warehouse. The merchant takes this deposit slip to his bank as proof of ownership and, assuming everything is in order, the bank will grant the merchant a loan, a loan based on the estimated market value of the grain, minus a percentage (to sometimes called “haircut”). The merchant then contacts the buyer in the Middle East, who agrees to purchase the merchandise from the seller’s public warehouse in Minnesota.
The L / C mechanism in this case is as follows: –
1. The contract of sale is agreed between the Minnesota seller and the Middle East buyer and both parties agree to do business on an L / C basis.
2. The buyer requests his bank to issue an L / C. This bank is the issuing bank. The letter of credit specifies that the seller must present certain documents to the bank before receiving payment and, in this case, the main documentary requirement is the deposit receipt.
3. The issuing bank notifies the seller through the correspondent bank (notifying bank) by SWIFT and then sends the original letter of credit to the seller.
4. The seller presents his bank with a bill of exchange (money order) based on the conditions of the letter of credit together with the deposit slip and requests the negotiation.
5. The seller’s bank verifies the L / C conditions and the warehouse receipt document. If the conditions of the L / C are found to be consistent with the documents, the seller’s bank pays the seller. However, the seller must be very careful as the bank cannot comply with the bill of exchange if there is any discrepancy between the conditions of the letter of credit and the documents provided by the seller. If a discrepancy occurs, the seller must inform the buyer and have him apply to the issuing bank for an amendment to the L / C accordingly.
The rules for letter of credit transactions are dealt with comprehensively under the International Chamber of Commerce (ICC) rules called “UCP 600”, which were updated this year.
For more information on developing warehouse receipts, letters of credit or UCP 600, contact the author of this article, Daniel Day-Robinson, Day Robinson International (UK) +44 1392 271222 or [email protected].