A Transferable Letter of Credit (LC) is a type of Letter of Credit that allows the original beneficiary (the first seller or intermediary) to transfer all or part of the credit to one or more secondary beneficiaries (suppliers). It is typically used in transactions involving intermediaries who act as middlemen between buyers and suppliers without directly handling the goods.
The issuing bank must explicitly designate the LC as “transferable,” allowing the original beneficiary to request a transfer of payment rights to secondary beneficiaries.
How Does a Transferable Letter of Credit Work?
- Trade Agreement:
- The buyer (importer) agrees to purchase goods from the intermediary (original beneficiary), who, in turn, sources the goods from suppliers (secondary beneficiaries).
- Issuance of the Transferable LC:
- The buyer’s bank (issuing bank) issues a transferable LC in favor of the intermediary.
- Request for Transfer:
- The intermediary requests their bank (transferring bank) to transfer all or part of the LC value to the supplier(s).
- Transfer to Secondary Beneficiary:
- The transferring bank issues a secondary LC in favor of the supplier(s) with the same terms as the original LC, except for:
- Reduced amount (if partially transferred).
- Altered expiry dates or shipment deadlines.
- The transferring bank issues a secondary LC in favor of the supplier(s) with the same terms as the original LC, except for:
- Goods Shipment:
- The supplier ships the goods directly to the buyer and submits the required documents to the transferring bank.
- Document Submission to the Issuing Bank:
- The transferring bank forwards the documents to the issuing bank under the terms of the original LC.
- Payment Distribution:
- The issuing bank releases payment to the transferring bank, which then pays the secondary beneficiary and remits the remaining balance (if any) to the original beneficiary.
Key Features of a Transferable LC
- Explicit Transferability:
- The LC must state that it is “transferable” for the intermediary to pass on payment rights.
- Partial Transferability:
- The LC can be split among multiple secondary beneficiaries.
- Documentary Compliance:
- All documents submitted must comply with the terms of the original LC.
- Limited Changes Allowed:
- Only specific terms, such as the amount, shipment deadlines, and expiry date, can be amended during transfer.
When Should a Transferable LC Be Used?
- Intermediaries in Trade:
- Used by brokers or traders who facilitate transactions between buyers and suppliers without direct involvement in goods handling.
- Limited Financial Resources:
- Allows intermediaries to secure goods from suppliers without upfront payment.
- Complex Supply Chains:
- Useful in industries with multi-tiered suppliers or subcontractors.
- Global Trade Transactions:
- Facilitates international trade by ensuring payment security for all parties involved.
Advantages of Transferable Letters of Credit
For Buyers (Importers):
- Simplified Supply Chain:
- Buyers deal directly with the intermediary while suppliers handle logistics and documentation.
- Secure Payment Framework:
- Ensures suppliers are paid only upon compliance with the LC terms.
For Intermediaries:
- No Upfront Capital Required:
- Intermediaries don’t need to prepay suppliers, as the LC guarantees payment.
- Flexibility:
- Can work with multiple suppliers by partially transferring the LC.
For Suppliers (Secondary Beneficiaries):
- Payment Assurance:
- Suppliers receive payment guarantees through the transferring bank.
- Efficient Operations:
- Payment terms and timelines are secured, streamlining transactions.
Challenges and Risks
- Limited Transfer Options:
- Transferable LCs are only issued upon request and are less common than standard LCs.
- Restricted Amendments:
- Only specific terms, such as the amount or shipment deadlines, can be modified.
- Documentation Errors:
- Errors in submitted documents may lead to delays or non-payment.
- Dependence on Intermediary:
- Suppliers rely on the intermediary’s compliance with LC terms to secure payment.
Comparison: Transferable LC vs. Back-to-Back LC
| Feature | Transferable LC | Back-to-Back LC |
|---|---|---|
| Number of LCs | Single LC with transfer rights | Two separate but linked LCs |
| Parties Involved | Issuing bank, intermediary, supplier | Issuing bank, intermediary, supplier |
| Use Case | For intermediaries passing payment rights | For intermediaries requiring direct supplier LCs |
| Complexity | Simpler than Back-to-Back LC | More complex due to dual LC structure |
Example of a Transferable LC Transaction
Scenario:
- A buyer in Germany orders clothing from an intermediary in India, who sources the goods from multiple factories in Bangladesh.
- The German buyer’s bank issues a transferable LC in favor of the Indian intermediary.
- The intermediary requests their bank to transfer parts of the LC to the Bangladeshi factories.
- Upon shipping the goods, the factories receive payment under the LC terms, and the intermediary receives the balance.
A Transferable Letter of Credit is a practical solution for intermediaries and multi-tiered supply chains, enabling seamless transactions without the need for upfront capital. By ensuring payment security for all parties, it facilitates global trade while minimizing financial risks. However, businesses must carefully manage documentation and compliance to avoid delays or disputes.