Ocean traders of North America is a firm based in Mobile, Alabama, that speciali
ID: 2698870 • Letter: O
Question
Ocean traders of North America is a firm based in Mobile, Alabama, that specializes in seafood exports and commonly uses letters of credit (L/Cs) to ensure payment. It recently experienced a problem, however. Ocean Traders has an irrevocable L/C issued by a Russian bank to ensure that it would receive payment upon shipment of 16,00 tons of fish to a Russian firm. This bank backed out of its obligation, however, stating that it was not authorized to guarantee commercial transactions.
a. Explain how an irrevocable L/C would normally facilitate the business transaction between the Russian importer and Ocean Traders of North America (the U.S. exporter).
b. Explain how the cancellation of the L/C could create a trade crisis between the U.S. and Russian firms.
c. Why do you think situations like this (cancellation of the L/C) are rare in industrialized countries?
d. Can you think of any alternative strategy that the U.S. exporter could have used to protect itself better when dealing with a Russian importer?
Explanation / Answer
ANSWER
Irrevocable letters of credit are used for two primary reasons: to facilitate international transactions and to secure payment when a seller is unwilling to offer trade credit to a customer. Doing business internationally often involves more risk than domestic transactions. Different business cultures, legal requirements and political landscapes may oblige the seller to insure payment with a letter of credit. The second reason a seller may request a letter of credit is when a buyer%u2019s creditworthiness does not meet the seller%u2019s minimum criteria for trade credit. In this case, the letter of credit is a guarantee that the customer%u2019s bank will pay balances owed should the customer fail to do so.
There are three primary parties involved in the issuance of an irrevocable letter of credit: the issuing bank, the beneficiary and the applicant. A fourth party might be the advising, or confirming, bank. The beneficiary is the seller. The buyer is the applicant. When a seller (beneficiary) requires a buyer (applicant) to obtain a letter of credit, the buyer will ask its bank (issuing bank) to issue a letter of credit guaranteeing the amount of the transaction. The beneficiary may ask its bank (advising bank) to review the letter of credit. If the advising bank guarantees a portion of the transaction, it becomes the confirming bank.
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