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A green clause letter of credit includes a special clause for advance payment to the beneficiary with certain conditions. We typically use It to extend the credit facility to the beneficiary as an advance payment and liquidated with the trade deal completion.
A green clause works similarly to a red clause with some exceptions of documentary evidence and insurance cover requirements from the seller side. It offers financial security to the seller as well as works as an unsecured loan.
What is a Green Clause Letter of Credit?
Both green and red clause letters of credit are used to make advance payments to the sellers. The green clause letter of credit extends the documentary control with a red clause for the buyer. It provides advance payment to sellers up to 70-80% of the total trade deal in comparison to a 25-30% in a red clause.
A green clause letter of credit enables the purchase of raw materials, packaging, storing in the warehouse, and shipping of the produced goods. The seller can utilize the facility of the green clause as a working capital management tool. The buyer can negotiate better trade terms by offering advance payments to the seller.
How Does Green Clause Letter of Credit Work?
A green clause letter of credit works as a financial guarantee to the seller. Additionally, it offers advance payments to the seller that are liquidated with the delivery of goods. It works as a secured form of documentary credit where the seller can obtain the facility by pledging the warehouse receipts.
The seller can demand the advance payments from a buyer, once they reach a trade deal. The buyer approaches the bank to issue a normal letter of credit. The buyer can ask the bank to attach a green clause to the letter of credit to facilitate the seller. The green clause LC must also contain the same terms and conditions as in the trade agreement between both parties.
The green clause LC requires delivering the goods shipped to the warehouses before the seller can begin production. A bonded or public warehousing company can work as the facilitator for issuing the confirmation documents. All documentation confirming the goods in the warehousing is issued to the issuing bank of the letter of credit. The bank releases the advance payments to the beneficiary after receiving the warehousing confirmation and insurance cover of the goods.
The green clause letters of credit are more common in commodity trades or for the regular supply of goods by established trade partners. Large international trade deals also require the shipment of goods in series of delivery packages. The advance payments through the green clause can work as a series of payments. These payments must be offset with the relevant payment balances and liquidated with the final delivery.
Key Points to Note with a Green Clause Letter of Credit
Red clause and green clause LCs work as a means of advance payment to the seller. These LCs provide the essential financial guarantee to the seller as a primary function with any documentary credit.
In terms of financial security, documentation, and advance payments, a green clause letter of credit differs to some extent from a red clause LC.
Some key differences between a red clause and a green clause letter of credit are:
- The bank will issue an advance payment in a green clause only after the warehouse receipts as collateral. These receipts are issued by a third-party public or bonded warehousing facilitator.
- The percentage of advance payment in a green clause is around 70-80% in a series of payments as compared with red clause payments of up to 25-30%.
- The buyer can be secured with a green clause as the payment is released only after the goods are placed in a warehousing facility.
- In a red clause LC, the seller can receive advance payments for raw material purchases and before the production can begin, while in a green clause the advances are issued after production reaches the warehousing phase.
In a nutshell, the buyer has more control over the documentary credit and trade deal with a green clause LC. Although the buyer issues a large proportion of the total trade deal, but the payments can be controlled through offsetting against the remaining balances. The buyer can also ensure the progress of goods through the warehousing facilitator working as a third-party manager.
Suppose the buyer company Green Star in the US purchases goods from Blue tech in the UK. Once both parties agree on a trade deal of $50,000, they decide the mode of payment through a green clause letter of credit. Green Star approaches bank A in the US to issue a green clause LC in favor of Blue tech.
Once the advising bank B in the UK informs blue tech of the receiving of LC, the seller can begin the production of goods. Once the produced goods are packed and sent to a warehousing facility, Blue tech approach for the advance. Blue tech presents necessary documents including insurance cover, the document of title, etc. to bank B. The buyer’s bank will confirm the authenticity of the documents and release the advance payment as agreed, say 50% of the total.
The seller can proceed to ship the goods after receiving advance payment. The buyer can release the final payment once he receives the bill of lading, invoices, and other documents through the bank. In addition, the buyer pays the interest and service charges for the advance payment. The buyer can settle the full amount and any adjustments with the final payment through the Letter of Credit.
Advantages of Green Clause Letter of Credit
A green clause is attached to a letter of credit to facilitate the seller. It provides certain benefits to both parties in the trade deal.
- It offers a cash flow solution to the seller in the form of advance payments.
- The buyer can be more secured with a green clause, as there is a facilitator involved in the arrangement that issues goods receipt confirmation in the warehouse.
- It allows the buyer to keep the control of deciding the proportion of advance payment and deciding for the series of payments.
- The buyer can negotiate better trade discounts by offering advance payments.
- The seller receives a financial guarantee in the form of documentary credit, additionally an advance payment through a green clause.
Disadvantages of Green Clause Letter of Credit
A green clause letter of credit has some limitations for both parties in a trade deal:
- The green clause that offers advance payment to the seller does not come as an obligation from the buyer’s side.
- It is more expensive than a regular documentary credit.
- The sellers may have to offer trade discounts that can put them at a disadvantage in a fiercely competitive market.
- For new trade deals, the buyer may need to obtain the services of a third-party collateral manager with a green clause LC.
A green clause letter of credit serves as a financial guarantee to the seller. It also provides advance payment to the seller. The buyer can negotiate better trade terms with the seller and issue payments only after goods are received at a warehousing facility. However, the facility is more expensive than a common documentary credit.