A letter of credit is used for the financial guarantee and mode of payment in large international trades. By default, a documentary credit is issued in favor of the beneficiary, the seller, or the brokers in the trade deals. The beneficiary cannot transfer the offered credit to any other party. Hence, documentary credits issued by default are untransferable to any other party.
What is a Non-Transferable Letter of Credit?
A documentary credit that a beneficiary cannot assign partially or full to any other party is called untransferable credit. A letter of credit is issued in favor of a particular beneficiary, usually a seller in trade deals. For financial security and convenience, the letter of credit remains untransferable other than the beneficiary.
By default, a non-transferable LC is irrevocable too. Hence the beneficiary cannot make any alterations or assign the approved credit to other parties. However, the seller may request to the buyer for a transferable letter of credit. The buyers utilize the assignment of documentary credit as the negotiation tool with sellers as it offers greater cash flows to the seller. The regular form of LC lacks the assignment feature though.
How Does Non-Transferable Letter of Credit Work?
The applicant of a non-transferable letter of credit does not have to go through any special arrangements. The approval process for the non-transferable LC is the same as for any other documentary credit. The buyer approaches the bank for the issuance of a non-transferable LC. The bank approves the credit facility after the appraisal of the creditworthiness of the applicant.
The main drawback for the seller with untransferable LC remains for the assignment of the approved credit. In many cases, the sellers need to outsource part of the production. The sellers may also look for credit approval for bulk purchases for raw materials. Either way, the assignment of credit proves beneficial for the seller. A non-transferable letter of credit does not offer the credit assignment to third parties by default. Once the seller fulfills the goods shipping terms, the buyer’s bank can proceed with the release of the LC.
Key Points to Note with Non-Transferable Letter of Credit
A non-transferable LC comes with a similar feature of financial security as for any other type LCs. The non-assignment of the approved credit comes with certain benefits for the buyer. Some key points that distinguish a non-transferable LC from other types of LCs.
- By default, the issued LC is a non-transferable letter of credit.
- The beneficiary cannot alter any terms in the LC without the applicant’s consent.
- The beneficiary cannot assign any credit approved to another party in part or full.
Transferable Vs Non-Transferable Letter of Credit
The transferability clause with a documentary credit offers further flexibility to the seller. The non-assignment of the documentary credit provides consistent security to the buyer. These differences of the utility in both forms of LCs provide contrasting benefits to both parties in the trade deals.
The transferability clause comes with additional costs. The buyer may agree to offer the transferability clause if the first beneficiary is a broker or a middleman. The buyer remains assured of the direct payment to the first beneficiary with the non-transferable letter of credit.
Approval of Non-Transferable Letter of Credit
The applicant of a non-transferable letter of credit does not require any special consideration. The approval criteria for a non-transferable LC is the creditworthiness of the applicant. The issuer bank approves the documentary credit after appraising the credit profile of the applicant. In some cases, the banks may require cash deposits against the issuance of the letter of credit. However, large and institutional clients can avail of the facility against their regular balances maintained with the bank.
There is only one bank involved in an untransferable letter of the credit arrangement. Unlike a confirmed LC, the seller’s bank plays a marginal role in the clearance of the untransferable LC. The intermediary bank cannot ask for the applicant’s creditworthiness appraisal or any alterations in the LC terms.
Suppose a buyer company Green Star in the UK approaches another company Blue Tech in Germany. Both parties agree on the trade deal and the mode of payment is agreed through a non-transferable letter of credit.
The applicant Green Star will approach its bank in the UK for issuance of a non-transferable LC. Once the seller processes the shipment of goods, the advisory bank may proceed for the clearance of the LC. Here, only the primary beneficiary the Blue Tech in Germany can receive the letter of credit payment. Blue Tech cannot assign the received credit in part or full to its suppliers or any other beneficiary.
Advantages of Non-Transferable Letter of Credit
Non-transferable letter of credit works in a simple and straightforward manner for both parties. Unlike confirmed and transferable letters of credit, the untransferable LCs are a convenient and regular option. Untransferable LCs offer several advantages to both parties in international trades.
- There are no special approval criteria or requirements for non-transferable LC.
- The conventional form of documentary credit is an untransferable LC.
- The buyer keeps the control for payment to the primary beneficiary only.
- The total costs associated with untransferable LCs are lower.
- It provides a financial guarantee to the seller in the most convenient form of documentary credit.
Disadvantages of Non-Transferable Letter of Credit
The simple form of a non-transferable letter of credit provides convenience to both parties yet comes with several limitations.
- The assignment of documentary credit provides great flexibility to the seller in large trade deals.
- The non-transferable letter of credit provides limited cash flow benefits.
- The seller cannot utilize the untransferable LC to provide assurance to its suppliers.
- Brokers and middlemen cannot utilize the non-transferable LC as a source of alternative finance.
- The buyer may be at a disadvantage with non-transferable letter of credit by forgoing the negotiation power on pricing in the trade deal.
Non-transferable letter of credit in the conventional form of documentary credit. It comes with a natural understanding to both parties. Its approval and processing are simple and convenient for both parties. However, the seller is at a disadvantage of the lack of flexibility with non-assignment of credit to other parties.