A transferable letter of credit can be described as a financial guarantee that one of the parties will transfer all or a part of the credit they have to the other party. Letters of credit are seen as protecting covenants that ensure that payment is made to the supplier of those particular goods and services.
Transferable Letter of Credit includes the buyer (who applies for the Letter of Credit), the middleman (or the First Beneficiary), and the seller (who is the final beneficiary). The Letter of Credit is used between these parties to ensure that payment is guaranteed from one party to another.
Key Features of Transferable Letter of Credit
A transferable Letter of Credit normally involves four parties.
The first part is the buyer. The buyer procures raw materials from the supplier, who might be situated abroad. Therefore, the seller of the goods and services might need a guarantee from the middleman (who is facilitating the purchase) that the seller will be paid for the goods or services.
Given that the middleman might not always have the resources to pay the seller an amount as a guarantee, he asks the first beneficiary to create a transferable Letter of Credit. Therefore, using this particular type of letter of credit, they can carry out the transaction safely and securely.
Therefore, the key features of the Transferable Letter of Credit include information about the transaction and the related parties that might be involved. It might also include covenants where the buyer lays down some terms and conditions about what is expected from the overall analysis.
How do Transferable Letters of Credit work?
As mentioned earlier, it can be seen that the transferable letter of credit creates an exchangeable provision between the parties involved. This works in that the buyer of the goods and services goes to the bank to ask it to be an intermediary.
This means that the bank is making a guarantee to the seller of the goods and services that they are going to be paid by the buyer.
This is important because the seller of goods needs to be ensured that they will eventually be paid for the goods they sell. They can only process the order once they have the guarantee, so they require a letter of credit.
In the case of a transferable letter of credit, the bank that issues the letter of credit includes a provision for extending the credit to the agreed-upon second beneficiary.
In this case, the second beneficiary is bound to be entitled to payment of the loan if it is required at the time of payment. However, it must be noted that the first beneficiary is considered liable for the payments in the case the bank disburses them.
Transferable Letter of Credit vs. Back-to-Back Letter of Credit
As far as Back to Back Letter of Credit is concerned, it provides the intermediary or the first beneficiary option to use the Letter of Credit as security when conducting a transaction with any other supplier.
Even though this can be used as a credit document, a back-to-back letter of credit involves the first beneficiary requesting the buyer to issue a transferable so that the transaction can be furthered and used for the supplier.
On the contrary, as far as a transferable Letter of Credit is concerned, it can be used as a credit document without further perusal because the beneficiary can be transferred.
Non-Transferable Letter of Credit
Non-transferable letter of credit is another type of credit that does not allow the transfer of credit to any other beneficiary except for the first beneficiary. Therefore, as far as a non-transferable letter of credit is concerned, only the first beneficiary can claim credit for it. It cannot be transferred, so it does not give the option to the first beneficiary to transfer the funds to anyone else.
Many organizations might prefer to work with non-transferable Letters of Credit because they want to ensure that their letter of credit is not transferred without their discretion. Hence, in this case, it can be seen that there is a need to have clear discretion about the letter of credit being transferable and only being specific to one party, the single beneficiary that the buyer has decided.