A Comprehensive Overview of Deferred Payment Letters of Credit

A deferred payment credit, commonly referred to as a deferred payment letter of credit (LC), is a financial instrument that specifies a set period for payment under the LC. This period, or tenor, is typically defined as a specific number of days from a predetermined date, such as either the shipment or invoice date. Payments made under deferred payment credits occur at the end of this specified tenor, distinguishing them from sight payment letters of credit.

While deferred payment LCs and sight payment LCs represent opposite ends of the payment spectrum, they are not the only methods available for making payments under letters of credit. In addition to deferred payment credits, LCs can also be structured for non-sight payment through methods such as acceptance and negotiation.

These methods—deferred payment, acceptance, and negotiation—are defined in the Uniform Customs and Practice for Documentary Credits (UCP), which outlines the standard practices of LC issuers and their correspondent banks. According to the UCP, each LC must specify its method of availability, indicating whether it is accessible by sight payment, deferred payment, acceptance, or negotiation.

Understanding the Different Methods of LC Availability

When considering future payments, LCs can utilize either deferred payment, acceptance, or negotiation methods. The principal differences among these methods hinge on the actions taken by the nominated bank when acting on its nomination:

• Deferred Payment Credits: In this scenario, the nominated bank honors the credit by incurring a deferred payment undertaking (DPU), committing to pay at maturity.
• Acceptance Credits: Here, the nominated bank fulfills its obligation by accepting a bill of exchange (draft) drawn by the beneficiary and paying at maturity.
• Negotiation Credits: In this case, the nominated bank negotiates by advancing or agreeing to advance funds to the beneficiary prior to the due date for reimbursement.

A nominated bank (NB) is a financial institution with which the LC is accessible, separate from the issuing bank. When an issuing bank makes its LC available through an NB, it allows for presentations to be made to that bank and commits to honoring any compliant presentation that the NB receives.

It is important to note that while an NB is not obliged to act on its nomination unless it has previously agreed to do so with the beneficiary, it retains the discretion to act upon receiving a presentation.

The Role of Drafts in Deferred Payment Credits

There is a common perception that deferred payment credits are utilized to circumvent the need for drafts. In certain jurisdictions, drafts may incur stamp duty, which can significantly increase the overall cost of utilizing letters of credit. As such, deferred payment credits serve as a direct alternative to acceptance credits, given that both methods involve the nominated bank honoring a presentation by providing a promise to pay at maturity. While acceptance credits rely on the acceptance of a draft, deferred payment credits do so through a DPU.

Interestingly, deferred payment credits are frequently employed as alternatives to negotiation credits rather than acceptance credits. Anecdotal evidence suggests that the majority of LCs available via negotiation still require drafts. Despite the UCP revisions over the years indicating that drafts are unnecessary for negotiation credits, many banks continue to request them, possibly due to longstanding practices that have not evolved alongside regulatory changes.

Both deferred payment credits and negotiation credits can effectively eliminate the necessity for drafts. Therefore, the avoidance of drafts is not a pertinent factor when choosing between these two types of credits.

Obligations of the Issuing Bank

For the issuing bank, the obligation to honor a compliant presentation remains consistent, regardless of the method of availability involving a nominated bank. The issuing bank is required to make payment at maturity if the nominated bank fails to honor or negotiate a compliant presentation. Conversely, if the nominated bank does honor or negotiate, the issuing bank must reimburse the bank at maturity.

In instances where an LC is solely available with the issuing bank—meaning there is no nominated bank—the issuing bank can only issue LCs via deferred payment or acceptance, unless it is a sight payment LC. Negotiation credits cannot be issued in this context, as negotiation involves the actions of a nominated bank advancing or agreeing to advance funds to the beneficiary prior to reimbursement by the issuing bank.

Role of the Nominated Bank

When an LC is available through a nominated bank via deferred payment, the nominated bank honors this by incurring a DPU, thereby committing to pay at maturity. Additionally, the nominated bank has the authority to purchase or prepay its DPU, enabling it to pay the beneficiary before maturity. When acting on its nomination, the bank adds its undertaking to the issuing bank’s obligation to pay the beneficiary. This effectively resembles a confirmation of the LC by the nominated bank, with payment made by the nominated bank being without recourse to the beneficiary, as it discharges the bank’s obligation to the beneficiary.

When to Consider Issuing a Deferred Payment LC

One crucial aspect to consider when contemplating the issuance of a deferred payment LC is whether the beneficiary has established an understanding or arrangement with the nominated bank. If the nominated bank is unwilling to incur a DPU, the deferred payment arrangement may hold little value for the beneficiary. However, if the nominated bank is prepared to assume this liability, it can significantly enhance the payment security for the beneficiary, providing an additional layer of commitment beyond that of the issuing bank.

Flexibility in LC Arrangements

In terms of flexibility in arrangements between the beneficiary and the nominated bank, negotiation availability appears to be the most advantageous option, provided the nominated bank is willing to negotiate. If the nominated bank is not prepared to either honor or negotiate, its role is limited to facilitating presentations, binding the issuing bank upon receipt of a compliant presentation.

Ultimately, the choice of LC availability should ideally rest with the beneficiary, rather than being dictated by the issuing bank or applicant, although the issuing bank must still agree to the terms as instructed by the applicant.

• It is important to note that drafts are unnecessary for negotiation credits; therefore, the avoidance of drafts does not factor into the consideration of preferring deferred payment availability over negotiation from the perspectives of both the issuing bank and the applicant.
• From the beneficiary’s standpoint, if the nominated bank is willing to act on its nomination under a deferred payment credit—regardless of whether it is confirmed—it represents an optimal method of availability.
• For the issuing bank, the method of availability does not influence its obligation to honor compliant presentations or to reimburse a nominated bank that has fulfilled its duties.