ESTABLISHING BACK-TO-BACK CREDITS
This is how the whole process works.
1) Issue of original LC
In documentary credit operations the buyer (i.e. the applicant) arranges to establish the (original) credit through a bank (the issuing bank or the opener) in favour of the seller (the beneficiary). The buyer and the seller are the primary parties to the contract for the specific transaction. The issue of a credit is advised through a bank (called the advising bank) usually located in the city of the beneficiary. The beneficiary receives the original credit through the advising bank and/or his own bank.
2) Issue of Back-to-Back LC
A back-to-back credit is (only then) established when the seller-***-original-beneficiary, after receiving the notification about the issue of the original credit, arranges for a second, stand-alone credit to be established in favour of the (actual) supplier/manufacturer of goods or raw materials. Accordingly, and usually based on the original credit, the advising/confirming bank issues its own letter of credit generally with terms exact or similar to the first i.e. the original LC (hence the term back-to-back) - except for alteration of beneficiary, expiry date, and invoicing requirements, if considered necessary.
3) No formal connection between the two LCs
Please be careful to note that there is no legal or formal connection between the original LC and the Back-to-Back Credit. Each credit stands on its own merit. The terms and conditions of the two are not the same because one has to make sure that the documents coming forward under the second credit come forward in such a form and in such a time that they can be presented under the first credit within the expiry date and in accordance with the terms and conditions of the first credit.
4) Back-to-Back LCs can be opened as a chain
If there are several middlemen (or manufacturers who must again procure input materials from other manufacturers), each may use the credit in his favour as security for the credit that he has to open in favour of his supplier in the chain of contracts, until first buyer in the chain has effectively opened a credit in favour of original supplier. In this chain, each credit except the original one is termed a credit that has been issued back-to-back to the previous one.
WHEN IS BACK-TO-BACK CREDIT REQUIRED?
A back-to-back arrangement may become necessary where the underlying contracts are on terms that do not match, or where a Transferable Credit is unable to maintain secrecy on a particular aspect of the transaction.
Need for such a credit may also arise where
a) ultimate buyer is not ready to open a transferable LC,
b) beneficiary is not ready to disclose or divulge to buyer source of his supply,
c) the manufacturer insists on payment against documents or goods but beneficiary is short of funds.
BACK-TO-BACK CREDIT NOT A PART OF THE UCP
Back-to-back Credit finds no mention in the UCP. Only transferable credit is mentioned. Therefore no specific or separate rules apply to back-to-back credit. (This should be evident from the fact that each LC is an independent entity and stands on its own footing.) A bank must treat each stage of the operation as a separate transaction, each legally independent of the other. Consequently, the issuing banks concerned must independently assess the risks and liabilities associated with issuance of each of the credits separately.
A CREDIT DECISION OF THE ISSUING BANK
The applicant for a Back-to-Back Credit takes off his hat as the beneficiary to the original credit and wears the hat of an applicant as far as the back-to-back credit is concerned. It is important to note that a bank may agree to issue a back-to-back credit only when the applicant-beneficiary is considered in the eyes of the advising bank (the issuer of the second, i.e. the Back-to-Back Credit) to be creditworthy on his own right. The decision by a bank to issue a (Back-to-Back) credit is neither a matter of right nor is it automatic especially not just because a seller-***-applicant in the chain happens to be in possession of another (the original) documentary credit as a beneficiary of the original credit.
UTILISATION: SAME AS WITH ANY NORMAL CREDIT
Since the back-to-back credit is an independent credit and because here we are not dealing with the transfer of a credit as defined in Article 47 (ICC 500) of the UCP, the practices and procedure for utilisation of a back-to-back credit would be the same as in the case of any LC. The documents required are, therefore, presented in the normal course by the beneficiary via his bank to the original advising bank. The documents are honoured provided they conform to the terms of the back-to-back credit to the debit of the intermediary (i.e. the original beneficiary who initiated the issue of the back-to-back credit).
Caution: The intermediary bank should not take comfort in the fact that the credit under which the documents are being handled is a back-to-back credit, thus causing it to be lax in recovering funds from the intermediary towards documents so received under its own (back-to-back) credit.
SUBSTITUTION OF DOCUMENTS
At this stage the exchange of invoices (and drafts, if any) is a must, because contrary to the transferred credit the original credit opened in favour of the intermediary / middleman cannot be negotiated by simply using the documents of the supplier. The actual supplier in the chain has no locus-standi as far as the applicant to the original credit is concerned.
Any other differences allowed in the opening of the back-to-back credit must also be eliminated at this point.
NEGOTIATION AND PAYMENT
After these changes have been effected, the documents are used for negotiation of the original credit and the proceeds are credited to the account of the intermediary / middleman (the original beneficiary) in the usual manner. Procuring, exchange and substitution of documents and the process of negotiation may now continue up the chain in the normal course.
BACK TO BACK LETTERS OF CREDIT
by Catalyst on 25 Oct 2007 22:15
Replying to [Oneworld]:
You won't find ANY bank, not in the US, not anywhere in the world who'd open a "Back-to-back" LC. Not even in the UCP. There is no such thing as a "back-to-back" LC. These have been explained in the article itself.
An LC that's opened on the *back* of another is called a "Back-to-back" LC. It is a matter of nomenclature. The two LCs are INDEPENDENT, STAND ALONE instruments of payment. All banks open LCs, some of which could be opened as "Back-to-back" LCs.
Re: BACK TO BACK LETTERS OF CREDIT
by GermanTrader on 23 Dec 2007 03:23
Replying to [Catalyst]: Dear Catalyst, very well explained for those who know something about the business.
I try to simplify a bit the "Back to Back L/C" (BtBLC) for THOSE being new to business.
First of all getting all the trading knowledge is a process of years of learning and doing, based on well education in this business, for example a bank specialist or foreign trade specialist, approved by an official school of the country he comes from : )
A BtBLC is used by a trader or trading company who does not have the money or credit line to purchase the goods he/they want to trade.
So their bank is not giving them any money unless they can secure their credit application (for buying the goods)
For this purpose they can use an other L/C to back (secure) their credit application. GOT IT ?
To my understanding the bank will only accept an IRREVOCABLE AND CONFIRMED LETTER OF CREDIT to back/secure it.
Anyhow a process not for a beginner as there are many MORE risks in such business.
BACK TO BACK LETTERS OF CREDIT
by Catalyst on 02 Jan 2008 02:39
Replying to [GermanTrader]:
Your explanation is absolutely correct.
But, every silver lining has a cloud attached to it...when the exporter gets an irrevocable LC, and then approaches his bank to issue another LC to pay his (domestic) supplier, that bank would like to examine its credit risks before it issues that (second, which is called the "back-to-back") LC. The issue here is, is the exporter capable of paying under the second (back-to-back) LC, IF unforunately the export LC fails to work, somehow; the exporter cannot ship, or not get paid for one reason or another?????