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Letter of Credit fraud: truth vs. scam

From The Dictionary of Financial Scam Terms

An easy-to-understand guide to financial terms used by swindlers  

Letter of Credit (LC):

Letters of credit became necessary when trade between countries made it impossible to simply do business by handshake.  They were initially introduced by the merchant banking system in Europe, and grew out of earlier contracts such as the "chop" in Asia and the personal "house" emblem embossed in hot wax used throughout Europe and Arabia.

Originally, a Letter of Credit was quite literally that - a letter addressed by the buyer's bank to the seller's bank stating that they could vouch for their customer, the buyer, and that they would pay the seller in case of the buyer's default.  

Nowadays, they are formatted to provide fill-in spaces for the various requirements of international or domestic business.  It is written by a bank on behalf of one of it's creditworthy customer, who's application for the line of credit has been approved.

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The sequence of information on Letter of Credit the language used is determined by rules set by the INTERNATIONAL CHAMBER OF COMMERCE (ICC).  The rules and language are very specific and cannot be changed, and are spelled out in the ICC's Uniform Customs and Practice for Documentary Credits, or UCP500.

The parties to a Letter of Credit are 

(1) the buyer (the applicant)

(2) the buyer's bank (the issuer)

(3) the beneficiary (the seller/payee)

(4) the beneficiary's bank.  

The LC outlines the conditions under which payment (credit) will be made to a third party (the beneficiary).  The conditions are specified by the buyer and may include insurance forms, Way Bills, Bills of Lading, Customs forms, various certificates - i.e. whatever documents are necessary to safeguard the integrity of the purchased product or service. 

It is the responsibility of the issuing bank to ensure, on behalf of its client the buyer, that all documentary conditions have been met before the Letter of Credit funds are released.

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In effect, a basic Letter of Credit is a financial contract between the bank, the bank's customer, and the beneficiary, and this contract* involves the transfer of goods or services against funds. 

*Not to be confused with the contract between the buyer and seller.  The neither of the banks have any interest in that kind of contract.

The Letter of Credit may be written for a short period of time, covering one shipment of goods, or may be written for a greater amount and for a longer period of time in order to cover say, a year's worth of shipments (Note: a valid Letter of Credit never carries the term "one year and one day" which is a meaningless term created by fraudsters).  

The maturity date on a Letter of Credit is the date on which the full value of the credit is payable.  

A Letter of Credit may have a discount rate.  That means that the buyer may not have been the one to close the deal with seller.  Perhaps it was arranged by a licensed broker, the buyer's agent, or perhaps the importer's bank acting as the buyer's agent.  

In that case, the difference between the actual amount available for purchase expenses and the full value of the Letter of Credit is the commission earned by the broker.

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In any event, the buyer has to either have the funds on deposit in his bank to cover the full value, or has to have made other arrangements with his bank to cover the full value.  A Letter of Credit cannot be purchased for only a small percentage of the face value and then cashed across the street for the full face value.  

There are several types of Letter of Credit: BACK-TO-BACK LETTERS OF CREDIT, CREDIT ENHANCEMENT, IRREVOCABLE LETTER OF CREDIT, STANDBY LETTER OF CREDIT, CONFIRMED LETTER OF CREDIT, and DOCUMENTARY LETTER OF CREDIT, TRAVELER'S LETTER OF CREDIT, as well as documentary commercial bill, red clause Letter of Credit, sight draft,  and time draft.   Once you understand the uses for a Letter of Credit, even uses for the ones not defined in this dictionary become self-evident.

The Scam: Fraudsters would like you to believe that Letters of Credit are investment securities, but as you can see, a Letter of Credit is written on an individual basis and must be thoroughly researched.

While a Letter of Credit may be forfaited, the financial instrument equivalent of factoring, that is not a procedure to be taken up by the inexperienced.  Without an intimate knowledge of trade finance, trade law, and international politics and economics, you can quickly find yourself up the creek without a paddle.

The usual swindler approach involves persuading you that a Letter of Credit or similar instrument can be purchased at enormous discount in exchange for your funds, and that a few weeks or months later this same financial instrument will be worth hundreds of thousands more.  Or can be sold for hundreds of thousands more.  Or can be turned around overnight.  Or traded for a higher value.

It just ain't so, and now you know why.

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