Back-to-Back Letters of Credit: A Practical Guide

Back-to-back letters of credit offer an alternative to transferable credits when the terms of a trade deal between the ultimate buyer and final supplier differ significantly. Unlike transferable credits, which operate under a single letter of credit, back-to-back credits involve two separate and distinct letters of credit.

How it Works:

Two Separate Credits: An intermediary, acting as both buyer and seller, obtains two letters of credit:
- Credit A: Issued by the bank at the request of the ultimate buyer in favor of the beneficiary- "intermediary".
- Credit B: Issued by the intermediary's bank at the request of the intermediary in favor of the ultimate beneficiary-"supplier".
Security Mechanism: Credit A serves as security for the issuance of Credit B. This ensures the intermediary's bank has the funds to fulfill its obligations under Credit B.
Document Alignment: The intermediary's bank and the intermediary must carefully structure Credit B to ensure that the documents presented by its supplier can be used, along with any necessary additions or substitutions, to comply with the requirements of Credit A.

Key Considerations:

Amendments: Any amendments to Credit A must be reflected in Credit B, requiring careful coordination between all parties involved.
Risk Management:
- Document Alignment: Credit B's terms and conditions should closely mirror those of Credit A.
- Transparency: The intermediary must provide clear explanations and assurances for any discrepancies between the two credits.
- Control: The issuing bank of Credit B may consider confirming Credit A to maintain control over any amendments.
- Legal Protection: The intermediary should execute appropriate legal documentation.
- Record Keeping: Both credit files should be clearly marked and cross-referenced.

Challenges:

Back-to-back credits present significant challenges. Banks typically only approve these arrangements for experienced and creditworthy traders due to the inherent complexities and risks involved.

In Summary

While back-to-back letters of credit offer a solution for complex trade scenarios, careful planning, meticulous documentation, and a strong understanding of the underlying risks are crucial for their successful implementation.

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