Some key points to note with a direct payment letter of credit include: However, the direct payment LC excludes the condition of presenting the proof of performance or a specific event. The primary purpose of a direct payment LC is to secure the buyer from non-performance risk. Its working mechanism closely resembles that of a standby documentary credit. Important Points to Note with Direct Pay Letter of CreditĪ Direct payment letter of credit is a special form of standby letter of credit. Contrarily, it possesses a higher degree of risks too for the buyer, as the bank does not control the title of goods or the bill of lading documents. It works similarly as a bank guarantee that offers fewer complications and clears the payments quickly. Hence, sellers usually prefer it over the complex commercial letters of credit. Once the seller approaches the bank with necessary documentation such as a payment draft, the issuing bank will release the payment.Ī direct pay LCis a quick and simpler payment method in international trades. It means the buyer can seek the security of performance by the seller with a trade contract only. The buyer then issues a direct pay LC to the beneficiary.Ī direct payment letter of credit is an independent contract from the trade deal. Once the buyer secures a documentary credit, it can proceed with the trade deals. The bank appraises the applicant’s creditworthiness and approves the credit facility. The process of a direct payment LC starts with the applicant approaching a bank.
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READ: Market Value of Debt: Definition and How to Calculate It A direct payment LC eliminates the condition of performance and clears the payment upon demand draft presentation by the beneficiary. The buyer provides a standby LC to mitigate the risk of non-payment, which helps both parties to boost the trust. How Does Direct Pay Letter of Credit Work?Ī standby letter of credit is used to protect the buyer from the non-performance of the seller. Although it does not happen often, the sellers can claim the payment without proceeding with the shipment of goods to the buyer. It offers a higher degree of risk as compared to a normal standby, such that it does not come with a covenant for the undertaking of a certain event happening. On the other hand, it also possesses similar risks to the applicant and the issuing bank.
Hence, it offers discrete financial security to both parties in the trade agreement. The direct pay LC works independently from the trade agreement. Unlike a standby, the beneficiary does not need to present the documents on default of the buyer only. The issuing bank clears the payment upon payment draft presentation by the beneficiary. In a direct pay letter of credit or simply direct pay LC, the advisory bank makes a direct payment to the beneficiary. In both forms, the issuing bank bears the responsibility of non-payment by the applicant. Whereas, a standby LC is used to make payments in case of default of the buyer. Like a standby, it can provide financial security to the seller by the presentation of the payment draft.Ī direct pay letter of credit differs from standby in the sense that it acts as a primary source of payment to the seller. It does not include any clause of performance or non-performance from the seller. With a direct payment letter of credit, the issuing bank directly pays to the beneficiary. A direct pay letter of credit is a special form of standby letter of credit.
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