Back-to-Back LC and Inherent Risks

When the beneficiary of a credit who is not the actual supplier of goods wishes to open a second credit in favour of his supplier, the first credit not being transferable, he may request a bank to issue a back to back credit (BBC), i.e. one which uses the first credit or master credit (MC) as sole security.

BBC resembles transferable credits (TC) in a number of particulars but it is essential to recognize that unlike transferable credits, the two transactions under BBC are quite separate. The bank issuing BBC may not necessarily be the bank that advises or confirms the MC, and in no circumstances can all the documents called for under one credit constitutes good presentation under the other.

If a bank agrees to issue a BBC it will insist that the terms thereof exactly meet the terms of the MC except that it will be for a lesser value; the unit price, if quoted, will be reduced; the centre of validity may be changed; and the validity, latest shipment date for presentation of documents may all be curtailed.

When conforming documents are presented to the bank issuing the BBC, settlement must be effected regardless of the situation of the MC. It follows therefore that the beneficiary of the MC will be called upon immediately thereafter to substitute his invoices and drafts if required, in order that these may be matched with the remaining documents and promptly presented for settlement under the MC. Timing and conformity of documents are critical elements in the transaction and in order to obtain maximum control and simultaneous proceeds, many banks will not issue a BBC unless the MC has been confirmed or advised by them.

As with a TC, the applicant for BBC, the beneficiary of the MC will, upon substitution, receive the difference in the invoice value less bank charges, as proceeds. With two separate credits and possibly several participants banks involved the likelihood of dispute is considerable. A few examples of the insecurities inherent in BBC operations are set out below:

1. Documents presented in accordance with the terms of the BBC must be honoured by the bank issuing it. If for any reason the first beneficiary is unable to supply documents for presentation under the MC (e.g. liquidation), settlement will not be effected under it.

2. The MC may expire before presentation of documents thereunder, e.g. the beneficiary is dilatory in substituting his invoices, or due to delays in the mail the documents presented by the supplier under the BBC fail to arrive in time for substitution and presentation under MC.

3. Unless the MC is confirmed by the intermediary bank (assuming that bank to be other than the one issuing the BBC), the bank is under no obligation to effect settlement.

4. The BBC may be expressed in different terms from the MC e.g. the terms of the MC may be CIF and the BBC CFR with the first beneficiary covering insurance, or the MC may require the ultimate buyer to be shown as notify party on the transport document whereas the first beneficiary may not wish his source to be disclosed. These and similar problems are encountered as they are with TC and may be dealt with in variety of ways from amendment to substitution of documents.

Risk no 1 above is the prime bank risk, but this can greatly minimized when dealing with first-rate applicants; and the other risks, although very real, are not insurmountable. Nonetheless, BBCs are refractory instruments which banks generally avoid, encouraging applicants to operate instead by the traditional means of transfer whenever possible.

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