The purpose of red clause in a documentary credit is to enable the beneficiary to obtain pre-shipment advances from the advising or confirming bank, at the expense of the beneficiary, but under the responsibility of the issuing bank. This red clause is so termed because it is usually printed in red on the credit to draw attention to this special feature of the credit terms.
Red clause has been used traditionally, in certain countries where goods, such as wool, cotton, meat, rubber etc, need to be purchased by a beneficiary who requires advances in order to pay for goods either directly or at auctions. Under the terms of the credit, an intermediary bank is authorized by the issuing bank to make advances to the beneficiary so that he may pay in this way. When in due course the goods are shipped and complying shipping documents presented, the proceeds are used to liquidate the pre-shipment advances, proportionate interest being taken or claimed.
Advances are usually made in local currency to avoid any fluctuation in exchange rates between the time of the advance and the time payment or negotiation is effected. If the credit is expressed in a currency other than local currency, it should stipulate for whose account any exchange difference will be.
If a red clause credit is available for negotiation rather than payment, it need not be restricted to the intermediary bank responsible for providing the advances as long as the eventual proceeds of the credit are made available to that bank.
There are two main types of red clause:
1. The unsecured or clean red clause, under which the advances are authorized against the beneficiary’s statement that they are required to pay for pre-shipped goods.
2. The secured or documentary red clause, under which advances are made against presentation of warehouse receipts or similar documents together with the beneficiary’s undertaking to deliver the bill of lading and/or other documents required upon shipment (The warehouse receipts are usually returned to the beneficiary in trust so that he may then obtain the bill of lading). Here, the beneficiary may also be required to insure the goods while they are in store.
In the event of subsequent default by the beneficiary, including failure to present documents in compliance with the terms and conditions of the credit, the intermediary bank has the right to claim refund of its advances, together with interest and any other charges, from the issuing bank.
There is a third type of clause which may be used, the ‘receipt and undertaking’ or ‘invoice and undertaking’ clause, which differs from both the above in that the intermediary bank makes advances against the beneficiary’s receipt or invoice together with his undertaking to refund the advance in the event of failure to present complying documents under the credit.
Advances under the ‘receipt and undertaking’ clause are not normally made from the intermediary bank’s own fund but against immediate reimbursement from the issuing bank, with the beneficiary being responsible to the issuing bank in the event of default.
Clean red clause:
“As the accredited may have to pay for the wool before shipment, kindly grant him advances to enable him to make such payments agaisnt his statement that the money is required for the purpose of the aforesaid. We accept responsibility for the repayment of anticipatory advances granted by you within the credit limits.”
Documentary red clause:
“As the accredited may have to pay for the goods before shipment please grant him advances for the purpose of making such payments against Warehouse Receipts or other documents evidencing the right to claim possession of the goods and the undertaking to deliver the relative Bills of Lading in due course. Such Warehouse Receipt or other documents may be entrusted to the accredited in exchange for his acknowledgement that the documents are held by him as trustee for you and as your agent to obtain for you in exchange the relative Bill of Lading. The goods, whilst in the warehouse pending shipment are to be insured by……………………. . We accept responsibility for the repayment of anticipatory advances granted by you within the credot limits.”
Invoicing and undertaking clause:
“As the accredited will have to pay for the goods, processing and ancillary charges before shipment, negotiation may be made to the beneficiary against invoices evidencing firstly cost of goods and/or processing and ancillary charges and the beneficiary’s undertaking to produce the relative shipping documents in due course. We accept responsibility for meeting such payments under the terms of the credit.”