Precautions to be taken when Opening a Back-to-Back Letter of Credit against an irrevocable letter of credit

Back-to-back Credit. Where the beneficiary under a letter of credit is an intermediary procuring goods from suppliers and likes the suppliers to get the benefit under the credit, it is done by transferring the credit in favor of the suppliers . But transfer of the credit is possible only if it is authorized by the credit itself. The problem is solved by the beneficiary requiring his bank (who may or may not be the intermediary bank for the credit) to open another letter of credit in favor of the supplier on the strength of the original credit. Such an ancillary letter of credit is known as the ‘back-to-back credit’ or ‘countervailing credit’ or ‘credit and counter credit’.

A back-to-back letter of credit is often an inland letter of credit. It is different from the original credit except that the original credit forms the security based on which the bank undertakes the risk under the back-to-back credit. The supplier (beneficiary of the back-to-back credit) ships goods to the importer or supply goods to the exporter and presents documents to the bank as is specified in the credit.

It is intended that the exporter would substitute his own documents and ship goods to the importer if necessary and present documents for negotiation under the original credit. His liability under the back-to-back credit would be adjusted out of these proceeds.

The following points may be kept in mind by the bank while opening a back-to-back letter of credit:

1. The terms and conditions of the back-to-back credit should be exactly as that of the original letter of credit but for curtailment in:

(a) the amount of the credit. This would leave margin of profit for the exporter .

(b) the validity and shipment dates. This would leave sufficient time for the exporter to prepare and substitute his documents and arrange for shipment to importer if the goods are supplied by the supplier to him. Only then the bank can get reimbursement under the original credit.

2. Though it is not necessary that only an intermediary bank under the original  credit should open a back-to-back credit, it would be better that such credits are opened only where the bank is also a negotiating bank. This would avoid the risk of the documents substituted by the exporter being not accepted by the negotiating bank as not fulfilling the conditions of the credit.

3. The original credit should be an irrevocable credit. A back-to-back credit has certain features in common with a transferable credit. Under both, the benefit under the credit is transferred to a third party. The documents  arc substituted by the first beneficiary under both types of credits. The possibility  of the importer knowing the real suppliers or vice versa is avoided in both cases.
But a back-to-back credit differs from a transferable credit in the following respects:

(a) There is an authority from the importer for the transfer of benefit under the credit in the case of a transferable credit. No such authority is there under a back-to-back credit.

(b) In a transferable credit the second credit is only an extension of the rim credit. A back-to-back credit has an existence independent of the original credit.

(c) Following from the above, under the transferable credit the negotiating bank can submit the documents submitted by the second beneficiary to the issuing bank in case the first beneficiary fails to submit his own documents (i.e., invoice, etc.) on first demand by the negotiating bank. Under a back-to-back credit submission  of documents submitted by the second beneficiary is not possible.