Red Clause Letter of Credit. Also known as `packing’ or ‘anticipatory’ credit, the letter of credit contains a clause usually printed in red authorizing the negotiating bank to grant advance to the exporter for the purchase and processing, packing and arranging for movement of goods up to the port for shipment. The advance, with interest and other charges, is recoverable from the bills that would be tendered under the letter of credit and only the balance would be paid to the exporter.
The amount of the advance should be less than the amount of the letter of credit so that it remains fully secured by obligation of the opening bank. The opening bank remains liable for the advance. If the exporter does not tender bills by the expiry date of credit, the bank should serve a notice on the exporter and also intimate the opening bank. If the advance fails the opening bank should reimburse the bank which has made the advance. The opening bank can recover the amount from the importer on whose request the credit has been established.
The negotiating bank is not required to supervise the utilization of the advance. Mere declaration from the exporter that he would be utilizing the funds for the exports under the credit would be sufficient. But the bank should see that the stipulations, if any, in the credit regarding the advance are scrupulously followed.
At the time of advising the credit and advancing under the credit, the bank should take the following precautions:
(a) The credit rating of the issuing bank should be verified. It should be kept in mind that in case the advance fails recourse has to be had to the issuing bank.
(b) If the credit requires certain documents to be taken or goods to be charged in favor of the bank or drafts to be obtained on the issuing bank, such formalities should be completed before the advance is made.
(c) If the beneficiary is not its customer, identification of the borrower is necessary before the advance is made. A report from the beneficiary’s bank may be obtained.
(d) To cover exchange fluctuations the borrower may be advised to book a forward contract for the amount of the credit. This would help keep the advance granted fully covered by the amount of the credit. The amount of advance should be less than the amount of the credit.
(e) An undertaking that he would tender documents under the credit before its due date should be obtained from the beneficiary.