Letter of Credit

Letter of Credit (LC) is method of payment that is frequently used in international trade. Letter of Credit (LC) is a fairly flexible form of payment were gives security to both buyer and seller. Letter of Credit (LC) is one of the safest methods of payment. Documentary Letter of Credit (LC) is a document given by a bank by which bank undertakes to pay the seller against presentation of a draft.

Letter of Credit (LC) specifies Bill of Exchange and other documents to be provided in order and presented within a specified period. Buyer’s bank, known as the issuing bank, acting on the instruction of the buyer, undertakes to make available a predetermined amount to the seller, who is known as the beneficiary. Opening of a Letter of Credit (LC) is normally done through the intermediary of another bank in the country of residence of the beneficiary. This is a general rule but there are exceptions. Generally, Letter of Credit (LC) is opened or established in the buyer’s country and payable there. Letter of Credit (LC) applicant (buyer) needs to state where the credit is to be paid, if it is not stated then it will be paid in the buyer’s country. Some countries may restrict where a Letter of Credit (LC) is established and paid because of foreign exchange problems or restrictions. Intermediary bank through which the Letter of Credit (LC) is established is known as the Advising/Confirming/Paying Bank.

Four (4) parties are involved in Letter of Credit (LC):

  1. Buyer: Applicant for Letter of Credit (LC)
  2. Seller: Beneficiary of Letter of Credit (LC)
  3. Buyers’ Bank: Issuing bank of Letter of Credit (LC)
  4. Advising/Confirming/Paying Bank: Intermediary bank

Banks may not re-interpret the terms of the Documentary Letter of Credit (LC) in any way. Banks must be adhered to exactly. In order to ensure uniformity of interpretation by banks in respect of Documentary Credits, the International Chamber of Commerce, in conjunction with other interested parties, has produced guidelines entitled Uniform Customs and Practice for Documentary Credits (UCP). Normally, Documentary Credits are described as Irrevocable (cannot be revoked once they have been opened). Documentary Credits will lapse if the documents are not presented within the stipulated time. On the buyer’s instruction the issuing bank irrevocably commits itself to pay the beneficiary (seller) on the correct presentation of the requirement documents.

If a seller is uncertain of the financial status of the buyer, seller require the credit to be confirmed. In other words, bank in the buyer’s country notifying the Letter of Credit (LC) gives an undertaking to pay without recourse to the seller, unless it is otherwise stipulated. Seller is certain of receiving payment after providing the right documents. Correspondent Bank may be willing to add their confirmation at the seller’s request and expense, if requested and/or authorized by the opening bank to do so. When the buyer instructs his bank to open a Letter of Credit (LC), buyer state explicitly the type of credit and the conditions under which the bank will pay the seller.

Generally, Letter of Credit (LC) stipulates that part-shipment is prohibited, but transshipment is allowed and that the documents must be presented for payment within certain days from the date of shipment. Expiry date is given and this would be the latest date for the presentation of documents by the seller. It is crucial that the required documents are presented to the bank by the seller within the time limit set. It is also essential the documents comply fully with the instructions in the Letter of Credit (LC) and are correctly completed in every detail.