Letter Of Credit

Summary of Letter Of Credit

A document issued by a commercial bank committing itself to honor drafts drawn in accordance with the terms of the credit. The party to whom the credit is issued is the beneficiary; the party on behalf of whom the bank issues the credit is the applicant. Letters of credit may be issued as either revocable, subject to recall or amendment at the option of the applicant, or irrevocable, not subject to recall or amendment during the specified life of the credit, except with the agreement of the beneficiary In addition, a letter of credit may be confirmed or unconfirmed. A confirmed letter of credit is one for which a bank, other than the issuing bank, has made itself responsible for honoring properly presented drafts; an unconfirmed letter of credit relies solely upon the good name of the issuing bank. Customarily, a bank will charge the applicant or beneficiary for adding its confirmation. Upon performance of the actions specified in the credit, usually the shipment of goods as evidenced by the submission of shipping documents, the bank will accept the beneficiary’s draft. A draft accepted by a bank is a banker’s acceptance. If the letter of credit provides for drafts at sight, the acceptance will be redeemed for cash; if the credit provides for time drafts, e.g., drafts at thirty days’ sight, the beneficiary may hold the draft to maturity or may discount it at the accepting bank or another financial institution; in most cases, the draft must be ac-companied by bills of lading, invoices, and other documents. In those cases where drafts or documents submitted are not in complete conformity with the conditions stipulated in the credit, the documents are said to suffer discrepancies, and the bank is under no obligation to accept the draft or make payment without the applicant’s approval. Any presentation, other than one in which all documents submitted conform precisely to the requirements stipulated in the credit, is a discrepancy presentation.

Recognizing the international character of letters of credit and the necessity for standardized terminology in their use, the international business community has developed a common code of usages for applying credits. These rules are embraced within the Uniform Customs And Practices (read this and related legal terms for further details), issued by the International Chamber of Commerce.

See Back-To-Back Letter of Credit, Delayed Payment Credit, Red Clause, Revolving Letter of Credit, Transferable Letter of Credit.

(Main Author: William J. Miller)

Letter of Credit (L/C) in International Trade

Meaning of Letter of Credit (L/C), according to the Dictionary of International Trade (Global Negotiator): A document issued by the importer’s bank stating its commitment to honor a draft, or otherwise pay, on presentation of specific documents by the exporter within a stated period of time. The documents the importer requires in the credit usually include, at least, a commercial invoice and clean bill of lading, but may also include a certificate of origin, inspection certificate or other documents. The most widely used type of credit in international trade is the irrevocable letter of credit, which cannot be changed or cancelled without the consent of both, the importer and the exporter. In a confirmed irrevocable letter of credit, the confirming bank adds its irrevocable commitment to pay the beneficiary (exporter). The confirmation is an additional guarantee of payment. The types of letters of credit are:

A credit the opening of which the beneficiary has been informed by a local bank.

Back-to-back. A system utilized by intermediaries/brokers to finance a single transaction through the use of two L/Cs opened in succession in order to permit the intermediaries/brokers to use the proceeds from the first credit to pay off his supplier the second credit.

L/C that has received an additional guarantee of payment by a local or highly reputable bank.

L/C of credit under which payment by the importer is to take place at a specified time after his receipt of the shipping documents.

Red clause. L/C of credit used to provide the supplier with some funds prior to shipment to finance production of the goods. The credit may be advanced in part or in full, and the buyer’s bank finances the advance payment.

L/C letter of credit that cannot be retracted or revoked once the beneficiary has been notified. There is a presumption under UCP 600 that every L/C is irrevocable.

L/C letter of credit which can be drawn against repeatedly by the beneficiary; it can take a variety of different forms depending on whether the credit is limited in terms of time, number o possible drafts, maximum quantity per draft, or maximum total quantity.

L/C letter of credit under which the beneficiary is entitled to present a sight draft or sight bill of exchange, which is a call for immediate payment upon acceptance of shipping documents.

L/C akin to demand guarantee or bank guarantee, the standby L/C is generally used to assure performance or payment by the counterparty.

L/C which allows the beneficiary to make part or all of his credit payable to another supplier; used in intermediary/broker context; distinguishable from back-to-back L/C as the transferable L/C requires the knowledge and authorization of the importer.

Also called Documentary credit (D/C). See irrevocable letter of credit; standby L/C. Model of Letter of Credit.