Letter of credit (L/C)
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.