International Trade Terms

Letter of Credit (LC)

Letters of Credit are often regarded as one of the most secure means of obtaining prompt payment for sale of goods. An LC is a document issued by a bank, according to the instructions of the buyer of the goods, committing to pay the seller if certain conditions are met. The risk in such payment lies with the bank not the buyer. The LC is not the sales contract – it can remain valid even if the sales contract becomes null and void. The LC is to assure the importer (buyer) that the goods are shipped prior to payment and to ensure the exporter (seller) of payment prior to shipment.

To obtain payment, it is necessary to present to the bank the documents that have been called for in the LC. The bank is chosen by the buyer, but before the LC is drawn up, the seller should endeavour to agree with the buyer the documents that need to be produced to exact payment. Payment could be delayed or even withheld otherwise. Almost all LCs require production of a commercial invoice and a transport bill of lading. Descriptions of goods on the invoice and bill of lading must be the same to ensure payment. The buyer and the bank may agree to payment after negotiation if the descriptions are not the same. Because LCs are drawn up by a third party they often need to be amended before the buyer can take delivery of the goods to remove ambiguity. If the goods have already been delivered, the buyer may attempt to use the amendment to negotiate a lower price because he knows that the seller will not be able to exact payment easily.

Every LC has three important dates:

  • date by which the goods must be shipped
  • date by which documents must be presented
  • expiry date for the LC.

Large margins for error should be allowed for on the part of the seller. Obtaining an extension to an LC is expensive and will reduce your profit margin on the deal.

There are three main types of LC:

  1. Confirmed Letter of Credit - issued by a foreign bank, with validity confirmed by a ‘local’ bank. An exporter who requires a confirmed letter of credit from the buyer is assured of payment by the local bank even if the foreign buyer or the foreign bank defaults.
  2. Deferred Letter of Credit - provides for payment some time after presentation of shipping documents by the exporter.
  3. Irrevocable Letter of Credit - has a fixed expiration date that carries the irrevocable obligation of the issuing bank to pay the exporter when all of the terms and conditions of the letter of credit have been met.

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