Letters of Credit: A Practitioner’s Primer

A letter of credit gives a seller a bank’s undertaking to pay when the required documents comply with the credit. It helps a buyer and seller manage payment in a trade transaction.

How a Letter of Credit Works

The issuing bank acts on the instructions of the applicant, usually the buyer, and undertakes to pay the beneficiary, usually the seller, against a complying presentation. Banks examine documents. Problems with those documents can delay or prevent payment even when the goods have arrived in good condition.

The Parties Involved

• Applicant: the buyer who asks the bank to issue the credit.
• Issuing bank: the applicant’s bank, which gives the payment undertaking.
• Advising bank: the bank that checks the apparent authenticity of the credit and advises it to the beneficiary.
• Confirming bank: a bank that adds its own payment undertaking when confirmation is arranged.
• Beneficiary: the seller who presents documents for payment.

The Documents Required

The credit specifies the documents to be presented. For credits subject to UCP 600, examination takes account of those rules and International Standard Banking Practice (ISBP). Common documents include:

• Commercial invoice: records the goods and amount claimed, in line with the credit’s requirements.
• Bill of lading or other transport document: provides evidence of shipment.
• Certificate of origin: states the origin of the goods.
• Packing list: provides details of the shipment contents and packing.
• Insurance document: provides evidence of cover where required by the credit.

Common Documentation Problems

Discrepancies can arise from missed shipment dates, inconsistent document details, incorrect invoice amounts or missing endorsements. Careful preparation and checks before presentation help avoid delays.

The bank’s payment undertaking depends on a complying presentation. Preparing the documents deserves as much attention as arranging the shipment.

A Practical Checklist

1. Read the full credit before shipment, including dates, amounts and tolerances.
2. Check that the goods description and commercial terms reflect the agreed transaction.
3. Allow realistic time for production, shipment and document presentation before expiry.
4. Check whether confirmation is required and which bank will provide it.
5. Check all documents against the credit and for consistency with one another before presentation.

A letter of credit works best when its terms are understood early and the documents are prepared carefully. Attention to dates, descriptions and presentation requirements is essential throughout the transaction.