Letter of credit for importers and exporters, step by step

What a letter of credit actually promises

A letter of credit is independent of the sales contract. The bank pays against documents, not against the goods and not against performance. If the documents comply on their face with the terms of the credit, the bank must pay, even if the goods are defective; if the documents do not comply, the bank may refuse, even if the goods are perfect. This "autonomy" and "strict compliance" is the whole point: it turns a commercial dispute into a documentary check a bank can perform.

For the buyer, the protection is that the bank pays only when the agreed documents (showing shipment, quantity, quality certificates, insurance) exist. For the seller, the protection is that a bank, not the distant buyer, owes the money.

The parties and the flow

The typical sequence:

1. Buyer and seller agree in the contract to settle by letter of credit and write the terms (amount, documents, latest shipment date, expiry, Incoterm).
2. The buyer applies to its bank; the issuing bank opens the credit and sends it to an advising bank near the seller.
3. The advising bank satisfies itself of the apparent authenticity of the credit and advises the seller of the terms it received, without any undertaking to honour or negotiate (UCP 600 Article 9), unless it also acts as confirming bank.
4. The seller ships the goods within the dates in the credit and assembles the documents.
5. The seller presents the documents to the nominated or confirming bank before expiry.
6. The bank examines the documents; if they comply it pays (at sight) or accepts a time draft (usance); the documents travel to the issuing bank, which reimburses and releases them to the buyer, who uses them to clear and collect the goods.

Types you can ask for

• Irrevocable — cannot be amended or cancelled without every party's agreement. Under current practice all documentary credits are irrevocable; do not accept a revocable one.
• Confirmed vs unconfirmed — a confirmed credit carries a second bank's independent promise to pay, usually a bank in the seller's country. Ask for confirmation when you doubt the issuing bank or its country (political or transfer risk). Confirmation costs extra.
• Sight vs usance (deferred / acceptance) — a sight credit pays on compliant presentation; a usance credit pays a set number of days after shipment or presentation, financing the buyer.
• Transferable — lets the beneficiary transfer all or part of the credit to a second beneficiary (a trader passing it to the actual producer).
• Back-to-back — two separate credits used for the same underlying trade when a transferable credit does not fit.
• Revolving — reinstates automatically for repeat shipments under a framework.
• Standby (SBLC) — a default instrument, closer to a guarantee: it pays only if the buyer fails to pay by the agreed means. Governed by UCP 600 or ISP98.
• Red clause — allows an advance to the seller before shipment.

The rulebook

Letters of credit are not governed by one statute but by ICC rules the parties incorporate:

• UCP 600 — the Uniform Customs and Practice for Documentary Credits, the core rulebook almost every commercial LC adopts.
• ISBP 821 — International Standard Banking Practice, how banks read documents in practice.
• eUCP — a supplement for electronic or mixed presentations.
• URR 725 — bank-to-bank reimbursements.
• URC 522 — the Uniform Rules for Collections, for documentary collections (a different, cheaper instrument, see below).
• URDG 758 — demand guarantees, and ISP98 for standby credits.

Name the applicable rules in the credit. Courts and banks read the credit against them.

Discrepancies: where LCs go wrong

Banks reject a large share of first presentations because the documents do not match the credit. Common defects: the presentation is late or after expiry; the goods description differs from the credit; weights or amounts are inconsistent across documents; the bill of lading is not "clean" or not marked as required; insurance is for the wrong amount, currency or risks; a certificate is missing or signed by the wrong party.

A discrepant presentation does not automatically fail — the buyer can waive the discrepancies — but it hands the buyer a reason to renegotiate or walk away, which destroys the protection the seller paid for. Practical defences for the seller:

• get a draft of the credit and check every term before shipment;
• make sure each document can be produced exactly as worded (especially third-party certificates);
• build in enough time between latest shipment date and expiry for the presentation;
• consider asking the nominated bank for a documentary check before formal presentation.

A document checklist compared line by line with the credit text, a discrepancy pre-screen, is cheap insurance before presentation.

Exporters often agree an internal presentation calendar that counts forward from the actual shipment date, applies the 21-day presentation period unless the credit says otherwise, and never runs past the credit expiry date.

Costs and who pays

Each step carries a fee: issuance (applicant), advising, confirmation, amendment, discrepancy, negotiation or acceptance, and reimbursement. Charges must be allocated explicitly in the credit and the contract: under UCP 600 Article 37(c), a bank instructing another bank to perform services is liable for that bank's charges unless the credit states they are for the beneficiary's account. Confirmation and usance financing are the expensive parts. Fold these into your landed cost comparison so an LC deal is compared with an open-account deal on the same basis.

When a letter of credit is overkill

An LC is justified by counterparty and country risk, not by habit. Lighter instruments:

• Documentary collection (URC 522) — the seller's bank releases documents against payment (D/P) or against acceptance of a time draft (D/A). Cheaper than an LC, but no bank guarantees payment; it suits parties with some trust and a reliable banking corridor.
• Open account with trade credit insurance — for an established relationship; see payment terms.
• Advance payment or a deposit — shifts risk to the buyer; common for first small orders.

Match the instrument to the risk and to the Incoterm: the point where risk and the transport documents pass shapes what the LC must demand.

Checklist before you agree to an LC

• Instrument chosen against real counterparty and country risk, not habit.
• Irrevocable, and confirmed if the issuing bank or country is a concern.
• Sight or usance decided, and the financing cost priced in.
• Document list in the credit matches what you can actually produce.
• Latest shipment date, expiry and presentation period are workable.
• Goods description and Incoterm identical to the contract.
• Applicable ICC rules (UCP 600, ISBP 821) named in the credit.
• Bank charges allocated between buyer and seller.

On Hiram you can agree payment terms with a counterparty inside the deal and keep the documents and the specification in one place. Go to the market.

Sources

• ICC, Uniform Customs and Practice for Documentary Credits (UCP 600): https://iccwbo.org/business-solutions/all-publications/ucp-600/ (opens in a new tab)
• ICC, International Standard Banking Practice (ISBP) 821: https://iccwbo.org/business-solutions/all-publications/international-standard-banking-practice-isbp-for-the-examination-of-documents-under-ucp-600/ (opens in a new tab)
• ICC, Uniform Rules for Collections (URC 522): https://iccwbo.org/business-solutions/all-publications/icc-uniform-rules-collections-urc-522/ (opens in a new tab)
• ICC, Uniform Rules for Demand Guarantees (URDG 758): https://iccwbo.org/business-solutions/all-publications/uniform-rules-for-demand-guarantees-urdg-758/ (opens in a new tab)
• International Trade Centre, Trade finance and documentary credits: https://intracen.org/ (opens in a new tab)
• ICC, UCP 600, Article 9 (advising of credits and amendments) and Article 37(c) (charges): see the UCP 600 publication above