A Letter of Credit (LC) is a financial instrument issued by a bank at the request of a buyer (the Applicant), undertaking to pay a seller (the Beneficiary) a specified amount, provided that the seller presents documents strictly complying with the terms and conditions of the LC.
Letters of Credit are widely used in international trade to mitigate commercial, banking, and country risks, as payment is made against documents rather than the underlying goods or services.
Types of Letters of Credit
Irrevocable Letter of Credit: An irrevocable LC cannot be amended or cancelled without the consent of the issuing bank, the confirming bank (if any), and the beneficiary.
Under UCP 600, all Letters of Credit are irrevocable unless expressly stated otherwise.
Confirmed Letter of Credit: A confirmed LC includes an additional, independent payment undertaking from a second bank (the Confirming Bank), usually located in a different jurisdiction from the issuing bank.
This provides enhanced security to the beneficiary, as payment is guaranteed by both the issuing and confirming banks.
Unconfirmed Letter of Credit: An unconfirmed LC is guaranteed only by the issuing bank. In this case, the beneficiary remains exposed to the issuing bank’s creditworthiness, country risk, and transfer risk.
Sight Letter of Credit: Payment is made immediately upon presentation and examination of compliant documents.
Time / Usance Letter of Credit. Payment is made at a future date (e.g. 30, 60, or 90 days) after shipment or document presentation, as specified in the LC.
Standby Letter of Credit: A standby LC functions as a secondary payment instrument or guarantee, typically used to secure performance or payment obligations rather than routine trade settlement.
Transferable Letter of Credit: A transferable LC allows the beneficiary to transfer all or part of the credit to one or more third parties (e.g. suppliers), subject to UCP 600 Article 38 and bank approval.
Back-to-Back Letter of Credit: A structure involving two separate LCs, where the first (master) LC is used as collateral for the issuance of a second LC in favor of another beneficiary.
Red Clause Letter of Credit: A red clause LC permits the beneficiary to receive a pre-shipment advance, usually for production or procurement purposes, before shipment of the goods.
Green Clause Letter of Credit: Similar to a red clause LC, but the pre-shipment advance is granted against additional evidence such as warehouse receipts or documents showing goods are ready for shipment.
Revolving Letter of Credit: A revolving LC automatically reinstates its value after each drawing, within defined limits and time periods, making it suitable for recurring transactions.
Note: Revocable Letters of Credit are considered obsolete and are not recognized under UCP 600.
Key Parties and Terms in a Letter of Credit
Applicant: The buyer or importer who requests the issuance of the LC.
Beneficiary: The seller or exporter in whose favor the LC is issued.
Issuing Bank: The bank that issues the LC at the request of the applicant.
Advising Bank: The bank that advises the LC to the beneficiary. It does not guarantee payment unless it also adds confirmation.
Confirming Bank: The bank that adds its own independent undertaking to honor or negotiate a complying presentation.
Expiry Date: The last date on which documents may be presented.
Documents Required: Documents specified in the LC, such as commercial invoice, transport document, packing list, export license, or insurance certificate.
Shipment Terms: Conditions governing shipment method, timing, and destination.
Amount and Currency: The maximum amount payable under the LC and the currency of payment.
Partial Shipments / Transshipment: Whether partial shipments or transshipment are permitted.
Incoterms: International commercial terms defining the responsibilities of buyer and seller (e.g. CPT, FOB, CIF).
Discrepancy Handling: Rules governing examination of documents, notification of discrepancies, and acceptance or refusal.
Reimbursement: Instructions governing reimbursement between issuing, confirming, or nominated banks.
Governing Rules – UCP 600
Most documentary credits are governed by the Uniform Customs and Practice for Documentary Credits (UCP 600) issued by the International Chamber of Commerce (ICC). Key principles include:
Article 4 – Credits vs. Contracts: Letters of Credit are independent of the underlying sales or service contract.
Article 5 – Documents vs. Goods:Banks deal with documents only, not with goods, services, or performance.
Articles 7 & 8 – Bank Undertakings:Define the obligations of issuing and confirming banks.
Articles 14–16 – Examination of Documents:Set standards for document examination, discrepancies, and refusal.
Articles 18–25 – Specific Documents:Regulate commercial invoices, transport documents, and insurance documents.
Article 36 – Force Majeure: Banks are not liable for consequences arising from events beyond their control and must comply with applicable law and sanctions.
Conclusion
A Letter of Credit is a cornerstone instrument of international trade, providing structured, bank-backed payment security when correctly drafted and confirmed.
Understanding the different types of LCs, the roles of the involved parties, and the application of UCP 600 is essential for managing risk effectively—particularly in cross-border and higher-risk markets.
LETTER OF CREDIT (LC)
CONFIRMED IRREVOCABLE TRANSFERABLE RED CLAUSE LETTER OF CREDIT
(PRE-SHIPMENT ADVANCE & FINAL PAYMENT GUARANTEED)
1. Issuing Bank Information
Bank Name: [Issuing Bank Name]
Address: [Issuing Bank Address]
Contact Person: [Name]
Telephone: [Phone Number]
Email: [Email Address]
SWIFT Code: [SWIFT]
2. Confirming Bank Information
Bank Name: [Top-Tier EU / International Bank]
Address: [Confirming Bank Address]
SWIFT Code: [SWIFT]
Notice: The LC shall not become operative until confirmation advice is issued by the Confirming Bank.
3. Applicant (Buyer) Information
Company Name: [Applicant Name]
Address: [Applicant Address]
Contact Person: [Name]
Phone: [Phone Number]
Email: [Email Address]
4. Beneficiary (Seller) Information
Company Name: [Seller Name]
Address: [Insert Address]
Contact Person: [Seller Contact Person]
Phone: [Insert]
Email: [Insert]
SWIFT Code: [Insert]
For the purposes of UCP 600 Article 38, the above-mentioned Beneficiary shall be deemed the “First Beneficiary”. Any party to whom this Letter of Credit is transferred in accordance with its terms shall be deemed the “Second Beneficiary”.
5. LC Details
LC Type: Confirmed, Irrevocable, Transferable, Red Clause
UCP: Subject to UCP 600 – ICC Publication No. 600
LC Number: [To be inserted]
Date of Issue: [Date]
Currency: [To be inserted]
Total LC Amount: [To be inserted]
Expiry Date: [Date]
Place of Expiry: [At counters of the Confirming Bank]
Available With: [Confirming Bank, by sight payment]
Partial Shipments: [Allowed]
Transferability: [Allowed under UCP 600 Article 38]
The First Beneficiary is entitled to transfer this Letter of Credit, in whole or in part, to one or more Second Beneficiaries for manufacturing, production, or supply purposes, including the right to transfer both the Red Clause pre-shipment advance and the final payment entitlement.
Confirmation and transferability are subject to the Confirming Bank’s internal compliance and sanctions policies; however, confirmation shall not be withheld for commercial reasons once compliance requirements are satisfied.
6. RED CLAUSE – PRE-SHIPMENT ADVANCE (PRODUCTION FUNDING)
Pre-Shipment Advance Amount: [To be inserted]
Where this Letter of Credit is transferred, the Red Clause pre-shipment advance may, at the First Beneficiary’s request, be paid directly to the Second Beneficiary under the transferred Letter of Credit.
The Confirming Bank is authorized and instructed to pay to the Beneficiary, or where this Letter of Credit is transferred, to the Second Beneficiary, a pre-shipment advance from its own funds upon presentation of the following documents:
- Beneficiary’s signed statement certifying:
“Advance requested under LC No. [LC Number] for commencement of production of goods.”
- Signed Proforma Invoice.
In the case of a transferred Letter of Credit, the pre-shipment advance paid to the Second Beneficiary shall be deemed a valid drawing under this Letter of Credit and shall reduce the available balance accordingly.
Conditions Applicable to the Advance:
- The pre-shipment advance is unconditional, irrevocable, and non-refundable.
- The pre-shipment advance shall be deducted from the total LC amount upon final settlement.
- The pre-shipment advance shall be recoverable from the first complying presentation under this Letter of Credit.
- The total amount drawn under this Letter of Credit, including the pre-shipment advance, shall not exceed the Total LC Amount.
7. Final Payment – Balance Sight
Balance Amount: [To be inserted]. Payable at sight upon presentation of compliant documents listed below (paragraph 8).
Final payment shall be effected at sight against complying presentation of documents and shall not be conditional upon shipment of the Goods. Shipment shall take place after full utilization of this Letter of Credit.
8. Documents required for final payment
In the event that this Letter of Credit is transferred and utilized for full pre-export payment, the following pre-shipment documents shall constitute a complying presentation under this Letter of Credit:
- Commercial Invoice – 1 original and 2 copies
- Packing List – 1 original and 2 copies
- Beneficiary’s (Second Beneficiary’s) Certificate of Readiness for Shipment
- Manufacturer’s Undertaking to Ship the Goods within [X] days following receipt of full payment
- Export License – copy (paper or electronic), where applicable
In such case, transport documents shall not be a condition for payment under this Letter of Credit.
9. Shipment terms
Incoterms: Incoterms® 2020
Port / Airport of Loading: [Insert]
Port / Airport of Discharge: [Insert]
Latest Shipment Date: [Insert]
Shipment of the Goods shall take place after full payment under this Letter of Credit and in accordance with the Manufacturer’s undertaking. Failure to ship the Goods within the agreed timeframe shall not affect the validity of any payment already made under this Letter of Credit.
10. Payment undertaking
The Confirming Bank irrevocably undertakes to honor and pay any complying presentation regardless of:
- Applicant’s refusal or delay
- Applicant’s insolvency or bankruptcy
- Disputes under the underlying contract
Payment is made solely against documents.
The Confirming Bank’s obligation to honor and pay is independent of reimbursement from the Issuing Bank.
This undertaking applies equally to payments made to a Second Beneficiary under a transferred Letter of Credit.
11. Sanctions/War Risk
The Confirming Bank undertakes to honor any complying presentation made prior to the effective date of any sanctions, governmental prohibitions, or force majeure events applicable to the Beneficiary or the Confirming Bank.
Nothing in this Letter of Credit shall require any bank to act in violation of applicable law or sanctions regulations.
12. Charges and Fees
All banking charges, commissions, confirmation fees, transfer fees, amendment fees, extension fees, country risk premiums, sanctions-related fees, and any interest, costs, or fees arising from the utilization of the Red Clause advance, whether charged by the Issuing Bank, the Confirming Bank, the Transferring Bank, or any other bank involved, shall be for the account of the Applicant (Buyer).
No charges, fees, interest, or commissions of any kind shall be deducted from or set off against amounts payable to the Beneficiary under this Letter of Credit.
Any such charges shall be settled directly between the Applicant and the relevant bank and shall not affect payment to the Beneficiary.
13. Amendments and Cancellation
This Letter of Credit may not be amended or cancelled without the written consent of:
- Issuing Bank
- Confirming Bank
- Beneficiary
Any amendment or cancellation request not expressly accepted in writing by the Beneficiary shall be deemed rejected.
14. REIMBURSEMENT
The Issuing Bank shall reimburse the Confirming Bank immediately upon honoring under this Letter of Credit via SWIFT MT202 or equivalent reimbursement instructions.
Reimbursement obligations shall apply equally to amounts paid to a Second Beneficiary under a transferred Letter of Credit.
15. GOVERNING RULES
This Letter of Credit is independent of the underlying contract in accordance with UCP 600 Article 4.
16. SIGNATURES
This Letter of Credit is issued by the Issuing Bank and confirmed by the Confirming Bank in accordance with UCP 600