A Letter of Credit (LC) is a document from a bank guaranteeing that a seller will receive payment in full as long as certain delivery conditions have been met. If the buyer cannot pay, the bank covers the cost.
The Mechanics of an LC
- Contract: Buyer and seller agree on terms and specify payment via LC.
- Issuance: The buyer applies to their bank (Issuing Bank) for an LC in favor of the seller.
- Advising: The Issuing Bank sends the LC to the seller's bank (Advising/Confirming Bank).
- Shipment: The seller ships the goods and gathers the required documents (Bill of Lading, Commercial Invoice, Packing List).
- Presentation: The seller presents the documents to their bank.
- Payment: If documents match the LC terms flawlessly, the bank releases payment.
Strict Compliance
Banks deal in documents, not goods. If the LC requires a "Bill of Lading showing 100 blue widgets," and the document says "100 azure widgets," the bank will reject it due to discrepancies. There is zero room for interpretation.