Letter of credit is a letter assuring a seller of issuing bank’s readiness to make payment to the seller in case their customer, a buyer defaults payment after order fulfilment. In my previous post, I discussed a few basic things you need to know about Letters of Credit. Our focus today will be on often used Letters of Credit in foreign business deals.
Types of Letter of Credit
There are at least eleven types of letters of Credit which include Confirmed LC, Unconfirmed LC, Revocable LC, Irrevocable LC, and Transferable LC. Others are Stand-by LC, Back-to-Back LC, Payment at Sight LC, Deferred Payment LC, Red Clause LC, and Green Clause LC.
Confirmed LC. One of the most commonly used letters of credit is confirmed Letter of Credit. This type of payment instrument requires confirmation by the buyer’s bank or any other reliable bank.
Furthermore, any bank saddled with the duty of confirming the LC is liable for performance of obligations. For instance, if Bank B confirms an LC issued by bank A, the former has to ensure the seller receives payment in due time.
Unconfirmed LC. Unlike Confirmed LC, an unconfirmed Letter of Credit does not transfer liability to any other but the issuing bank. Be that as it may, whichever one a seller accepts, he is sure of getting paid as and when due.
Revocable LC. A Revocable Letter of Credit usually puts the beneficiary at risk. This reason is that the buyer may choose to instruct his bank not to pay. Also, a Revocable LC is prone to needless change order and usually leaves the seller at the mercy of the buyer and his bank.
Irrevocable LC. An Irrevocable Letter of Credit is possibly the best LC every seller wants. It is most preferred because neither the buyer nor his bank can reverse the order once issued.
Also, it is a reliable LC because no one can alter it without the consent of the beneficiary. Furthermore, the issuing bank is liable to the holder provided he (seller) doesn’t breach any of its clauses.
Transferable LC. Sellers use transferable Letter of Credit when they need to assign payment to other payees. It is needful if the seller is not the sole supplier and other parties opt for transferable LC for payment. Also, it is useful in curbing issuing of multiple Letters of Credit on the same transaction.
Other Commonly Used Letters of Credit
Stand-by LC. A Stand-by-LC is a form of guarantee from the buyer’s bank to the seller. It implies that the issuing bank is ready to make payment in case their customer defaults.
Back-to-Back LC. Back-to-Back Letters of Credit occur when two dependent LCs are needed to complete a business transaction. However, one essential condition for Back-to-Back LC is that both LCs must share everything in common. In other words, all terms, inspection, shipping dates, and every extra detail must match each other.
Payment at Sight LC. Payment at Sight Letters of credit ensures immediate payment as soon as the seller submits all required documents. Typically, payment usually falls within seven days after receipt of the relevant papers. Who doesn’t want to get paid on time?
A Deferred Payment LC. A Deferred Payment Letters of Credit entails that the seller will have to wait a little longer even after submitting documents. In this case, a buyer can defer payment for goods to a later date and in most cases, till when he takes possession of goods.
Red Clause LC. Red Clause Letter of Credit opines that the sellers can request for an advance payment from the buyer before shipment of goods. The essence of the red clause that is usually in red prints is to draw attention to the advance payment term of the credit.
Green Clause LC. Green Clause LC shares the same features with red clause LC. Additionally, it enables a seller to receive advance payments for warehouse and insurance at the port of shipment provided they can provide receipts to back it up.
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Don’t forget to trade safely.