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.