If you’ve used one before, you know that a Letter of Credit (LC) is a great way to secure the payment and release of goods on your international shipments. For those who haven’t used one before, a Letter of Credit is a contractual commitment by a bank to ensure that full payment is received and all goods are shipped in the transaction between a buyer and seller. An LC is similar to a cash against documents (CAD) arrangement except that it is managed by the bank. Letter of Credit terms are useful as an extra security measure when a shipper and buyer have not worked together in the past, are in different countries, and customs laws differ at each location.
A Letter of Credit, consigned to and issued by the buyer’s bank gives the bank control over the payment for the goods. The bank will not release payment for the goods until the seller has given over all shipping documents indicating the validity of the shipment. The typical process for issuing a Letter of Credit is as follows:
After Letter of Credit (LC) is agreed upon as the payment method, the buyer will request an LC from his bank. The bank will first ensure that the buyer will be capable of making payment for the goods, and once confirmed, will create and issue the Letter of Credit to the seller. Both the seller and buyer can review the LC to ensure that all terms stated match those terms originally agreed upon. The seller will then ship the goods and present all requested documents to the buyer’s bank who, when all documents are confirmed, will release payment for the goods to the seller. In other words, the LC serves as a cash-against-documents contract, but with the bank in charge of the payment receiving and document releases.
Typical documents which may be required to be presented per the terms on the LC could be: