In order to help with understanding the common types of Letters of Credit (L/Cs), we have put together this brief guide on the types of letters of credit. (If you’re new to L/Cs, you can also find our Beginner’s Guide here). The following details the main types of letters of credit, with a short explanation of the features and uses associated with each type;
Irrevocable
All L/Cs are irrevocable. This means that once the Letter of Credit is established by the opening bank, it cannot be cancelled. Unless that is, by written agreement of both the Applicant and the Beneficiary.
Unconfirmed
With unconfirmed Letters of Credit, the payment undertaking (guarantee of payment against a compliant presentation of documents) is given by the opening bank in the foreign country. If the standing of the opening bank is not known, this may represent a payment risk to the Beneficiary. It also means that the payment period is likely to be longer. This is because the proceeds will not usually be paid until the opening bank has received and checked the documents.
Confirmed
With a confirmed L/C, the payment undertaking moves to the confirming bank in the exporter’s country. This means it will often be confirmed by the exporter’s own bank or another reputable bank. Therefore, there is no payment risk to the exporter, providing the documents fully comply of course. Payment is made once the documents have been received and checked by the confirming bank. Payment is also made much more quickly.
Sight Payment
With a sight payment L/C, payment is made as soon as the documents have been checked (seen) by the bank giving the payment undertaking. This would be either the opening bank for an unconfirmed L/C or the confirming bank for a confirmed L/C. Payment is normally made within a few days under confirmed Letters of Credit. For an unconfirmed L/C, this might take two to three weeks. The speed of payment will also depend upon the reimbursing arrangements contained in the terms of the L/C.
Deferred Payment
A deferred payment L/C (also known as a usance L/C) is payable at a future date as opposed to at sight. The deferred payment or usance period will be specified within the terms of the Letter of Credit. For example, something like sixty days from date of shipment. A deferred payment L/C would be used if credit terms have been agreed in the associated sales contract.
Red Clause
This type of Letter of Credit contains the facility to claim payment in advance of the shipment of goods.
Revolving
A revolving L/C is used where the buyer (L/C Applicant) and the seller (L/C Beneficiary) have a long-term, multiple shipment sales contract in place. Instead of opening an individual L/C for each shipment, the Applicant opens a revolving L/C to cover multiple shipments. After each shipment and payment claim, the L/C revolves (renews) ready for the next shipment and claim. The L/C can revolve based upon value or time. The basis for renewal would be specified in the terms and conditions of the Letter of Credit.
Transferable
A transferable L/C is used in cases where there are three parties involved in a transaction. These are typically the buyer (importer), an intermediary party (agent, broker etc) and the supplier or manufacturer of the goods. The buyer would open a transferable L/C which facilitates payment to two beneficiaries – the intermediary and the supplier/manufacturer. The intermediary is the first beneficiary and the supplier is the second beneficiary. Once the goods have been shipped, the documents are presented for payment. The transferring bank makes payment to the first beneficiary and transfers an agreed amount to the second beneficiary. The process of setting up and managing transferable Letters of Credit is potentially complex. Care needs to be taken, particularly to ensure that details of the transaction are not inadvertently disclosed to the wrong party.
Back to Back
Back to back L/Cs are also used in transactions involving three parties, as transferable L/Cs are. However, instead of one transferable L/C facilitating payment to two beneficiaries, separate back to back L/Cs are used. This way, it keeps the ultimate buyer and seller involved in the sale separate.
Standby
Standby Letters of Credit are a backup payment instrument. The buyer and seller may agree on a sales contract whereby the buyer pays the seller on open account terms. The seller may, however, request the buyer to establish a standby L/C in their favour. If the buyer defaults on a payment, the seller has the security of claiming payment via the standby L/C.
With well over thirty years of international trade experience, we have a wealth of knowledge and experience of handling all types of L/Cs. These have covered a diverse range of commodities to many global export markets. Get in touch to take advantage of our Letter of Credit service. Receive expert help with setting up or managing the different types of L/C. We can make sure the L/C process runs smoothly and efficiently for you!