Letter of Credit (LC)

A letter of credit (LC or L/C) is an irrevocable undertaking by the buyer's bank to pay the seller a stated amount when the seller presents documents that comply with the credit's terms. In shipping, an "LC shipment" is cargo sold on those terms, so the bill of lading, invoice, packing list and certificate of origin have to match the credit exactly before the bank will pay.

The parties

• Applicant: the buyer, on whose request the credit is issued
• Beneficiary: the seller, in whose favor it is issued
• Issuing bank: the buyer's bank, which gives the payment undertaking
• Advising bank: a bank in the seller's country that authenticates the credit and passes it on
• Confirming bank: a bank that adds its own undertaking to the issuing bank's, at the issuing bank's request
• Nominated bank: the bank authorized to examine the documents and pay, accept or negotiate

Types of letter of credit

• Irrevocable: under UCP 600 a credit is irrevocable even if it does not say so, and cannot be amended or canceled without the beneficiary's agreement
• Confirmed: a second bank, usually in the seller's country, adds its own guarantee to cover issuing-bank and country risk; unconfirmed credits rely on the issuing bank alone
• Sight: pays on presentation of complying documents. Usance (deferred payment or acceptance): pays a fixed number of days after shipment or presentation, giving the buyer credit
• Standby: a secondary means of payment, drawn only if the buyer fails to pay under the contract
• Transferable: the beneficiary, typically a trading house, can transfer all or part of the credit to its own supplier
• Back-to-back: a second, separate credit issued to the supplier against the security of the first, used when the first is not transferable

The documents the bank checks

UCP 600, the ICC rules that govern most credits, give each bank a maximum of five banking days after presentation to decide whether the documents comply, judged on the documents alone.

The usual set is the transport document (ocean bill of lading or air waybill), the commercial invoice, the packing list, a certificate of origin and, on CIF or CIP sales, the insurance document.

Documents must be presented within 21 calendar days of the shipment date and before the credit expires, unless the credit sets a shorter period. The credit's latest shipment date is the last date the bill of lading may show as shipped on board; ship after it and the presentation is discrepant.

Why documents get rejected, and how a forwarder's bill fits

ICC surveys have repeatedly found that most first presentations are refused for discrepancies, with transport documents the most common cause:

• a bill dated after the latest shipment date
• a goods description that does not match the invoice and the credit
• a missing on-board notation
• a port name spelled differently

UCP 600 article 20 requires the bill of lading to name the carrier and be signed by the carrier, the master or a named agent for one of them. A house bill of lading issued by an NVOCC in its own name as carrier meets that test unless the credit excludes forwarder bills, so confirm at booking which bill the credit calls for.

What drives the cost

Banks charge for issuance, advising, confirmation, amendments, examination and discrepancies, and the issuing bank ties up the applicant's credit line for the amount. Confirmation costs more where the issuing bank or its country carries risk, usance credits carry discounting or interest, and every amendment or discrepancy adds a fee and days. Agreeing the credit's wording to your shipping documents before it is issued is where the savings are.

LC versus open account, collection and advance payment

Cash in advance is the safest method for the seller and the riskiest for the buyer; open account is the reverse, with payment typically due 30, 60 or 90 days after shipment. A documentary collection sits between them: the seller's bank forwards the documents through the buyer's bank against payment or acceptance of a draft, but no bank guarantees payment. A letter of credit is the one method in which a bank commits to pay, which is why it is used for new relationships, higher-value orders and markets where the buyer's credit is hard to assess.

Shipping under an LC with Airlift

Share the credit with us at booking. Airlift is an FMC-licensed NVOCC and issues its own house bills on the ocean freight it books; we draft the shipper, consignee, notify party, ports, goods description and on-board date to the credit's wording and send you the draft to check before it is released, so the presentation goes in clean and inside the latest shipment date. Air freight air waybills are prepared the same way, and the Incoterms tool shows which party has to produce the insurance document on each term.