Letters of Credit

Letters of Credit in International Sales Transactions Letters of Credit

A letter of credit is a banking device which allows buyers to offer secure terms to sellers. Letters of credit are particularly useful when the buyer (importer) and the seller (exporter) are located in different countries. Letters of credit benefit the seller because they protect against a buyer who is of unknown creditworthiness or if the buyer is located in a country where economic conditions may hamper payment.

Specifically, a letter of credit is a promise to pay made by a bank (issuing bank) on behalf of a buyer (applicant) to pay a seller (beneficianry) a given amount of money. Normally the issuing bank promises to pay the seller upon presentation of specific documents representing the supply of goods such as invoices, bills of lading or other transport documents.

Exporters use letters of credit to be assured that they will recieve payment propmptly from the buyer's bank upon reciept by that bank of documents in compliaince with the terms of the letter of credit. Importers use letters of credit to assure themselves that payment will be made to the seller only if the terms and conditions of the letter of credit are satisfied, which terms should include that the goods or services conform to that of the purchase and sales contract.

Note that the letter of credit does not protect against trade disputes unless the document is well written. The issuing bank's responsibility is to comply with the terms of the letter of credit and pay if the documents presented are in order, not to examine the goods provided. Conversely, if the documents which are presented do not conform to the letter of credit, payment will be rejected even if the goods or services provided are in perfect order. Therefore, the letter of credit should match the sales contract or contain other safegaurds to ensure that the goods conform to the contract and that payment is made in a timely fashion.