Letter of Credit
A Letter of Credit (LC) is a financial document issued by a bank or Financial Institution that guarantees payment to a seller on behalf of a buyer, provided that the seller meets specific conditions outlined in the letter. It serves as a secure payment mechanism in international trade, reducing the risk of non-payment.
There are several types of Letters of Credit, including:
- Revocable Letter of Credit: Can be amended or canceled by the buyer without the seller’s consent.
- Irrevocable Letter of Credit: Cannot be changed or canceled without the agreement of all parties involved.
- Confirmed Letter of Credit: A second bank guarantees payment, adding an extra layer of security for the seller.
Examples:
- A U.S. importer orders machinery from a supplier in Germany. The importer requests an irrevocable LC from their bank, which assures the supplier that payment will be made once the machinery is shipped and the required documents are submitted.
- A Canadian company sells goods to a buyer in Brazil. The Brazilian buyer arranges for a confirmed LC through a local bank, ensuring that the Canadian seller receives payment even if the buyer defaults.
In cases where the terms are not met, the bank may refuse payment, thereby protecting the interests of the buyer. Additionally, in the event of disputes or issues with quality or delivery, the seller’s obligations under the LC must still be fulfilled to receive payment.