Key Takeaways

• A Letter of Credit (L/C) is an international payment instrument in which banks play a role according to the terms and documents specified in the L/C.
• Banks examine “documents”; they do not inspect the actual condition or quality of the goods. Therefore, documents must comply with the L/C terms in detail.
• Under UCP 600, a Documentary Credit is irrevocable. As a result, the old distinction between Revocable and Irrevocable L/Cs should not be used as the primary classification today.
• Sight L/Cs and Usance / Deferred Payment L/Cs differ in the timing of payment.
• Exporters should review the Draft L/C before shipment because impractical conditions can lead to discrepancies and affect payment.

International trade involves more risk than domestic trade because the Buyer and Seller may be located in different countries, may never have done business together, and must move goods, documents, and money across borders.

This raises an important question:

How can the Seller be confident that they will receive payment after shipping the goods?

And from the other side:

How can the Buyer be confident that the Seller will fulfill the agreed terms after payment is made?

One instrument used to manage these risks is a Letter of Credit (L/C).

However, an L/C is not simply a matter of “having the bank act as an intermediary.” The process places significant emphasis on documents and terms. If the documents do not comply, payment can become problematic even if the goods have actually been shipped.

What Is a Letter of Credit (L/C)?

A Letter of Credit, also known as a Documentary Credit, is an arrangement under which the issuing bank undertakes to pay the beneficiary when documents complying with the L/C terms are presented.

In simple terms:

Importer asks the bank to issue an L/C → Exporter ships the goods and presents the documents → Bank examines the documents → If they comply with the terms, payment proceeds according to the L/C

The key point is:

The bank examines the documents, not the actual goods.

Therefore, an L/C does not mean that the bank guarantees that:

• The goods are of good quality
• The goods are the correct color
• The machinery works
• The actual quantity inside the boxes is complete

Instead, the bank considers the documents presented in accordance with the L/C terms.

Why Is an L/C Important in International Trade?

When a Buyer and Seller do not yet have a strong business relationship, each party may have different concerns.

Risks for the Exporter

The Exporter may be concerned that:

• The Buyer may cancel after production
• The goods may be shipped but payment never received
• The Buyer may pay late
• The Buyer may have credit problems

Risks for the Importer

The Importer may be concerned that:

• The Supplier may not ship the goods after receiving an advance payment
• The Supplier may miss the deadline
• The documents may not be ready
• The shipment may not comply with the terms of sale

An L/C therefore brings a bank into the payment structure to increase confidence by specifying the terms and documents required to claim payment.

An L/C Is Not a Sales Contract

This point is very important.

An L/C is a transaction separate from the Sales Contract.

Although an L/C arises from a sale of goods, the bank examines the terms of the Credit and the documents presented. It does not directly adjudicate disputes about the quality of the goods.

Businesses should therefore establish the following separately and clearly:

• Purchase Order
• Sales Contract
• Product Specification
• Quality Requirement
• Incoterms
• Delivery Term
• Warranty

An L/C cannot fully replace a Commercial Contract.

Who Is Involved in a Letter of Credit?

An L/C transaction may involve several parties. The main roles include:

1. Applicant

The Applicant is the party that requests the issuance of the L/C.

This is generally the Importer or Buyer.

The Applicant submits an application to its bank to issue a Letter of Credit under the agreed terms of sale.

2. Beneficiary

The Beneficiary is the party entitled to receive payment under the L/C.

This is generally the Exporter or Seller.

The Exporter must perform the required actions and prepare documents that comply with the terms before presenting them to claim payment.

3. Issuing Bank

The Issuing Bank is the bank that issues the L/C at the Applicant’s request.

It has obligations under the terms of the Credit when it receives a Complying Presentation.

4. Advising Bank

The Advising Bank is the bank that advises the Beneficiary of the L/C and authenticates the Credit through the applicable banking process.

This does not necessarily mean that the Advising Bank also undertakes to make payment.

5. Confirming Bank

Some transactions may also involve a Confirming Bank.

This bank adds its own undertaking to honor the Credit, provided the presentation complies with its terms.

A Confirmed L/C can be useful when the Exporter wants additional protection against Issuing Bank Risk or Country Risk.

However, it involves additional fees under the bank’s terms.

What Are the Steps in an L/C Transaction?

The overall process can be divided into the following steps.

Step 1: Buyer and Seller Agree on the Sale

Both parties agree on:

• Product
• Quantity
• Price
• Currency
• Incoterms
• Shipment Date
• Payment Term
• Documents

They also specify that an L/C will be used as the payment method.

Step 2: Importer Requests the L/C

The Importer, or Applicant, submits an application to the Issuing Bank.

The application specifies information such as:

• Beneficiary
• L/C Amount
• Currency
• Expiry Date
• Latest Shipment Date
• Port / Airport
• Incoterms
• Required Documents
• Payment Term

Step 3: The L/C Is Sent to the Exporter’s Bank

The Issuing Bank sends the Credit through banking channels to the Advising Bank.

The Advising Bank then notifies the Exporter of the details.

Step 4: Exporter Reviews the L/C Terms

Before production or shipment, the Exporter should review every clause.

If any requirement cannot be met, the Exporter should request an Amendment before shipping the goods.

Step 5: Exporter Ships the Goods

Once the terms can be met, the Exporter proceeds with:

• Booking
• Export Customs Clearance
• Shipment
• Preparation of Shipping Documents

Step 6: Exporter Presents the Documents to the Bank

The documents are checked against the terms of the L/C.

Step 7: The Bank Examines the Documents

If the documents comply with the terms, the process moves to Honor / Negotiation / Payment, depending on the Credit structure.

If errors are found, a Discrepancy may arise.

What Documents Are Commonly Used with an L/C?

The required documents depend on the terms of each L/C. Common examples include:

• Commercial Invoice
• Packing List
• Bill of Lading
• Air Waybill
• Certificate of Origin
• Insurance Document
• Inspection Certificate
• Weight Certificate
• Quality Certificate
• Beneficiary Certificate
• Other documents specified in the L/C

Not every L/C requires all of these documents.

The important thing is to use the Document List specified in the actual L/C.

How Must the Commercial Invoice Match the L/C?

The Invoice is one of the key documents.

Check details such as:

• Beneficiary
• Applicant
• Invoice Amount
• Currency
• Product Description
• Quantity
• Incoterms
• Required References

Do not assume that small differences between documents are acceptable.

A Documentary Credit requires careful examination of document consistency.

Before issuing the Final Invoice, compare it with the L/C again.

Why Is the Bill of Lading Important for an L/C?

For Sea Freight, if the L/C requires a Bill of Lading, the document must be prepared in accordance with the relevant terms.

Examples of information that may be relevant include:

• Shipper
• Consignee
• Notify Party
• Port of Loading
• Port of Discharge
• On Board Date
• Freight Term
• Number of Originals
• Cargo Description

If the L/C specifies B/L requirements before shipment, ask the Freight Forwarder to review the relevant requirements as well.

Once the Original B/L has been issued, amendments may involve additional steps and costs.

Can an Air Waybill Be Used with an L/C?

Yes, if the shipment is by air and the L/C requires an Air Transport Document.

However, an Air Waybill differs from an Ocean Bill of Lading in several ways.

B/L requirements should therefore not automatically be applied to an AWB.

Before sending Air Freight, check what the L/C says about:

• Airport of Departure
• Airport of Destination
• Consignee
• Freight Term
• Shipment Date

Suggested Internal Link: What Types of Goods Are Suitable for Air Freight? What Should You Know Before Shipping?

How Is a Certificate of Origin Related to an L/C?

If the L/C requires a Certificate of Origin, the Exporter must prepare the C/O in accordance with the stated requirements.

However, distinguish between:

Documents required by the L/C

and

Documents used to claim preferential tariff treatment

For example, if the Importer needs Form D or Form E to claim a Preferential Tariff, the required document format should be specified and agreed upon before the L/C is issued.

Suggested Internal Link: What Is a Certificate of Origin? Types of C/O and Required Documents

Suggested Internal Link: What Are Form A, Form D, and Form E? How to Claim Import–Export Tariff Preferences

What Is UCP 600?

UCP 600, or the Uniform Customs and Practice for Documentary Credits, is a set of international rules for Documentary Credits issued by the International Chamber of Commerce (ICC).

Many L/Cs used in international trade state that they are subject to UCP 600.

One important point is that, under UCP 600, a Credit is Irrevocable, even if the word “Irrevocable” is not explicitly stated.

Therefore, the old classification of L/Cs into:

• Revocable L/C
• Irrevocable L/C

should not be used as the main framework for explaining Documentary Credits today.

Businesses should focus more on the Credit’s payment terms and structure.

Can an L/C Be Cancelled or Amended?

An L/C can be amended, but the Applicant generally cannot change its terms at will after the Credit has been issued.

Any amendment must follow the applicable process and be accepted by the relevant parties as required.

The Buyer should therefore review the draft before issuance, and the Seller should review the L/C immediately upon receipt.

If any of the following are incorrect or impractical:

• Latest Shipment Date is too soon
• Product Description is incorrect
• Document Requirements cannot be met
• Port is incorrect
• Amount is incorrect
• Incoterms do not match

the terms should be amended before shipping.

What Is a Sight L/C?

A Sight L/C is a Credit that provides for payment when documents complying with its terms are presented and examined through the applicable process.

It is suitable for Sellers who want to receive payment sooner than under a Credit that specifies payment at a future date.

However, “Sight” does not mean:

Present the documents today and receive the money instantly.

The process may still involve:

• Document Examination
• Banking Process
• Courier / Electronic Transmission
• Settlement

What Is a Usance L/C or Deferred Payment L/C?

This type of Credit specifies that payment will be made in the future after an agreed period.

Examples include:

• 30 Days
• 60 Days
• 90 Days

The period may be calculated from:

• B/L Date
• Invoice Date
• Sight
• Another date specified in the Credit

The terms must therefore be reviewed carefully.

Usance or Deferred Payment gives the Importer additional credit time, but the Exporter must consider its own cash flow.

What Is the Difference Between a Sight L/C and a Usance L/C?

The main difference is when the Seller receives payment.

Sight L/C

Suitable when the Seller wants payment promptly after presenting Complying Documents and completing the applicable process.

Usance / Deferred Payment L/C

The Buyer receives a credit period before payment, according to the specified terms.

The choice should take into account:

• Working Capital
• Bargaining Power
• Relationship
• Credit Risk
• Bank Cost
• Product Lead Time

What Is a Confirmed L/C?

A Confirmed L/C is a Credit to which another bank adds its confirmation in addition to the Issuing Bank’s undertaking.

It may be appropriate when the Seller is concerned about:

• Issuing Bank Risk
• Country Risk
• Political Risk
• Transfer Risk

However, confirmation is not free.

Fees and conditions must be agreed upon with the bank.

What Is a Transferable L/C?

A Transferable L/C allows the first Beneficiary to transfer rights under the Credit to a second Beneficiary, subject to the specified terms.

It is often relevant to certain trading or intermediary business models.

An L/C can be transferred only if it is designated Transferable.

Do not assume that every L/C can be transferred.

Is a Standby Letter of Credit the Same as a Regular Trade L/C?

Not entirely.

A Standby Letter of Credit (SBLC) often functions as a supporting instrument in case a party fails to perform an obligation or make a payment as agreed.

A regular Documentary Credit, by contrast, is designed to serve as a payment mechanism in an ordinary transaction.

The two terms should not be used interchangeably.

What Is a Discrepancy?

A Discrepancy is an inconsistency between the documents presented and the L/C terms or applicable rules.

For example:

The L/C specifies the Latest Shipment Date as:

30 November

But the B/L shows an On Board Date of:

1 December

Or the L/C specifies:

100 Cartons

while the Commercial Invoice shows:

110 Cartons

These cases may cause the documents to be considered discrepant.

What Are Common L/C Discrepancies?

Examples to watch out for include:

• Shipment after the Latest Shipment Date
• Documents presented after the Presentation Period
• Invoice Amount does not match
• Product Description is inconsistent
• Incorrect Quantity
• Incorrect Port
• Incorrect Consignee
• B/L Date does not comply with the terms
• Insufficient Insurance Coverage
• Missing Certificate
• Conflicting information across documents
• Incorrect spelling or other key information

Therefore, an L/C shipment requires documentation planning before Booking.

If There Is a Discrepancy, Will Payment Be Refused Completely?

Not necessarily in every case, but a discrepancy increases risk and complexity.

Possible outcomes include:

• The bank notifies the parties of the Discrepancy
• A Waiver is requested from the Applicant
• A Discrepancy Fee is charged
• Payment is delayed
• The Buyer refuses to accept the documents

The Exporter should aim for a Clean Presentation, rather than submitting incorrect documents and hoping the Buyer will waive the discrepancies later.

Why Should Exporters Review the Draft L/C Before Shipment?

Some requirements may be impossible to meet from the outset.

For example, an L/C may require:

• A Certificate that no relevant authority issues
• Freight Document wording that the Carrier cannot include
• A Shipment Date earlier than the production lead time allows
• A Port with no available service
• A Product Description that does not match the actual Invoice

If these issues are identified before shipment, an Amendment can still be requested.

Once the goods have been shipped, making changes can become much more difficult.

Should the Freight Forwarder See the L/C?

If the L/C contains requirements related to Transport Documents, the relevant requirements should be shared with the Freight Forwarder before Booking and before the documents are issued.

Pay particular attention to:

• Shipper
• Consignee
• Notify Party
• Port / Airport
• Freight Prepaid / Collect
• On Board Date
• Number of Originals
• Transshipment
• Partial Shipment
• Transport Document wording

The Forwarder does not need to interpret every banking condition, but the requirements related to Shipping Documents should be checked for consistency.

What Is Partial Shipment?

Partial Shipment means dividing an order or L/C shipment into more than one shipment.

For example, an order for 1,000 units could be shipped as:

• Shipment 1 = 500 Units
• Shipment 2 = 500 Units

Whether this is permitted depends on the terms of the Credit.

If the production plan requires split shipments, Partial Shipment should be checked before the L/C is issued.

What Is Transshipment, and Why Must It Be Specified in an L/C?

Transshipment means transferring cargo from one conveyance to another during a route.

Transshipment is common on many international shipping routes.

If the L/C contains conditions concerning Transshipment, the Logistics Team should check whether the planned route and booking can comply.

Do not issue an L/C with terms that conflict with actual shipping operations.

How Are L/Cs Related to Incoterms?

An L/C is a payment method.

Incoterms define the responsibilities of the Seller and Buyer regarding:

• Transportation
• Costs
• Risk
• Export / Import Clearance, as specified by the applicable rule
• Insurance under certain rules

The two are connected, but they are not the same thing.

For example, under:

CIF

the Seller has obligations relating to Freight and Insurance under the applicable Incoterms rule.

The L/C may therefore require an Insurance Document for the transaction.

If the chosen Incoterm does not align with the required documents, operational problems may arise.

How Does an L/C Work with Sea Freight?

Sea Freight is a mode of transport in which Documentary Credits are commonly used, particularly for high-value commercial shipments.

The Transport Document commonly used is the Bill of Lading.

Before shipment, check the following against the L/C:

• Container / Cargo Ready Date
• Cut-off
• Vessel
• ETD
• Port
• On Board Date
• B/L Requirement

Missing a vessel by just one sailing can cause the On Board Date to fall after the Latest Shipment Date.

Can an L/C Be Used for Air Freight?

Yes.

If the Buyer and Seller agree to use an L/C for an air shipment, the Credit can specify an Air Waybill and related documents.

This may be suitable for goods such as:

• High-value Cargo
• Urgent Commercial Shipment
• Machinery Parts
• Electronic Components

However, the Flight Schedule and Document Requirements must be checked for consistency, just as they are for Sea Freight.

Does an L/C Eliminate All Risks for the Exporter?

No.

An L/C helps manage certain payment risks, but other risks remain, including:

• Documentary Risk
• Bank Risk
• Country Risk
• Currency Risk
• Fraud
• Quality Dispute
• Logistics Delay
• Political Risk

Exporters should also assess the Counterparty and the overall transaction.

Does an L/C Eliminate All Risks for the Importer?

No.

The bank examines documents; it does not open the container to inspect the actual goods.

Importers should therefore still use measures such as:

• Supplier Verification
• Sample Approval
• Product Specification
• Inspection
• Quality Control
• Contract
• Insurance

as appropriate.

Opening an L/C does not remove the need to verify the Supplier.

What Is the Difference Between an L/C and T/T?

T/T, or Telegraphic Transfer, is a transfer of funds through the banking system.

Common payment arrangements include:

• 100% Advance
• Deposit + Balance
• Payment Before Shipment
• Payment After Shipment

T/T involves a simpler process than an L/C in many cases, but the level of risk depends on the payment terms.

An L/C involves more banking structure and documentation, and therefore generally has:

• More steps
• Higher costs
• More detailed document requirements

However, it may be suitable for transactions where trading partners want to reduce payment risk.

What Is the Difference Between an L/C, D/P, and D/A?

These are Trade Finance payment methods with different structures.

L/C

The bank has an undertaking under the terms of the Credit.

D/P – Documents against Payment

The Buyer receives the documents after making payment under the Collection Process.

D/A – Documents against Acceptance

The Buyer receives the documents after accepting an obligation to pay in the future according to the agreed term.

Their risk levels and costs differ.

Businesses should choose a method based on:

• Relationship with the Counterparty
• Transaction Value
• Creditworthiness
• Cash Flow
• Country Risk

What Fees Are Involved in Opening an L/C?

Fees vary by bank, country, currency, and transaction.

Possible charges include:

• L/C Issuance Fee
• Advising Fee
• Amendment Fee
• Confirmation Fee
• Negotiation / Handling Fee
• Discrepancy Fee
• SWIFT Charge
• Document-related Charge

Before agreeing on a price, the Buyer and Seller should clearly specify which party is responsible for each bank charge.

Banking fees can affect the transaction margin.

Who Should Pay the L/C Fees?

This depends on the Commercial Agreement.

There is no single answer for every transaction.

Responsibility should be clearly specified in the:

• Sales Contract
• Purchase Order
• L/C Application

Clarify who is responsible for:

• Charges in the Buyer’s country
• Charges outside the Buyer’s country
• Confirmation Charge
• Amendment Fee

This helps prevent disputes later.

Checklist for Importers Before Opening an L/C

Importers should check:

• Is the Supplier correct?
• Sales Contract
• Product
• Quantity
• Price
• Currency
• Incoterms
• Latest Shipment Date
• Expiry Date
• Port / Airport
• Partial Shipment
• Transshipment
• Required Documents
• Payment Term
• Sight or Usance
• Banking Charges
• Import Permit
• HS Code
• FTA / C/O Requirement

If the Logistics details have not yet been confirmed, avoid putting rigid shipping conditions into the L/C that may be difficult to amend.

Checklist for Exporters Upon Receiving an L/C

Before shipment, check:

• Beneficiary name is correct
• Amount is correct
• Currency is correct
• Product Description can be met
• Quantity is correct
• Incoterms match the Sales Contract
• Latest Shipment Date allows sufficient time
• Expiry Date allows sufficient time
• Presentation Period is achievable
• Port / Airport is correct
• Partial Shipment
• Transshipment
• Commercial Invoice Requirement
• Packing List Requirement
• Transport Document Requirement
• C/O Requirement
• Insurance Requirement
• Other Certificates can actually be obtained
• Bank Charges
• Payment Term

If any requirement cannot be met, request an Amendment before production or shipment.

Frequently Asked Questions About Letters of Credit (FAQ)

What Is a Letter of Credit (L/C)?

An L/C is a Documentary Credit under which a bank undertakes to pay the Beneficiary when documents complying with the Credit terms are presented.

If There Is an L/C, Is the Exporter Guaranteed to Receive Payment?

The Exporter must present documents that comply with the L/C terms. Discrepancies may cause delays or create payment risk.

Does the Bank Inspect the Actual Goods?

In principle, the bank deals with documents rather than inspecting the actual condition or quality of the goods. A separate Contract and Quality Control process are still needed.

What Is the Difference Between a Sight L/C and a Usance L/C?

A Sight L/C focuses on payment after compliant documents have been presented and processed. A Usance / Deferred Payment L/C specifies a future payment date or period under the stated terms.

Is Every L/C Irrevocable?

Under UCP 600, a Credit is considered Irrevocable even if this is not explicitly stated. Amendments or cancellation must follow the applicable process and conditions.

Does the Freight Forwarder Need to Know the L/C Terms?

The Forwarder should receive information relevant to the Transport Document and shipment, such as the Port, Consignee, Shipment Date, Freight Term, and B/L or AWB requirements, before the documents are issued.

International Shipping and Import–Export Documentation Services with CPL INTER

CPL INTER provides international freight services by air, sea, and road, along with Packing, Shipping Documents, and Customs Clearance services according to the scope of each shipment.

For shipments using a Letter of Credit, Exporters should communicate logistics and Transport Document requirements before Booking. In particular, they should clarify the Latest Shipment Date, Port / Airport, Consignee, Freight Term, and Required Shipping Documents to help reduce the risk of shipping information conflicting with the L/C terms.

The issuance of an L/C, examination of documents for payment, and Trade Finance conditions should be confirmed directly with the relevant bank before the transaction proceeds.

Tel: 02-519-4426 / 091-519-4426
LINE: @cplinter

Written by: CPL Inter Logistics Operations Team, specialists in international freight and customs clearance, with more than 15 years of experience and an ISO 9001:2015-certified quality management system.