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When an importer arranges a Letter of Credit (LC), the exporter gains assurance of payment upon presenting compliant documents.
The issuing bank replaces the buyer’s credit with its own. It assumes payment responsibility once the LC terms are fully met.

How a Letter of Credit Operates

A typical documentary credit transaction involves five parties: importer, issuing bank, exporter, advising or confirming bank, and carrier.

The importer requests its bank to issue a letter of credit for the exporter.
The issuing bank creates the LC and sends it to the advising or confirming bank.
It guarantees payment once the exporter meets every condition.

The exporter ships the goods and submits the required documents—bill of lading, invoice, and packing list—to the advising or confirming bank.
That bank checks the documents for compliance and verifies their accuracy.

After confirming compliance, the advising bank pays the exporter.
It forwards the documents to the issuing bank and collects reimbursement from the importer after shipment proof.

The core principle is that banks deal in documents, not goods. Under Article 4 of UCP 600, the LC is independent from the underlying contract of sale. Therefore, precision in the drafting of documents is crucial, as even minor discrepancies can delay or prevent payment.

Why Precision in Drafting Is Critical

A letter of credit works effectively only when every document, date, and condition align perfectly. Even minor inconsistencies in the description of goods, shipping terms, or presentation deadlines cause banks to reject documents. Drafters often cause issues by entering wrong expiry dates or defining payment availability unclearly.
They also omit governing rules or describe bank responsibilities ambiguously.

Banks follow the rule of strict compliance under UCP 600.
Any deviation from LC terms cancels payment, even when the exporter ships goods correctly.

Updated Standards and Rule Considerations

Letters of Credit must specify the governing rule set and the rights of each party:

• UCP 600 remains the international standard for documentary credits, consisting of 39 articles governing issuance, presentation, and examination of documents.
• eUCP supplements UCP 600 for electronic records and presentations. It ensures that digital documents, such as electronic bills of lading, have equal legal force when properly incorporated.
• The independent nature of the LC means that any dispute under the sales contract cannot affect the bank’s obligation to pay.
• Banks have a maximum of five banking days after presentation to determine compliance and issue a notice of acceptance or refusal.
• Transferable credits, under Article 48, must state explicitly that they are transferable and name the bank authorised to execute the transfer.
• Standby Letters of Credit are generally governed by the International Standby Practices (ISP 98) rather than UCP 600, given their guarantee-like nature.

Types of Letters of Credit

Irrevocable and Revocable: Under modern practice, all credits are irrevocable unless stated otherwise. An irrevocable LC cannot be modified or cancelled without the consent of all parties.

• Confirmed and Unconfirmed: A confirmed LC adds the confirming bank’s independent undertaking to pay, providing the exporter dual security in case the issuing bank defaults.
• Transferable: Enables the exporter to transfer all or part of the LC to another beneficiary, often used by intermediaries or traders.
• Back-to-Back: Involves two linked credits—one from the importer to the intermediary, and another from the intermediary to the manufacturer—allowing middlemen to finance transactions without revealing their sources.
• Standby: Acts as a secondary guarantee of payment, ensuring the exporter is compensated if the importer fails to perform.
• Sight and Deferred Payment: Sight credits are payable immediately upon presentation; deferred payment credits allow payment at a future date, serving as a financing tool for the importer.
• Revolving: Allows multiple shipments under a single LC within a defined period, replenishing the credit amount automatically after each drawdown.
• Red Clause: Authorises pre-shipment advances to the exporter, enabling production financing before dispatch.

Common Omissions That Create Risk

An incomplete LC exposes traders to serious commercial losses. Common omissions arise when issuers fail to specify exact expiry and presentation periods, describe goods precisely, cite applicable rules, clarify insurance requirements, or provide clear instructions for transport documents and partial shipments.

Every LC must define the payment mechanism (sight, deferred, negotiation, or acceptance), name the nominated bank, and state which party covers banking charges. Drafters should also include jurisdiction, sanctions, and force majeure clauses, especially in cross-border transactions.

The Impact of Poor Drafting on Negotiation, Acceptance, and Payment

When the bank drafts the LC poorly, discrepancies arise easily. Exporters may face delayed payments or outright refusals because the documents, although genuine, fail to match the credit’s wording. Importers risk supply interruptions or higher costs due to amendment fees or shipment delays.

In complex arrangements—such as transferable or back-to-back credits—unclear language can break the chain of obligations, leaving one or more parties exposed to loss. A single clerical error can trigger disputes, arbitration, or litigation, undermining the purpose of using an LC in the first place.

Practical Guidance for Professionals

• Always ensure the LC mirrors the sales contract and logistical realities.
• Confirm that the LC explicitly states it is subject to UCP 600 and, where relevant, eUCP.
• Verify that all required documents are obtainable and correctly worded before shipment.
• Request prompt amendments for any mismatched clauses before goods are dispatched.
• Engage the advising or confirming bank early for document review and compliance checks.
• Keep a comprehensive checklist aligned with LC conditions, including invoices, transport documents, and insurance certificates.
• In digital trade environments, verify whether electronic documents and e-presentations are accepted.
• Maintain precise communication records regarding amendments, confirmations, and charge allocations.

Conclusion

A letter of credit provides one of the most secure instruments in international trade, but it delivers that security only when parties draft and follow it precisely. Mistakes in terms, omitted clauses, or inconsistent documentation weaken its validity and trigger disputes or financial losses. When traders apply UCP 600 and related standards, align credit terms with their commercial contracts, and maintain meticulous document accuracy, they turn letters of credit from complex paperwork into reliable tools of global trust and payment assurance.

Other useful articles:

• Common Mistakes in Drafting a Letter of Credit (MT700) – Part 1
  Explains the most frequent drafting and documentation errors made in MT700 issuance and how to prevent them.
• Everything About Letters of Credit – Key Rules, Structure, and Practice
  Comprehensive overview of LC types, operational processes, and compliance standards under UCP 600.

References:

1. International Chamber of Commerce – UCP 600: Uniform Customs and Practice for Documentary Credits
   The foundational international standard defines rules and practices governing letters of credit worldwide.
2. ICC eUCP – Supplement to UCP 600 for Electronic Presentation
   Clarifies rules for digital and paperless documentary credit presentations in global trade.
3. HFW – Client Guide to Letters of Credit (2018)
   Legal analysis of LC mechanisms, bank obligations, and dispute resolution under UCP 600 and eUCP frameworks.
4. Investopedia – Transferable and Back-to-Back Letters of Credit Explained
   Educational summary distinguishing transferable and back-to-back LCs with practical trade examples.