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When export and import transactions demand early financing, two special variations of the standard Letter of Credit (LC) come into play: the Red Clause and Green Clause LCs. Both allow the exporter to receive an advance before shipment, but they differ in the amount of advance permitted, the form of security required, and the allocation of risk among the parties. Understanding these differences is essential for drafting accurate LCs that balance liquidity and protection.

What Are Red Clause and Green Clause Letters of Credit

A Red Clause LC authorises the issuing or nominated bank to advance funds to the exporter before shipment. The clause historically appeared in red ink on the LC, hence its name. The advance is usually a percentage of the LC amount and enables the exporter to purchase raw materials, begin manufacturing, or cover pre-shipment expenses. The exporter’s undertaking to ship the goods and deduct the advance from the final payment serves as assurance to the bank.

A Green Clause LC extends this concept. It provides a higher advance amount, usually secured by warehouse receipts, insurance certificates, or proof that the goods have already been stored at an approved location. This offers stronger protection to the importer and the bank, while giving the exporter a larger pre-shipment credit line.

How They Work

Under both mechanisms, the importer requests that the LC include the respective clause. Once the LC is issued, the exporter may request the advance by presenting the specified documents. The bank disburses the advance and records it against the total LC value. When the goods are shipped, the exporter presents the complete set of shipping documents—such as the bill of lading, invoice, and packing list—and the final payment is made after deducting the advance previously taken.

In a Red Clause LC, only a simple receipt or written undertaking may be required. In a Green Clause LC, the exporter must produce warehouse receipts and proof of insurance showing that the goods are stored and insured for the benefit of the bank. The green clause thereby adds a collateral element, making the credit safer for the bank and importer.

Comparative Overview

Drafting Considerations

When including a red or green clause in an LC, accuracy of wording is crucial. Each clause should clearly state:

• The percentage or amount of advance allowed.
• The documents required before the advance (undertaking, warehouse receipts, insurance).
• The deduction mechanism from the final payment.
• The security interest in stored goods and warehouse verification procedures.
• The expiry date, shipment deadline, and presentation period aligned with production and transport schedules.
• Whether the LC is subject to UCP 600, and if any deviations apply.
• Allocation of charges and fees between the importer and the exporter.
• Default provisions for non-shipment or warehouse discrepancies.

A sample clause might read:
“The beneficiary is authorised to draw up to [percentage]% of this credit before shipment upon presentation of an undertaking to ship the goods as per the contract. Any amount advanced shall be deducted from the final payment under this credit upon presentation of compliant shipping documents.”
For a green clause, the clause would add references to warehouse receipts, insurance certificates, and verification conditions.

Risk and Compliance Factors

Banks must exercise caution in assessing the credibility of exporters and the authenticity of warehouse documentation. Since UCP 600 does not specifically regulate red or green clauses, these provisions rely heavily on mutual agreement and local banking practice. To mitigate exposure, issuing banks often require the importer to provide collateral or reimbursement guarantees. In high-risk jurisdictions, standby LCs or performance guarantees may be used as substitutes.

Additionally, because pre-shipment financing may fall under export-credit and anti-money-laundering regulations, all parties must comply with applicable KYC, sanctions, and export-control laws. Name the issuing bank as the loss payee in the insurance coverage, and ensure licensed warehouses allow independent inspection for verification.

Practical Applications

Red and green clauses are most common in industries where production or storage precedes shipment, such as:

• Commodity trading (grain, metals, and minerals).
• Textile and manufacturing sectors require raw material procurement.
• Construction-equipment supply chains with staged fabrication and delivery.
• Agricultural exports require storage at port silos before shipment.

In these cases, the clauses balance the exporter’s need for liquidity with the importer’s need for assurance that funds are protected.

Major Advantages and Drawbacks

For Exporters:

• Immediate working capital and smoother production.
• Ability to fulfil larger orders without external borrowing.
• Potential for better terms due to the buyer’s advance support.

For Importers and Banks:

• Stronger supplier relationships and faster delivery schedules.
• Risk of non-shipment or loss of funds if documents are falsified.
• Increased administrative burden in verifying compliance.

Conclusion

Both the red clause and the green clause add flexibility to traditional letters of credit. The red clause prioritises speed and simplicity, offering early advances based largely on trust. The green clause prioritises security, requiring collateral documentation but providing larger financing.

For modern trade and project-based supply chains, choosing between them depends on the balance of trust, liquidity, and control. Drafting must ensure unambiguous terms, compliance with UCP 600, and integration with the sale contract to safeguard all parties. In expert hands, these clauses remain powerful instruments for linking finance and trade execution.

References

1. Contract Directory – UCP 600: Uniform Customs and Practice for Documentary Credits
2. Investopedia – Red Clause Letter of Credit: Definition and Process
3. Drip Capital – Red Clause and Green Clause Letters of Credit Explained
4. EFinance Management – Green Clause Letter of Credit: Meaning and Example