Letter of Credit (LC)

A document, issued by a bank per instructions by a buyer of goods, authorizing the seller to draw a specified sum of money under specified terms, usually the receipt by the bank of certain documents within a given time. Some of the specific descriptions are:

• Back-to-Back:A new letter of credit issued to another beneficiary on the strength of a primary credit. The second L/C uses the first L/C as collateral for the bank. Used in a three-party transaction.
• Clean:A letter of credit that requires the beneficiary to present only a draft or a receipt for specified funds before receiving payment.
• Confirmed:An L/C guaranteed by both the issuing and advising banks of payment so long as seller’s documents are in order, and the L/C terms are met. Only applied to irrevocable L/C’s. The confirming bank assumes the credit risk of the issuing bank.
• Deferred Payment:A letter of credit issued for the purchase and financing of merchandise, similar to acceptance-type letter of credit, except that it requires presentation of sight drafts payable on an installment basis.
• Irrevocable:An instrument that, once established, cannot be modified or cancelled without the agreement of all parties concerned.
• Non cumulative:A revolving letter of credit that prohibits the amount not used during the specific period from being available afterwards.
• Restricted:A condition within the letter of credit which restricts its negotiation to a named bank.
• Revocable:An instrument that can be modified or cancelled at any moment without notice to and agreement of the beneficiary, but customarily includes a clause in the credit to the effect that any draft negotiated by a bank prior to the receipt of a notice of revocation or amendment will be honored by the issuing bank. Rarely used since there is no protection for the seller.
• Revolving:An irrevocable letter issued for a specific amount; renews itself for the same amount over a given period.
• Straight:A letter of credit that contains a limited engagement clause which states that the issuing bank promises to pay the beneficiary upon presentation of the required documents at its counters or the counters of the named bank.
• Transferable:A letter of credit that allows the beneficiary to transfer in whole or in part to another beneficiary any amount which, in aggregate, of such transfers does not exceed the amount of the credit. Used by middlemen.

Unconfirmed: A letter of credit forwarded to the beneficiary by the advising bank without engagement on the part of the advising bank.