Writing a Letter of Credit

06/09/2023

29 min

Note: Links to our free templates are at the bottom of this long guide.
Also note: This is not legal advice

Introduction

Letter of credit is a financial instrument that plays an important role in protecting both parties in a trade transaction. It ensures payment and delivery of goods by guaranteeing that the buyer will pay for the goods supplied by the seller within a specified time period. This assurance provides buyers and sellers with peace of mind, knowing that either party will fulfill their obligations and be protected from defaults.

The use of letter of credit offers more flexibility in international trade as well. It allows parties to negotiate terms such as payment terms, delivery terms, and other conditions which are all legally binding. This means that in the event of any dispute occurring between buyers and sellers, they may rely on the terms stated in the document. Moreover, it can also help manage risk related to non-payment amidst unfamiliar parties or across borders where trust may be hard to establish.

At Genie AI, we have developed ‘the world’s largest open source legal template library’ so that anyone can draft up high quality legal documents without needing to call on a lawyer; our millions of data points teach our AI what a market-standard letter of credit looks like giving you access to reliable protection when trading with others! Check out our step-by-step guidance below or take advantage of our community template library today - no Genie AI account required!

Definitions

Definition of a Letter of Credit
Definition of a Commercial Letter of Credit
Definition of a Standby Letter of Credit
Types of Letters of Credit
Revocable Letter of Credit
Irrevocable Letter of Credit
Confirmed Letter of Credit
Unconfirmed Letter of Credit
Transferable Letter of Credit
Back-to-Back Letter of Credit
Why Letters of Credit are Used
Parties Involved in a Letter of Credit
Beneficiary
Applicant
Issuing Bank
Advising Bank
Confirming Bank
Requirements for a Letter of Credit
Credit Amount
Expiration Date
Payment Terms
Documents Required
How to Write a Letter of Credit
Gather the Necessary Information
Draft the Letter of Credit
Review and Finalize the Letter of Credit
Negotiation of a Letter of Credit
Negotiate Terms
Match Documents to Requirements
What to Do if a Letter of Credit is Rejected
Analyze Reasons for Rejection
Resubmit Documents
Risks Involved with a Letter of Credit
Credit Risk
Documentary Risk
Compliance Risk
Fraud Risk
Alternatives to a Letter of Credit
Bank Guarantee
Cash in Advance
Documentary Collection
Open Account

Get started

Definition of a Letter of Credit

Understand what a letter of credit is: a financial instrument or document issued by a bank or financial institution that guarantees payment to a seller of goods or services provided certain conditions are met.
Learn the differences between a letter of credit and other forms of payment, such as a check or cash.
When you can confidently explain what a letter of credit is, you can move on to the next step.

Definition of a Commercial Letter of Credit

Understand the definition of a Commercial Letter of Credit. A Commercial Letter of Credit is an agreement between a buyer and seller that gives the seller assurance that the buyer will pay for goods and services according to the terms outlined in the letter.
Research the rules and regulations for Commercial Letters of Credit. Depending on the type of credit, there may be different regulations and terms that need to be followed.
Know the different types of Commercial Letters of Credit. There are several types of Commercial Letters of Credit, including Revolving, Back-to-Back, Standby, and Transferable.
When you have an understanding of the definition of a Commercial Letter of Credit, the related rules and regulations, and the different types, you can check this step off your list and move on to the next step.

Definition of a Standby Letter of Credit

Understand the purpose of a standby letter of credit and how it works
Know the difference between a standby letter of credit and a commercial letter of credit
Be aware of the risks involved with a standby letter of credit
Know when a standby letter of credit is used
Understand the terms and conditions of a standby letter of credit

Once you understand the purpose, risks, and terms of a standby letter of credit, you can check this off your list and move on to the next step.

Types of Letters of Credit

A letter of credit is a financial instrument used to guarantee payment between two parties.
There are several different types of letters of credit, including commercial letters of credit, standby letters of credit, revocable letters of credit, irrevocable letters of credit, and confirmed letters of credit.
Commercial letters of credit are used to finance the purchase of goods and services between parties.
Standby letters of credit are used to guarantee performance in the case of a contractual agreement.
Revocable letters of credit are issued by a bank and can be modified or cancelled by the issuing bank at any time.
Irrevocable letters of credit are issued by a bank and cannot be modified or cancelled by the issuing bank without the consent of both parties.
Confirmed letters of credit are issued by a bank and are also backed by a second bank, typically in a foreign country.

You will know that you have completed this step when you are able to clearly identify and describe each of the types of letters of credit.

Revocable Letter of Credit

Know the difference between a revocable letter of credit and an irrevocable letter of credit
Understand the terms of the revocable letter of credit which will include the expiry date, payment terms and credit limits
Draft the letter of credit according to the terms agreed upon with the seller, including the expiry date, payment terms, and credit limits
Sign the letter of credit documents as the issuing bank
Have the seller sign the documents as the beneficiary
Once the documents have been signed, you can check off this step and move on to the next step which is an irrevocable letter of credit

Irrevocable Letter of Credit

Obtain a letter of credit application from the bank and fill it out with the relevant information.
Submit the letter of credit application to your bank for approval.
Once the application is approved, the bank will provide you with an irrevocable letter of credit.
Make sure that the letter of credit contains all the required information, including the payment amount, currency, date of payment, and other details.
Confirm that all parties involved in the transaction have signed the letter of credit.
You will know that this step is complete once you have a valid, approved irrevocable letter of credit.

Confirmed Letter of Credit

Contact the issuing bank and provide them with the credit information, including the amount of credit, the expiry date, and other details
The issuing bank will then confirm the credit and provide a document that states the terms and conditions of the confirmed credit
The confirming bank is then provided with the confirmed credit document and is obligated to honour the terms and conditions as agreed upon
Once the confirming bank has received and accepted the confirmed credit, the beneficiary may draw against it
The transaction is complete when the beneficiary is able to collect the payment

You will know when you can check this off your list and move on to the next step when the confirming bank has accepted and honoured the terms and conditions of the credit.

Unconfirmed Letter of Credit

Contact the issuing bank and provide them all necessary information, such as the name, address, and contact information of the beneficiary, amount of the credit, expiration date, and any other necessary details
Request that the issuing bank issue an unconfirmed letter of credit
The issuing bank will then issue the unconfirmed letter of credit to the beneficiary
The beneficiary must then accept the terms of the unconfirmed letter of credit
The issuing bank will then confirm the letter of credit, after which it becomes a confirmed letter of credit
You will know that you have completed this step when the issuing bank has issued the unconfirmed letter of credit to the beneficiary, and the beneficiary has accepted the terms of the unconfirmed letter of credit.

Transferable Letter of Credit

A transferable Letter of Credit (L/C) is an L/C that can be transferred to a third party by the beneficiary.
When setting up a transferable L/C, the issuer must state in the L/C that it is “transferable”.
The beneficiary must request transfer to the third party from the issuer and obtain the issuer’s consent.
The beneficiary will receive a new L/C from the issuer with the same terms as the original L/C, but with the third party listed as the beneficiary.
You will know you have completed this step when you have received the new L/C from the issuer, with the third party listed as the beneficiary.

Back-to-Back Letter of Credit

Understand the terms of the original letter of credit and the requirements of the issuing bank and beneficiary
Review the terms of the original letter of credit and check that it is still valid
Draft a second letter of credit using the terms of the original letter of credit
Submit the application for the back-to-back letter of credit to the issuing bank
Once the issuing bank has approved the application, it will issue the back-to-back letter of credit
You will know you can check this step off your list and move on to the next step when the back-to-back letter of credit has been issued by the issuing bank.

Why Letters of Credit are Used

Understand why letters of credit are used: they are used as a form of payment security; they guarantee that buyers will pay the suppliers, and suppliers will deliver the goods to the buyer.
Understand the purpose of letters of credit: they are a form of payment security; they guarantee that buyers will pay the suppliers and suppliers will deliver the goods to the buyer.
Learn the different types of letters of credit: there are three main types of letters of credit- irrevocable, revocable, and confirmed. Each type of letter of credit has different features and benefits.
Know the risks involved with letters of credit: it is important to understand the risks involved with letters of credit, such as the risk of non-payment and the risk of fraud.

When you can check this step off your list: When you have a thorough understanding of why letters of credit are used and the purpose and different types of letters of credit, as well as the risks associated with them.

Parties Involved in a Letter of Credit

When writing a letter of credit (LC), the most important parties to consider are the issuer, the beneficiary, and the advising bank.
The issuer is the party who will ultimately pay for goods or services upon receiving the required documents from the beneficiary.
The beneficiary is the party who will be receiving payment for goods or services provided.
The advising bank is the party who advises the beneficiary of the LC and is also responsible for verifying the beneficiary’s documents.
Once you’ve identified each of the parties involved in the LC, you can check this step off your list and move on to the next step.

Beneficiary

Identify the beneficiary of the letter of credit. This is usually the seller of the goods or services being paid for.
Make sure to include the beneficiary’s full name and address.
When you have identified the beneficiary and included their full name and address, you can check this step off your list and move on to the next step.

Applicant

Applicant should review the Letter of Credit and its terms to ensure they can comply
Applicant should sign and return an acceptance form to the Beneficiary
Applicant should ensure that the necessary documents and compliance are completed according to the terms of the Letter of Credit
Applicant should be prepared to provide evidence of goods, services, or other items as specified in the Letter of Credit
Applicant should check with the issuing bank to ensure all documents and payments have been made, and that the Letter of Credit has been accepted
Once all documents and payments have been made, the Applicant can check this step off their list, and move on to the next step (Issuing Bank).

Issuing Bank

Contact the issuing bank and obtain the letter of credit form
Fill out the form with the necessary information, such as the applicant and the beneficiary
Submit the form to the issuing bank, along with any other requested documents
Wait for the issuing bank to approve the letter of credit
Once approved, the issuing bank will issue a confirmation letter to the applicant and the beneficiary
This completes the issuing bank’s part of the process and you can move on to the next step of finding an advising bank

Advising Bank

The Advising Bank issues the Letter of Credit to the Beneficiary upon request from the Issuing Bank
The Advising Bank will check the documents presented by the Beneficiary and confirm that they are in compliance with the terms and conditions of the Letter of Credit
The Advising Bank will also verify that the Beneficiary is a valid and legitimate company
Once the documents are verified and the Beneficiary is confirmed, the Advising Bank will issue the Letter of Credit to the Beneficiary
You can check this step off your list and move on to the Confirming Bank when the Letter of Credit is issued to the Beneficiary.

Confirming Bank

Contact the issuing bank and request for a confirmation of the letter of credit
Ask for the confirming bank to provide a full guarantee of payment to the beneficiary
Provide the confirming bank with all relevant information about the letter of credit, including the issuing bank and beneficiary, the credit amount and all other terms and conditions
Receive confirmation from the confirming bank that they will guarantee payment to the beneficiary
Check off this step from your list and proceed to the next step, which is to understand the requirements for a letter of credit.

Requirements for a Letter of Credit

Ensure that all parties involved in the Letter of Credit are aware of the applicable rules, regulations, and requirements.
Determine the amount of the credit and the terms and conditions of the transaction.
Establish the type of credit that will be used and the applicable payment terms.
Establish the payment schedule and any special instructions related to the payment.
Include any other specific requirements, such as documents required for payment.

Once you have determined all the requirements and have established the terms and conditions of the transaction, you can move on to the next step of the guide.

Credit Amount

Calculate the total credit amount that will be issued by the issuing bank
The credit amount will be the maximum amount that the beneficiary can draw against the letter of credit
Make sure to include any additional fees in the credit amount
When you have determined the total credit amount, you can check this step off your list and move on to the next step: Expiration Date

Expiration Date

Set a definite expiration date for the letter of credit, taking into account the time it will take for goods to be shipped and received
This should not be more than six months from the date of issuing the letter of credit
The expiration date should be clearly stated in the letter of credit
Once the date is set, the letter of credit can be issued and you can move on to the next step
You’ll know that you’re done with this step when the expiration date is set and stated in the letter of credit

Payment Terms

Determine the payment terms for the letter of credit - this will typically be a certain number of days after shipment
If the buyer and seller have already agreed on payment terms, make sure these are listed in the letter of credit
If payment terms need to be negotiated between the buyer and seller, make sure these are incorporated into the letter of credit
Once the payment terms have been agreed upon and set out in the letter of credit, you can check this step off your list and move on to the next step.

Documents Required

Gather information about the buyer, seller, and goods the buyer is purchasing
Obtain a credit application from the buyer, which should include the buyer’s financial information and creditworthiness
Ensure that necessary documents such as the purchase contract, invoice, and shipping documents are available
When all necessary documents have been gathered and reviewed, you can move on to the next step!

How to Write a Letter of Credit

Prepare the letter of credit documents, including the credit application, bank instructions, and the credit agreement
Make sure all documents are signed, dated, and include all necessary information
Submit documents to the issuing bank
Confirm that the bank has accepted the documents
You will know when you can check this off your list when the issuing bank has accepted the documents for processing

Gather the Necessary Information

Identify the issuing bank and the beneficiary
Ensure that the terms of the letter of credit are within the issuing bank’s credit limits
Confirm the credit amount, currency, and expiration date
Identify the goods or services to be provided
Gather any other relevant documents that may be needed
When all of the necessary information is gathered and checked, you can move on to drafting the letter of credit.

Draft the Letter of Credit

Determine the relevant information needed, such as the date, letter of credit number, issuing bank, etc.
Gather the necessary documents, such as the buyer’s order and the seller’s commercial invoice.
Use the information gathered to create a draft of the letter of credit.
Ensure that all relevant information is included in the letter of credit, as well as any special instructions.
Double-check that all information is accurate, and that the letter of credit is compliant with the Uniform Customs and Practice for Documentary Credits (UCP).

When you can check this off your list and move on to the next step:

Once the draft of the letter of credit is complete and all information is accurate, you can move on to the next step.

Review and Finalize the Letter of Credit

Check the Letter of Credit (LOC) for accuracy, completeness, and compliance with all relevant regulations
Ensure the bank’s terms and conditions are included in the LOC
Ensure all parties involved have agreed to the LOC
Ensure all signatures have been obtained
Ensure all documents required to support the LOC are in order
Ensure that the LOC is properly authorized by the issuing bank
Once all these points are checked and verified, the LOC can be issued
You can check this step off your list once the LOC has been issued and all signatures have been obtained.

Negotiation of a Letter of Credit

Contact all parties involved in the transaction to agree on the terms and conditions of the letter of credit
Discuss any differences between the letter of credit and the underlying sales contract
Ensure all conditions are acceptable to all parties involved
Make any necessary amendments to the letter of credit to ensure all parties agree to the terms
Sign and date the letter of credit
When all parties have agreed to the terms and conditions, the letter of credit is ready to be issued.

Negotiate Terms

Have the customer and supplier agree on all terms of the sale, including the payment, delivery and other details
Make sure all terms are written, signed and dated by both parties
Discuss and agree on the documents that both parties will need to provide, such as invoices, shipping documents and other proof of delivery
Determine who is responsible for any costs associated with the transaction, such as shipping costs or fees
Once all terms have been agreed upon and documented, you can move on to the next step of matching documents to the requirements of the letter of credit.

Match Documents to Requirements

Ensure the documents presented by the seller for the purpose of drawing on the letter of credit match the terms of the credit
Check that the documents are in accordance with the Uniform Customs and Practices for Documentary Credits (UCP)
Ask the seller to provide additional documents if necessary
Confirm that the documents are presentable and complete
Once the documents are confirmed to match the terms of the credit, the buyer can move forward to the next step
If the documents are not in accordance with the terms of the credit, the buyer will have to reject them

What to Do if a Letter of Credit is Rejected

Contact the issuing bank to find out why the documents were rejected.
Request a formal rejection document, which will list the specific reasons for rejection.
Review the rejection document to identify the reasons for the rejection.
Make changes to documents to address the points of rejection, or provide additional documents or information as needed.
Resubmit the documents to the issuing bank, and request that the documents be reviewed again.
Once the documents have been approved by the issuing bank, you can move on to the next step.

Analyze Reasons for Rejection

Review the letter of credit to identify any discrepancies or errors
Check if the discrepancies or errors can be corrected
Contact the issuing bank to discuss the discrepancy or error
If corrections are needed, determine what documents need to be resubmitted and ensure they are accurate
Ask the issuing bank to confirm if the correction is sufficient
Once the issuing bank confirms that the corrections are sufficient, you can move on to the next step of resubmitting documents.

Resubmit Documents

Check the rejection letter to understand the reasons for rejection
Make the necessary changes to the documents and resubmit them
Make sure to include all the information that the issuing bank needs
Check the documents to ensure they are accurate and comprehensive
Resubmit the documents to the issuing bank
Confirm that the documents have been accepted by the issuing bank
Once you receive confirmation, you can move on to the next step in the process

Risks Involved with a Letter of Credit

Understand the different types of letters of credit
Consider the risk of non-payment
Understand the different parties involved in a letter of credit
Consider the risk of fraud
Research the different rules and regulations governing letters of credit
Consider the impact of foreign exchange risks

You can check off this step when you have a good understanding of the different types of letters of credit, the parties involved, the different rules and regulations, and any risks that can be associated with them.

Credit Risk

Understand the credit risk associated with the buyer, seller, and guarantor
Verify that the buyer, seller, and guarantor have the financial capacity to fulfill their obligations
Understand the terms and conditions, and any additional fees and interest associated with the letter of credit
Make sure the buyer, seller, and guarantor are aware of the credit risk and financial obligations associated with the letter of credit
When all parties have been informed of the credit risk, you can check this off your list and move on to the next step.

Documentary Risk

Ensure that documents specified in the letter of credit match the goods and services being shipped, and that they are in accordance with the instructions of the issuing bank
Ensure documents comply with the letter of credit’s terms, conditions, and any applicable regulations
Verify that documents are properly signed and that signatures are authentic
Ensure documents are dated and valid
Compare documents to the description of goods and services in the credit
You will know when this step is complete when all documents have been reviewed and verified in accordance with the letter of credit’s terms and conditions.

Compliance Risk

Ensure that all parties listed are legally allowed to enter into the agreement.
Verify that the legal documentation of the parties is accurate and up to date.
Make sure that all regulations, laws and guidelines are followed in the agreement.
Ensure that the currency and language used in the agreement are allowed by the governing regulations.
Check that all documents used in the agreement are compliant with the regulations.

Once all the requirements are met, you can move on to the next step: Fraud Risk.

Fraud Risk

Ensure the information provided by both parties is accurate and complete.
Verify the buyer’s credit history and payment track record to ensure that the buyer is trustworthy.
Ensure that the parties involved are legitimate and have the legal authority to enter into the agreement.
Verify the security of the transaction to ensure that the money will be secure and protected.
Monitor the transaction and its progress to ensure that it is completed as agreed.

When you have completed the above steps, you can move on to the next step in the guide.

Alternatives to a Letter of Credit

Research bank guarantees and other payment methods that can replace Letters of Credit
Speak to your bank about the best option for your needs
Compare costs, fees, and other factors related to each payment method
Once you have identified the best option for your needs, you can check this off your list and move on to the next step.