Useful Notes on 9 Different Types of Letter of Credit

2. Irrevocable L/C:

Once this kind of L/C is issued by the issuing bank, it cannot be cancelled, amended by the buyer or the issuing bank without consent of all parties. According to UCP, in the absence of explicit indication otherwise, the L/C shall be treated only as irrevocable. The payment under an irrevocable L/C, however, can be denied if there are discrepancies in the documents i.e., the seller has failed to follow strict compliance rule or committed some fraud.

3. Confirmed L/C:

If the seller is suspicious of the credit of the issuing bank or the country of issuing bank (having shortage of foreign exchange, large foreign debt or a poor balance of payment record), he may insist upon confirmation of the L/C by a foreign bank (say an American bank operating in buyer’s country).

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A confirming bank becomes liable to payment to the beneficiary, if the issuing bank defaults. Refusal to pay by the confirming bank will invite legal action against it. Normally, the confirmation is sought from a bank of the seller’s country. Confirmation clause should not be “confirms the existence of an L/C”, but “obligation” of the confirming bank.

Confirmed L/C offers many benefits – the risk is shifted from the weak to the strong, the issuing bank knows the importer pretty well, the confirming bank knows the issuing bank and the transfer risk is better assessed by the confirming bank than the exporter.

4. Unconfirmed L/C:

When the issuing bank is financially strong enough, the seller may not insist upon confirmation by another bank. In this case the seller may accept an L/C issued by issuing bank. After all, confirmation requires extra charges to be borne either by the seller or the buyer as agreed upon between the two.

5. Standby L/C:

The standby L/C may be used to guarantee that a party will fulfill obligations under a service contract, construction contract or sales contract. It is issued to guarantee a seller’s obligation under a contract. It is used for the purposes such as a performance bond, bid bond, surety bond or to insure the repayment of a loan. In such cases it is the seller who opens an L/C naming the buyer as the beneficiary. Most of the Standby L/Cs are performance guarantees.

6. L/C at sight and Usance L/C:

L/C at sight (demand) refers to wherein the buyer immediately negotiates the L/C after getting information about the arrival of documents in his bank. In case of Usance L/C, the documents are released by the buyer’s bank the moment the buyer signs or accepts the draft (Bill of Exchange). However, the payment is made only after the time period mentioned in the L/C (it may be 30, 60 or 90 days as agreed upon by the two parties).

7. Back-to-back L/C:

When an exporter has to pay a large sum to his own supplier, he may be required to open an L/C favoring the supplier as the beneficiary. If the exporter does not have sufficient working capital to finance the supplies, he can use the L/C received from his buyer as collateral security for its bank to open a second L/C in favor of his supplier. The exporter assigns the proceeds of the Original L/C to its bank and the second L/C is called back-to-back L/C.

It is important to note that a back-to-back L/C is separate from the original L/C. The bank issuing back-to-back L/C is liable to pay to the supplier irrespective of non-compliance of the original L/C.

8. Revolving L/C:

If a buyer intends to import on a regular basis from a particular seller, he may use a revolving L/C. Instead of opening up several L/Cs, he may open up one L/C with a maximum amount available during a certain period of time. As the shipments and draws against the credit are made, the full amount becomes available again and continues until the expiry of credit.

9. Red Clause L/C:

A red clause L/C is similar to a normal L/C, but it differs from it in the sense that it is a financing tool for small sellers who need funds to produce the merchandise to be shipped under an L/C. A red clause in an L/C is a promise by the issuing bank to reimburse the seller’s bank for loans made to the seller.

The loan is in fact an advance on the credit. Such loans can be used only for purchase of raw materials and other necessary overheads for the goods to be finally shipped. If the seller defaults on shipment or repayment the liability will fall on the buyer. Thus, it is a very risky preposition.

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