Late payment or non-delivery can wreck a cross-border deal. Letters of Credit (LCs) reduce that risk by replacing buyer promise with bank promise. In short, an LC is a bank’s commitment to pay against compliant documents. This guide explains UCP 600 rules in plain language, outlines the LC process step-by-step, and shows how to avoid costly mistakes. It’s written for exporters and importers who want reliable, safe trade transactions.
How Letters of Credit Work: A Simple Guide for Buyers and Sellers
A Letter of Credit (LC) is a bridge of trust between buyer and seller — backed by banks. The buyer’s bank promises payment once the seller submits correct documents. It’s not about product quality or shipment delays; it’s about paper accuracy. That’s what makes LCs so powerful and strict at the same time.
The key players in a Letter of Credit
- Buyer (Applicant): Requests the LC from their bank.
- Seller (Beneficiary): Receives payment once documents comply.
- Issuing Bank: Buyer’s bank that issues and reviews compliance.
- Advising Bank: Seller’s bank that authenticates the LC.
- Confirming Bank: Optional – adds a second layer of payment guarantee, often used in higher-risk countries.
The golden rule: Banks deal in documents, not goods. Even if goods are damaged or delayed, a compliant set of papers still gets paid under LC terms.
Step-by-step LC flow: from quote to payment
- Quote and contract: Agree on price, Incoterms, and LC payment terms.
- Issuance: Buyer requests LC; issuing bank sends it to advising bank.
- Review and amendment: Seller checks LC immediately and requests corrections if needed.
- Shipment and documents: Seller ships goods and prepares required LC documents.
- Presentation: Seller submits documents to the advising bank for review.
- Payment: If all documents comply, the issuing bank releases payment.
Accuracy is non-negotiable. Even a small spelling or date mismatch can stop payment — that’s how strictly banks follow UCP 600 compliance.
Common Types of Letters of Credit
- Sight LC: Immediate payment upon document presentation.
- Usance LC: Payment after a set period (e.g., 60 or 90 days).
- Confirmed LC: Includes a confirming bank’s promise, ideal for exporters dealing with high-risk markets.
- Transferable LC: Can be transferred to another beneficiary, useful for traders and intermediaries.
- Standby LC: Functions as a backup payment guarantee, often under ISP98 rules rather than UCP 600.
Each LC type serves a different trade scenario. Exporters should always confirm which version applies before production or shipment.
UCP 600 Rules Explained: What Banks Check and Why It Matters
The UCP 600 (Uniform Customs and Practice for Documentary Credits) is the global standard for how banks process and review LCs. Published by the International Chamber of Commerce (ICC), these rules govern how banks examine documents, timelines, and obligations. Understanding them reduces disputes and delays.
1. Irrevocable credits and the independence principle
Under UCP 600, all credits are irrevocable — they cannot be changed without consent from all parties. The LC stands independent from the sales contract. Banks pay based on documents, not product quality or performance.
2. Exact compliance (Article 14)
Banks ask two simple questions: Are all required documents presented? Do all details match exactly? Common checks include:
- Names, addresses, and company titles must match exactly.
- Amounts and currency must not exceed LC tolerance.
- Dates must fall within the shipment and presentation period.
- Goods description should be concise and identical to the LC text.
Example: If the LC states “ABC Exports Pvt. Ltd.” but the invoice says “ABC Exports Private Limited,” the LC can be rejected. This is called a discrepancy.
3. Timelines that matter
- Shipment deadline: Goods must ship by the last date mentioned in the LC.
- Presentation period: Usually 21 days from shipment unless otherwise stated.
- Bank examination time: Maximum 5 banking days under UCP 600 Article 14(b).
4. Key transport documents
- Bill of Lading (B/L): Proves shipment. Must be clean, on board, and consistent with invoice details.
- Air Waybill: Non-negotiable; must name consignee and notify party as per LC.
- Courier or Postal Receipt: Used for small shipments or samples.
Keep descriptions short and consistent. Avoid adding extra product details that aren’t in the LC text.
Common LC Mistakes and How to Avoid Them
Over 70% of export LCs are initially rejected due to documentation errors. Avoiding these saves time, cost, and reputation. Here’s what to watch:
1. Vague product or shipping terms
- Use short, consistent product descriptions.
- Include Incoterms with location and version (e.g., FOB Chennai – Incoterms 2020).
- Ask for LC amendments early if shipment plans change.
2. Mismatched documents
- Beneficiary name and address must be identical on every document.
- Invoice value must match LC value.
- Transport documents must fit shipment date and Incoterm.
- Weights, quantities, and units must be consistent.
3. Missed deadlines
- Late shipment or presentation voids payment rights.
- Always account for weekends and bank holidays in deadlines.
- Present documents early – not on the final day.
4. Wrong LC type or missing confirmation
- For high-risk buyers or banks, request a confirmed LC.
- Avoid transferable LCs unless necessary.
- Review the LC draft with your bank or trade consultant before accepting.
Download reference: HFW Client Guide on Letters of Credit
Real-World Example: LC Dispute and Resolution
Consider an Indian exporter shipping garments to Germany. The LC required “Cotton T-Shirts – 100% Cotton, 5000 pcs.” The invoice mistakenly read “Cotton T-Shirts – 5,000 pcs.” Although the number was correct, the bank rejected it for format discrepancy. Result: payment delayed by 12 days and extra courier costs.
Lesson: Precision matters more than intention. Always double-check document formats, not just content.
Letter of Credit vs. Bank Guarantee
While both instruments reduce risk, they serve different purposes:
- Letter of Credit: Payment guarantee for goods/services once documents comply.
- Bank Guarantee: Compensation promise if one party fails to perform.
In short, LC ensures payment; BG ensures performance. Exporters prefer LCs; contractors prefer guarantees.
Indian Exporters’ Perspective: RBI and DGFT Guidelines
In India, LCs are regulated under RBI guidelines and fall within FEMA regulations. Exporters must also report LC payments under EDPMS (Export Data Processing and Monitoring System). For imports, the IDPMS applies.
Before accepting an LC, ensure:
- The issuing bank is on the RBI approved list.
- The LC complies with UCP 600 and Exchange Control Manual provisions.
- Your AD Code is active and linked to your port of shipment.
Learn more about export documentation on Perumala Overseas.
Expert Tips for Hassle-Free LC Payments
- Keep all document templates ready before shipment.
- Align product descriptions with the LC verbatim.
- Request sample LCs from your buyers to understand their bank formats.
- Train your team on UCP 600 basics.
- Use trade finance services for document verification if unsure.
At Perumala Overseas, we help exporters streamline documentation and ensure smooth LC settlements through trusted banking channels.
Conclusion
Letters of Credit are the backbone of secure international trade. When handled properly, they eliminate payment risk and ensure smooth transactions between buyers and sellers worldwide. Following UCP 600 rules is not just a compliance step — it’s a competitive edge.
Action Checklist:
- Agree on LC terms in writing before shipment.
- Review draft LC carefully with your bank.
- Use standard document templates and check alignment.
- Present early and maintain full copies of all submissions.
Consistency, clarity, and compliance — these three pillars will keep your LC transactions stress-free and profitable.
For trade support or LC documentation assistance, contact Perumala Overseas — your trusted partner in global trade.
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