{"id":2243,"date":"2024-12-20T20:40:03","date_gmt":"2024-12-20T17:40:03","guid":{"rendered":"https:\/\/danil-hristich.com\/?p=2243"},"modified":"2026-05-28T10:59:08","modified_gmt":"2026-05-28T07:59:08","slug":"letter-of-credit","status":"publish","type":"post","link":"https:\/\/danil-hristich.com\/en\/letter-of-credit\/","title":{"rendered":"Letter of Credit"},"content":{"rendered":"<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_71 counter-hierarchy ez-toc-counter ez-toc-transparent ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">\u0421\u043e\u0434\u0435\u0440\u0436\u0430\u043d\u0438\u0435<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/danil-hristich.com\/en\/letter-of-credit\/#How_a_Letter_of_Credit_Works\" title=\"How a Letter of Credit Works\">How a Letter of Credit Works<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/danil-hristich.com\/en\/letter-of-credit\/#The_Key_Feature_of_a_Letter_of_Credit\" title=\"The Key Feature of a Letter of Credit\">The Key Feature of a Letter of Credit<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/danil-hristich.com\/en\/letter-of-credit\/#Key_Concepts_and_Participants_in_a_Letter_of_Credit\" title=\"Key Concepts and Participants in a Letter of Credit\">Key Concepts and Participants in a Letter of Credit<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/danil-hristich.com\/en\/letter-of-credit\/#What_Happens_if_Documents_Do_Not_Comply_with_the_Letter_of_Credit\" title=\"What Happens if Documents Do Not Comply with the Letter of Credit\">What Happens if Documents Do Not Comply with the Letter of Credit<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/danil-hristich.com\/en\/letter-of-credit\/#When_the_Bank_May_Refuse_Payment_at_Its_Discretion\" title=\"When the Bank May Refuse Payment at Its Discretion\">When the Bank May Refuse Payment at Its Discretion<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-6\" href=\"https:\/\/danil-hristich.com\/en\/letter-of-credit\/#Main_Types_of_Letters_of_Credit\" title=\"Main Types of Letters of Credit\">Main Types of Letters of Credit<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-7\" href=\"https:\/\/danil-hristich.com\/en\/letter-of-credit\/#The_Letter_of_Credit_as_a_Key_Condition_for_Contract_Performance\" title=\"The Letter of Credit as a Key Condition for Contract Performance\">The Letter of Credit as a Key Condition for Contract Performance<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-8\" href=\"https:\/\/danil-hristich.com\/en\/letter-of-credit\/#UCP_600_What_It_Is\" title=\"UCP 600: What It Is\">UCP 600: What It Is<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-9\" href=\"https:\/\/danil-hristich.com\/en\/letter-of-credit\/#Why_Is_UCP_600_Important\" title=\"Why Is UCP 600 Important?\">Why Is UCP 600 Important?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-10\" href=\"https:\/\/danil-hristich.com\/en\/letter-of-credit\/#Key_Provisions_of_UCP_600\" title=\"Key Provisions of UCP 600\">Key Provisions of UCP 600<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-11\" href=\"https:\/\/danil-hristich.com\/en\/letter-of-credit\/#The_Difference_Between_a_Letter_of_Credit_and_Other_Financial_Instruments\" title=\"The Difference Between a Letter of Credit and Other Financial Instruments\">The Difference Between a Letter of Credit and Other Financial Instruments<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-12\" href=\"https:\/\/danil-hristich.com\/en\/letter-of-credit\/#Difference_Between_a_Letter_of_Credit_and_a_Bank_Guarantee\" title=\"Difference Between a Letter of Credit and a Bank Guarantee\">Difference Between a Letter of Credit and a Bank Guarantee<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-13\" href=\"https:\/\/danil-hristich.com\/en\/letter-of-credit\/#Difference_Between_Escrow_and_a_Letter_of_Credit\" title=\"Difference Between Escrow and a Letter of Credit\">Difference Between Escrow and a Letter of Credit<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-14\" href=\"https:\/\/danil-hristich.com\/en\/letter-of-credit\/#Difference_Between_a_Letter_of_Credit_and_Cash_Against_Documents_CAD\" title=\"Difference Between a Letter of Credit and Cash Against Documents (CAD)\">Difference Between a Letter of Credit and Cash Against Documents (CAD)<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-15\" href=\"https:\/\/danil-hristich.com\/en\/letter-of-credit\/#Why_It_Is_Important_to_Carefully_Review_Letter_of_Credit_Instructions\" title=\"Why It Is Important to Carefully Review Letter of Credit Instructions\">Why It Is Important to Carefully Review Letter of Credit Instructions<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-16\" href=\"https:\/\/danil-hristich.com\/en\/letter-of-credit\/#Conclusions\" title=\"Conclusions\">Conclusions<\/a><\/li><\/ul><\/nav><\/div>\n\n<p>A letter of credit is a secure payment method between a seller and a buyer, ensuring payment for the delivery of goods or services upon the presentation of relevant documents to the bank. In this introductory article, we will explore what a letter of credit is, how it works, its key features, differences from other financial instruments, and practical tips for its use.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"How_a_Letter_of_Credit_Works\"><\/span>How a Letter of Credit Works<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>In simple terms, a letter of credit is an irrevocable financial guarantee issued by the buyer&#8217;s bank, ensuring payment is made if the seller meets the conditions stipulated in the letter of credit. Payment under a letter of credit is based solely on documents that comply with its terms. In essence, a letter of credit functions as follows:<\/p>\n\n\n\n<ol start=\"1\" class=\"wp-block-list\">\n<li>The buyer and seller enter into a contract, which stipulates the use of a letter of credit as the payment method. The contract lists the documents required for payment under the letter of credit.<\/li>\n\n\n\n<li>The buyer approaches their bank to open a letter of credit and provides the seller with a draft for approval.<\/li>\n\n\n\n<li>The seller reviews all details and compares them with the contract (such as the documents required for payment, their descriptions, the amount, and the beneficiary\u2019s details).<\/li>\n\n\n\n<li>The buyer\u2019s bank issues the letter of credit and notifies the seller\u2019s bank.<\/li>\n\n\n\n<li>The seller ships the goods and submits the required documents to their bank.<\/li>\n\n\n\n<li>The buyer\u2019s bank meticulously checks the documents provided by the seller against the terms of the letter of credit.<\/li>\n\n\n\n<li>If the documents meet the conditions of the letter of credit, the bank makes the payment.<\/li>\n<\/ol>\n\n\n\n<p>Thus, transactions involving a letter of credit are governed by two agreements: the primary sales contract and a separate letter of credit agreement, which specifically regulates the payment procedure. However, it is important to note that for the purposes of payment, the terms of the sales contract do not take precedence over the terms of the letter of credit.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"The_Key_Feature_of_a_Letter_of_Credit\"><\/span>The Key Feature of a Letter of Credit<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>One of the key characteristics of a letter of credit is its irrevocability. Once a letter of credit has been issued, the buyer cannot instruct the bank to withhold payment. This rule applies even in cases where the goods do not meet the buyer\u2019s expectations or other issues arise. The bank acts strictly on the basis of the documents specified in the terms of the letter of credit and does not consider the actual circumstances or take instructions from the buyer or any other party.<\/p>\n\n\n\n<p>The only exception occurs when all parties to the agreement agree to amend the letter of credit. For instance, during the execution of a contract, it may be discovered that the letter of credit contains an incorrect document description, which was initially overlooked by both the seller and the buyer. In such cases, the parties can jointly submit a written request to the bank to make the necessary changes.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Key_Concepts_and_Participants_in_a_Letter_of_Credit\"><\/span>Key Concepts and Participants in a Letter of Credit<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Earlier, we reviewed the typical chronology of a transaction involving a letter of credit. However, in practice, more parties are involved. Since letters of credit originate from the banking sector, specific terms are used to describe the participants. Let us examine them in detail.<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>Applicant:<\/strong> The buyer who requests the bank to issue a letter of credit. Essentially, the applicant instructs the bank to reserve their funds and guarantee payment to the seller upon fulfilment of the letter of credit&#8217;s terms.<\/li>\n\n\n\n<li><strong>Beneficiary:<\/strong> The seller who receives payment under the letter of credit. The beneficiary is the recipient of the bank&#8217;s promise.<\/li>\n\n\n\n<li><strong>Issuing Bank:<\/strong> The buyer\u2019s bank that issues the letter of credit and guarantees payment to the seller upon compliance with the terms. While formally any bank can act as the issuing bank, it is typically the buyer\u2019s servicing bank, as it already has a relationship with the client, understands the nature of their business, and is more willing to undertake the obligation.<\/li>\n\n\n\n<li><strong>Advising Bank:<\/strong> Usually located on the seller\u2019s side, this bank assists the seller in understanding the letter of credit, preparing, and forwarding the required documents to the issuing bank. When the letter of credit is issued, the issuing bank sends the notification to the advising bank via the SWIFT system. The advising bank verifies the authenticity of the letter of credit and informs the beneficiary accordingly.<\/li>\n\n\n\n<li><strong>Nominated Bank:<\/strong> This is the bank authorised to process documents and payments under the letter of credit, typically on the seller&#8217;s side. It is often the same as the advising bank but not necessarily.<\/li>\n\n\n\n<li><strong>Confirming Bank:<\/strong> If the seller desires additional assurance, the confirming bank, usually located on the seller&#8217;s side, adds its own commitment to pay. When might this be necessary? For example, if the issuing bank is located in a country experiencing military conflict, the seller may fear that the issuing bank could become insolvent and fail to honour the payment. In such cases, the seller can engage a confirming bank or demand the buyer involve one. Should the issuing bank fail to make the payment (provided the documents comply with the letter of credit), the confirming bank assumes the payment obligation.<\/li>\n<\/ul>\n\n\n\n<figure class=\"wp-block-image size-large\"><img loading=\"lazy\" decoding=\"async\" width=\"1024\" height=\"768\" src=\"https:\/\/danil-hristich.com\/wp-content\/uploads\/2024\/12\/Haven_Cherson-1024x768.jpg\" alt=\"\" class=\"wp-image-2214\" title=\"\" srcset=\"https:\/\/danil-hristich.com\/wp-content\/uploads\/2024\/12\/Haven_Cherson-1024x768.jpg 1024w, https:\/\/danil-hristich.com\/wp-content\/uploads\/2024\/12\/Haven_Cherson-800x600.jpg 800w, https:\/\/danil-hristich.com\/wp-content\/uploads\/2024\/12\/Haven_Cherson-1536x1152.jpg 1536w\" sizes=\"auto, (max-width: 1024px) 100vw, 1024px\" \/><\/figure>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"What_Happens_if_Documents_Do_Not_Comply_with_the_Letter_of_Credit\"><\/span>What Happens if Documents Do Not Comply with the Letter of Credit<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>If the documents provided by the seller do not comply with the terms of the letter of credit, the buyer\u2019s bank will refuse payment. In this case, the following scenarios may occur:<\/p>\n\n\n\n<ol start=\"1\" class=\"wp-block-list\">\n<li>The buyer is notified of the discrepancy. The issuing bank informs the buyer, through the advising bank, that the documents do not conform to the terms of the letter of credit.<\/li>\n\n\n\n<li>The buyer may choose to accept the documents. The buyer can instruct the bank to proceed with payment despite the discrepancies if they deem the issues minor.<\/li>\n\n\n\n<li>Documents are returned to the seller for correction. If feasible, the seller can correct the errors or provide missing documents, which are then re-examined by the issuing bank.<\/li>\n\n\n\n<li>Risk of losing payment. Letters of credit typically specify an expiration date. If the documents remain non-compliant by this deadline, the seller forfeits the right to payment.<\/li>\n<\/ol>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"When_the_Bank_May_Refuse_Payment_at_Its_Discretion\"><\/span>When the Bank May Refuse Payment at Its Discretion<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>An exception to the obligation to pay arises in cases of fraud. If the bank receives evidence that the documents are forged or contain false information, it has the right to refuse payment, even if the documents formally comply with the terms of the letter of credit. This rule is based on the principle of good faith and aims to prevent abuses in international trade.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Main_Types_of_Letters_of_Credit\"><\/span>Main Types of Letters of Credit<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Let us explore the main types of letters of credit used in international transactions:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>Transferable Letter of Credit<\/strong>: this allows the beneficiary to transfer payment rights to other parties. It is commonly used when the seller is an intermediary who needs to allocate a portion of the payment to their supplier.<\/li>\n\n\n\n<li><strong>Revolving Letter of Credit<\/strong>: enables the letter of credit to be used multiple times under a single contract. It is often employed for shipments made in instalments (e.g., 1,000 tonnes of wheat per month) to avoid the need to issue a new letter of credit for each delivery.<\/li>\n\n\n\n<li><strong>Standby Letter of Credit<\/strong>: functions as a form of bank guarantee. In this arrangement, the buyer typically pays directly (e.g., against scanned copies or CAD \u2013 cash against documents). If the buyer fails to make payment, the seller can use the letter of credit to secure funds. In essence, the letter of credit serves as a backup mechanism, resembling a performance bond in this context.<\/li>\n\n\n\n<li><strong>Irrevocable and Revocable Letters of Credit<\/strong>: according to international standards (such as UCP 600, discussed in detail later), letters of credit must be irrevocable. This means the applicant cannot unilaterally cancel the letter of credit. Technically, a bank can issue a revocable letter of credit if instructed by the applicant, but in practice, revocable letters of credit are rarely used.<\/li>\n\n\n\n<li><strong>At Sight and Deferred Letters of Credit<\/strong>: Letters of credit can be classified by the type of payment. A payment &#8220;at sight&#8221; means the seller receives the funds immediately upon presenting the required documents. A deferred payment, on the other hand, stipulates payment after a certain period following the fulfilment of the terms specified in the letter of credit. This approach is often used to provide flexibility in long-term transactions.<\/li>\n<\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"The_Letter_of_Credit_as_a_Key_Condition_for_Contract_Performance\"><\/span>The Letter of Credit as a Key Condition for Contract Performance<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>A letter of credit is a condition precedent to the contract. Its issuance is a fundamental requirement of the agreement and a precondition for the seller&#8217;s performance of their obligations. For instance, if the contractual period under a CIF Marmara agreement is specified as 1 to 15 December, the letter of credit must be issued by 30 November. Failure to do so may allow the seller to declare the buyer in default, terminate the contract, and claim damages.<\/p>\n\n\n\n<figure class=\"wp-block-image size-large\"><img loading=\"lazy\" decoding=\"async\" width=\"1024\" height=\"683\" src=\"https:\/\/danil-hristich.com\/wp-content\/uploads\/2024\/12\/image-1024x683.png\" alt=\"Letter of credit as condition of the contract\" class=\"wp-image-2220\" title=\"\" srcset=\"https:\/\/danil-hristich.com\/wp-content\/uploads\/2024\/12\/image-1024x683.png 1024w, https:\/\/danil-hristich.com\/wp-content\/uploads\/2024\/12\/image-900x600.png 900w, https:\/\/danil-hristich.com\/wp-content\/uploads\/2024\/12\/image-1536x1024.png 1536w, https:\/\/danil-hristich.com\/wp-content\/uploads\/2024\/12\/image-270x180.png 270w, https:\/\/danil-hristich.com\/wp-content\/uploads\/2024\/12\/image-770x515.png 770w\" sizes=\"auto, (max-width: 1024px) 100vw, 1024px\" \/><\/figure>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"UCP_600_What_It_Is\"><\/span>UCP 600: What It Is<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>UCP 600 (Uniform Customs and Practice for Documentary Credits) is an international standard developed by the International Chamber of Commerce (ICC) that governs the use of letters of credit. These rules provide a unified approach to handling letters of credit globally, facilitating international trade.<\/p>\n\n\n\n<p>In the context of the rules, a letter of credit is referred to as &#8220;documentary&#8221; because it relies solely on the examination of documents presented in accordance with its terms. This makes a documentary letter of credit a reliable instrument in international trade.<\/p>\n\n\n\n<p>Formally, UCP 600 does not automatically apply to letters of credit. However, most banks incorporate these rules into the credit by explicit reference. For example, a letter of credit might include a clause stating: &#8220;This Letter of Credit is subject to the Uniform Customs and Practice for Documentary Credits, UCP 600.&#8221; Such a reference renders UCP 600 binding for the particular letter of credit.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Why_Is_UCP_600_Important\"><\/span>Why Is UCP 600 Important?<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><strong>Unified Approach:<\/strong> It standardises many aspects of letters of credit, reducing the risk of misunderstandings between parties.<\/p>\n\n\n\n<p><strong>Protection of Interests:<\/strong> The rules safeguard both buyers and sellers by establishing clear procedures.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Key_Provisions_of_UCP_600\"><\/span>Key Provisions of UCP 600<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>Here are some of the key provisions of UCP 600:<\/p>\n\n\n\n<p><strong>Article 3:<\/strong> All letters of credit are irrevocable, even if not explicitly stated, unless otherwise specified in the credit.<\/p>\n\n\n\n<p><strong>Article 4:<\/strong> The instructions in the letter of credit take precedence over the terms of the contract.<\/p>\n\n\n\n<p><strong>Article 6:<\/strong> A letter of credit must clearly specify whether payment is at sight or deferred.<\/p>\n\n\n\n<p><strong>Article 14:<\/strong> Establishes standards for the examination of documents by banks. Specifically, a confirming bank has five banking days to determine whether the presentation complies with the terms of the letter of credit.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"The_Difference_Between_a_Letter_of_Credit_and_Other_Financial_Instruments\"><\/span>The Difference Between a Letter of Credit and Other Financial Instruments<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Let us explore how a letter of credit differs from a bank guarantee, escrow arrangements, and cash against documents.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Difference_Between_a_Letter_of_Credit_and_a_Bank_Guarantee\"><\/span>Difference Between a Letter of Credit and a Bank Guarantee<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>The term &#8220;guarantee&#8221; is used here solely to illustrate the nature of a letter of credit. Legally, letters of credit and bank guarantees differ significantly:<\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li><strong>Nature of Obligation:<\/strong> under a letter of credit, the issuing bank guarantees payment to the seller upon the presentation of documents that comply with the terms of the credit. It is a financial instrument tied to trade transactions. In contrast, under a bank guarantee, the bank promises payment in the event that the buyer fails to fulfil their obligations. It acts as a form of compensation for breach of contract.<\/li>\n\n\n\n<li><strong>Mechanism:<\/strong> payment under a letter of credit is made only after the documents specified in the credit&#8217;s terms are verified. For a bank guarantee, the bank disburses funds if the buyer defaults on their obligations, provided the seller submits a valid claim.<\/li>\n\n\n\n<li><strong>Purpose:<\/strong> a letter of credit is designed to facilitate payments between parties in commercial transactions. A bank guarantee is used to mitigate risks associated with non-performance of contractual obligations.<\/li>\n<\/ol>\n\n\n\n<p>Thus, a letter of credit is more suited for financing trade transactions, while a bank guarantee serves as a risk mitigation tool in cases of non-fulfilment of obligations.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Difference_Between_Escrow_and_a_Letter_of_Credit\"><\/span>Difference Between Escrow and a Letter of Credit<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>Both letters of credit and escrow arrangements aim to ensure the fulfilment of obligations between parties. However, they differ significantly in their mechanisms and areas of application:<\/p>\n\n\n\n<ol start=\"1\" class=\"wp-block-list\">\n<li><strong>Parties to the Agreement:<\/strong> in the case of a letter of credit, interaction occurs through the buyer\u2019s bank and, if necessary, additional banks (advising or confirming banks). Escrow involves a mediator\u2014an escrow agent, who may be a bank, a law firm, or a specialised company.<\/li>\n\n\n\n<li><strong>Financial Guarantee:<\/strong> a letter of credit guarantees payment to the seller upon presentation of the required documents. Escrow ensures the security of both parties by holding the buyer\u2019s funds until certain conditions are met, such as the transfer of property or the completion of services.<\/li>\n\n\n\n<li><strong>Priority of Documents:<\/strong> a letter of credit operates strictly based on the documents specified in its terms. Escrow arrangements depend more on the actual circumstances and the physical fulfilment of obligations.<\/li>\n\n\n\n<li><strong>Application:<\/strong> letters of credit are commonly used in international trade as a method of payment. Escrow, on the other hand, is often employed in cases of disputes or transactions requiring the secure holding of funds until specific conditions are satisfied.<\/li>\n<\/ol>\n\n\n\n<p>Thus, letters of credit are better suited for providing financial guarantees in large transactions with clearly defined documentary requirements. In contrast, escrow offers greater flexibility and security in agreements requiring personal or physical performance.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Difference_Between_a_Letter_of_Credit_and_Cash_Against_Documents_CAD\"><\/span>Difference Between a Letter of Credit and Cash Against Documents (CAD)<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>A letter of credit can be compared to other forms of payment, such as Cash Against Documents (CAD). The differences are as follows:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Under CAD, the bank ensures the release of documents to the buyer only after payment is made, but it does not guarantee the payment itself. The bank acts solely on the instructions of its client.<\/li>\n\n\n\n<li>In contrast, a letter of credit guarantees payment provided the required documents comply with its terms. The issuing bank is obligated to pay regardless of the buyer\u2019s opinion or any arrangements made between the parties.<\/li>\n<\/ul>\n\n\n\n<figure class=\"wp-block-image size-large\"><img loading=\"lazy\" decoding=\"async\" width=\"1024\" height=\"683\" src=\"https:\/\/danil-hristich.com\/wp-content\/uploads\/2024\/12\/adrianna-kaczmarek-PMNSy4ZEkT4-unsplash-1024x683.jpg\" alt=\"Cash against documents and letter of credit difference\" class=\"wp-image-2217\" title=\"\" srcset=\"https:\/\/danil-hristich.com\/wp-content\/uploads\/2024\/12\/adrianna-kaczmarek-PMNSy4ZEkT4-unsplash-1024x683.jpg 1024w, https:\/\/danil-hristich.com\/wp-content\/uploads\/2024\/12\/adrianna-kaczmarek-PMNSy4ZEkT4-unsplash-900x600.jpg 900w, https:\/\/danil-hristich.com\/wp-content\/uploads\/2024\/12\/adrianna-kaczmarek-PMNSy4ZEkT4-unsplash-1536x1024.jpg 1536w, https:\/\/danil-hristich.com\/wp-content\/uploads\/2024\/12\/adrianna-kaczmarek-PMNSy4ZEkT4-unsplash-270x180.jpg 270w, https:\/\/danil-hristich.com\/wp-content\/uploads\/2024\/12\/adrianna-kaczmarek-PMNSy4ZEkT4-unsplash-770x515.jpg 770w\" sizes=\"auto, (max-width: 1024px) 100vw, 1024px\" \/><\/figure>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Why_It_Is_Important_to_Carefully_Review_Letter_of_Credit_Instructions\"><\/span>Why It Is Important to Carefully Review Letter of Credit Instructions<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Banks only examine the documents submitted in accordance with the letter of credit instructions. They do not consider the actual circumstances or the terms of the underlying contract. Although a letter of credit is issued to facilitate the performance of the main agreement, in cases of discrepancies, the terms of the credit take precedence over the contract. This creates the following risks:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>Discrepancies Between the Contract and the Letter of Credit<\/strong>. For instance, a letter of credit may require more documents than stipulated in the contract. If the seller does not notify the buyer of this issue, the letter of credit will take precedence over the contract.<\/li>\n\n\n\n<li><strong>Chain Risks<\/strong>. In cases where you are involved in both a sales and a purchase contract, it is crucial to ensure that the terms of both letters of credit align.<\/li>\n<\/ul>\n\n\n\n<p>Let us consider an example from practice:<\/p>\n\n\n\n<p class=\"has-pale-cyan-blue-background-color has-background\">Global Agro Solutions LLC (GAS) sold American wheat to AgriTrade SA in Argentina under CFR Buenos Aires terms. Payment under the contract was to be made via a letter of credit. GAS purchased the goods from its American suppliers on CAD terms, intending to use the funds received under the letter of credit to settle payments with its suppliers.<br><br>During the performance of the contract, it was discovered that the letter of credit required a document not stipulated in the contract\u2014a quality certificate at the port of discharge. AgriTrade SA refused to amend the terms of the letter of credit. At the same time, the American suppliers declined to ship the goods to the port of discharge without advance payment. This resulted in GAS defaulting on both its sales and purchase contracts.<\/p>\n\n\n\n<p>This case highlights the importance of carefully reviewing the instructions in a letter of credit and ensuring their alignment with the contract to avoid similar situations.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Conclusions\"><\/span>Conclusions<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>A letter of credit is a complex yet one of the most reliable financial instruments for ensuring security in international transactions. It helps minimise the risks associated with non-payment when used correctly. To work effectively with letters of credit, it is crucial to:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>Carefully review instructions.<\/strong> Any discrepancies can lead to financial losses.<\/li>\n\n\n\n<li><strong>Ensure consistency of letters of credit across the contract chain.<\/strong> This helps avoid defaults and other legal risks.<\/li>\n\n\n\n<li><strong>Thoroughly understand UCP 600 provisions.<\/strong> These form the foundation for the standard operation of letters of credit.<\/li>\n<\/ul>\n\n\n\n<p>With proper preparation, the use of letters of credit significantly reduces risks in international trade, making transactions more secure and predictable.<\/p>\n\n\n\n<p>If you require legal assistance with matters related to letters of credit, feel free to contact me via <a href=\"mailto:danielhristich@gmail.com\">email<\/a>, <a href=\"https:\/\/t.me\/danilhristich\" target=\"_blank\" rel=\"noreferrer noopener\">Telegram<\/a>, or <a href=\"https:\/\/wa.me\/380632956265\" target=\"_blank\" rel=\"noreferrer noopener\">WhatsApp<\/a>.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>A letter of credit is a secure payment method between a seller and a buyer, ensuring payment for the delivery of goods or services upon the presentation of relevant documents to the bank. In this introductory article, we will explore what a letter of credit is, how it works, its key features, differences from other<\/p>\n","protected":false},"author":1,"featured_media":2212,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"inline_featured_image":false,"rank_math_title":"%title%. Types of Letters of Credit ","rank_math_description":"What is a letter of credit? How does a letter of credit work? Basic concepts and participants of a letter of credit. Types of letters of credit. ","rank_math_focus_keyword":"Letter of Credit","footnotes":""},"categories":[1],"tags":[466,467,465,871,464,469,470,872],"class_list":{"0":"post-2243","1":"post","2":"type-post","3":"status-publish","4":"format-standard","5":"has-post-thumbnail","7":"category-main","8":"tag-cad-2","9":"tag-cashagainstdocuments-2","10":"tag-lc-2","11":"tag-letter-of-credit-en","12":"tag-letterofcredit-2","13":"tag-payment-3","14":"tag-tradefinance-2","15":"tag-ucp-600-en"},"_links":{"self":[{"href":"https:\/\/danil-hristich.com\/en\/wp-json\/wp\/v2\/posts\/2243","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/danil-hristich.com\/en\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/danil-hristich.com\/en\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/danil-hristich.com\/en\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/danil-hristich.com\/en\/wp-json\/wp\/v2\/comments?post=2243"}],"version-history":[{"count":1,"href":"https:\/\/danil-hristich.com\/en\/wp-json\/wp\/v2\/posts\/2243\/revisions"}],"predecessor-version":[{"id":2244,"href":"https:\/\/danil-hristich.com\/en\/wp-json\/wp\/v2\/posts\/2243\/revisions\/2244"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/danil-hristich.com\/en\/wp-json\/wp\/v2\/media\/2212"}],"wp:attachment":[{"href":"https:\/\/danil-hristich.com\/en\/wp-json\/wp\/v2\/media?parent=2243"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/danil-hristich.com\/en\/wp-json\/wp\/v2\/categories?post=2243"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/danil-hristich.com\/en\/wp-json\/wp\/v2\/tags?post=2243"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}