Ask Your Logistics Experts… What Is a Letter of Credit?

Q: What Is a Letter of Credit?
A: A letter of credit is an agreement between two parties—a buyer and a seller— that is issued by a bank acting as an uninterested party. The seller will only get paid after performing specific actions that the buyer and the seller agree to.

Example: A seller must deliver goods to a specific airport to satisfy the requirements of the letter. Once the goods are delivered, the seller must provide documents proving delivery was made. The credit can now be paid by the buyer.

A letter of credit deals in documents, not goods. Typically, the letter of credit requires that a commercial invoice, bill of lading, certificate of origin, or any other document pertaining to the goods be provided within a specified time frame. The previous example stated that the seller needed to provide documentation showing the goods were delivered to a particular location before payment could be made. The bank issuing the letter of credit does not ensure the goods are in proper order, but rather the documentation itself.

Steps in the Letter of Credit Process:
1. Buyer and seller negotiate terms for a letter of credit, including mode of transport, payment terms, and latest date of shipping.
2. Buyer applies for the letter of credit from the issuing bank.
3. Issuing bank sends letter to advising bank, which authenticates the letter and notifies seller.
4. Seller checks over letter to ensure it matches agreement and all terms can be satisfied.
5. Seller ships goods and prepares necessary documents listed in letter.
6. Advising bank checks documents against letter and, if in good order, sends payment to seller and sends documents back to issuing bank.
7. Issuing bank checks the documents against letter and, if in good order, sends payment back to advising bank and debits buyer.
8. Documents are now released to buyer, and buyer can retrieve goods.

When shipping “under a letter of credit”, the seller must make sure to comply with all the terms and conditions listed on it. Failure to comply could delay payments and ultimately jeopardize the entire transaction.

If you need help with shipping under a letter of credit, please contact us at: sales@allynintl.com.