A letter of credit is a means to ensure payment will be made correctly in almost all transactions especially international ones. Such a letter is a letter from the buyer’s bank to the seller. It guarantees that the buyer’s payment will be paid to the seller on time, that is, only once the bank receives confirmation of shipment of goods. The ‘guarantee’ part indicates that the bank is acting for the buyer (the “holder of the letter of credit”) to cover the amount (in full or in part) if the buyer defaults (i.e. unable to make payment).
The letter of credit is a document proving a payment commitment of the bank vis-a-vis the seller buyer. The bank undertakes by this document to pay the seller, on behalf of the buyer, if the seller provides the documents ( transport document, invoice, insurance document, packing list). A letter of credit is one such instrument issued by the bank on the request of an importer, in which the bank promises to pay the beneficiary upon presentation of documents specified in the letter of credit. It is a security for both the parties, i.e., the supplier and the purchaser. It limits the risks in comparison to other methods of payment.
The following is a sample of Credit Letter
United Central Bank,
224 McDonald Street
Ottawa, ON K1P 5M7
Bolton Engineering Corporation
1900 Justice Street
Ottawa, ON K1P 5M7
Re: Irrevocable Letter of Credit No#: B323394
We at this moment open this irrevocable credit in your favor for the sum of Eighty thousand dollars ($80,000), which will be available through your request for the purpose of payment on sight of your draft presentation with the following statement:
‘Bolton Engineering Corporation has a right to the amount drawn according to the terms and conditions of as per Agreement by the exporter.’
This Letter of Credit is valid until DD/MM/YYYY, which will be automatically extended without amendment for another two years from the present or any future expiration date thereof. Unless the Issuing Bank issues a written notice of not less than thirty days (30) days before the expiry date to Bolton Engineering Corporation. The notice required below is deemed to be served upon your receipt, only then can any action be taken on our part. Before that nothing can be done.
This Letter of Credit issued is by the Standard Customs and Practice for Documentary Credits, 2008 Version National Chamber of Commerce Publication No. 400
United Central Bank