Letters of Credit (LC): Comprehensive Guide to Conduct

Currently, Vietnam is experiencing strong growth in foreign trade, with markets expanding globally and partners coming from various countries. To ensure security in the payment process, parties often choose suitable payment methods. One of the most effective and widely used payment methods is the documentary credit method. Below, Viet An Law Firm provides legal information regarding the Documentary Credit (Letter of Credit – LC) method.

What is a Letter of Credit (LC)?

According to Article 2 of UCP 600, a Letter of Credit is any arrangement, however named or described, that constitutes an irrevocable undertaking by the issuing bank to honor a complying presentation.

Benefits and Risks of Using Letter of Credit (LC): Comprehensive Guide to Conduct

Benefits

• It is a commitment to pay or accept payment, not merely a promise.
• Issued by one party, but may benefit one or multiple beneficiaries.
• It is a conditional and time-bound payment commitment.
• Since the parties in the contract are often located in different countries and may lack mutual trust, the LC helps eliminate this barrier.
• The exporter is guaranteed payment by the issuing bank if the required export documents are properly presented.
• The importer is guaranteed not to make payment until the conforming import documents are received.

Risks

The accuracy of documents must strictly comply with the terms and conditions of the LC.

Banks examine documents, not goods, so the goods delivered may not match the agreed quality.

The importer is still required to place a margin deposit with the issuing bank.

Key Characteristics of the LC Method in International Trade

•  LC is a legal instrument issued by the bank, at the request of the importer (buyer), committing to pay a specific amount of money to the exporter (seller) within a specified period, after the conditions stated in the LC are fulfilled.
• The LC transaction is completely independent from the sales contract or any other contract that serves as a basis for the LC. Under all circumstances, the bank is neither related nor bound to such contract, even if the LC refers to it.
• LC is a document-based transaction and payment is made solely on the basis of documents.
• LC requires strict compliance with the document set. In order to receive payment, the exporter must prepare a compliant set of documents that strictly adheres to the terms and conditions of the LC, including the types, number of copies, and content required for each document.
• According to the UCP, the applicable version must be explicitly stated in the Letter of Credit.

Contents of a Letter of Credit (LC)

• LC number, place and date of issuance
• Type of LC
• Names and addresses of related parties: applicant (buyer), beneficiary (seller), involved banks, etc.
• Amount and currency
• Validity period, payment period, and shipment period
• Shipping terms: delivery terms (Incoterms), place of shipment, destination, etc.
• Goods description: name, quantity, weight, packaging, etc.
• Required documents to be presented by the beneficiary: draft (bill of exchange), commercial invoice, bill of lading, insurance certificate, certificate of origin, etc.
• Issuing bank’s undertaking/commitment
• Other relevant terms and conditions

Common Types of Letters of Credit (LC) in Trade Finance

Classification by the bank’s commitment validity

• Irrevocable Letter of Credit: A type of letter of credit that, once issued, the issuing bank has no right to amend, supplement, or cancel during its validity period, except when agreed upon by all parties involved.
• Revocable Letter of Credit: A letter of credit that, once issued, the importer (applicant) can amend, supplement, or cancel at any time without prior notice to the beneficiary. This type is rarely used because a revocable LC is merely a promise without a firm commitment guarantee.

Classification by maturity

• Sight Letter of Credit: The simplest case of letter of credit where payment to the beneficiary is made immediately by the bank based on the presentation and verification of documents.
• Usance Letter of Credit: A type of letter of credit where the bank pays the beneficiary after a specified period, usually after the shipment date.

Step-by-Step Process of the Letter of Credit (LC) Method

Step 1: The importer requests the issuing bank to open an LC based on the payment terms in the contract.

Step 2: The issuing bank opens the LC based on this request and sends the LC to the advising bank.

Step 3: The advising bank reviews the LC and forwards it to the exporter.

Step 4: The exporter ships goods to the importer according to the LC and the underlying contract agreement.

Step 5: The exporter prepares the set of shipping documents and submits them to the advising bank.

Step 6: The advising bank checks the documents and presents them to the issuing bank.

Step 7: The issuing bank examines the documents; if they comply with the LC terms, the issuing bank remits payment to the advising bank.

Step 8: The advising bank credits the exporter’s account with the payment.

Step 9: The issuing bank presents the documents to the importer for inspection and hands over the documents so the importer can take delivery of the goods.

Important Notes When Receiving a Letter of Credit (LC) Application

• Prevent the importer from including underlying contract documents, quotation invoices, or similar documents as mandatory components of the LC;
• Avoid including too many details in the LC, as this may be disadvantageous for all parties involved. The longer and more detailed the LC, the higher the risk of errors or misunderstandings for the beneficiary, applicant, and the banks. It is a misconception that the more detailed the goods description and terms in the LC, the better protection it provides to the importer;
• Depending on the customer profile, the issuing bank will set a reasonable margin requirement ranging from 0% to 100% of the LC value;
• The LC application is an economic contract between the importer and the issuing bank, which becomes effective once the issuing bank accepts the LC application.

If you need further legal consultation on Letters of Credit (LC): Comprehensive Guide to Conduct methods, please contact Viet An Law Firm for the best support!