Letter of credit is one of the most important payment methods in domestic and international business transactions. It is a crucial tool in major business transactions, especially in cases where the parties enter into a transaction with each other for the first time or require assurance about the other party and its position. Karimi & Associates Law Firm, benefiting from specialists in domestic and international commercial contracts and arranging letters of credit, is fully prepared to provide all services related to this field to Iranian and foreign business people and companies, giving you the reassurance you need.
The substance of the letter of credit
Letter of Credit (L/C), one of the common payment methods and financial tools in commercial contracts and exchanges, was established in 1933 by the International Chamber of Commerce. As a contractual agreement between the parties of a commercial transactions, this payment method is a type of guarantee and reassurance from one of the parties to the contract. It is executed with the utmost professionalism and security by banks and financial credit institutions, ensuring the smooth flow of commercial transactions.
For instance, in an international contract for the sale of goods, the involved parties, hailing from two distinct countries, often require adequate guarantees to initiate a transaction and foster mutual trust. In this context, the seller’s request for the buyer to furnish a letter of credit is a significant step, ensuring the receipt of the transaction price and reflecting the seller’s need for security in international transactions.
After opening an account in a bank or financial institution, the purchaser can receive a letter of credit for the total amount of the contract or a part of it and present it to the seller. This process is designed for convenience, as it ensures that after the seller fulfills the obligations and sends the goods to the purchaser, they will receive the contract fee in the letter of credit issuing bank by presenting the shipping documents.
Therefore, a letter of credit is a promise to pay and a document that one of the parties, a natural person or a legal entity, receives from the bank or financial credit institution with which they have opened a letter of credit account to reassure the other party. That bank or institution should pay the relevant amount to the seller instead of the purchaser.
Types of letters of credit
Letters of credit can be issued and used for domestic and international transactions. There are also different types of this document, which the most useful types come below:
Revocable and Irrevocable LC
In revocable L/C, the issuing bank can modify or change the terms of the credit without notifying and obtaining the seller’s consent; However, in irrevocable L/C, any change in the letter of credit will be subject to the seller’s acceptance and consent.
Confirmed and Unconfirmed L/C
A confirmed letter of credit is approved by the issuing bank (beneficiary/broker) or any other reliable bank requested by the seller in addition to the credit-issuing bank. If the seller accepts it without confirmation by another bank, the letter of credit is considered unconfirmed.
Transferable and Nontransferable L/C
In transferable letters of credit, the main beneficiary or the seller has the right to assign all or part of the credit to someone else, but the beneficiary does not have such a possibility in non-transferable L/Cs.
Back to Back L/C
A back-to-back letter of credit consists of two letters used to finance the same transaction. These are usually used as financial support during international transactions. The purchaser’s bank issues the first letter of credit to an intermediary.
Red Clause L/C
This type of letter of credit allows the seller to receive part or even all of the funds before sending the goods to the buyer, in the form of a prepayment from the bank that issues or approves the letter of credit. The term derives from the bank that issued such a credit for the first time. To attract more attention, the text of the credit conditions, which included the possibility of paying a part of the credit in advance, was in red.
Uniform Customs and Practice for Documentary Credits
These regulations are a set of 39 articles regarding the issuing and using letters of credit in 175 countries and cover approximately $1 trillion of global trade annually.
The latest version of ucp600 was issued and published by the International Chamber of Commerce in 2007.
L/C Advantages
Letters of credit, as one of the most modern methods of payment in domestic and international commercial transactions, have significant advantages, some of which are mentioned below:
- Reducing the risks in transactions, especially international ones, due to the bank or financial institutions’ roles as payers of the contract amount.
- Assurance of the parties towards each other and fulfilling the obligations of each party: In international transactions, the fear of non-compliance due to various factors such as geographical distance, language barriers, cultural differences, and diverse legal systems and business customs is a common concern. However, using letters of credit effectively mitigates this fear, reassuring all parties involved.
- Increasing the speed of transactions.
- Diversity of letters of credit and the possibility of choosing the best according to the conditions of the transaction and the agreement of the parties.
- The possibility of obtaining facilities after opening an account.
- The possibility of controlling the shipping time and the final delivery of the goods.
L/C Disadvantages
Along with the advantages of letters of credit, these documents may also cause some challenges and risks, including:
- Risk of fraud by the seller:
By forging the document or making some changes, the seller might submit the forged document to the bank without delivering the goods to the purchaser and receive the amount stated in the letter of credit.
- Risks related to regulations and restrictions imposed by governments, including banking and financial sanctions
- Suspension of contract implementation due to events such as Acts of God, war, rebellion, etc.
It should be noted that the issuance of letters of credit in Iran is subject to the National Law and the regulations of the Central Bank. Conversely, letters of credit issued outside of Iran need to be checked and verified by legal experts, including banking and financial law experts. In this regard, Karimi & Associates Law Firm, with a team of lawyers and experts in financial and banking law, is ready to provide services related to opening documentary accounts, issuing documentary credits, and reviewing foreign documentary credits.