Letter of Credit (L/C)

A letter of credit is a standard payment security instrument in international trade. The English term Letter of Credit – L/C for short – is often used for this. An L/C (letter of credit) serves to reduce risks when exporting and importing goods and thus fulfills an important function in international trade.

Legally, the letter of credit represents an abstract promise to pay from a bank commissioned by the importer, from which the exporter can demand payment of the purchase price after delivery has taken place on presentation of suitable documents.
A letter of credit usually runs as follows:

• After the conclusion of a sales contract, the importer instructs his bank to open an L/C (letter of credit) in favor of the exporter. To do this, he must have a corresponding line of credit.
• The bank opens the letter of credit. A (correspondent) bank in the country of the exporter is usually used for processing. In the L/C (letter of credit), the goods of the commercial transaction are described in more detail and the documents to be submitted are specified. The bank irrevocably undertakes to pay the exporter upon presentation of the documents.
• The correspondent bank checks the regularity and offers to process the documents.
• The exporter arranges for the goods to be shipped. He will then receive the documents to be submitted.
• The exporter submits the documents to his bank and receives the agreed purchase price in return. The transport documents are then forwarded to the importer.
• With these, the importer can take possession of the goods, provided that the right of possession is attached to them. This is particularly the case with bills of lading (sea freight). In the case of air or land transport, on the other hand, the importer is often already the owner. The letter of credit then only serves to secure payment.