If a new overseas buyer wants goods on credit and you have no history with them, a letter of credit (LC) lets you ship with a bank’s promise to pay standing behind the deal. This article explains how an LC actually protects you, when it is worth the cost, and the document mistakes that get payment refused even when your goods are perfect.
What a letter of credit really is
A letter of credit is a written undertaking from the buyer’s bank (the issuing bank) to pay the seller once the seller presents documents that comply with the terms in the credit. The key idea is independence: the bank pays against documents, not against the goods and not against the buyer’s opinion. If your paperwork matches the LC, the bank must pay, even if the buyer changes their mind.
That independence is the whole value. It replaces trust in an unknown buyer with trust in a bank. It is governed by a real, widely used rulebook: the ICC’s Uniform Customs and Practice for Documentary Credits (UCP 600). Most banks worldwide apply it.
The parties involved
- Applicant — the buyer, who asks their bank to issue the LC.
- Issuing bank — the buyer’s bank, which makes the payment promise.
- Beneficiary — you, the seller.
- Advising / confirming bank — a bank in your country that passes on the LC and, if it confirms, adds its own payment guarantee.
When an LC is worth it — and when it is not
An LC is not free. Expect issuance, advising, confirmation, and amendment fees, plus the buyer’s cash may be tied up. Use one when the situation earns that cost.
| Use an LC when | Skip it when |
| First deal with an unvetted buyer | Long, trusted relationship on open account |
| High order value relative to your cash buffer | Small orders where fees eat the margin |
| Buyer’s country has payment or currency risk | You can secure advance payment instead |
| Buyer insists on credit terms you can’t verify | You already hold credit insurance covering the buyer |
A confirmed LC adds a second bank’s guarantee, which matters when the issuing bank or its country carries risk. If the issuing bank is a strong international institution, an unconfirmed LC may be enough.
A real scenario
A packaging manufacturer takes a first order from a distributor in a market it has never sold to. The buyer wants 60-day terms. The manufacturer instead asks for an irrevocable LC confirmed by a bank in its own country. It ships, presents a clean bill of lading, commercial invoice, and packing list, and the confirming bank pays on presentation. The buyer’s later complaint about delivery timing becomes a separate commercial matter and does not touch the payment already received.
Common mistakes and how to fix them
The failure point is almost never the goods. It is documents. Banks routinely reject presentations for small discrepancies, and a rejected presentation means you have shipped without a guaranteed payment.
- Name and spelling mismatches — the company name on your invoice differs from the LC. Fix: copy the LC’s wording exactly, character for character.
- Late presentation — you miss the presentation period or the LC expiry. Fix: calendar both dates the day the LC arrives and build your shipping plan backward from them.
- Inconsistent documents — the weight on the packing list differs from the bill of lading. Fix: reconcile every figure and description across all documents before submitting.
- Accepting terms you cannot meet — the LC demands a document you cannot obtain in time. Fix: review the draft LC before it is issued and request an amendment early, not after shipment.
Read the LC before you accept it
Treat the incoming LC like a contract you must perform to the letter. If any term is unworkable, ask the buyer to amend it before you ship. Once goods are on the water, your leverage drops.
Action checklist
- Confirm the LC is irrevocable.
- Decide whether you need it confirmed based on the issuing bank and country risk.
- Check that every required document is one you can actually produce.
- Verify shipment, presentation, and expiry dates are achievable.
- Match all names, descriptions, and quantities to the LC’s exact wording.
- Present documents early, never on the last allowed day.
Conclusion and next step
A letter of credit converts an unknown buyer’s promise into a bank’s obligation, but only if your documents are flawless. Your next step: build a per-LC document checklist template so nothing is discovered too late. Involve your bank’s trade finance desk before you accept the next LC, not after.
FAQ
Does an LC guarantee I get paid no matter what?
It guarantees payment against compliant documents. If your presentation has discrepancies, the bank can refuse. Clean, matching documents are the condition.
What is the difference between confirmed and unconfirmed?
An unconfirmed LC relies only on the issuing bank. A confirmed LC adds a second bank’s independent promise to pay, useful when the issuing bank or its country carries risk.
Who pays the LC fees?
It is negotiable. Typically the buyer pays issuance and their own bank’s charges, while the seller pays advising and confirmation fees, but you can agree otherwise in the sales contract.
Is an LC the same as documentary collection?
No. In a documentary collection the bank only handles documents and does not guarantee payment. An LC carries the bank’s payment undertaking, which is stronger and costs more.
References
- International Chamber of Commerce (ICC) — Uniform Customs and Practice for Documentary Credits, UCP 600.
- ICC — International Standard Banking Practice (ISBP) for document examination.