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Q.What is a Letter of Credit?
A.A letter of credit simplistically explained is a letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. It is a contractual agreement between a bank, known as the issuing bank, on behalf of one of its customers (a business owner), guaranteeing payment to the recipient so long as the recipient meets the terms and conditions set forth in the letter. Generally the letter of credit will require the seller to present his bank with the required shipping forms confirming the delivery of goods within a specified time.
A letter of credit is often requested by foreign suppliers to ensure they get paid. For the US company, it ensures that it receives the goods bargained for – otherwise the supplier will not get paid.
There are four (4) types of Letters of Credit:
- A Revocable Letter of Credit can be modified, amended or cancelled. Because it can be modified, most suppliers will not accept a revocable letter of credit.
- An Irrevocable Letter of Credit is a payment guarantee, and as such is preferred by most suppliers.
- A Standby Letter of Credit is a payment guarantee that allows the recipient to draw on the letter of credit if the client does not pay.
- A Transferable Letter of Credit can be either revocable or irrevocable, but in either case allows the recipient to transfer part or all of the benefits to another party.
Qualifying for a letter of credit typically requires either: (1) the business owner to have the amount guaranteed by the letter of credit on deposit with the bank issuing the letter of credit; or (2) qualification for a line of credit with the bank issuing the letter of credit.
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