Irrevocable Letter of Credit: All You Need to Know

To understand an Irrevocable Letter of Credit, imagine a Jordanian firm (hereinafter buyer) entering into a contract to buy reinforced steel rods from a British firm (hereinafter seller) that needed to be delivered in two instalments. The buyer requested the issuing bank to issue two letters of credit in favour of the seller, out of which one LC was realized and paid as per the agreement upon the delivery of 1st instalment.

After this, it was discovered that the consignment was not as per the contract, and the buyer requested to stop the realization of the 2nd LC, where the court held that a confirmed LC constituted a contract between the banker and the vendor, imposing an obligation upon the banker to pay, regardless of a dispute between the parties or whether or not the goods met contract requirements. 

A similar verdict was rendered in another case, where the court stated that courts should not stop banks from honouring LC, as it creates confusion and undermines confidence in the banks. 

From the above two statements, it can be concluded that a letter of credit cannot be stopped regardless of any reason, and payments are assured and paid to the seller’s bank.

What is an irrevocable letter of credit?

It is a primary legal instrument that assures you the payment of the goods or services rendered by the seller as soon as the requirements are met, assuring the buyer of timely delivery of goods and the seller of timely payment in a secure manner. This document can’t be edited, amended, or cancelled by the parties involved or the bank except in the conditions explicitly mentioned in any clause. The LC is generally used in international transactions where the buyer and seller are unknown to each other due to distance, varying laws, and no specific communication channels and data. This LC refrains any parties to the contract and even the bank from committing fraud and securing the transaction. 

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There are two kinds of irrevocable letters of credit. One is a confirmed letter of credit in which three parties are involved, i.e. issuing bank, seller, and confirming bank. With this LC, the issuing bank does not have the authority to amend or edit the LC without the beneficiary’s and confirming the bank’s consent. An unconfirmed irrevocable letter of credit includes the issuing bank and the seller. In this LC, the issuing and confirming bank cannot edit the LC without the beneficiary’s consent.

Also, read: Top Tips About Revocable Letter of Credit

What is an irrevocable letter of credit at sight?

Irrevocable LC at sight guarantees payment to the seller in return for the goods and services rendered by the seller. There’s no significant difference in an LC or irrevocable LC at sight except that the latter is the quickest way to make the payment, i.e. within 5-10 days of meeting the requirements of the contract. Like an ordinary LC, LC at sight is presented to the issuing bank along with the supporting documents. This process of verifying and submitting the documents is called sighting LC. 

Benefits of Using an Irrevocable Letter of Credit

For Sellers:

Sellers experience substantial benefits when engaging in transactions secured by an Irrevocable Letter of Credit. The essential advantage for sellers is the payment guarantee the issuing bank provides. The ILOC serves as a contractual commitment that the seller will receive payment from the bank upon meeting the specified requirements. This assurance substantially mitigates the risks associated with non-payment or delayed payment, providing sellers with financial security and predictability in their international trade dealings. By leveraging an ILOC, sellers can confidently engage in transactions, knowing that the agreed-upon terms will be honoured, fostering trust and reliability in the business relationship.

For Buyers:

Buyers gain significant advantages through the utilization of an Irrevocable Letter of Credit (ILOC). The foremost benefit lies in the assurance that payment will only be executed upon the proper documentation and compliance with pre-established conditions. This mechanism significantly mitigates the risk of non-performance by the seller, enhancing the buyer’s confidence in international trade transactions. By relying on an ILOC, buyers introduce a stringent framework that safeguards their financial interests, ensuring that payment is contingent upon successfully fulfilling agreed-upon terms and conditions.

How to get an irrevocable letter of credit?

Once the parties have entered into a contract, the applicant can request your bank to issue you a letter of credit, subject to the conditions agreed, after which your creditworthiness will be checked and verified, and if it seems promising to the bank, the irrevocable LC is issued and sent to you. Please don’t try to draft the LC by yourself, as this can prove dangerous for your trade and even result in financial losses, this may seem economical to you, but it can be an expensive affair since the bank may refuse payment even in major situations where the contractual requirements aren’t met, such as late delivery of goods, and even minor issues such as documentation errors. 

Specifications for irrevocable letters of credit:

• It cannot be changed or amended.
• These are authenticated and transferred through SWIFT. 
• This comes with greater security and quicker payments. 

How does an Irrevocable Letter of Credit Work?

This is a conditional document until and unless the seller’s bank completes its obligation to do the work. The buyer’s bank is not required to pay for it, but how does Irrevocable LC work in these transactions? Well, the process involves the following steps:

• The parties enter into a contract, post which the buyer requests the issuing bank to issue an LC which is then issued to the advising bank. After verifying the details, the advising bank forwards and communicates this to the seller. 
• The goods are shipped, relevant documents of delivery are sent to the advising bank, and the payment is realized per the payment terms.

Contents of an ILOC

Specifications for an Irrevocable Letter of Credit (ILOC) can vary depending on the context in which it is utilized and the specific transaction conditions. Generally, an ILOC encompasses the following details:

• Buyer’s Information: Buyer’s name and complete banking details, including their bank account information.
• Seller’s Information: Seller’s name and comprehensive banking information.
• Information on the Issuing Bank: Identify the name, address, and contact details of the financial institution issuing the letter.
• Information on the Beneficiary: Identifying the seller or beneficiary with their name, address, and contact details; the beneficiary receives funds upon meeting the ILOC’s conditions.
• Credit/Dollar Amount: Stating the maximum cash amount the beneficiary may receive upon fulfilling ILOC requirements.
• Issuance and Expiry Dates: Date of issuance and the expiration date of the letter of credit.
• Conditions for Validity: Conditions that must be met by both buyer and seller for the contract to be valid, establishing the transaction’s creditworthiness.
• Verification Requirements: Specifications on verification processes, such as written confirmation from the seller that goods or services have been provided before payment.
• Bank Representative Signature: The letter of credit must bear the signature of an authorized bank representative and may need to be printed on official bank letterhead for validity.
• Terms and Conditions: Specifying requirements for payment satisfaction, which may include shipping, inspection, documentation, and compliance with laws and rules.
• Required Documentation: Detailing the specific paperwork the beneficiary must provide for payment, such as commercial invoices, transportation records, origin-certification records, and inspection records.

Is Irrevocable LC Safe?

Yes, irrevocable LC is safe from all other forms of LC, especially the revocable letter of credit. The contract cannot be changed or amended by one party without the prior approval of the other parties facilitating international trade and guarantees payment to the seller once the requirements are met. This gives both parties credit risk protection and a sense of relief that the payment and goods will be honoured as per the contract, encouraging international trade.

Alternatives to Irrevocable Letters of Credit (ILOC)

In scenarios where an irrevocable letter of credit (ILOC) may not be the most suitable option, buyers and sellers have several alternatives to consider:

• Cash in Advance: This involves the buyer making a full upfront payment to the supplier before receiving the goods or services. While the upfront payment provides the seller with significant protection, it may be less advantageous for the buyer due to the sizable upfront cost.
• Open Account Transactions: in this option, both parties agree to postpone payment until after receiving the product or service. Ideal for established, long-term relationships built on mutual trust, this method relies on the buyer’s willingness to pay, introducing a larger risk for the seller.
• Documentary Collection: This involves the exchange of paperwork and payments through a bank, acting as a mediator without guaranteeing payments, suitable for certain trade relationships. Bank guarantees, such as payment or performance guarantees, provide sellers with assurances from banks on behalf of buyers, offering compensation in case of default.
• Bank Guarantees: Under this option, Banks offer assurances to sellers on behalf of buyers, guaranteeing compensation up to a specified amount in case of buyer default or non-performance. This option has various categories including; Payment guarantees, performance guarantees and bid bonds, tailored to specific needs. It offers more advantages to sellers by offering enhanced security for sellers with customizable guarantees.
• Escrow Services: This entails using a third-party agent to hold funds until specific conditions are met, providing security for both the buyer and the seller, with funds released upon buyer confirmation of satisfaction. 

FAQs

Do all Letters of Credit have are irrevocable nature?

As per the latest version of UCP 600, which is a set of private rules for trade, article 2 of it defines credit that any arrangement named or described as “irrevocable” article 3 of it talks about the interpretation which states that credit is irrevocable even if there is no indication that it is. Hence, yes! all letter of credit is irrevocable. 

Can an Irrevocable Letter of Credit be revoked or cancelled?

Article 10 of the UCP600 rules clearly state that a letter of credit cannot be amended or cancelled without the permission of the beneficiary. This ensures that the security related to the money associated with the letter and the transfer of the LC remains intact.

Who can issue an irrevocable letter of credit?

These LCs are issued as a guarantee or written commitment by the commercial bank or federally insured financial institution to make the payments mentioned in the contract as soon as the contract’s requirements are met. 

What is the difference between an irrevocable letter of credit and a standby letter of credit?

Irrevocable LC works as a primary payment method and does not require any specific conditions to be met for the contract to be successful, unlike SLBC, which is a secondary payment method that only becomes active once the buyer fails to make the payments, post which the seller needs to furnish the relevant documents like proof of delivery date and period. 

Irrevocable LC is generally issued as a short-term instrument (up to 90 days), while an SLBC is issued for a long term (one year or longer). The SLBC’s cost of issuance (ranges from 1%- 10% ) is more than Irrevocable LC (ranges from 0.75%-1.50%). 

How to Cancel a Letter of Credit?

In accordance with the letter of credit rules, under article 10, a credit cannot be cancelled or edited. However, this statement can be interpreted as “LC cannot be cancelled solely by the issuing bank. However, it can be done if a written declaration is submitted to the issuing bank by the beneficiary(and by the seller depending upon the contract) regarding the cancellation of the LC. 

What is a clean irrevocable letter of credit?

Clean Irrevocable LCs do not have any performance obligations clause or require specific documentation submitted to the bank or financial institution for payments. For example, in an Irrevocable LC, the seller sends the shipment and gets his payment without showing any financial documents like proof of delivery. This document is generally used with established financial institutions and trading partners. One of the key differences between clean Irrevocable LCs and commercial LC is that the former is used as a payment mode while the latter serves as a guarantee of payment.

 Conclusion

An irrevocable letter of credit must be obtained through the bank. You should not try to craft a letter or adapt somebody else’s letter of credit. Doing so can put you at risk of an expensive legal battle, potentially overseas. This instrument is pivotal and fosters trust and security in international trade transactions. For buyers, it safeguards against non-performance by ensuring payment upon proper documentation and compliance. Simultaneously, sellers benefit from the payment guarantee the issuing bank provides, offering them confidence and mitigating the risks of non-payment or delays. The ILOC, with its structured framework and assurance mechanisms, plays a crucial role in facilitating smooth and reliable transactions and promoting financial security for both parties involved. In the dynamic landscape of global commerce, the Irrevocable Letter of Credit stands as a cornerstone, reinforcing the foundation of trust and efficiency in cross-border trade relationships. 

LegaMart’s team of experienced lawyers is always there to help you or provide the necessary information to obtain your letter of credit. Contact them now!