Irrevocable Letter of Credit: All You Need to Know
- What is an irrevocable letter of credit?
- What is an irrevocable letter of credit at sight?
- How to get an irrevocable letter of credit?
- How does an Irrevocable Letter of Credit Work?
- Is irrevocable LC safe?
- Do all Letters of Credit have are irrevocable nature?
- Can an Irrevocable Letter of Credit be revoked or cancelled?
- Who can issue an irrevocable letter of credit?
- What is the difference between an irrevocable letter of credit and a standby letter of credit?
- How to Cancel a Letter of Credit?
- What is a clean irrevocable letter of credit?
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.
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.
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.
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.
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.
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.
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!
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