A letter of credit (LC) is the most commonly sought document for international trade transactions, especially when the buyer and the seller are unfamiliar with one another, are separated by distance, and follow their respective country’s laws and trading customs. Irrevocable Letter of Credit (ILOC) which is a type of LC helps facilitate trade from the point of view of the seller.
What is an Irrevocable Letter of Credit?
An ILOC gives the seller a guarantee that he/she will receive the fixed amount due, and also by the right time from the buyer. As the name suggests, the document is irrevocable i.e. it cannot be revoked unless all the parties ask for a modification; only then, an exception can be made. An ILOC provides added risk protection for the seller by promising a guarantee from both the buyer's and the seller's bank.
What is a Clean Irrevocable Letter of Credit?
A clean LC is a mechanism through which the beneficiary of the credit can draw a bill of exchange that too without any extra documentation. A clean LC is irrevocable till the period of review begins.
Who issues an Irrevocable Letter of Credit?
An LC that is issued by a commercial bank guarantees that the correct payment amount is received by the seller on time. Suppose a buyer is unable to pay, the bank is liable to pay on his/her behalf, either for the remaining or for the complete amount of the purchase, whatever the case may be.
Terms & Conditions of Irrevocable Letter of Credit
The terms and conditions of ILOC are fixed and cannot be amended without the consent of the involved parties. The stakeholders, i.e. the buyer and the seller have to agree on all the clauses mentioned in the letter under the different possible scenarios. E.g. there are provisions about responsibilities for every stakeholder in case of any misconduct or fraud, omission, insolvency, etc. About misconduct, the letter specifies more provisions about security, blacklisting, and boycott.
Besides laying down terms and conditions for credit, issuing of credit, and event of a conflict, authority is also defined for disbursements in different scenarios. Also, provisions about timely occurring payments, renewals, settlements, and other obligations are mentioned in the terms and conditions. Special instances which require the prior consent of the stakeholders are also included in the list. There are cases about special deposits, and similar requirements wherein it is allowed to make assumptions, estimate allocations in good faith, and deem as appropriate. Moreover, provisions are made specifying the possession of goods, and acknowledgment of documents in conformity with terms and conditions of the credit.
How to get an Irrevocable Letter of Credit?
To obtain an ILOC, you need to reach out to your bank who will provide you with a representative. This representative has prior experience in international trade or hails from such a similar background, and will work with you to fulfill your requirements.
Don’t try to draft an LC on your own or attempt to copy someone else’s. This may lead to a greater legal and financial complication in the future even in case of a minor error. You may also not be able to claim your goods for which you have paid a fortune.
Writing your ILOC may seem right in the short run to save money. However, it can quickly escalate into an expensive affair and damage your business. Hence, it is advised to take help from your bank.
How does an Irrevocable Letter of Credit work?
An ILOC provides security to buyers and sellers with the assistance of their respective banks. The buyer doesn’t have to pay anything until the cargo has been shipped. And as long as the conditions of the letter have been fulfilled, the seller will get his/her money. An ILOC works as per the details of the letter and the documents attached. However, the basic elements remain the same in every LC. The elements and conditions are listed below.
- The bank makes the guarantee of the payment
- The LC is made on behalf of the buyer to pay the seller the said amount of money
- A specific set of documents are required to verify the supply of goods/services
- The following details must be mentioned– dates, locations, time limit, and the method of transaction
- All the attached documents must comply with the LC
As soon as the cargo has been shipped, a set of documents specifying details of the shipment will be sent to the buyer’s bank, according to the terms and conditions laid down by the parties involved. Then, the buyer’s bank sends these documents to the seller’s bank for review and payment. The bank then passes the LC to the seller along with any necessary paperwork required for claiming when the shipment arrives.
Although an LC is issued for security purposes, it does not eliminate risks. Both the parties, i.e. the buyer and the seller need to meet the requirements of the letter with 100% compliance to ensure smooth transactions and a guarantee of payment to the seller.
The bank has all the rights to refuse payment in case anything goes wrong. This includes the following:-
- Major problems such as delays in sending the shipment
- Minor problems like a typing error in the documents
Thus, both, the buyer and the seller must carefully examine every step to facilitate smooth and hassle-free transactions of goods and on-time payment to the seller. All the conditions laid down in the LC have to be fulfilled for 100% compliance.
Irrevocable Letter of Credit - Cost
A generic ILOC is usually priced in the range of 1-2% of the amount covered in the contract. The cost depends on the type of ILOC used, customer credit history, tenure, safeguarding clauses, and various other factors. The rate also depends on the bank selected as they will add some margin to the LC.
For example, if the seller wants a credit of $100,000, out of which the buyer is ready to cover 10%, the ILOC will be drafted for $10,000. Considering the cost of ILOC to be 2% of the amount covered, the cost for ILOC will be $200.
Irrevocable Letter of Credit form - Template
Difference between Irrevocable Letter of Credit and Other terms
Irrevocable LC - Key Difference with other terms
In Irrevocable LC, the exporter feels more secure knowing that the bills drawn under the credit will be honored by the issuing bank after the fulfillment of conditions of the LC agreement. In terms of payment, any amendment or cancellation of credit will not be effective unless the exporter gives consent to such amendment or cancellation.
Whereas in Revocable LC, the exporter is not at an advantage here as there is not an absolute undertaking by the issuing bank. In terms of payment, the bank in the exporter’s country is not aware of any cancellation or amendment, therefore bears the risks of payment being refused by the issuing bank.
Again in Bank guarantee, this becomes active only when the applicant defaults on the payment. The payment is made to the beneficiary only after non-fulfillment of the obligations.
Standby Letter of Credit
A Standby Letter of Credit becomes active only after the primary Letter of Credit is defaulted by the buyer. This letter provides security to the seller that he/she will be paid without another default. If the buyer does not meet the payment terms mentioned in the primary document, the seller can show this letter to the buyer's bank for payment.
Performace and Surety Bond
In case of a default, the Performance bond surety company will not take an unconditional liability to pay. It will investigate the issue and then transfer the payment. Whereas, a surety bond does not mature until the principal obligor defaults on the underlying contract. After that, the third party is liable for the payment. In both cases, the payment is made by the bond surety company only after proper investigation.
FAQs on Irrevocable Letter of Credit
1. Are all Letters of Credit irrevocable?
Under the latest UCP 600 (Uniform Customs & Practice for Documentary Credits) rule, all Letters of Credit are irrevocable. These letters are further classified into Unconfirmed and Confirmed Irrevocable Letters of Credit.
2. Can an Irrevocable Letter of Credit be canceled?
No, an Irrevocable Letter of Credit cannot be canceled. For modifications or amendments, the issuing bank must take prior consent from all the parties involved.
3. Can an Irrevocable Letter of Credit be revoked?
No, an Irrevocable Letter of Credit cannot be revoked. For modifications or amendments, the issuing bank must take prior consent from all the parties involved.
4. What is an Irrevocable Letter of Credit payable at sight?
It is a document that verifies the payment of goods or services. In this case, the payment is done once the Sight Letter of Credit is presented along with the necessary documents. This type of Letter of Credit is payable to the beneficiary once the required documents backing the letter are presented to the financial institution.
5. What is an Irrevocable Letter of Credit without confirmation?
An unconfirmed Irrevocable Letter of Credit provides a commitment by the issuing bank to pay, accept, or negotiate a Letter of Credit. An advising bank forwards the Letter of Credit to the beneficiary without undertaking any responsibility or commitments on its part, yet confirming the authenticity of the document.
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