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The letter of credit (LC) allows the buyer and Seller to contract a trusted intermediary
(a bank) that will guarantee full payment to the seller provided that he has shipped
the goods and complied with the terms of the agreed-upon Letter. This instrument,
although inherently simple, can have many variations.
LCs are typically irrevocable, which means that once the LC is established it cannot
be changed without the consent of both parties. Therefore the seller, especially when
inexperienced, ought to present the agreement for an LC to an experienced bank, a
trusted broker, and its freight forwarder so that they can help to determine if the LC is
legitimate and if all the terms can be reasonably met. A trusted bank, other than the
issuing or buyer's bank can guarantee the authenticity of the document for a fee.
Disadvantages
The LC has certain disadvantages. If even the smallest discrepancies exist in the
timing, documents or other requirements of the LC the buyer can reject the
shipment. A rejected shipment means that the seller must quickly find a new buyer,
usually at a lower price, or pay for the shipment to be returned or disposed. Besides
being one of the most costly forms of payment guarantee LCs also take time to draw
up and usually tie up the buyer's working capital or credit line from the date it is
accepted until final payment, rejection for noncompliance, expiration or cancellation
(requiring the approval of both parties).
Titany answered the question on November 25, 2021 at 11:20
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