1.
0 Introduction
1.1 Letter of Credit
A letter of credit is a crucial financial instrument in international trade,
providing a guarantee from a bank that a buyer’s payment to a seller
will occur on time and for the specified amount. When buyers face
challenges in meeting their financial commitments, the bank steps in
to cover unpaid amounts, ensuring seamless trade transactions.
This arrangement is vital in overcoming challenges inherent in
international dealings, such as differing national laws and the
geographical distance between trading parties. As a result, letters of
credit are indispensable in protecting both buyers and sellers from
potential risks during trade.1 Letters of credit facilitate trade by
lowering risk, building trust, and ensuring all parties meet their
expectations.
1
Kagan J, Understanding Letters of Credit: Definition, Types, and Usage available at
<[Link] > accessed on 17th February
2026
Buyers who make major purchases can use letters of credit in
domestic and international trade.
A bank issues a letter of credit to guarantee payment to the seller,
ensuring that the seller is paid. The buyer must prove to the bank that
they have enough assets or a sufficient line of credit to pay before the
bank will guarantee the payment to the seller.2
A Letter of Credit is usually issued as Irrevocable which cannot be
amended or cancelled without the agreement of all parties, including
banks, at a minimum, there are two banks involved in a Letter of Credit
transaction the Buyer’s bank (Issuing Bank) and the Exporter’s bank
(Advising/Negotiating Bank). The Exporter’s bank advises the Letter of
Credit to the Exporter and subsequently presents the Exporter’s
documents to the Issuing Bank on the Exporter’s behalf.3
1.2 How to Apply for a Letter of Credit
The letter of credit process commences with the buyer and seller
agreeing on the terms of the transaction. The buyer then approaches
2
Ellinger, P. and Neo, D. The Law and Practice of Documentary Letters of Credit (Hart Publishing, 2010).
3
Ellinger, E.P. Documentary Letter of Credit: A Comparative Study (University of Oxford, 1964).
their bank to initiate the letter of credit process by submitting an
application and the seller draws up a purchase and sales agreement.
The purchase and sales agreement between the buyer and the seller
stipulates that payment is made through a letter of credit. The buyer
requests his bank to issue a letter of credit. The letter of credit must be
in accordance with the purchase and sales agreement.
The buyer provides the bank with the necessary information for the
letter of credit, such as both the buyer's name and address and the
seller's name and address, terms of payment, amount, the currency
to be used, the validity period of the letter of credit, shipment details
(for example, shipment method, port of loading and discharge), the
required documents (for example, commercial invoice, packing list,
bill of lading, certificates), and any special conditions, such as partial
shipments or transshipment.4
4
[Link] Accessed on 23rd February 2026
Letters of credit help avoid costly mistakes and payment delays. Due
to industry variations and the variety of letters of credit, each may be
approached differently.
Here's an import-export example.
a) The importer's bank's credit must satisfy the exporter and their
bank. The exporter and importer complete a sales agreement.
b) Under the agreement, the importer's bank drafts the letter of
credit, which is sent to the exporter's bank. The exporter's bank
reviews the letter and sends it to the exporter after approval.
c) The exporter ships the goods as per the letter of credit. Any
required documentation is submitted to the exporter's bank.
d) The exporter's bank reviews documentation to ensure the letter
of credit's terms and conditions are met. If approved, the bank
submits documents to the importer's bank.
e) The importer's bank sends payment to the exporter's bank. The
importer can now claim the goods sent.
2.0 Uniform Customs & Practice for Documentary Credits (UCP 600)
The Uniform Customs & Practice for Documentary Credits (UCP 600)5
is a set of rules issued by the International Chamber of Commerce
(ICC), published in 2007. It governs the Letters of Credit. The UCP 6006
rules do not hold legal force in any country, but apply to Letters of
Credit almost anywhere in the world, and must be incorporated by
express reference in them.7
The UCP 600 is used to standardize the rules governing Letters of Credit
to standardize transactions and benefit all parties. The rules were
created by industry experts, and are mandated by the ICC Banking
Commission rather than through legislation. This means that the same
set of rules are applicable in the same way in nearly every country.
The first UCP was created in 1933 and has been revised periodically
by the ICC. The UCP 600 is the latest version of the rules governing
letters of credit; a supplement, the UCP, was published in 2019 to
govern electronic transactions.8
5
(ICC Publication No. 600).
6
Ibid.
7
< [Link] > accessed on 17th February 2026.
8
Ibid.