What are the terminologies used in a Letter of Credit transaction?

(This post explains about  LC on Sight Payment and LC on Usance terms, LC (Inland) and LC (Foreign), Freely negotiable and Restricted Letters of Credit, Uniform Customs and Practice (UCP) for Documentary Credits.)

Definition of Letter of Credit: Letter of credit (LC) is an undertaking letter issued by the importer’s (buyer’s) bank wherein the seller is assured of full payment of goods/service sold by him on a condition that the supplier fulfills his part of the sale contract embodied in Letter of Credit.

Letter of Credit (LC) is called as “Documentary Credit”  in view of credit available to the supplier (seller) immediately against submission of documents to his bank for negotiation. 

 LC on Sight Payment and LC on Usance terms 

‘LC on Sight Payment’ means the payment should be made on receipt of the document by LC issuing Bank. The other type of LC is ‘LC on Usance terms’.  LC Bills under Usance terms are the bills payable by the buyer/importer at a specified period ‘after date’ or ‘after sight ’of the bill. The term ‘after date’ means the due date will be calculated from the date of the bill. The term ‘after sight’ means the due date will be calculated from the date of presentation of the bill.  In both the cases, the exporter would get immediate payment from negotiating bank. However, for negotiation of LC under usance terms, the beneficiary /seller/exporter has to pay interest/discount charged by the negotiating bank for usance period.

 LC (Inland) and LC (Foreign) 

If an LC is issued to a beneficiary (seller) in the same country, such LC is called ‘Inland LC’ and if the LC is issued to a beneficiary of the foreign country such LC is called ‘LC (foreign)’.

 Freely negotiable and Restricted Letters of Credit

Letter of credit which is marked ‘freely negotiable’ indicates that it may be negotiated by any bank chosen by the beneficiary. It is possible to open a letter of credit marked to designated bank to negotiate the LC. Such LC where negotiation is restricted to designated bank is called ‘Restricted Letter of Credit’. 

Uniform Customs and Practice (UCP) for Documentary Credits

Uniform Customs and Practice (UCP) for Documentary Credits is a set of uniform rules established and published by International Chamber of Commerce on the issuance of Letter of credit and method of handling letter of credit in international trade finance. The voluntary codes of UCP are applied by the banks and commercial parties in more than 175 countries all over the world. Though drawn up rules of UCP do not have the binding of law, they have gained almost universal acceptance and are incorporated as a reference in all documentary credits. The International Chamber of commerce with their headquarters in Paris first published Uniform Customs and Practice for Documentary Credits in 1933 and same was periodically revised 1951, 1962, 1974, 1983, 1993 & 2007. The latest UCP revision is done in July 2007 under publication No.UCP 600 of ICC. UCP is a voluntary code applied by the banks all over the world.

Related articles:   (i) Mechanism of the letter of Credit transactions (ii) Folks tangled in the issuance of a letter of Credit (iii)  Standby LCs of different types  (iv) Uniform Customs and practice for Documentary Credit

(v) All about different kinds of letters of credit