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Letters of credit: A primer for creditors

Letters of credit are a tool that can aid in business transactions. These documents can serve as a mechanism for payment during certain business transactions. In order for a letter of credit to be valid, a number of criteria must be met.

Although the details will vary with each transaction, the three basic "Ps" of these dealings are listed below:

  • Payment. The issuing bank undertakes payment from the buyer, known as the applicant, to the seller, known as the beneficiary.
  • Presentation. The transaction occurs when certain documents are presented that represent the goods as agreed upon by the parties in the terms and conditions of the letter of credit.
  • Prompt. The transaction must occur within the agreed upon time period.

When the payment to the beneficiary is fulfilled as outlined in the letter of credit, the applicant or buyer is liable for payment to the issuing bank.

How common are letters of credit? A recent publication by the Credit Research Foundation points out that the use of letters of credit as a means to mitigate the risk of certain types of business transactions has grown in the last decade.

What kind of issues can arise with these documents? Creditor rights issues can take a number of forms in these types of transactions. A beneficiary may have difficulties attempting to collect on the letter of credit or a bank may experience issues seeking payment from the applicant.

Those who find themselves in these situations are wise to consult with a business debt lawyer. This legal professional will review the details of the transaction and work to better ensure your interests are protected.

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