LC payment (Letter of Credit): Process, benefits and risks

LC payment is an international payment method through which the bank, on behalf of the importer, commits to the exporter to make payment when the exporter presents documents in accordance with the provisions of the LC. This process ensures the rights of both parties in international trade transactions. This article will analyze in detail the process, benefits, risks and prevention in LC payments.

What is LC payment?

LC (Letter of Credit) payment is an international payment method in which the bank, on behalf of the importer, commits to the exporter to pay a certain amount of money within a specified time, when the exporter presents a set of documents in accordance with the terms and conditions stated in the LC.

Parties involved in LC payment:

• Person requesting to open LC (Applicant): Buyer, importer of goods.
• Beneficiary of LC (Beneficiary): Seller, exporter of goods.
• LC Issuing Bank (Issuing Bank): The bank representing the buyer is responsible for issuing the LC.
• Advising Bank: The bank that advises the LC to the seller, usually the correspondent bank of the LC issuing bank.

Benefits of LC payment

LC payment brings benefits to both importers and exporters, specifically:

For exporters:

• The bank commits to make payment on time when the exporter presents a set of valid documents.
• Minimize the risk of buyers not paying or paying late.
• L/C helps strengthen the exporter’s reputation in international transactions.
• Minimize delays in transferring documents.
• Payment is made as soon as the documents are transferred to the issuing bank, or the deferred L/C will be paid on a specified date (if).
• To have money in advance to prepare for contract implementation, the seller can request a L/C discount.

For importers:

• Guarantee of goods: Only pay when the goods are delivered according to the provisions in the L/C.
• Have the right to check the quality of goods through documents.
• The importer must pay only when the goods are actually delivered.
• To ensure that the exporter will be paid, the exporter will have to do everything as specified in the L/C.

LC payment process

The L/C payment process is carried out as follows:

Step 1: Sign a sales contract and include an agreement to pay by L/C.

Step 2: The importer requests the bank to issue a L/C and submits the necessary documents to the bank.

Step 3: The bank issues the L/C and transfers it to its correspondent bank in the exporting country.

Step 4: The bank notifies the transfer of the original L/C to the exporter.

Step 5: The exporter delivers the goods in accordance with the provisions of the L/C.

Step 6: The exporter submits a set of documents in accordance with the provisions of the L/C.

Step 7: After checking the validity of the set of documents, the agent bank transfers it to the issuing bank. (or payment bank).

Step 8: The bank issuing the letter of credit checks the set of L/C payment documents:

• If it does not comply with the provisions of the L/C, refuse payment and return the set of documents to the exporter.
• If in accordance with the provisions of the L/C, proceed to pay or accept the draft. (For deferred L/C payment).

Step 9: The importer pays the bank and receives the goods and related documents.

Types of LC documents and letters of credit

There are many different types of L/C, but the most common are:

• Irrevocable L/C (Irrevocable L/C): A type of letter of credit that, after being opened, can only be amended, supplemented or canceled by the bank according to the agreement of all parties involved.
• Confirmed L/C: This type of L/C is confirmed by a second bank, ensuring payment even if the issuing bank does not pay.
• Confirmed irrevocable letter of credit (Confirmed irrevocable L/C): Is an irrevocable letter of credit, guaranteed by another bank to pay at the request of the bank opening the letter of credit.
• Transferable L/C: An irrevocable letter of credit, which stipulates the right of the paying bank to fully or partially pay the letter to one or more people according to the order of the first beneficiary.

Risks of LC payments and how to avoid them

Although LC is a secure payment instrument, some risks still exist. Buyers and sellers need to understand these risks and apply preventive measures.

Risks for importers:

• Sellers may present fake documents to receive payment.
• The delivered goods are not as described in the contract.
• Goods were not delivered on time.
• Exchange rate risk.
• Risk due to the bank issuing the LC going bankrupt.

Risks for exporters:

• The issuing bank may refuse payment if the documents do not comply with the terms of the LC.
• Political risks and risks due to importing country laws.

Risks for the LC issuing bank:

• Credit risk: Banks advance money but cannot recover it.
• Risk due to document errors: Banks pay when documents are invalid or refuse to pay when documents are valid.
• Fraud risk: The seller or buyer commits fraud to receive payment.

Risk prevention measures:

• Carefully check the terms of the LC before signing.
• Use LC confirmation to minimize banking risks.
• Carefully check documents before presenting them.
• Use independent cargo inspection services.
• Closely monitor the political, legal, and economic situation of the buyer and seller’s country.
• Find out the bank that issues the LC.
• Buy payment insurance.

Safe and effective LC payment consulting service at Long Phan Consulting Company

Long Phan provides comprehensive consulting and support services on LC payments, helping customers minimize risks and ensure benefits in international trade transactions. Our Services include:

• Consulting on choosing the right type of LC for the transaction;
• Drafting and reviewing sales contracts and LCs;
• Check documents and support document presentation;
• Consulting on LC payment process;
• Consulting on risks and effective ways to prevent them;
• Consulting and supporting customers in negotiating and signing sales contracts;
• Consulting on dispute resolution if any;
• Consulting and answering other related issues.

Frequently asked questions about LC payments

Here are some questions we often receive about LC payments:

How long is the validity period of L/C?

The validity period of the L/C is agreed upon by the parties and clearly stated in the L/C. This deadline usually includes delivery time, document presentation time and payment time.

Which party is responsible for paying the L/C opening fee?

Normally, the L/C opening fee is paid by the person requesting to open the L/C (importer). However, the parties may agree otherwise on the division of these costs.

Can L/C be transferred to a third party?

Yes, in case the L/C has a transferable L/C clause, the beneficiary can transfer all or part of the L/C value to one or more third parties.

What happens if the presented documents do not comply with the L/C?

If the presented documents do not comply with the terms and conditions of the L/C, the issuing bank has the right to refuse payment and return the documents to the exporter.

Why do we need a confirmed L/C?

Confirmed L/C is confirmed by a second bank, usually a bank in the exporter’s country. This is to increase safety for exporters, ensuring they will be paid even if the issuing bank has problems.

How do Incoterms affect L/C?

Incoterms clearly stipulate the responsibilities and costs between buyer and seller during the delivery process. Incoterms terms need to be clearly stated in the L/C to avoid future disputes.

In what cases can importers face risks even when paying by L/C?

The importer may be at risk if the exporter provides fake documents, or the actual goods do not match the description in the documents, even though the documents comply with the terms of the L/C.

How to minimize the risk of document errors when paying L/C?

To minimize the risk of document errors, parties need to carefully check the terms of the L/C before transaction, use professional document checking services, and ensure that the set of documents is prepared accurately and completely according to the requirements of the L/C.

Conclusion

LC payment is a safe and effective international payment method, helping to protect the interests of both buyers and sellers. However, to ensure a successful transaction, the parties need to clearly understand the process, benefits and risks involved. If you have any questions or need further advice, please contact Long Phan via the hotline: 0906735386.