A Letter of Credit (L/C) is a document that provides a measure of security for a seller of goods to an overseas buyer by having a financial institution, usually a bank, guarantee payment as long as the conditions of the L/C are complied with. The buyer is also secured since the L/C also guarantees that he will receive the goods that have been ordered.
A letter of credit is generally termed as being irrevocable even though if it is not mentioned as being irrevocable it is treated as being revocable.
What is the difference? A revocable letter of credit can be amended without reference to any other party, an irrevocable letter of credit can only be amended with the agreement of all parties
Under an irrevocable L/C, none of the terms can be changed without the agreement of all parties involved.
This is the basis under which the document provides the highest degree of security to all parties.
For example, under a revocable letter of credit, if the seller was unable to ship within the stipulated time period, he could simply amend the shipment date to whenever suits him. That may not suit the buyer, but he would be powerless. Under an irrevocable Letter of Credit, if the shipper is unable to ship within the agreed upon time period, he would have to apply to the buyer to have the L/C extended and that may not suit his supply chain requirements and he has the right to refuse.
Letters of credit are not only used for trade transactions, they can be used as a guarantee of service or performance. In this case the L/C is termed a Standby Letter of Credit.
The same terms apply to a commercial L/C because it must be irrevocable to provide all parties with security. Under a standby letter of credit there is generally only one document that must be presented. That document is generally a statement from the beneficiary that the applicant hasn’t fulfilled the terms of a contract between them. Confirmation can still be added, so for a beneficiary, a confirmed irrevocable standby letter of credit is preferable. Standby Letters of Credit are becoming more common as they take away the legal issues when guarantees are issued with two parties in different legal jurisdictions.
The difference between revocable and irrevocable letters of credit is a matter of enforceability. A revocable L/C is virtually unenforceable since any party can change the terms in his favour or to the detriment of the other party. Under an irrevocable L/C all parties can receive comfort from the fact that unless there is agreement from all sides, the terms of the L/C will be in accordance with the original agreement.
About Alan Hill
Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”