Obtaining a Letter of Credit for International Business

A letter of credit, or LC, is a way to reduce risk when performing international business transactions that has gained many loyal followers over the years. Because international trade can be a gamble at best, a letter of credit is a binding legal document that works by promising the seller that he will receive payment for the goods or services he sells. In order to receive payment in accordance with the guidelines of a letter of credit, the seller presents the bank with the shipping documents that confirm the products were actually delivered within a certain amount of time.

There are a number of different types of letters of credit, and each one serves a different purpose:

• Confirmed Letter of Credit. This is a letter of credit that is first issued by a foreign bank, usually the bank of the buyer. A Confirmed Letter of Credit has been confirmed and guaranteed trustworthy by the seller's domestic bank in case the international bank or buyer fails to pay for the goods or services. This is the type of letter of credit a seller will purchase when handling business overseas.
• Commercial Letter of Credit. The commercial letter of credit provides assurance to the seller that the bank will pay for any goods that are shipped to the customer. In order for them to pay however, the seller must provide the necessary documents to prove the shipment and transaction actually took place.
• Irrevocable Letter of Credit. This type of letter of credit is a guarantee by the bank that issues the letter of credit will in fact be honored, as long as the buyer abides by all of the terms and conditions in the letter.
• Revocable Letter of Credit. The Revocable Letter of Credit states that the issuing bank has the right to cancel or modify the letter of credit after it has been issued.
• Standby Letter of Credit. This type of letter of credit promises the beneficiary that if the bank's customer fails to pay the seller, the standby letter of credit can be used to receive payment from the customer's bank.

How It All Works
In a nutshell, the letter of credit process works like this: A seller in the United States agrees to sell a product to a foreign buyer. The seller requests a letter of credit to guarantee he will receive payment for the product from his bank. Once the letter of credit is approved and forwarded back to the seller, the seller then ships the goods to the foreign buyer. In the process, he keeps or acquires all of the necessary documents as set forth in the letter of credit that proves the shipment was made. Once the bank verifies these documents are in accordance with the terms in the letter of credit, it then collects the payment for the seller by debiting the buyer's account.

While a letter of credit is not necessary for selling goods overseas, it is highly recommended. A letter of credit will help to ensure payment to a seller who is unfamiliar with the country, the buyer's business, or international trade procedures, regardless of instability of the country or failure to pay for the goods on behalf of the buyer. If the seller and buyer have already established a good working relationship and the seller is certain the buyer can be trusted, a letter of credit isn't always necessary.