DEFINITION
A irrevocable Letter of Credit is a contract between a buyer, usually an importer, and the bank. The bank agrees that it will pay the exporter (seller) once certain conditions have been met.
The Key Takeaways
- A letter of credit irrevocable is issued by a bank that represents an importer and agrees to pay an exporter for an international transaction.
- Both buyers and sellers can reduce their risks by using a letter of credit to ensure that goods are shipped and paid for.
- Terms and conditions of an irrevocable credit letter are set and cannot be altered without the consent of all parties.
- A letter of credit irrevocable should be requested from a commercial institution and never by an importer or exporter.
Definition and example of irrevocable letter of credit
A letter of guarantee issued by a bank is an irrevocable Letter of Credit. The letter of credit creates an agreement in which the bank of the buyer agrees to pay the vendor as soon as certain transaction conditions are met.
These letters eliminate the worry that unidentified buyers will not pay for goods received or that unidentified sellers won’t deliver goods after payment. These letters allow companies and individuals to conduct business in confidence.
- Alternative name: Line of Credit Irrevocable
- Acronym: ILOC
They are used in domestic trade as well. Letters of credit that are irrevocable cannot be altered or cancelled without the consent of all parties involved, including the buyer, seller and banks.
How does an irrevocable letter of credit work?
A letter of credit that is irrevocable provides security for both the buyer and seller in a particular transaction. The buyer will not pay until the goods or services are delivered, while the seller gets paid as long the conditions of the letter are met.
How an irrevocable credit letter works depends on the specifics of the letter as well as the documents used for verification. All letters of credit have the same basic elements.
- Banks guarantee payment.
- A payment is made by a buyer or applicant to a seller (or beneficiary).
- Documents specific to the goods/services supplied are required.
- The transaction is specified, including the time limit, location, dates and the manner in which it will be conducted.
- The letter of credit must be followed.
The seller must then provide to the bank the documents specified in the letter to prove that the goods were shipped according to its terms. The documents are sent to the bank of the seller, who reviews them and pays. The seller receives the documents from the bank, along with any paperwork needed to claim the shipment once it arrives.
Note:
The seller may have to pay the bank at various points. You can, for example:
- The seller provides the funds up front, and they are held in the bank until the transaction has been completed.
- After the transaction, a seller who has sufficient credit and security repays his bank.
- The bank provides a loan for the seller’s payment. This is repaid in installments.
Although an irrevocable Letter of Credit facilitates the transaction, it does NOT eliminate all risks. For the transaction to go smoothly and the seller to be paid, both parties must comply with the letter’s requirements.
The bank may refuse to pay if anything is wrong, including:
- Sending the shipment late is a major problem.
- Minor mistakes, such as typographical errors or the substitution of “Unit” for “Suite” in the address
Buyers and sellers must carefully review the terms of the letter of credit in order to avoid any issues with payment or shipment.
What is an irrevocable letter of credit?
You have to be able to trust someone you don’t even know, or who you have never met. Both buyers and sellers may be concerned about shipping and payment. These risks can be reduced by irrevocable letters.
Letters of credit can be a great tool for sellers because they are able to rely not on the strength or reliability of the buyer, but rather the Bank. You will be paid as soon as the bank confirms that you have met the terms of the agreement. This eliminates the need to evaluate the financial stability or trustworthiness in foreign countries.
Letters of credit are a way for buyers to verify that something was actually shipped. Your bank will pay your seller once he provides the documents that prove a shipment has been made. The shipment will not arrive until you receive it. You can manage the risk by requiring an inspection certificate as one of the documents required before payment.
Alternatives to a Letter of Credit Irrevocable
You can also look at other options, such as:
- Trade credit insurance is less expensive.
- There are different types of letters of Credit
You should avoid letters of credit that can be rescinded without everyone’s consent.
In general, sellers want irrevocable letters of Credit so that they can avoid shipping and producing goods without a guarantee of payment. Buyers may also be looking for things to be set in stone. They don’t want the seller to change their order quantity or ship late.
The greatest risk of using a letter of credit revocable is that it can be used by sellers to avoid payment. They may have to pay for both the production and the shipping costs. Avoid any transaction involving a letter of credit that is revocable.
It is very difficult to find a credit letter that isn’t irrevocable. It’s worth checking whether you have a revocable or irrevocable document.
How to get an irrevocable letter of credit
Speak to your bank if you require a letter credit. You’ll likely be working with a representative of the international trade department (or a similar one).
Do not try to create a letter or credit by yourself, or modify one created by someone else. You could be in for an expensive legal battle if you miss a detail. This may even happen overseas, where the laws are different. You may not be able to claim the goods that you paid for, or receive payment for the goods that you shipped.
It may seem cost-effective to write your own irrevocable letters of credit, but this can be costly and detrimental for your business. Always ask the bank involved in your transaction for help to get a letter.
