What is irrevocable letter of credit, definition and application?
Irrevocable letter of credit term is one of the most frequently seen lc definition in international trade finance world. We know that lc world is working with an over-capacity in terms of misunderstandings, improper industry practices including irregular banking practices, false informations and so on. Irrevocable letter of credit is no exception. Many traders attribute irrelative or false meanings to irrevocable letter of credit term. Let me give you a quick example: One of the international trading company owner told me that he would secure the payment from his bank as long as he will receive an irrevocable letter of credit from his buyer. He was mistakenly believing that irrevocable letters of credit give %100 payment assurance. Let me tell you the truth. There is no such a world.
Definition of irrevocable letter of credit?
We can define an irrevocable letter of credit (ILOC) as a type of documentary credit which can not be cancelled or amended by the issuing bank without the agreement of the parties of the letter of credit transaction. Table 1 shows the parties to the irrevocable letter of credit transaction. If lc is confirmed than the parties are issuing bank, confirming bank and the beneficiary. If lc is not confirmed than only issuing bank and the beneficiary are the parties of the irrevocable letter of credit transaction.
Table 1 : Parties to the irrevocable letter of credit
Issuing bank can not cancel or amend an unconfirmed irrevocable letter of credit without the written consent of the beneficiary.
As we can see above beneficiary of an irrevocable letter of credit knows that the terms and conditions of the credit will not be changed without his approval. Also he knows that lc will not be cancelled either. But is this means that the beneficiary have %100 payment guaranty under an irrevocable l/c. As I said earlier. No. Let me write down my reasons,
Letter of credit is a conditional payment method. In order to be getting paid under a letter of credit, irrevocable or revocable, you have to make a complying presentation. In simple words, you have to make the shipment and collect all trade documents requested under the l/c and present them to the issuing bank (nominated bank or confirming bank in some cases). Afterwards issuing bank will check the documents and pays you only if the issuing bank finds the documents compliant.
If issuing bank finds documents noncompliant than issuing bank will send you an advice of refusal. Banks send advice of a refusal as a swift message, MT 734 Advice of a Refusal. After you have received the advice of the refusal from the issuing bank you would have 3 options as a beneficiary.
If you have still time you can try to correct the discrepancies by submitting new documents. But you have two main time constraints for a new presentation. First, expiry date of the letter of credit, second period for presentation of the documents. If your presentation contains a transport document than you have to present your documents within 21 days after the date of shipment. Also you have to present your documents before the expiry date. So once you received advice of refusal from the issuing bank you may have already ran out of time for a second presentation.
Your second option would be to apply your buyer to accept the discrepancies. If you have no good connections with your buyer than this option may not be workable for you either.
Your final option would be recalling the documents from the issuing bank and trying to find a new buyer to your goods.
What do you think about irrevocable letters of credit after reading this article? Do they give %100 payment guarantee?
We can define an irrevocable letter of credit (ILOC) as a type of documentary credit which can not be cancelled or amended by the issuing bank without the agreement of the parties of the letter of credit transaction.