A letter of credit (LoC) is a document issued by a bank (the issuing bank) at the request of its customer by which the issuing bank provides a binding undertaking to make a payment of money to a third party (the beneficiary). It is a financial contract between a bank, a bank’s customer and, typically, the client or supplier of that customer. LoCs are often used during international trade transactions to “bridge the trust gap” that is, the risks run by one party that it will not receive the goods or services it has contracted for, and by the other party that it will not get paid.
A LoC can be of the standby variety, in which case it is not meant to be drawn unless a party has defaulted, or of the irrevocable variety, in which case it is meant to be a method of payment. While a LoC is drawn up in the context of a contract for the purchase or goods or services, its strength lies in the principle of autonomy, which ensures that notwithstanding any disputes or disagreements arising from the performance of the underlying contract, the issuing bank must pay the supplier as long as the demand for payment is accompanied by the documentation that had been agreed upon when the LoC was issued. At HazloLaw – Business Lawyers, our lawyers can work with your bank to craft a LoC that will best protect your interests.