A Documentary Letter of Credit (DLC, often just "LC") is the buyer's bank promising to pay the seller when the seller presents the shipping documents named in the credit, exactly as named. It is the main payment method in international commodity trade because the seller is paid by a bank, not by the buyer, and the buyer only pays when documents prove the goods were shipped as agreed.
Definition
A Documentary Letter of Credit is an irrevocable undertaking by the issuing bank to honour a complying presentation of documents. "Complying" is the operative word: banks deal in documents, not goods. If the documents match the credit, the bank pays, even if the buyer has changed its mind. If the documents do not match, the bank may refuse, even if the goods are perfect.
Almost every DLC in international trade is issued subject to UCP 600, the ICC rules that define the parties' obligations and the five banking days a bank has to examine documents.
Parties and flow
- Applicant (buyer) asks its bank to open the credit in favour of the seller, on the terms of the sales contract.
- Issuing bank issues the credit and sends it (SWIFT MT700) to a bank in the seller's country.
- Advising bank authenticates the credit and passes it to the seller. If asked to confirm, it adds its own promise to pay.
- Beneficiary (seller) ships the goods and presents the documents to its bank within the presentation period.
- The banks examine the documents. If they comply, the seller is paid at sight or at the agreed usance date, and the buyer receives the documents to collect the cargo.
Types of DLC you will meet in commodity contracts
| Term | Meaning | Who it favours |
|---|---|---|
| Irrevocable | Cannot be changed or cancelled without the beneficiary's consent. Under UCP 600 every credit is irrevocable. | Seller |
| Confirmed | A second bank (usually the seller's) adds its own undertaking to pay. Removes issuing-bank and country risk. | Seller |
| Unconfirmed | Only the issuing bank is bound. Cheaper; the seller carries the risk of that bank. | Buyer |
| At sight | Paid as soon as complying documents are presented. | Seller |
| Usance / deferred | Paid a fixed number of days after shipment or presentation (30, 60, 90 days). | Buyer |
| Transferable | The beneficiary can transfer all or part of the credit to a second beneficiary, typically the actual supplier. | Intermediary sellers |
| Revolving | Reinstates automatically for repeat monthly shipments under a term contract. | Both, in long-term supply |
The documents
The credit lists the documents the seller must present. In a physical commodity deal the usual set, also shown on our procedures page, is:
- Commercial invoice
- Full set of clean on-board bills of lading (or tanker bills for liquid cargo)
- Certificate of origin
- Packing list (for bagged or containerised goods)
- Certificate of quality and certificate of quantity from the named inspection company, for example SGS
- Insurance certificate, when the sale is CIF
- Any certificate specific to the product or destination: halal, phytosanitary, veterinary health, radiation-free, and so on
Discrepancies: where DLCs go wrong
Industry surveys have long found that a large share of first presentations are rejected for discrepancies. The common ones are late shipment, presentation after the expiry date, a description of goods that does not match the credit word for word, missing signatures or endorsements, and inconsistent quantities between invoice, bill of lading and inspection certificate. Each discrepancy gives the issuing bank the right to refuse, and gives the buyer leverage to renegotiate. The cure is boring and effective: draft the credit from the signed contract, have the seller review the draft before issuance, and check every document against the credit before presentation.
DLC versus SBLC
The two are often confused. A DLC is the payment: it is meant to be drawn on every shipment. An SBLC is security: it is meant never to be drawn and only pays on default. Many commodity contracts use both, a DLC (or payment against documents) for each cargo and an SBLC or performance bond behind it.
Timeline and cost
Opening a credit takes a few days once the buyer's bank has approved the credit line. The credit must allow enough time for loading, inspection and document preparation before its latest shipment date and expiry. Costs are borne mostly by the buyer (issuance and amendment fees) and partly by the seller (advising, confirmation and document-handling fees). Every amendment costs money and time, which is why the credit should be right the first time.
- Never ship before the credit has been received and authenticated by your own bank.
- Insist on seeing the draft credit and compare it line by line with the contract.
- Name the inspection company, the documents and the tolerances in the contract first, then copy them into the credit.
- Prefer confirmation when the issuing bank or its country is unfamiliar to you.
Structuring a purchase or a supply contract and want the instruments in the right order? Request a consultation or message us on WhatsApp at +1 941 202 4887.