The hallmark that makes a letter of credit such a secure form of fund remittance is the strict compliance requirements, an avenue for sellers to be at ease when conducting international trade. An irrevocable Letter of Credit is one such permutation of a secure payment method. As logisticians, we are accustomed to seeing an international trade settled with an irrevocable letter of credit (ILOC), but not so for a revocable letter of credit. In this article, we will try to shed some light on the key distinctions between the two.
A revocable letter of credit can be amended or canceled at any time without notice or consent of the beneficiary. Whereas an irrevocable letter of credit cannot be amended or canceled at any time without notice or consent of both the beneficiary and the issuing bank. If not instructed, all import or export Letter of Credit will be arranged as an Irrevocable Letter of Credit, following the UCP 600 guidelines.
Irrevocable Letter of Credit
Letters of Credit are full of dichotomy. For instance, a letter of credit can be either: –
- Confirmed vs Unconfirmed LC
- Transferrable vs Non-Transferrable LC
- Revocable vs Irrevocable LC
These dichotomies are features or arrangements of the Letter of Credit made available to the sellers and buyers.
Amongst these features, it can be argued that an Irrevocable Letter of Credit is near unequivocally preferred over a revocable letter of credit. Let us state our premise.
To restate the definition of an Irrevocable Letter of Credit, it is a form of LC that cannot be amended, changed, or canceled at any time, without the consent of both beneficiary and the issuing bank.
the UCP 600 guidelines (Uniformed Customs and Practice for Documentary Credit), is a guide accepted by over 175 countries for the useful practices of utilizing a Letter of Credit.
The guidelines have a strict rule against document discrepancies. Since the issuing and beneficiary bank of the LC will not be able to inspect the traded commodity, the banks rely on the accuracy of the documents presented when the applicant buyer requests for payment remittance to the beneficiary bank.
An irrevocable letter of credit simply means that all the terms drafted in the letter of credit are immutable. Therefore, to a certain degree, it is more secure.
Some of the terms that both buyers and sellers have agreed upon before drawing a Letter of Credit are: –
- Letter of Credit Expiry Date
- Beneficiary Details
- Terms of Payment (At Sight, or X days after sight)
- Monetary Denomination (USD)
- Documentary Requirements (Signed Commercial Invoice, Number of Packing List copies)
- Shipping INCOTERMs
… among other things.
When to use an Irrevocable Letter of Credit
As a rule of thumb, both the importers and exporter will always prefer an irrevocable letter of credit over a revocable letter of credit.
This is especially the case when the business relationship between the buyer and the seller, or even the relationship between the bank and the applicant is relatively new.
This is the period where each party is “sussing out” each other’s commitment to the business transaction.
There is a certain level of comfort as well for the buyer as they can spell out as many documentary requirements as they see fit in order to quell their doubts over the seller’s authenticity.
For instance, the buyer can negotiate for the shipment to have adhered to European CE Marking by requesting relevant certifications as a condition for the letter of credit.
Revocable Letter of Credit
Let’s discuss what using a Revocable Letter of Credit entails. A letter of credit that can be revoked can be amended, or canceled by the issuing bank at any time without notice or consent of the beneficiary.
This sort of arrangement signifies a few things, that either the issuing bank is not willing to take the risk of guaranteeing the underlying payment between the buyer and the seller, or that the issuing bank does not have the financial fortitude to guarantee payment of the underlying payment.
From the perspective of the issuing bank, it is all about the risk to reward ratio. Make no mistake that banks will not be willing the risk of payment to the buyer without receiving adequate compensation for the risk.
If the risk does not justify the reward, they can request for a secured revocable letter of credit, the least risky form of Letter of Credit by the issuing bank.
Because, a secured LC requires the applicant of the LC to post a personal guarantee with an asset (mostly mortgages) as a collateral for the bank in the event the applicant default on its payment.
When to use a Revocable Letter of Credit
As importers and exporters, a revocable letter of credit would not be your top priority LC of choice. Always seek for an irrevocable letter of credit.
That way, the exporters and importers are guaranteed that the banks will honour the terms and conditions of the Letter of Credit once it is drawn.
Can Irrevocable Letter of Credit be amended?
Yes. The term “irrevocable” is not used to describe that the obligations of the seller and buyers can be revoked, but it implicates that the issuing or the beneficiary bank has to honor the immutable terms and will meet its obligation as a financial intermediary.
To paraphrase, the issuer is irrevocably bound to honor the seller/beneficiary’s presentation of complying documents once the LC has been issued.
In an irrevocable LC, amendments to the LC can only be prompted by either the buyer or the seller. Although, both parties have to agree upon the proposed amendments.
Can Irrevocable Letter of Credit be revoked or cancelled?
Yes. Under the UCP 600 guidelines, all letters of credit must contain an expiry, and the last date by which the shipping documents must be presented (usually within 21 days of the date of shipment).
The importers and exporters have to be wary of the transit time of the cargo transported, and factor that into consideration when drafting a Letter of Credit’s expiry date.
If the LC has expired, or the document is presented after the last day in the LC. The banks have the right to revoke the irrevocable LC.