A documentary letter of credit (DLC) is a payment instrument issued by a bank on behalf of a buyer, guaranteeing payment to a seller upon the presentation of specified documents in strict compliance with the credit terms. Governed primarily by the Uniform Customs and Practice for Documentary Credits (UCP 600), published by the International Chamber of Commerce, documentary credits are among the most widely used instruments in international trade finance.
The principal parties to a documentary credit transaction are: the applicant — the importer or buyer who instructs the issuing bank to open the credit; the issuing bank — the bank that opens the credit and undertakes to honour compliant presentations; the beneficiary — the exporter in whose favour the credit is established; and, in confirmed credits, the confirming bank, which adds its own undertaking to that of the issuing bank.
Types of Documentary Credit
Documentary credits may be irrevocable — the default position under UCP 600 — or, where expressly stated, revocable. A confirmed credit carries an additional layer of bank undertaking from a second institution, typically in the beneficiary's country, providing the exporter with greater certainty of payment independent of the issuing bank's jurisdiction risk.
Common types encountered in structured trade finance include sight credits (payable on presentation of compliant documents), usance credits (payable at a specified deferred date), transferable credits (permitting the beneficiary to transfer all or part of the credit to one or more second beneficiaries), and back-to-back credits (a separate credit opened using the first credit as security).
The Strict Compliance Principle
Strict compliance is the governing principle of documentary credit practice. Discrepancies in documents — even minor typographical inconsistencies between the credit terms and the documents presented — entitle the issuing bank to refuse the presentation and withhold payment. The presenter's obligation is to tender documents that comply precisely with the credit terms on their face.
For practitioners operating in this space, the practical consequence is that document preparation must be rigorous and reviewed prior to presentation. Common grounds for discrepancy include inconsistencies in the description of goods, incorrect port names, missing endorsements, and dates that fall outside the credit's validity period.
This article is published for informational and educational purposes only. It does not constitute financial, legal, or investment advice and should not be relied upon as such. VIVAR International Advisory Group does not guarantee the accuracy or completeness of information contained herein. Full disclaimer.