Letter of Credit Basics: How an LC Protects Both Sides of a Trade

A Letter of Credit (LC) is a conditional payment undertaking issued by a bank (the issuing bank) on behalf of a buyer (the applicant), promising to pay a seller (the beneficiary) once the seller presents documents that strictly comply with the terms of the LC.

Why exporters ask for an LC. An LC substitutes the buyer's promise to pay with a bank's promise to pay, which matters when the buyer and seller are in different countries and may not have an established trust relationship.

The core parties. Applicant (buyer), issuing bank, beneficiary (seller), and usually an advising bank in the seller's country that authenticates the LC and passes it on. Many LCs also involve a confirming bank if the beneficiary wants an additional payment guarantee.

Documents, not goods. Banks deal in documents, not goods — a foundational principle under UCP 600 (Uniform Customs and Practice for Documentary Credits). If the documents presented (invoice, bill of lading, packing list, certificate of origin, etc.) match the LC terms exactly, the bank must pay, regardless of the actual physical condition of the goods.

Incoterms matter. The Incoterm agreed between buyer and seller (for example FOB, CIF, EXW) determines which party bears freight, insurance, and risk at each stage of shipment, and should align with what the LC specifies.