Letter of Credit Process: An Importer’s Guide to Payment Triggers and Document Risk

The letter of credit process helps importers and suppliers replace a simple promise to pay with a bank’s documentary payment undertaking. Its central limitation matters just as much as its protection: banks examine documents, not the goods those documents describe.

For an importer, success means agreeing conditions that provide useful shipment evidence, are achievable by the supplier, and match your funding arrangements. An LC is not a substitute for supplier due diligence, a clear purchase contract, or appropriate inspection.

Choose the payment structure before signing

Workable payment terms depend on supplier leverage, shipment value, trading history, and access to finance. No structure removes every risk.

• Advance payment: You fund the supplier before receiving goods. This supports the supplier’s cash flow but exposes you to non-delivery and performance risk.
• Documentary collection: Banks handle documents and collection instructions without providing an LC-style payment undertaking. Supplier acceptance often depends on relationship strength and control over delivery documents.
• Letter of credit: The issuing bank undertakes to honor a complying presentation. You gain documentary conditions, while the supplier gains a bank payment commitment. Fees, collateral, and administration can be significant.
• Open account: You pay on an agreed date, usually after shipment or delivery. This generally benefits buyer cash flow but leaves the supplier carrying credit risk unless separately mitigated.

Discuss financing alongside payment terms. An LC may consume your credit facility or require cash collateral before the supplier ships. A deferred payment date does not necessarily mean your cash remains unrestricted until maturity.

Map the letter of credit process from contract to settlement

A typical process follows these stages, although bank roles and financing arrangements vary.

1. Purchase agreement: Buyer and supplier agree goods, price, delivery terms, documents, and the intended LC structure.
2. Bank application: You request issuance and arrange the required facility, collateral, fees, and reimbursement terms.
3. Issuance: The issuing bank sends the LC through the banking channel, normally to an advising bank.
4. Advising: The advising bank checks the apparent authenticity of the credit and advises it to the supplier. Advising alone does not add a payment undertaking; confirmation, if added, does.
5. Shipment: The supplier ships within the credit’s conditions and obtains the required documents.
6. Presentation: The supplier presents documents at a permitted bank and place, within the credit’s terms and applicable deadlines.
7. Examination: The issuing bank and any other bank required to examine the presentation assess it against the credit and applicable rules. A nominated bank’s obligations depend on its role and whether it has agreed to act.
8. Honor and reimbursement: A complying presentation requires the issuing bank to honor by sight payment, a deferred payment undertaking, or acceptance, as applicable. Where the credit is available by negotiation, an agreeing nominated bank may purchase complying documents or drafts. Your obligation to reimburse the issuing bank follows your banking agreement.

The key commitment begins at issuance: an irrevocable LC cannot simply be cancelled because the buyer changes its mind. Payment depends on documentary compliance and the credit’s terms—not buyer satisfaction on arrival.

Negotiate the draft before issuance

Ask the supplier and your bank to review the proposed wording before issuance. Fixing an impractical draft is usually easier than amending an issued credit.

Align the shipment and presentation timetable

Check the latest shipment date, document presentation period, expiry date, and presentation location together. The supplier needs enough time after shipment to obtain carrier documents, certificates, and any inspection report, then present them correctly.

Expiry is not necessarily the payment date. Under a usance credit, a timely complying presentation can establish an obligation payable after expiry.

Agree responsibilities and costs

Specify who bears issuance, advising, confirmation if required, amendment, discrepancy, and financing charges. Confirm the allocation with the banks; a commercial agreement does not automatically change a bank’s charging arrangements.

Check that delivery terms, transport mode, insurance responsibility, and LC documents match. For example, do not require the supplier to provide insurance evidence if the transaction assigns insurance procurement to you and no workable arrangement exists.

UCP 600, the International Chamber of Commerce’s rules for documentary credits, applies when the credit expressly incorporates it. If those rules apply, ensure the draft and review process account for them and any express modifications in the credit. Have your trade finance bank explain the consequences rather than treating a template as universally suitable.

Set useful letter of credit document requirements

Every required document should have a purpose, an identifiable issuer, and achievable wording.

Common documents include:

• Commercial invoice: Identifies the transaction, goods, quantities, and value.
• Packing list: Supports checks on packages, weights, and packing details.
• Transport document: Provides shipment or receipt evidence appropriate to the transport mode and credit terms.
• Certificate of origin: Provides stated origin evidence where required for the transaction.
• Insurance document: Evidences specified cover when required under the credit.
• Inspection certificate: Records a defined inspection by an agreed issuer.

Avoid demanding every conceivable certificate. Extra documents create more opportunities for discrepancies without necessarily improving protection.

Make inspection conditions specific

Instead of requiring “goods of satisfactory quality,” identify the inspection provider, inspection stage, scope, and required certificate statement. Confirm that the provider can actually issue the requested document. Under UCP 600, banks disregard a condition that does not specify a document to indicate compliance with it.

An inspection certificate can provide useful evidence, but documentary compliance is not proof that every item is defect-free. Banks examine the certificate as a document; they do not repeat the inspection or warrant the goods.

Keep specifications, sampling methods, warranties, rejection rights, and remedies in the purchase contract. Documentary controls and contractual protections serve different purposes.

Sight vs usance letter of credit: when is payment due?

Sight payment

A sight LC is payable upon a complying presentation following the applicable examination process. It does not mean instant payment when goods leave the factory, arrive at port, or pass your warehouse inspection.

Plan liquidity around document presentation and bank processing. Payment may become due before you receive or resell the goods.

Usance or deferred payment

A usance LC provides payment at a determinable future maturity, such as a specified number of days after a defined shipment or document event. Depending on its structure, the bank may accept a time draft or incur a deferred payment undertaking.

Define the maturity calculation precisely. “Pay after arrival” can create uncertainty unless the event, evidence, and calculation are clearly structured and accepted by the bank.

Usance may improve working-capital timing, but interest, fees, collateral, and facility usage affect the benefit. Document release and reimbursement arrangements should be agreed separately with your bank; neither should be assumed from the maturity wording alone.

Handle letter of credit discrepancies deliberately

A discrepancy is a documentary failure against the credit or applicable rules. Examples include late shipment, late presentation, a missing required document, or conflicting information. Not every wording difference is a discrepancy; the applicable examination standards matter.

When a bank identifies discrepancies and refuses the presentation, it must follow the applicable notice requirements. The issuing bank may approach you for a waiver, but your approval does not automatically compel it to accept the documents.

Before deciding:

• Obtain the exact discrepancy list and the deadline for your response to the bank.
• Ask whether corrected documents can be presented within the available time.
• Assess customs, insurance, cargo-release, and commercial consequences.
• Check shipment status and any concerns independently of the paperwork.
• Record your decision and obtain confirmation of the bank’s treatment.

Waiving a discrepancy communicates your acceptance of the identified documentary issue for that presentation. It does not itself settle a product-quality dispute or amend the supplier’s contractual obligations. The bank must still confirm whether it accepts the waiver.

The reverse is equally important: defective goods do not automatically make a complying presentation discrepant. Seek urgent bank and legal advice if fraud or serious non-performance is suspected; do not assume you can stop payment unilaterally.

Letter of credit vs documentary collection

Under a documentary collection, banks transmit documents and seek payment or acceptance according to collection instructions. They do not provide the same independent payment undertaking as an issuing bank under an LC.

Documents against payment: D/P

Documents are released against payment under the collection instructions. The supplier retains a degree of documentary control until payment, but its practical value depends on the transport document and cargo-release arrangements.

Not every transport document controls delivery. Confirm this before relying on document retention as security.

Documents against acceptance: D/A

Documents are released against the importer’s acceptance of a time draft, with payment due later. The supplier therefore takes the risk that the importer will not pay at maturity, unless a separate bank undertaking or other protection applies.

Collections can suit established relationships where both parties accept the risks. They are not simply cheaper LCs offering equivalent protection, and banks do not conduct the same LC compliance examination.

Separate currency, insurance, and goods risks

An LC does not hedge foreign-exchange exposure. If the credit is denominated in a foreign currency, exchange-rate movements can change your domestic-currency cost before settlement. Discuss currency exposure and any suitable hedging separately with your treasury team or bank.

Export credit insurance generally protects the insured exporter or lender against specified non-payment risks, subject to policy terms. It does not guarantee goods quality to the importer.

Cargo insurance addresses covered transit losses, not every quality, delay, or supplier-performance problem. Match each risk to the appropriate contract, inspection, insurance, or financing measure.

Pre-issuance checklist for importers

Before authorizing issuance, confirm:

• [ ] Supplier acceptance of the draft and banking route.
• [ ] Bank approval, facility availability, collateral, and reimbursement terms.
• [ ] Feasible shipment, presentation, and expiry deadlines.
• [ ] Obtainable documents with clear issuers and requirements.
• [ ] Consistency with transport, delivery, and insurance arrangements.
• [ ] Defined sight or usance payment triggers and maturity calculation.
• [ ] Agreed responsibility for bank and amendment charges.
• [ ] Funding for settlement, duties, freight, and other landed costs.
• [ ] Internal ownership of discrepancy decisions and escalation.

Frequently asked questions

Does a letter of credit guarantee the goods will meet specifications?

No. Banks examine documents rather than goods. Use contractual specifications, supplier due diligence, and appropriate inspection alongside the LC.

Can an importer refuse LC payment because goods are defective?

A quality dispute does not ordinarily remove the bank’s obligation to honor a complying presentation. Contractual remedies and any potential legal exception require separate assessment.

Can the supplier correct discrepant documents?

Sometimes. Correction depends on the document, issuer, discrepancy, and remaining deadlines. Contact the bank promptly; some issues cannot be cured by replacing paperwork.

Is a usance LC always better for importer cash flow?

No. Deferred maturity may help, but collateral, facility usage, fees, and financing costs can offset that benefit. Compare the complete funding arrangements.

Build the supplier relationship before issuing the credit

Workable payment terms start with a capable counterparty and a clear order. Explore supplier sourcing and business listings on IMEX Center, then conduct due diligence and align the contract, documentary requirements, and payment funding with your supplier and trade finance bank before committing.