Letters of Credit Explained: Getting Paid (and Paying) Safely in Global Trade

International trade has a trust problem. A buyer in one country and a seller in another, who may never meet, have to exchange a container of goods for a large sum of money — and neither wants to go first. The seller fears shipping and not being paid; the buyer fears paying and not receiving. The letter of credit is the centuries-old, bank-backed mechanism that solves this standoff. It’s also where a surprising number of shipments get stuck. This guide explains how letters of credit work, when to use one, and how to avoid the discrepancies that trip up most importers.

What a letter of credit is

A letter of credit (L/C, or “documentary credit”) is a guarantee issued by the buyer’s bank promising to pay the seller a defined amount, provided the seller presents a specified set of documents proving they shipped the right goods on the right terms. The crucial shift is that the payment risk moves from the buyer (who might not pay) to a bank (which is good for the money). The seller no longer has to trust the buyer — only the bank.

The deepest principle of an L/C is this: banks deal in documents, not goods. The bank never sees the cargo. It pays against paperwork that complies exactly with the L/C terms. That’s the source of both its power and its pitfalls.

How a letter of credit works, step by step

1. Agreement. Buyer and seller agree to settle by L/C and write the terms into the sales contract — amount, documents required, latest shipment date, Incoterm.
2. Issuance. The buyer (applicant) asks their bank (the issuing bank) to issue the L/C in favour of the seller (beneficiary).
3. Advising. The issuing bank sends the L/C to a bank in the seller’s country (the advising bank), which confirms its authenticity to the seller.
4. Shipment. The seller ships the goods and obtains the transport document — for ocean freight, the bill of lading, which is also a document of title.
5. Presentation. The seller presents the required documents — invoice, packing list, bill of lading, certificates — to the bank.
6. Examination & payment. The bank checks the documents against the L/C terms. If they comply, the bank pays. The documents (including the title document) then pass to the buyer, who uses them to claim the goods.

The types you’ll encounter

• Irrevocable L/C. Cannot be changed or cancelled without all parties’ agreement. This is the standard — an L/C that could be revoked offers the seller little security.
• Confirmed L/C. A second bank (usually in the seller’s country) adds its own guarantee on top of the issuing bank’s. Worth paying for when the issuing bank’s country carries political or financial risk.
• Sight vs. usance (term) L/C. A sight L/C pays on presentation of compliant documents; a usance L/C pays at a fixed period after — effectively giving the buyer credit terms.
• Transferable L/C. Allows the beneficiary to transfer part of the credit to a third party — useful for intermediaries and trading houses.

The discrepancy problem

Here is the single most important thing for an importer to understand: most L/C document presentations are rejected on first submission — not because of fraud, but because of tiny discrepancies. Because banks pay only against documents that comply exactly with the terms, the smallest mismatch can hold up payment and, by extension, the release of your goods.

Common discrepancies that cause rejections:

• Inconsistent details — a company name spelled differently across documents, a quantity or weight that doesn’t match between invoice and packing list.
• Expired or late presentation — documents presented after the L/C’s expiry or outside the presentation window.
• Shipment after the latest date — the bill of lading shows a load date past the L/C’s latest shipment date.
• Description mismatch — the goods description on the invoice doesn’t exactly match the wording in the L/C.
• Missing documents — a certificate the L/C required wasn’t included.

Every discrepancy means delay, possible fees, and renewed payment risk. Precision in the document pack isn’t pedantry here — it’s the whole game.

When to use an L/C — and when not to

Letters of credit aren’t free or fast. They carry bank fees and administrative overhead, so they’re not the default for every shipment. Use one when:

• You’re dealing with a new supplier you don’t yet trust.
• The order value is large enough that the risk justifies the cost.
• The supplier’s country carries political or economic risk that makes you want a bank guarantee.
• The supplier insists on payment security before producing.

As trust builds, importers typically graduate toward cheaper, simpler methods — documentary collections, then open account with a deposit. The L/C is the trust-building tool for the early, risky phase of a supplier relationship.

How L/Cs interact with the rest of your import chain

An L/C touches everything. The Incoterm you choose determines which transport and insurance documents the seller must present, so L/C terms and Incoterms must align. The bill of lading sits at the centre because it’s both a required document and the title to the goods. And because payment hinges on flawless paperwork, the L/C raises the stakes on getting your documentation exactly right — the same discipline that keeps customs clearance fast.

The bottom line

A letter of credit is how strangers trade safely across borders: it swaps the risk of an unknown counterparty for the reliability of a bank. But its power rests entirely on documentary precision — banks pay against papers, not goods, and reject on the smallest mismatch. Master the document discipline and an L/C is a powerful safety net; neglect it and the very tool meant to protect you becomes the thing that strands your shipment.

Navvic’s trade desk prepares L/C-compliant document sets in-house and aligns them with your Incoterms and clearance, so presentations pass first time and payment — and goods — move without friction. Tell us about your transaction and we’ll make sure the paperwork holds up.