Letter of credit

A letter of credit is an document in commercial law that consists of a promise by a bank (or similar entity) that it will honor a demand for payment if certain conditions are satisfied. Generally, they come in two different types.

A Standby Letter of Credit is issued normally as a type of performance surety. For example, a municipality may require a contractor working on municipal property to post a Standby Letter of Credit to fund the completion of the work if the contractor is unable to do so.

A Documentary Letter of Credit usually consist of delivery of certain goods in long-distance sales. If an exporter was selling goods to a foreign country, he might insist on a Documentary Letter of Credit from the buyer's bank, but guaranteed by the seller's bank. The exporter would then be paid upon presentation of documents such as commercial invoices, bills of lading, weight certificates or any number of documents evidencing the shipment of goods. Letters of credit enable a buyer to establish a line of credit upon which a seller in a long-distance transaction can rely.