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Letter of Credit
Practical Law Glossary Item 3-382-3574 (Approx. 2 pages)
Glossary
Letter of Credit
A three-party instrument or document issued by a bank that guarantees the payment of a customer's draft up to a stated amount for an express period of time. The purpose is to substitute the issuing bank's credit for that of the applicant and eliminate the risk to the beneficiary that the applicant will not pay. Letters of credit are irrevocable unless expressly stated otherwise. They are used in many circumstances and are prevalent in international trade.
There are several different types of letters of credit including:
- Commercial, used as a primary means of making payments (such as paying for goods shipped from overseas).
- Standby, used as a secondary source of payment (in lieu of a guaranty) or as a direct payment on a debt issue (such as monthly interest payments on municipal bonds).
- Performance, issued to guarantee performance under a contract.
- Confirmed, provided by a correspondent bank and guaranteed by the issuing bank.
For the purpose of the UCC a letter of credit is a definite undertaking that satisfies the requirements of Section 5-104 of the UCC by an issuer to a beneficiary at the request or for the account of an applicant or, in the case of a financial institution, to itself or for its own account, to honor a documentary presentation by payment or delivery of an item of value (UCC § 5-102(a)(10)). A letter of credit is an asset type over which an entity can grant a security interest under Article 9 of the UCC.