What Is a Letter of Credit (L/C)? A Complete Guide to UCP 600 in International Trade

In an international deal, the seller fears shipping the goods and not being paid, and the buyer fears paying and not receiving the goods. A letter of credit (L/C) is a banking tool built to reduce that two-sided risk. The buyer’s bank undertakes to pay the seller, provided the seller presents the required documents in exact compliance with the terms of the credit. Most letters of credit today are issued subject to the Uniform Customs and Practice for Documentary Credits, UCP 600, published by the International Chamber of Commerce (ICC). For anyone organizing cargo transport in Iran, or trading with Iranian partners, knowing how an L/C works helps you plan shipping and documents around it.

What Is a Letter of Credit?

A letter of credit is an independent undertaking by a bank (the issuing bank) to pay a stated amount to the seller (the beneficiary) against documents that comply with the terms of the credit. The key point is that the bank deals in documents, not goods. It never inspects the shipment. It only checks whether the documents presented match what the credit requires.

The Main Parties to a Letter of Credit

• Applicant: Usually the buyer, who asks their bank to open the credit.

• Beneficiary: The seller, who is paid on presenting complying documents.

• Issuing bank: The buyer’s bank, which issues the credit and commits to pay.

• Advising bank: The bank that notifies the credit to the seller.

• Confirming bank: Where needed, a bank that adds its own independent payment undertaking on top of the issuing bank’s.

Why a Letter of Credit Is Irrevocable?

Under UCP 600, a credit is irrevocable by nature. It cannot be cancelled or amended without the agreement of all the parties concerned, and that is what gives the seller confidence. UCP 600 is not state law. It governs a credit only when the credit’s text states that it is subject to these rules.

How a Letter of Credit Works, Step by Step

1. Buyer and seller agree in the sales contract to pay by L/C.

2. The buyer asks their bank to open the credit.

3. The issuing bank issues the credit and has it advised to the seller through the advising bank.

4. The seller checks the credit terms against the contract and ships the goods.

5. The seller presents the documents (invoice, bill of lading, insurance document and others) to the bank.

6. The bank examines the documents and, if they comply, pays or accepts.

Common Types of Letters of Credit

• Sight L/C: Payment is made as soon as the documents are found to comply.

• Usance (deferred payment) L/C: Payment is made at a later date, for example 90 days after the bill of lading date.

• Confirmed L/C: A second bank also guarantees payment. It suits a seller who has doubts about the issuing bank or about country risk.

• Transferable L/C: The beneficiary can transfer all or part of the credit to one or more second beneficiaries, which helps trading intermediaries.

• Standby L/C: Works more like a guarantee and pays out only if the buyer defaults.

The Compliance Rule: Why Even a Small Mismatch Can Cause Trouble?

The bank examines documents on their face only. Under UCP 600, the data in different documents does not have to be identical, but it must not conflict with the credit or with the other documents. If the bank finds a discrepancy, it may refuse to pay. Each bank has a maximum of five banking days after the day of presentation to decide whether the presentation complies. If it refuses, it must issue a single notice that lists every discrepancy at once.

Key Deadlines

• Presentation period: Unless the credit states another period, documents including a transport document must be presented within 21 calendar days after the date of shipment, and in any event before the credit expires.

• The bank’s five-day examination period: It is not shortened by the credit’s expiry date. Presenting on the last day therefore leaves no time to correct and re-present documents.

• Latest shipment date and expiry date: Both appear in the credit’s text and should be matched with the shipping plan from the start.

Common Mistakes With Letters of Credit

Late presentation of documents: The most common discrepancy. The bill of lading is issued on time, but the documents reach the bank after 21 days or after expiry.

Goods description that doesn’t match: The description in the invoice should match the credit’s wording, not a shortened or reworded version.

Claused bill of lading: A bill noting damage or shortage (see our article on the bill of lading) is generally not accepted.

Ignoring insurance conditions: If the credit requires an insurance document, its cover and amount must match the credit. Under UCP 600 the cover should generally be at least 110% of the CIF or CIP value.

Ignoring amendments: After a credit is amended, the documents must match the new terms.

Incoterms and documents out of step: The Incoterm in the sales contract (for example FCA or CIF) must be consistent with the type of transport and insurance documents the credit requires.

Letters of Credit and Trade Involving Iran

Whether an L/C can be opened and used in a deal involving Iran depends on the banks’ access to settlement networks, their correspondent relationships, and the restrictions in force. Before signing a contract, ask your bank which type of credit can be opened and paid in practice. On the Iranian side, order registration and the currency allocation route must also be settled separately and before shipping, and they do not take the place of an L/C. Getting this right early also helps the rest of the chain, from cargo transit in Iran to customs clearance in Iran, run on schedule.

Practical Tips Before Accepting or Opening a Letter of Credit

• As soon as you receive the credit, compare every clause with the sales contract. If an amendment is needed, request it immediately, not after shipping.

• Record the latest shipment date, the presentation period, and the expiry date in your shipping plan.

• Write the goods description in the invoice exactly as it appears in the credit.

• Make sure the bill of lading is issued clean, and compare all documents against each other before sending them to the bank.

• Present documents several days before the final deadline so there is room to fix any problem.

• Review the credit’s terms, the Incoterm, and the type of bill of lading with a transport specialist at the same time.

Frequently Asked Questions About Letters of Credit

Does the bank check the quality of the goods?

No. The bank only examines the documents and takes no view on the quality, quantity, or real condition of the goods. For quality control, use a separate inspection.

What happens if the documents contain a discrepancy?

The bank may refuse payment, or the applicant may waive the discrepancy. In practice banks usually also charge a separate fee for handling discrepant documents.

How long do I have to present the documents to the bank?

Unless the credit sets another period, no more than 21 calendar days after the shipment date, and in any case before the credit expires.

A letter of credit, used with an understanding of its parties, its types, the document compliance rule, and the UCP 600 deadlines, goes from a complicated banking process to a practical tool for reducing payment risk. For help coordinating transport, documents, and Incoterms around your letter of credit, including cargo transport in Iran and customs clearance in Iran, contact the Shahan Kalaban team.