New letters of credit: Overview, definition, and example
What are new letters of credit?
New letters of credit refer to a fresh or newly issued financial instrument from a bank or financial institution that guarantees payment for a transaction. In international trade, a letter of credit (LC) serves as a commitment by the bank to pay the seller upon receiving specific documents that prove the buyer’s order has been fulfilled. New letters of credit are issued for specific transactions, and they help mitigate the risk of non-payment or fraud, ensuring that both the buyer and the seller meet the agreed-upon terms.
A "new" letter of credit simply means that it is being issued for the first time for a specific trade or agreement and has not been issued previously for the same purpose or transaction.
Why are new letters of credit important?
New letters of credit are important because they provide a secure and reliable method for facilitating payments in transactions, especially in international trade. These financial instruments help both buyers and sellers by ensuring that payments will be made once the seller meets the contractual conditions, such as delivering goods or providing services. For businesses, using new letters of credit helps build trust, reduce risks, and facilitate smooth transactions with international partners, as they offer protection against the potential for non-payment.
For the buyer, the new letter of credit ensures that the seller will only receive payment when they meet the necessary terms, such as delivering goods on time. For the seller, it provides assurance that they will be paid, as long as they comply with the terms set in the letter of credit.
Understanding new letters of credit through an example
Imagine a U.S.-based company, Company A, wants to purchase raw materials from a supplier in India. The supplier is concerned about getting paid, so Company A requests a new letter of credit from its bank. The bank issues a new letter of credit, specifying that once the supplier ships the materials and provides the required shipping documents (like the bill of lading), the bank will make the payment.
The new letter of credit gives the supplier assurance that they will receive payment for the goods once the conditions are met, and Company A knows that the supplier will only be paid once the shipment has been made and documented correctly.
In another example, a business that is about to export goods to another country might request a new letter of credit to guarantee payment from the overseas buyer. The letter is issued by the bank and ensures that the payment will be made once the buyer has received the goods and confirmed that all terms are satisfied.
An example of a new letter of credit clause
Here’s how a clause for issuing a new letter of credit might appear in an international trade agreement:
“The Buyer shall arrange for a new letter of credit to be issued by a bank of their choice in favor of the Seller. The letter of credit shall be issued in a timely manner and be irrevocable, guaranteeing payment for the agreed-upon goods upon receipt of the required documents as set forth in this Agreement.”
Conclusion
New letters of credit are essential tools in international trade, providing security and trust between buyers and sellers. By ensuring payment is made upon fulfillment of agreed terms, they reduce financial risks and help businesses complete transactions with confidence.
For businesses involved in global commerce, understanding how to use and request new letters of credit is critical to ensuring smooth, secure, and reliable transactions, while minimizing risks associated with non-payment or contract disputes.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.