A letter of credit is an agreement between four parties: a buyer, an issuing bank, a seller (beneficiary) and an advising bank. Letters of credit typically are used for large-scale purchases or service agreements between individuals or companies conducting business internationally. When a buyer agrees to purchase goods or services from a seller (beneficiary), the issuing bank creates a letter of credit that agrees to pay the seller upon the completion of the transaction. The advising banks acts in a consulting role to oversee the transaction.
Letters of credit provide documentation of an international transaction. After a letter of credit is delivered, the seller performs the necessary actions, such as delivering goods to a specified location, to complete the transaction. In this example, after the goods have been delivered according to the constraints of the LOC (letter of credit) and documentation has been provided to prove such actions, the buyer can withdraw funds from the issuing bank.
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Importance of Language
Letters of credit are ironclad. Because most of them represent large-scale purchase transactions, their language must reflect exactly how the transaction will take place. Dates, locations, times, dollar figures and proper identification of the parties involved are crucial to the legitimacy of the document. Similarly, buyers and sellers must confirm the legitimacy and reputation of both the issuing and advising banks before proceeding with a letter of credit.