Letters of Credit for Commodity Imports: Types, Documents and Pitfalls

A letter of credit (LC) is a bank's undertaking to pay the seller, provided the seller presents documents that comply exactly with the credit's terms. The bank pays against paper, not against the product, so most LC problems come from documents that do not match, not from cargo that is bad. For importers, the practical lesson is to write an LC that the seller can actually comply with. For exporters, it is to check the draft before the cargo moves.

This guide covers how documentary credits work for commodity and petrochemical imports, the main types, the documents presented, the basics of UCP 600, how discrepancies arise, and the alternatives. It is general guidance, not legal or banking advice; your own bank will have its own rules and requirements.

How a documentary credit works

The buyer (the applicant) asks its bank (the issuing bank) to open a credit in favour of the seller (the beneficiary). The credit is usually sent to the seller through another bank (the advising bank), which authenticates it. The sequence runs like this:

1. Buyer and seller agree a sales contract that names the LC as the payment method.
2. The buyer applies to its bank, which issues the credit.
3. The advising bank notifies the seller. The seller checks it against the sales contract.
4. If the credit is acceptable, the seller loads and ships the goods.
5. The seller collects the documents the credit calls for and presents them to the nominated bank (or the issuing bank) before the credit expires and within the permitted period after shipment.
6. The bank examines the documents. If they comply, it pays (sight credit) or commits to pay at a later date (usance credit).
7. The documents go to the buyer, who uses them to take delivery of the cargo.

Two principles from UCP 600, the ICC rules that govern most commercial credits, shape everything else. First, the credit is a separate transaction from the sales contract: the bank is not concerned with the contract, even if the credit refers to it. Second, banks deal with documents, not goods: they do not check whether the cargo is the right quality or even whether it was shipped.

Types of letter of credit

Sight and usance

• Sight credit. Payment is due once the bank has examined the documents and found them compliant. Under UCP 600 the bank has a maximum of five banking days following the day of presentation to decide.
• Usance (deferred payment) credit. Payment is due at a set time after a trigger, for example 60 or 90 days after the bill of lading date. The bank undertakes to pay on the maturity date. This gives the buyer time to sell the goods before paying.

For the seller, usance means waiting for money. It may be able to discount the bank's undertaking to receive funds early, at a cost. Check who bears the discount charges: the contract and the credit should say whether the buyer or seller pays for the usance period. A credit that says "usance at buyer's account" shifts those costs to the buyer, whereas a standard usance credit may leave them with the seller.

Confirmed and unconfirmed

An unconfirmed credit carries only the issuing bank's promise. If the issuing bank is in a country with transfer restrictions or political risk, or the bank itself is weak, the seller's payment depends on it.

A confirmed credit adds a second undertaking from a bank, usually in the seller's country, which pays the seller if the documents comply, regardless of what happens to the issuing bank. Confirmation costs money, and the bank will only confirm if it is comfortable with the issuing bank and the country risk. The credit must authorise or request the confirmation.

Rules of thumb for sellers:

• Ask for confirmation when the issuing bank or the country is unfamiliar, or when the amounts are large relative to your balance sheet.
• Agree in the sales contract who pays for confirmation. If the buyer does not agree to pay, the seller will bear it or lose the protection.
• A "silent" confirmation, arranged privately between the seller and a bank without the issuing bank's knowledge, is a separate commercial arrangement. Understand its terms before relying on it.

Standby letters of credit (SBLC)

A standby LC works differently. It is a back-up payment promise: the beneficiary only draws on it if the applicant fails to pay. Typical documents are a signed demand and a statement that the applicant has defaulted. SBLCs can be issued under UCP 600 or under the International Standby Practices (ISP98), and a related instrument, the demand guarantee, is covered by URDG 758.

For commodity trade, SBLCs are used to support open-account or deferred payment terms. A seller might ship on 30 days' credit and hold an SBLC to cover non-payment. Two cautions:

• An SBLC is not a payment instrument in the way a documentary credit is. It does not substitute for the shipping documents the buyer needs.
• Be careful with offers of SBLC "leases" or "monetisation" from unregulated intermediaries. Real SBLCs come from regulated banks, are transmitted through bank channels, and are not traded on request by brokers. See our guide on how to verify a petrochemical supplier.

The documents presented

The credit lists the documents required, how many originals and copies, and who must issue them. Typical sets for a petrochemical cargo include:

For more detail on each document and how errors creep in, see our guide to export shipping documents.

Notes on the main documents

Bill of lading. Unless the credit allows otherwise, banks expect a full set of originals, showing the goods were shipped on board a named vessel, with no adverse remarks about the condition of the goods. If the credit allows a charter party bill of lading, different examination rules apply. Check that the type of bill the credit accepts is one the carrier will actually issue; for example, a credit that demands a negotiable bill when the shipment moves on a sea waybill creates an impossible condition.

Commercial invoice. The description of goods must correspond with the credit. It does not need to be a copy, but it must not conflict with it. Do not add or shorten wording.

Certificate of analysis and inspection certificate. If the credit demands that a named company such as an independent inspection firm issue the certificate, a certificate from anyone else will be rejected. Make sure the results shown meet any specification written into the credit. Chemineral can arrange SGS or Intertek pre-shipment inspection for buyers who want a certificate that satisfies a bank and gives independent evidence of quality and quantity.

Insurance. If the credit is CIF or CIP-based, UCP 600 sets the minimum insured amount at 110% of the CIF or CIP value, unless the credit says otherwise. Understand the Incoterm, as the insurance required differs; our Incoterms 2020 guide explains the cover levels.

UCP 600 basics

UCP 600 is the ICC's set of rules for documentary credits, in force since 2007. A credit is subject to it only if it says so. Features that matter most in practice:

• Irrevocable by default. A credit under UCP 600 cannot be amended or cancelled without the agreement of the issuing bank, any confirming bank and the beneficiary.
• Examination time. A bank has a maximum of five banking days following the day of presentation to decide whether the presentation complies.
• Presentation period. If the credit does not state otherwise, documents must be presented within 21 calendar days after the date of shipment and not later than the expiry date. A credit that expires on the shipment date, or that allows too few days, is a trap.
• Place of expiry. The credit must state a place for presentation. If the place is the issuing bank's counters in the buyer's country, the seller bears the risk of courier delays, public holidays and closures. Ask for presentation at a bank in the seller's country wherever you can.
• Documents must not conflict. Data in a document need not be identical to the credit, but it must not conflict with data in that document, any other stipulated document, or the credit.
• Non-documentary conditions are disregarded. If a credit contains a condition without a document to prove it, banks will treat it as not stated. Do not rely on such conditions for protection.
• Quantity and amount tolerances. Unless the credit says otherwise, a tolerance of 5% more or less in the quantity of goods is acceptable if the credit does not state the quantity in packing units or individual items, as long as the total drawn does not exceed the credit amount. Do not assume this applies; check the credit's wording, and state any tolerance expressly.
• Partial shipments and transhipment. Partial shipments are allowed unless the credit prohibits them. Transhipment rules depend on the transport document and the wording of the credit.
• "On or about". A date described this way is read as five calendar days before to five calendar days after the stated date.

Discrepancies: why they happen and how to avoid them

A discrepancy is a difference between the documents and the credit's terms, or between the documents themselves. When a bank finds one, it can refuse to pay. It must give the seller a single notice stating every discrepancy, within the five banking day limit. The documents can then be corrected and re-presented before expiry, or the buyer can be asked to waive the discrepancies. The buyer is under no obligation to agree, and may use the opportunity to renegotiate the price, particularly if the market has fallen.

Most common causes

• Late shipment or late presentation. Shipment after the latest date in the credit, or presentation beyond the permitted days.
• Mismatched names and addresses. The beneficiary, applicant, consignee or notify party spelled differently between documents.
• Goods description. Abbreviated or reworded on the invoice, certificate or bill of lading.
• Quantity or weight differences. The invoice, bill of lading, inspection certificate and packing list showing slightly different figures.
• Unclean or wrongly endorsed bill of lading. Remarks about the condition of the cargo or packaging, or a missing original.
• Wrong issuer. An inspection or analysis certificate issued by a body other than the one named.
• Insurance shortfall. Insured value below 110%, wrong voyage, or the wrong risks.
• Port names and routing. The credit says "Sohar" and the bill of lading says a different loading port, or the vessel is not allowed by the credit.

Controls that work

1. Review the draft credit line by line against the contract on the day it arrives, not the day before loading. Demand amendments immediately for any term you cannot meet.
2. Remove conditions that depend on the buyer. Examples are certificates signed by the buyer, or inspection by a body the buyer will nominate later. They hand the buyer control over whether you get paid.
3. Check dates backwards. Work from expiry back to the last shipment date, the presentation period, and the days you need to collect the documents.
4. Build a master data sheet with the exact names, addresses, goods description, quantity and unit that every document must repeat. Issue documents from that sheet.
5. Have the documents checked before presenting them, ideally by someone who did not prepare them. Many banks and forwarders offer a pre-check; use it.
6. Request amendments early. They need the agreement of all parties and take time.

Clauses to watch before you accept a credit

• Expiry only at the issuing bank's counters, with a short presentation period.
• Requirements for documents that the issuer cannot or will not provide, such as a certificate of origin from a body the seller cannot access.
• Insistence on an unusual bill of lading type, or a named vessel or carrier that has not been agreed.
• A requirement that the inspection certificate be issued by a company the applicant will name later.
• Charges: confirm that all bank charges outside the issuing bank's country are for the applicant's account, if that is what the contract says.

Alternatives to a letter of credit

LCs are not the only way to pay, and for repeat business or smaller shipments they can be heavier than needed. The main alternatives, from lowest to highest seller risk:

Documentary collections follow the ICC's Uniform Rules for Collections (URC 522). Banks handle the paper but do not guarantee payment.

A few cautions on each:

• TT advance is simple, but buyers should only pay to a verified account in the seller's company name, after confirming bank details through a known channel. Be especially careful with any request to change bank details. See the supplier verification guide.
• Documents against payment gives the seller control of the originals until the buyer pays, but only if the bill of lading is a negotiable original sent through the banks. Releasing cargo by telex release or sea waybill removes that control.

Which payment terms apply is agreed per transaction and depends on the product, the volume, the destination and the parties' history. Ask the trade desk at quotation stage.

A short checklist

For buyers opening a credit:

• Match the credit to the sales contract term by term.
• List only documents the seller can obtain.
• Allow a presentation period that works for the cargo's real timetable.

For sellers receiving a credit:

• Check the beneficiary name, amount, currency and quantity.
• Check shipment dates, expiry date and place.
• Check every document requirement against what you can produce, and ask for confirmation if the risk warrants it.
• Present early, with room to fix errors.

Frequently asked questions

What is the difference between a sight LC and a usance LC?

A sight LC pays once the bank has found the documents compliant. A usance LC commits the bank to pay at a later date, such as 60 days after the bill of lading date. Usance gives the buyer time to resell the goods; the seller waits unless it discounts the bank's undertaking.

Do I need a confirmed LC?

Not always. Confirmation makes sense if you doubt the issuing bank, or the country imposes transfer or political risks. It adds cost, and the confirming bank must be willing. If the buyer is meant to pay for confirmation, say so in the sales contract.

Is an SBLC the same as a letter of credit?

No. A documentary LC is the primary way of paying; the seller presents shipping documents and is paid. An SBLC is a back-up that is drawn on only if the buyer fails to pay. It does not replace the documents the buyer needs to collect the cargo.

What happens if the bank finds a discrepancy?

The bank must send a notice listing all discrepancies within five banking days of presentation. The seller can correct and re-present the documents while the credit remains valid, or ask the buyer to waive the discrepancies. The buyer may agree or refuse. Banks often charge a fee for each discrepant presentation.

How long do I have to present documents?

If the credit does not state a period, documents must be presented within 21 calendar days after the date of shipment, and never after expiry. A credit can set a different period, so read it carefully.

Is a letter of credit a guarantee that the cargo is right?

No. The bank pays on documents that comply with the credit. If you want evidence of quality and quantity, require an independent inspection certificate, and agree what specification it must show.

Next step

If you are planning a purchase from Sohar or Salalah and want to discuss payment structure, documents and inspection before you instruct your bank, contact the Chemineral trade desk.