Under an irrevocable letter of credit, the issuing bank (irrevocable unconfirmed credit), or the advising bank (irrevocable confirmed credit) are legally obliged to pay the seller upon presentation of documents that comply with the terms of the credit (articles 2 and 7, UCP 600).
The promise to pay the seller by the banks is, therefore, irrevocable; contrary to a revocable letter of credit, that exposes the seller to the risk of being denied payment, the irrevocable letter of credit guarantees the seller to receives his due money. As long as the banks involved are reputable, solvent banks, the seller is assured to get paid.
There are two types of irrevocable credit, which may incorporate different levels of risk depending on the circumstances.
Irrevocable Unconfirmed Credit
If the credit is irrevocable but unconfirmed, the legal undertaking to perform payment occurs between the seller and the issuing bank only. There is no need of getting confirmation from an advising bank; the issuing bank will provide payment to the seller in his country (through a branch or a network bank instructed by the issuing bank) upon presentation of documents.
The nuisance for the seller in such arrangement is that, in case of dispute, he has to sue the issuing bank in a foreign country. That could happen, for example, because the issuing bank refuses to pay the seller due to discrepancies in the presented documents; an extreme case would be if the issuing bank is insolvent.
If the seller’s country and the buyer’s country have signed an extensive free trade agreement, or are in the same trading block such as the EU or the ASEAN, the exporter should be able to obtain his money. That would be also the case if the issuing bank is a reputable international bank, with branches in several countries that the seller can have access to, such as the UK.
But in other situations, the fact that part of the credit transaction is out of the control of the seller is an element of risk. In that case, an irrevocable confirmed credit would be preferable.
Irrevocable Confirmed Credit
An irrevocable credit becomes confirmed when the advising bank, in this case also called confirming bank, adds its legal obligation to pay the seller on top of that of the issuing bank.
The advantage for the seller is clear: under an irrevocable confirmed credit, the seller has the assurance to receive payment from a bank in his country. Any dispute between the seller and the advising bank will be dealt with under the their domestic legal system.
Therefore, the irrevocable letter of credit eliminates any risk for the seller, apart from the ones related to the solvency of the banks, and should be the preferred payment method in an international sale.
When does the credit becomes irrevocable?
If you happened to read our article about revocable letters of credit, you would know that, at some point, even that type of credit has to become irrevocable. In that case, a revocable credit becomes irrevocable when the advising bank accepts the documents presented by the seller according to the terms of the credit. The problem there is that the seller ships the goods without being sure that the bank will pay.
Under an irrevocable letter of credit the seller receives confirmation that the issuing or advising bank will pay at the moment he is notified by either bank, depending on whether the credit is confirmed or unconfirmed, that the buyer has opened a letter of credit with the seller as beneficiary.
Since the opening of a letter of credit is conditional for the shipment the goods, in an irrevocable credit the seller ships the goods knowing that he will get paid.
Therefore, apart from certain situations where the sale transaction occurs between group companies, or supplier and buyer have a long history of working together, sellers should insist that the letter of credit be always irrevocable.
Globartis Research Center