By Dr Domenico Del Sorbo, LIBF Qualified Trade Finance Expert

In the realm of international trade finance, the most accurate and widely recognised definition of a letter of credit is found in Article 2 of the ICC’s Uniform Customs and Practice for Documentary Credits (UCP 600):

“Credit means any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation.”

At its core, a letter of credit (LC) is an irrevocable undertaking by the issuing bank to honour a presentation of documents that complies strictly with the terms and conditions of the credit.

Key Features Explained

1. “However named or described”

The designation or title of the instrument is legally irrelevant. In line with the principle of substance over form, the legal status of a credit is determined by its content, not by what it is called. Whether it is labelled a “Documentary Credit”, “Letter of Credit”, or otherwise, what matters is the binding undertaking to pay against compliant documents.

2. Irrevocable Nature

Since the implementation of UCP 600, all LCs are deemed irrevocable by default. This means the credit cannot be amended or cancelled unilaterally—any changes require express agreement from the issuing bank, the confirming bank (if any), and the beneficiary.

3. Issuing Bank – Not Always a Traditional Bank

While UCP 600 refers explicitly to an “issuing bank”, in practice, letters of credit can be issued by non-bank financial institutions such as insurers, forfaiting houses, export credit agencies, and corporate treasuries. These entities can undertake similar obligations, even though they fall outside the traditional banking framework.

4. Honour vs. Negotiate

The issuing bank’s obligation is to “honour” a complying presentation:

• By paying at sight,
• By undertaking deferred payment and settling at maturity,
• Or by accepting a draft and paying at maturity.

In contrast, “negotiation” refers to the purchase of drafts or documents under a complying presentation. Only nominated banks may negotiate under UCP 600 unless otherwise agreed. Issuing banks do not normally perform negotiation functions.

5. What Constitutes a “Complying Presentation”?

A complying presentation must conform to:

• The specific terms of the credit,
• The rules of UCP 600,
• And international standard banking practice (ISBP 821).

Importantly, banks assess presentations documentally, not based on actual goods or services. Expert references include ICC Opinions and judicial interpretations through DOCDEX.

6. Electronic vs. Paper Presentations

UCP 600 governs only paper-based documentation. Faxed documents are not permitted. However, where the LC expressly states it is subject to the eUCP supplement, electronic records (or a combination of paper and electronic submissions) may be accepted.

7. Independence from Underlying Contracts

Articles 4 and 5 of UCP 600 confirm that a letter of credit is a separate undertaking from the underlying sales contract or service agreement. Banks deal only with documents—and not with the goods, services, or performance those documents may represent.

Final Thoughts

A letter of credit is more than just a method of payment—it is a complex legal and operational tool with deep roots in international commercial law. A solid understanding of UCP 600, ISBP, and documentary compliance is essential for any business or financial institution seeking to use LCs effectively as instruments of risk mitigation and transactional certainty.