# Irrevocable Letters of Credit: Definition, Uses, and Types

## What Is an Irrevocable Letter of Credit (ILOC)?

An irrevocable letter of credit (ILOC) is a bank-issued document guaranteeing that a buyer's payment to a seller will be honored. This payment assurance becomes crucial in international trade, providing security for both buyers and sellers. Once issued, ILOCs cannot be canceled or altered without the consent of all parties involved, including the buyer, the seller, and the bank. These guarantees enhance trust and facilitate transactions across borders, reducing associated risks.

### Key Takeaways

*   An irrevocable letter of credit (ILOC) provides a payment guarantee issued by a bank for the purchase of goods and services, which cannot be revoked or modified without all parties' consent.
*   ILOCs are primarily used in international trade to mitigate credit risk and ensure payment security between unfamiliar parties across borders.
*   A confirmed ILOC offers additional protection for the seller by providing a payment guarantee from both the buyer's and seller's banks.
*   The ILOC includes important transaction details such as price, payment terms, delivery deadlines, and required documentation.
*   Alternatives to using an ILOC include cash-in-advance, open accounts, documentary collections, and bank guarantees, each with varying degrees of risk and protection.

## How Does an Irrevocable Letter of Credit Work?

A letter of credit is issued by a commercial bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make a payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase.

Due to the nature of international dealings, including factors such as distance, differing laws in each country, and difficulty in knowing each party personally, the use of letters of credit has become a very important aspect of international trade.

Although an ILOC is irrevocable while it is in force, generally the time period during which a proposed transaction is expected to be completed, an ILOC expires at a specified point in time, which is noted in the letter of credit.

> **Important**
>
> An ILOC can be reversible and amended, but every party involved must agree to the change.

An ILOC helps facilitate a deal between a buyer and seller with support from their banks. The buyer requests an ILOC from his bank, which is then sent to the seller's bank. An ILOC not only offers credit risk protection but also specifies transaction details like price, payment terms, and delivery information.

If the buyer doesn't pay, their bank pays the seller's bank, which then pays the seller.

ILOCs can also be either confirmed or unconfirmed. A [confirmed ILOC](https://www.investopedia.com/terms/c/confirmed-letter-credit.asp) offers additional risk protection for the seller by providing a guarantee of payment from both the buyer's bank and the seller's bank. With an unconfirmed ILOC, the seller's bank has no liability for payment and essentially serves only as a go-between to transfer payment to the seller from the buyer's bank.

## Key Specifications of an Irrevocable Letter of Credit

Irrevocable letters of credit are official bank documents sent and verified through the [Society for Worldwide Interbank Financial Telecommunications](https://www.investopedia.com/terms/s/swift.asp) (SWIFT) banking system. This is a global setup for facilitating financial transactions between banks or other financial institutions, and an ILOC is transmitted as MT700—message type 700.

An ILOC offers more payment security to the seller, who is the letter's beneficiary. ILOCs are frequently sought for large construction projects because they are not subject to claims of preference in the event of a [bankruptcy](https://www.investopedia.com/terms/b/bankruptcy.asp).

ILOCs are most commonly used to facilitate international trade because of the additional credit risk involved when two parties unfamiliar with each other are transacting business across national borders. An ILOC assures the seller of receiving payment because it is a guarantee by the issuing bank, the buyer's bank, that it will make payment in the event the buyer fails to do so. By providing the seller with an assurance of payment, an ILOC also assists the buyer in arranging a transaction that the seller might otherwise be reluctant to make.

## What Information Does an Irrevocable Letter of Credit Include?

Each irrevocable letter of credit may address a unique creditor or situation. All irrevocable letters of credit generally include similar information. This information includes but is not limited to:

*   **Information on the Issuing Bank:** The ILOC should clearly identify the name, address, and phone number of the financial institution that issuing bank of the letter.
*   **Information on the Buyer or Applicant:** The ILOC should include the buyer's or applicant's name, address, and contact information in order to identify them. The applicant is the party asking for the ILOC to be issued.
*   **Information on the Beneficiary:** The ILOC should identify the seller or beneficiary and include their name, address, and phone number. The beneficiary is the person or entity who will receive money after the ILOC's terms and conditions are met.
*   **Dollar Amount:** The particular dollar amount that the issuing bank is guaranteeing should be stated in the ILOC. This number is the maximum cash that the beneficiary may receive from the bank upon fulfillment of the ILOC requirements.
*   **Expiration Date:** The ILOC should provide the date by which the beneficiary must submit the necessary paperwork in order to receive payment.
*   **Other Terms and Conditions:** The ILOC will specify the requirements that the beneficiary must satisfy in order to be paid. These criteria could specify that goods be shipped, inspected, documented, and in accordance with all applicable rules and laws.
*   **Required Documentation:** The ILOC will detail the precise documentation that the beneficiary must provide to the issuing bank in order to receive payment. Commercial invoices, transportation records (including airway bills or [bills of lading](https://www.investopedia.com/terms/b/billoflading.asp)), origin-certification records, and inspection records are examples of common papers.
*   **Prevailing Governing Regulations:** The ILOC may specify the regulations that apply to the transaction such as the Uniform Customs and Practice for Documentary Credits (UCP 600).
*   **Shipments in Parts:** The ILOC may state whether or not shipments in parts are permitted. If partial shipments are allowed, it should specify the restrictions and requirements that apply to them.
*   **Port of Loading/Discharge:** In order to ensure that items are carried as agreed, the ILOC may request the beneficiary to identify the chosen port of loading and discharge for the shipment. This may also extend to International Commercial Terms ([incoterms](https://www.investopedia.com/terms/i/incoterms.asp)) which control delivery and the transfer of risks between the buyer and seller.
*   **Insurance Requirements:** The ILOC could specify what kind of insurance is needed for the cargo, how much insurance is needed, and any other particular guidelines.

## Steps to Acquiring an Irrevocable Letter of Credit

1.   **Confirm Consent**: Verify that both parties agree to use an ILOC for transactions.
2.   **Select a Bank**: Choose a reputable bank with expertise in ILOCs and international trade.
3.   **Provide Details**: Submit necessary information, including amount, beneficiary details, and terms.
4.   **Review Approval**: The bank reviews and assesses the transaction and the applicant's creditworthiness.
5.   **Issue ILOC**: Upon approval, the bank issues the ILOC.
6.   **Verify Details**: Ensure the ILOC accurately represents agreed terms and rectify discrepancies if any.

When pursing an ILOC, consider opting for a reputable bank with knowledge in ILOC transactions and global trade. Various factors that may impact your ability to receive and trust in the ILOC process include the bank's financial stability, global reach, and credit handling experience. In many ways, the ILOC is not only a reflection on the buyer or applicant but a judgment on the validity of the issuing bank. If applicable, ensure the letter is drafted in compliance with [international trade laws](https://www.investopedia.com/articles/investing/011916/brief-history-international-trade-agreements.asp).

Banks often have an approval process in which they intake ILOC details such as the desired ILOC amount, beneficiary information, expiry date, required documents, and any specific terms and conditions. This information is evaluated, and an assessment is made not only on the transaction but on the creditworthiness of the requester. Once approved, the letter is prepared.

After issuance, review the ILOC to confirm it matches the agreed terms. To prevent issues throughout the payment process, any discrepancies or errors should be brought up right away with the issuing bank. Keep an eye on the ILOC's expiration date to make sure that all required documentation is provided and payment is requested within the allotted time limit. The letter could become null and void if this is not done.  

> **Tip**
>
> The hidden value of an ILOC is the fact that it is often issued by a Federally-insured financial institution. This level of protection is often unachievable by a seller on its own.

## Other Options Besides an Irrevocable Letter of Credit

In many cases, the buyer or applicant may be able to use an alternative to an irrevocable letter of credit. Sometimes, the buyer fully pays the supplier before getting the goods or services. As it requires a sizable upfront payment, it may be less advantageous for the buyer while providing the seller with a high level of protection when there is a [**cash-in-advance**](https://www.investopedia.com/terms/c/cashinadvance.asp) requirement.

In an open account transaction, payment is delayed until the product or service is received. This approach is excellent for established, long-term relationships because it is founded on mutual trust. Payment depends on the buyer's desire to pay; hence, the risk to the seller is larger.

In a [**documentary collection**](https://www.investopedia.com/terms/d/documentary-collection.asp), the buyer and seller exchange paperwork while also paying each other using a bank. In contrast to letters of credit, this form of e-bank serves as mediators but do not guarantee payments. Instead, they help with the document exchange and obtain money from the buyer on the seller's behalf.  

**Bank guarantees** are a type of assurance that a bank gives to a seller on behalf of a buyer. It guarantees the seller that the bank will compensate the seller up to a certain sum in the case of a default or non-performance by the buyer. Bank guarantees, such as payment guarantees, performance guarantees, or bid bonds, can be customized to fulfill particular needs.  

Last, some entail the use of a dependable third-party agent via [**escrow services**](https://www.investopedia.com/terms/e/escrow.asp) to hold the funds until specific requirements are completed. Once the buyer has affirmed satisfaction with the products or services they received, the money is given to the seller. Escrow services provide security, but one party must complete its part before the other can proceed.

## Practical Example of an Irrevocable Letter of Credit

The General Services Administration of the United States government provides the following example of an ILOC. After specific information is provided, the following confirmation may be added and signed by the issuing bank.

![ILOC Example](https://www.investopedia.com/thmb/0Bayli7-_Piclrf5z8-i5X4fDtc=/1490x0/filters:no_upscale():max_bytes(150000):strip_icc()/ILOC-2f20bbd5f8454515a4bff43ec9d80bf2.PNG)

*ILOC Example.*

Note that in many cases, this format is acceptable and can be used for a variety of types of transactions. It may be that a specific template for an ILOC can be used with specific fields input or relevant bits of data added. This ILOC example outlines the terms of expiration, prevailing rules it may be subject to, and signature blocks required by different parties.

## What Is the Role of the Issuing Bank in an Irrevocable Letter of Credit?

The issuing bank is the financial institution that issues the ILOC on behalf of the buyer. It undertakes the obligation to pay the beneficiary upon presentation of compliant documents. The issuing bank's creditworthiness and reputation are crucial factors influencing the acceptability of the ILOC.

## What Are the Benefits of Using an Irrevocable Letter of Credit for Buyers?

Buyers benefit from the assurance that payment will only be made upon proper documentation and compliance. An ILOC reduces the risk of non-performance by the seller and provides a level of security in international trade transactions.

## What Are the Benefits of Using an Irrevocable Letter of Credit for Sellers?

Sellers benefit from the payment guarantee provided by the issuing bank. The ILOC assures them that, upon fulfilling the specified requirements, they will receive payment from the bank, mitigating the risk of non-payment or delayed payment.

## Can an Irrevocable Letter of Credit Be Amended?

Yes, an ILOC can be amended if both the buyer and the beneficiary agree to the changes. Amendments can modify the ILOC's terms, extend the expiry date, or adjust other conditions. All parties involved, including the issuing bank, need to agree and endorse the amendment.

## The Bottom Line

The irrevocable letter of credit (ILOC) is a crucial financial tool in international trade that assures sellers of payment and offers buyers confidence in their transactions. An ILOC, issued by the buyer's bank, guarantees payment to the seller once the specified terms and conditions are met, enhancing trust between parties unfamiliar with each other across borders. By requiring consensus for any amendments, an ILOC mitigates the risks of non-performance and ensures reliability in global transactions. Buyers benefit by demonstrating creditworthiness, while sellers gain payment security even in complex international exchanges.

> **Article Sources**
>
> 1.  US General Services Administration.  “[52.228-14 Irrevocable Letter of Credit](https://www.acquisition.gov/far/52.228-14).”
>     
> 2.  Society for Worldwide Interbank Financial Telecommunications. “[Category 7 - Documentary Credits and Guarantees](https://www.swift.com/sites/default/files/documents/swift_solutions_sr2019_cat_7_advanceinformation.pdf).”
>     
> 3.  International Trade Administration. “[Open Account](https://www.privacyshield.gov/ps/article?id=Trade-Finance-Guide-Chapter-5-Open-Account#:~:text=or%2090%20days.-,An%20open%20account%20transaction%20in%20international%20trade%20is%20a%20sale,risky%20option%20for%20an%20exporter.).”
>     
> 4.  International Trade Administration. “[Documentary Collection](https://www.trade.gov/documentary-collections).”