Letter of Credit Guide: How Documentary LCs Work in 2026
Complete guide to documentary letters of credit (LC). How LCs work, types (sight, usance, standby, revolving), UCP 600 rules, and when to use LC vs. open account.
A letter of credit (LC) is one of the most widely used instruments in international trade finance. When a buyer and seller are located in different countries, have no prior relationship, and operate under different legal systems, an LC provides the payment security that makes the transaction possible. In 2026, LCs remain the backbone of trade finance for transactions exceeding $500,000, particularly in emerging markets where counterparty risk is significant.
What Is a Letter of Credit?
A letter of credit is a written commitment issued by a bank (the issuing bank) on behalf of a buyer (the applicant), guaranteeing payment to the seller (the beneficiary) provided the seller presents documents that strictly comply with the terms and conditions of the LC. The bank's credit substitutes for the buyer's credit — so the seller no longer relies on the buyer's ability or willingness to pay, but on the financial strength of the issuing bank.
The legal foundation for most commercial LCs is the Uniform Customs and Practice for Documentary Credits (UCP 600), published by the International Chamber of Commerce (ICC). UCP 600 has been in force since July 2007 and governs the rights and obligations of all parties involved.
How a Letter of Credit Works: Step by Step
UCP 600: The Rules That Govern Letters of Credit
UCP 600 (Uniform Customs and Practice for Documentary Credits, 2007 Revision) is the ICC rulebook that standardizes LC practice globally. Key articles every trade finance professional should know:
Article 2 defines key terms: credit, complying presentation, confirming bank, nominated bank, honour.
Article 14 — Standard for Examination of Documents: banks examine documents to determine whether on their face they constitute a complying presentation. Banks do not verify that goods actually correspond to documents; they only check document compliance.
Article 16 — Discrepant Documents, Waiver, and Notice: if documents are discrepant, the issuing bank may either refuse and return, or contact the applicant for a waiver. The bank has 5 banking days.
Article 38 — Transferable Credits: defines when and how an LC may be transferred.
For electronic documents, the eUCP (Version 2.0) supplement applies alongside UCP 600.
Common Documentary Discrepancies
According to ICC surveys, over 70% of first presentations under LCs contain discrepancies. The most common:
1. Late presentation — documents presented after the LC expiry date or after the maximum 21-day presentation period post-shipment.
2. Description of goods — the invoice description does not exactly match the LC (extra words, abbreviations, punctuation differences).
3. Bill of lading issues — "on deck" notation when LC requires clean on-board BL; BL not marked "freight prepaid" when required; incorrect consignee or notify party.
4. Inconsistency between documents — amounts or quantities differ between invoice, packing list, and BL.
5. Partial shipments — made when LC prohibits them; or transhipment when prohibited.
6. Amount errors — invoice amount exceeds LC amount; overdrawn presentation.
Discrepant documents give the issuing bank the right to refuse payment. Exporters should build an internal document checklist tied to every LC before presenting.