What is a Letter of Credit?
A letter of credit is a payment tool used in international trade transactions, which provides an irrevocable guarantee from a bank to a buyer that payment will be made to the seller, provided that certain conditions are met. The letter of credit is an agreement between the buyer, the seller, and the bank. The buyer’s bank administers the letter of credit to the seller after receiving a request from the buyer. The seller is then guaranteed payment from the bank upon complying with all the conditions specified in the letter of credit.
The letter of credit minimizes the risk of non-payment for the seller, as the buyer’s bank is obligated to pay the seller once all the prerequisites of the letter of credit have been met. The credit letter also helps protect the buyer, as payment is only made once the seller has fulfilled their contractual obligations.
The letter of credit includes the following:
- The issuing bank.
- The beneficiary.
- The amount.
- The currency.
- The expiration date.
- The documents required for payment.
- The applicable law.
- The payment terms.
- Any other conditions must be met before payment.
What is a Letter of Undertaking?
A Letter of Undertaking is a legal document to guarantee that an individual or organization will fulfill an agreed-upon obligation. It is used when one party needs assurance that the other party involved in an agreement will meet its end of the deal.
The letter is also used to assure that the individual or organization will not pursue a particular course of action or will not make any claims against the other party. The letter of undertaking contains details of the contract, the parties involved, and the obligations of each of them.
The undertaking may be legally binding or non-binding, depending on the context. The letter should be drafted carefully to ensure that all the terms and conditions are unambiguous. It is essential to ensure that the letter is legally binding and that all parties have agreed to the terms.
The letter of undertaking is a valuable tool for parties to provide assurance to each other and to ensure that their obligations are fulfilled. It also provides a basis for resolving disputes between the parties.
Difference Between Letter of Credit and Letter of Undertaking
- A Letter of Credit is a binding legal instrument, while a Letter of Undertaking is a non-binding agreement.
- A Letter of Credit involves the involvement of a third party (the issuing bank), while a Letter of Undertaking does not involve any third party.
- A Letter of Credit covers all aspects of a transaction, while a Letter of Undertaking covers only specific elements.
- A Letter of Credit is transferable, while a Letter of Undertaking is not transferable.
- A Letter of Credit covers the total amount of a transaction, while a Letter of Undertaking covers only a portion of the total amount.
Comparison Between Letter of Credit and Letter of Undertaking
| Parameters of Comparison | Letter of Credit | Letter of Undertaking |
| Purpose | A Letter of Credit guarantees payment to the beneficiary. | A Letter of Undertaking is used to guarantee the performance of a contract. |
| Validity | A Letter of Credit is valid for a fixed period. | A Letter of Undertaking is valid until the completion of the contract. |
| Applicability | A Letter of Credit applies to domestic and international transactions. | A Letter of Undertaking applies to domestic transactions only. |
| Types | A Letter of Credit is available in different types (e.g., revocable and irrevocable) | A Letter of Undertaking is a single type. |
| Enforcement | A Letter of Credit can be enforced in court. | A Letter of Undertaking cannot be enforced in court. |