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Mistakes to Avoid When Using Letter of Credit

Mistakes to Avoid When Using Letter of Credit | Dhanguard

In international trade, a letter of credit is a financial document. It is a payment guarantee provided by the bank to the products seller. If the customer fails to make payments, the bank will provide a "Credit Letter" as a type of guarantee to the goods seller.

Letter of Credit in the UAE

The 'Lifeblood of International Commerce' is the Letter of Credit.

Letters of Credit are governed in the UAE under Federal Law No. 18 of 1993, the Commercial Transactions Law. A letter of credit is a contract in which a bank (the Issuing Bank) agrees to provide a large sum of money at a certain time when the applicant demands it. The funds will be disbursed in the name of the products seller, sometimes known as the beneficiary. This financial help is guaranteed by a document that reflects products that are being transported or are being readied for shipment. In a letter of credit, the credit supplied must be indicated in relation to the sale agreement that both the buyer and the seller have agreed to. The seller has the right to reject it if the credit specified in the Letter of Credit and the agreement are not the same.

What are the Components of a Letter of Credit?

Given below are the components of a Letter of Credit:

Issuing Bank

The name and contact information for the bank that is providing you with credit should be included.


The applicant's name and contact information who arranges for payment.


The name and contact information for the person who will receive the money from the issuing bank.

Time Limit Specified

It is necessary to state the payment deadline.


The parties to the Letter of Credit should agree on the letter's Terms and Conditions.

Specified Location

The document must be delivered at a specific location, which must be indicated in the text.

Types of Letters of Credit

There are two forms of letters of credit, revocable and irrevocable, according to commercial transactions legislation.

Revocable Letter of Credit

The credit can be terminated or altered at any time with this sort of letter of credit. Finally, it will not be held liable in any way for the beneficiary. The letter of credit is honoured after the terms and conditions, as well as the paperwork, are met. It is commonly used to convey shipping instructions.

Irrevocable Letter of Credit

A beneficiary, issuing bank, and confirming bank must all agree before an irrevocable letter of credit can be cancelled. It allows the bank and the beneficiary to have a good working relationship. As a result, this type of Letter of Credit provides the beneficiary with payment security.

What is the Process of Letter of Credit in the UAE?

The beneficiary or any other communicator bank in the beneficiary's place will be informed of the credit once the bank has validated the credit amount. After that, the communicating bank will contact the beneficiary to obtain authorization. The communicator bank will now be responsible for making payments to the beneficiary.

What are the Principles of a Letter of Credit in the UAE?

Under UAE law, the Letter of Credit is governed by a number of principles:

Autonomy Principle

Documentary credit might be regarded a separate contract from the underlying sales contract under the Principle of Autonomy. Letters of Credit's independence might be considered an advantage in international sales because they serve as a business assurance to parties operating in the international market in multiple nations. If banks were able to deny payment under a Letter of Credit if a dispute arose between the trading parties, a large flow of international trade would be halted.

Strict Compliance Doctrine

The Doctrine of Strict Compliance is the second important principle for Documents Credit. It is a need that the terms and conditions of the issued documents are followed. The Letter of Credit will be deemed to be in compliance with the document's conditions and free of any faults.

The Mistakes to be Avoided When Using a Letter of Credit?

Given below are the mistakes to be avoided:

To Understand the Real Purpose of the Letter of Credit

This is where you should start if you want to avoid any mistakes in the manuscript. If you don't know what a letter of credit is for, you won't know how to use it or if you're satisfying its conditions. It's possible that you'll inadvertently complicate (or simplify) details.

When Another Mode of Payment is Desired, A Letter Of Credit Is Chosen

We assumed at the outset of this post that you had already decided that a letter of credit was the best method of payment for your export. However, according to Novak, it's critical that you take the time to think about this option. If you choose a letter of credit as your payment option on the spur of the moment, you could be making a costly error.

Failure To Negotiate The Terms Of A Letter Of Credit While The Contract Is Being Negotiated

If you don't negotiate all of the conditions upfront, you risk being legally committed to them, even if they aren't in your best interests. This is especially crucial if you're working with a sales staff that only wants to sell and isn't concerned with the specifics of how they'll be compensated.

Improper Review of the Letter of Credit

A bank will examine a letter of credit from its own standpoint, thus sellers must examine the document from their own viewpoint. The bank will guarantee that everything is in order on its end, but it is the exporter's responsibility to ensure that what they evaluate and approve corresponds to what was agreed upon in the agreement, proforma invoice, or contract. If you don't, resolving a dispute or obtaining an amendment may take time, delaying your payout.


Because the UAE has business dealings all over the world, letters of credit are more vital in trade. Dhanguard assists its clients in overall banking services as our connection with a pool of banks enables us to help clients in a hassle-free manner. If you are looking forward to any banking-related services. Connect with us, we will gladly assist you.


Frequently Asked Questions

Letter of Credit is a contract in which the issuing bank agrees to provide a noteworthy amount of funding at a specific period when the applicant requests for it.

The letter of Credit has a certain steps that are required to be followed. Contact us at Dhanguard to know more about this process.

There are several types of Letter of Credit. As per the UAE law, there are two most common type of credit known as Revocable & Irrevocable Letter of Credit.

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