Letters of Credit

Letters of credit have always proven to be very useful. They are extensively used today in internationally as well as in intranationally. I have found that they are primarily associated with international trade because of the security and flexibility their use affords. Letters of credit are even used to help acquire utility company accounts or to secure both corporate or residential leases.

Attachment 1884

In essence, a letter of credit is an agreement whereby at least one party (the issuer):

(i) authorizes or invites another party (i.e. the beneficiary) to draw on or to make monetary demands against the issuer for a specific amount or amounts in connection with liabilities arising with respect to an account held by another person (i.e. account holder or account party) although the issuer of a letter of credit can issue a letter of credit for its/her/his own account;
(ii) binds the one making the letter of credit to honor drafts or demands made in association with the letter of credit;
(iii) instructs the beneficiary as to requirements for the drafts even as to what must accompany the draft or demand.

There are quite a few study treatises and references on the topic of letters of credit. Though my point here is to boil things down to their simplicity. No matter what the extra verbiage a letter of credit contains, it comes down to those three elements: (i) establishment and the invitation or authorization to draw the beneficiary typically with respect to the holder of an account (which can be the issuer's own account--i.e. a bank can issue a letter of credit for its own account); (ii) the agreement or engagement to honor the drafts; (iii) instruction as to requirements for what is an acceptable draft.

Many people seem interested in money--some have even killed for it. But what is it that few will bother reading learned treatises on things money?

Attachment 1885
Letters of credit might seen old, antiquated, boring or dusty but I'd beg to differ. More modern renditions of letters of credit are traveler's check and credit cards. With a credit card, the issuing bank (issuer) allows the cardholder (account party) to drawn on the issuing bank for charges made against the account party by merchants. The type of letter of credit where the amount is 'reset' periodically is called a 'revolving letter of credit'.

FYI, if you're aiming to study old books (1700s to early 1900s) on letters of credit they were often referred to as "circular credits" or "banker's credits" though also as "letters of credit".

Here, I have boiled down to useful essentials.

Attachment 1886

Letters of introduction, letters of credit and traveler's checques are somewhat related. But still, it really takes a comprehension of fundamental negotiable instrument practices to really get the usefulness of letters of credit. Fortunately, a study of letters of credit can lead to sound study of negotiable instruments and the like (all which are IMHO a subset of contract law).

Attachment 1888
Drafts (Checks, Bills of Exchange & Money Orders)
But for convenience let's consider the following:

1. A demand or order to pay money is a draft (i.e. the person making the demand is charging or drawing and the person to which the draft is made is being drawn upon or is playing to role of 'drawee'-- REPEAT someone demanding money from you is issuing you a draft verbally or in writing);
2. Since banks and others might be holding on to money or valuables for some of us from time to time then there comes in the potential of deflecting (that word again) or re-directing the charges to another party (typically a bank or some other fiduciary)--i.e. if you keep your money somewhere you can instruct a fiduciary to honor demands made against you (however with a typical bank account, a check is drawn on the bank not on the account holder with the account agreement likely authorizing the bank to get money/credit it has on account of yours to cover the item).


Related:
Understanding and Using Letters of Credit, Part I
Understanding and Using Letters of Credit, Part II
The Circular Letter of Credit