An open letter of credit is a form of letter of credit that can be paid with a simple draft, without the requirement of documentary title. It is a financial instrument in which a bank commits to honouring a draft or payment request made by a third party, as long as the draft or request meets specific conditions, regardless of whether the customer and beneficiary have fulfiled any underlying agreement. Open letters of credit are regulated by Article 5 of the UCC and are utilised when there will be multiple drafts within a single transaction or multiple transactions within a single credit.
An open letter of credit is a form of letter of credit that can be paid on a simple draft without the need for documentary title. It is a commercial law instrument in which the issuer, typically a bank, agrees to honour a draft or other demand for payment made by a third party, as long as the draft or demand meets specified conditions, regardless of whether any underlying agreement between the customer and the beneficiary is fulfiled. For instance, if a company in the United States wants to purchase goods from a company in China, they may utilise an open letter of credit. The U.S. company’s bank would issue the letter of credit to the Chinese company’s bank, guaranteeing payment upon presentation of a simple draft. This allows the Chinese company to ship the goods without concern for payment, and the U.S. company to receive the goods before making payment.
An open letter of credit is a type of letter of credit that allows the beneficiary to draw on the credit multiple times within a specified period.
The issuer of the letter of credit sets a limit on the amount that can be drawn and a time period during which the beneficiary can draw on the credit. The beneficiary can draw on the credit as needed within the specified time period.
Open letters of credit are commonly used in international trade transactions, where the buyer and seller have an ongoing relationship and the buyer needs to make multiple purchases from the seller.
An open letter of credit provides flexibility for the beneficiary to draw on the credit as needed, without having to apply for a new letter of credit each time. It also provides assurance to the seller that they will be paid for their goods or services.
The main risk is that the issuer of the letter of credit may become insolvent or default on their obligations, leaving the beneficiary without access to the credit.
A regular letter of credit is typically used for a single transaction, whereas an open letter of credit can be used for multiple transactions within a specified time period.
The buyer and seller must agree on the terms of the credit, including the amount, time period, and any other conditions. The buyer then applies to their bank for the letter of credit, which is issued to the seller’s bank.
If the beneficiary exceeds the limit of the credit, the issuer may refuse to honor any further draws on the credit.
Yes, the buyer can cancel the open letter of credit at any time, but they may be liable for any costs or damages incurred by the seller as a result.
If there is a dispute over an open letter of credit, the parties may need to seek legal advice and potentially go to court to resolve the issue.
This site contains general legal information but does not constitute professional legal advice for your particular situation. Persuing this glossary does not create an attorney-client or legal adviser relationship. If you have specific questions, please consult a qualified attorney licensed in your jurisdiction.
This glossary post was last updated: 17th April 2024.
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