Publication date: January 05, 2026
A documentary letter of credit (L/C) is a form of non-cash monetary settlement made through a bank. It serves to protect the interests of the parties in commercial transactions, particularly in sales contracts. Its essence is the bank’s commitment to pay an appropriate amount of money upon receipt of specific documents, which are assumed to constitute confirmation of the obligation’s fulfillment. The use of letters of credit is now standard in international trade.
General information
From a legal perspective, a documentary letter of credit is a legal relationship between the parties (in the example of a sales contract) the importer (buyer), the exporter (seller), and the bank issuing the letter of credit (buyer’s bank). In some cases, the exporter may wish to utilize the services of its own bank, which can collect the letter of credit documents from the exporter or confirm the letter of credit (intermediary bank). In the sales contract (underlying agreement), the buyer and seller specify that payment for the goods will be made via letter of credit and specify which documents the seller will need to submit to the bank to receive the funds. The agreement commits one party (usually the buyer) to conclude a letter of credit agreement with a specific bank under specific terms. After issuing the letter of credit, the buyer deposits funds. After the seller obtains the documents specified in the sales contract, they submit them to the bank (directly or through an intermediary bank). After the bank examines the documents, the importer receives the funds immediately or after a period specified in the letter of credit agreement. The bank’s obligation to pay the funds is abstract in nature, which means that their payment is not dependent in any way on the underlying agreement, but only on the presentation of the relevant documents.
The source of the Polish regulation on letters of credit is Article 85 of the Banking Law. This provision describes this institution more broadly than its traditional form, in a manner similar to a bank guarantee. However, banking law regulations are relatively binding, so banks are not required to comply with them. In international trade, the Uniform Customs and Practices Concerning Documentary Letters of Credit (UCP 600) issued by the ICC and the International Banking Practices (ISBP 745) are used. These documents constitute commercial law, which is binding when incorporated into a contract. Currently, they constitute the standard basis upon which banks create their letter of credit offers.
There are many types of L/C that meet the different needs of participants in international trade.
A letter of credit can be either revocable or irrevocable. A revocable letter of credit allows the importer to instruct the bank to revoke the letter of credit, resulting in the seller losing the ability to obtain funds from the issuing bank, the security being forfeited, or its terms being changed to less favorable terms for the seller. An irrevocable letter of credit, on the other hand, cannot be changed without the exporter’s consent. Due to its purpose, the letter of credit is much more popular. Letters of credit compliant with the UCP 600 standard are always irrevocable.
A letter of credit may be transferable or non-transferable. The standard is a letter of credit. A non-transferable letter of credit, from which funds can only be withdrawn by the beneficiary (exporter). A transferable letter of credit requires the letter of credit agreement to explicitly stipulate that the bank may, with the exporter’s consent, withdraw funds to other parties, most often designated by the exporter. The exporter may instruct the bank to make the letter of credit available to its suppliers to facilitate settlements with them.
A letter of credit may be payable on first demand (upon presentation of the letter of credit documents) or on a deferred payment basis. Some banks offer exporters the option of obtaining funds from a letter of credit opened with the importer’s bank before the due date at a discount (letter of credit discounting).
If the exporter decides to use the services of an intermediary bank, this bank may act as an advising bank, whose task is merely to inform the exporter of the opening of a letter of credit, accept the letter of credit documents, and transfer payment. In this case, the letter of credit will be unconfirmed. Alternatively, the intermediary bank can confirm the letter of credit. In this situation, it will become the confirming bank, which will independently disburse the funds under the letter of credit to the exporter upon presentation of the documents. The confirming bank has its own obligation to the beneficiary of the letter of credit, thus providing security not only to the importer but also to the issuing bank. After disbursement, the confirming bank will settle the accounts with the issuing bank itself.
A stand-by letter of credit (LC) serves a similar function to a bank guarantee. It serves solely to secure the claim and does not serve as a settlement method. Settlement of the transaction should be made directly by the parties. The exporter may withdraw funds from a stand-by letter of credit only if the importer defaults. This type of L/C can also be used to secure non-commercial relationships, such as credit agreements, claims for damages, or claims for improper performance. Typically, documentary requirements are limited to a document confirming the importer’s default, and sometimes even to a written declaration of the beneficiary’s default.
Back-to-back (tied) letter of credit is an advanced form of transferable letter of credit. It involves the exporter opening a second letter of credit and transferring part or all of the original letter of credit to it. This structure can be used by the exporter to settle accounts with its suppliers if they do not accept the original letter of credit or it is non-transferable, or to conceal the actual seller of a given good from the importer.
Revolving (renewable) letter of credit serves to secure multiple transactions between parties (e.g., in the case of regular deliveries). Its essence is that it does not expire after the funds are paid to the exporter. Instead, to secure the next transaction, the importer re-deposits the amount on the letter of credit (the balance), which is then paid to the exporter again upon presentation of documents. A revolving letter of credit can be cumulative, in which case unused balance transfers to the next balance, or non-cumulative, in which case no such mechanism exists.
In the construction of a documentary letter of credit, the documents that the importer must present to receive payment are crucial. Their proper identification and description in the underlying agreement and the letter of credit agreement are crucial to safeguarding the interests of the parties. The documents serve to confirm that the importer has properly fulfilled its obligation and is therefore entitled to payment.
When evaluating the submitted documents, the bank is guided by the principle of formalism. This means that only their formal characteristics, as defined in the underlying agreement, are examined. The bank, however, has no authority to verify the documents’ compliance with the factual circumstances, in particular, to assess whether the obligation was properly performed. The standard for document examination is defined in UCP 600. Furthermore, commercial custom and general principles of civil law are helpful in determining this standard. In the Polish system, a bank is obligated under Article 355 § 2 to exercise due diligence, which is assessed in relation to the professional nature of banking activities. In practice, this means that the bank will not accept documents that are not clean (e.g., contain additions), are contradictory, or are obviously forged. However, banks maintain a certain level of tolerance, for example, when the documents contain obvious clerical errors, some of the presented documents contain only general information, or there are minor inconsistencies between the content of the documents. In each case, however, it is necessary to present the bank with documents that correspond to the quantity, type, and description specified in the letter of credit.
The parties have complete freedom to determine the type and number of documents to be presented to the bank. The precise content of the agreement in this regard will depend primarily on the subject matter of the contract, the method of delivery, and the level of mutual trust between the parties. However, three basic types of letter of credit documents can be distinguished:
Transport documents
Insurance documents
Commercial documents
Transport documents confirm that the goods were shipped within a specified time, in a specified condition, and were properly packaged. The most common transport document is the bill of lading. It is used in maritime transport. It is issued by the carrier to confirm that the goods have been accepted on board the vessel for transportation to the destination port. This document provides evidence that the carrier has accepted the cargo in a specified quantity and condition. In land and air transport, a waybill is typically used. Depending on the mode of transport, there are different types, but it contains the same essential information as a bill of lading.
Insurance documents confirm that the goods have been insured under specific terms. They take the form of policies or certificates issued by the insurer. Policies contain all insurance terms and conditions, while certificates merely confirm that the cargo is covered.
Commercial documents confirm the delivery of goods and their compliance with the contract. The basic sales document is the commercial invoice. It contains detailed information about the goods, their quantity, and price. Commercial documents used to confirm the quality of delivered goods include, among others, quality certificates specifying the quality, technical, or sanitary standards of the goods, a certificate of origin confirming the goods’ country of origin, and a certificate of inspection of the goods performed by an independent quality control company.
The parties may also specify other letter of credit documents in their agreements, as needed. For example, if the exporter is obligated to pay customs duties, the required document may be a customs declaration or a confirmation of customs payment. If the letter of credit secures a service agreement, the parties may condition payment of the amount on the presentation of a service completion certificate.
For a letter of credit to effectively protect the interests of the contracting party, its provisions must be properly crafted. Due to conflicting interests between the parties, contractual clauses regarding letters of credit may be more favorable to the importer or exporter. It is also crucial to specify the letter of credit documents so that they correspond to the obligations of the contracting parties arising from the underlying agreement.
If the sales contract stipulates that the exporter’s sole obligation is to release the goods from its warehouse, limiting the letter of credit documents to an invoice is sufficient. If the exporter has obligations related to the delivery of the goods, it seems reasonable to also require a bill of lading or bill of lading. If the exporter is also obligated to pay customs duties and insurance, the contract should also include a receipt confirming payment of customs duties and an insurance policy.
It is in the exporter’s best interest to minimize the number and formal requirements of documents, as their submission determines whether they will receive funds from the letter of credit. The seller should also strive for an irrevocable letter of credit, as only such a document provides real security for the buyer’s fulfillment of the obligation. Furthermore, it is in their best interest for the letter of credit to be available upon first demand and transferable, as this will provide them with greater financial liquidity. The exporter should seek a letter of credit from a reputable bank or obtain a letter of credit confirmation from such a bank, as this reduces the risk of bank insolvency. The exporter may also wish to use a stand-by letter of credit or a bank guarantee, which typically imposes fewer formal requirements but provides a similar level of security.
Contrary to the exporter’s interests, the importer should strive to maximize the number and formal requirements of documents. In particular, they should ensure that the exporter is obligated to present commercial documents confirming the quality of the delivered goods (e.g., quality certificates). It is in the buyer’s interest that the letter of credit be revocable, as in the event of an anticipated breach of contract, they can instruct the bank to revoke it. Typically, the buyer bears the costs associated with the letter of credit. In such a case, it is in their interest for the letter of credit to be non-transferable, deferred, and unconfirmed, as these types of L/Cs impose the fewest obligations on the bank and, consequently, are cheaper. The buyer also wants to use the bank that offers the most attractive prices, i.e., a lower-tier bank.
A documentary letter of credit is a useful tool in international trade, ensuring transaction security for both buyer and seller. Thanks to precisely defined payment terms and required documentation, it minimizes the risk of non-performance or improper performance of the contract. The variety of letter of credit types allows for tailoring this mechanism to the specific needs of the parties, and knowledge of its principles is crucial for the effective management of international transactions.