China sourcing glossary
What Is a Letter of Credit (L/C)? Does It Protect You Against Bad Goods From China?
What is a letter of credit?
The buyer (the applicant) asks its bank (the issuing bank) to open the credit in favour of the seller (the beneficiary). The seller ships the goods, collects the documents the credit lists, such as the commercial invoice, packing list, bill of lading and any inspection certificate, and presents them. If they comply, the bank pays or accepts a draft to pay later.
Most credits say they follow UCP 600, the ICC's rules for documentary credits. Where the parties choose no rules, a Chinese court applies the UCP or other international practice (art. 2). Check which kind you are asked to open: payable at sight or later, negotiable through another bank or not, and confirmed by a second bank or not.
Does a letter of credit protect you against bad goods?
Only as far as the documents do. A Chinese court asks whether the documents match the credit, and each other, on their face (art. 6). If the credit asks only for the seller's own quality statement, the seller can write one and be paid for goods no independent inspector has seen.
A claim that the goods are defective belongs under the sales contract. The narrow exception is L/C fraud: forged documents, documents with false content, or a seller that deliberately ships nothing or worthless goods (art. 8). In those cases the buyer can ask a court to suspend payment if the fraud would cause harm that can't be undone (art. 9).
These examples are based on matters I have handled. Names, products, places, dates, amounts and other identifying details have been removed or changed. They show the kind of work involved. They don't promise any result.
Acting for a buyer
The draft L/C asked only for the seller's own quality statement
A buyer believed that using an L/C meant someone would check quality, but the draft credit required only a quality statement from the seller. I had the client list the risks it wanted to control, such as the shipping date, the quantity, or quality points that needed an independent inspector, and then asked the bank whether each could become a clear document the seller could actually obtain. The supplier had concerns about who would sign the inspection certificate and when, so I lined up the inspection date with the timing for preparing documents, to avoid finding out after shipment that the certificate could not be obtained in time. I also checked the contract delivery date against the credit's latest shipment date, and where they differed, had both sides explain and adjust the terms in writing. The bank and both parties confirmed the revised terms could be carried out, and the buyer opened the credit on the final text.
How do you turn your requirements into L/C terms?
Start from what you want to control, then ask which document can prove it. Ask only for documents the seller can actually obtain, from an issuer you can name.
| Your concern | Document the credit can call for | Check before you open |
|---|---|---|
| Goods ship on time | Bill of lading showing an on-board date no later than the latest shipment date | The date matches the contract delivery date |
| Right quantity | Packing list, plus a quantity statement in the inspection certificate | Who counts, and at what stage |
| Quality | Inspection certificate issued by [named inspection company], stating the goods conform to [specification, version] | The inspector will issue it, the seller can book it, and it arrives before the presentation deadline |
| Right goods | Commercial invoice describing the goods as in the contract | The same description on every document |
Keep three dates apart:
- Latest shipment date. The last day the goods may ship.
- Presentation period. How long after shipment the seller has to present the documents. Under UCP 600, if the credit sets none, it is 21 calendar days after shipment.
- Expiry date. The last day for presenting documents at all. The presentation period always ends on or before it.
Plan the inspection so the certificate is in hand well inside the presentation period. Before you open the credit, have your trade team, the bank and the inspection company read the draft together. If the contract changes later, such as a new delivery date, amend the credit to match.
Questions from overseas buyers
Can I stop payment under an L/C because the goods are defective?
Generally no, if the documents comply. Defects are a claim against the seller under the sales contract. A Chinese court can suspend payment only in a case of L/C fraud, such as forged documents or a seller that deliberately ships nothing (arts. 5, 8 and 9).
What is a confirmed letter of credit?
A second bank, usually in the seller's country, adds its own promise to pay. It protects the seller if the issuing bank doesn't pay. It does nothing for the buyer on quality.
I draft purchase contracts whose payment terms match the documents your bank will check →
Sources and translations
- SPC Provisions on Several Issues Concerning the Trial of Letter of Credit Dispute Cases (2005, revised 2020), arts. 2, 5, 6, 8 and 9.
- ICC Uniform Customs and Practice for Documentary Credits (UCP 600), referred to by name only.
Translations are mine and unofficial.
Have a China-side question?
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