A letter of credit (L/C) is an instrument issued by the buyer's bank promising to pay the seller a fixed amount once the seller presents documents — typically a bill of lading, commercial invoice, packing list and inspection certificate — that strictly comply with the credit's terms, usually under the UCP 600 rules. Payment turns on documents, not on whether the goods themselves are good.
Why it matters
In China trade, the L/C solves a mutual trust problem: the exporter will not ship a container on open account to a buyer it has never met, and the buyer will not prepay 100% to a factory it cannot sue easily. The bank's promise bridges the gap. For buyers, the key insight is that banks check paper, not products — so the document list is your only quality lever. Requiring an inspection certificate from a named third-party agency confirming the agreed AQL standard turns the L/C into a quality gate: no passing inspection, no conforming documents, no payment. The L/C terms must also align with the Incoterms used, since the transport document depends on who books freight.
How it works in practice
A Brazilian importer issues an irrevocable L/C in favor of a Ningbo machinery exporter, payable at sight against a clean on-board bill of lading and an SGS inspection certificate referencing the contract's technical specifications. The factory only gets paid after the inspection passes and the goods are loaded — and the factory, in turn, knows a confirmed bank undertaking awaits, so it releases the goods without a 100% prepayment.
Common mistakes
- Leaving the inspection certificate out of the required documents, so payment ignores quality
- Vague document descriptions that let discrepant paperwork slide through
- Ignoring discrepancy games — sellers curing trivial defects while goods sit accruing demurrage
- Using an unconfirmed L/C from a small bank the seller does not trust
- Mismatching L/C terms with the contract and the chosen Incoterm