red clause letter of credit what it is how it works sample
- Abhilasha Sharma
- Feb 13, 2024
- 3 min read
Updated: Feb 17, 2024
What is a red clause letter of credit?
A "red clause letter of credit" is a type of letter of credit that includes a specific provision allowing the beneficiary (seller or exporter) to receive partial or full payment in advance of shipping the goods. This provision is known as the "red clause" because the relevant text is often printed in red ink for easy identification. Red clause letters of credit are commonly used in international trade to provide financial assistance to the seller before the goods are delivered to the buyer.
Red Clause LCs help both the exporter as well as the importer. For the importer, no liquid cash gets involved, as the LCs can only be liquidated if all the terms of it are met. For the exporter, the money is assured if the products are delivered as termed in the LC.
Who guarantees it?
Red clause letter of credit is issued by a bank that guarantees the payment of goods from the importer to the exporter.
How does a red clause letter of credit generally works?
Issuance of the Letter of Credit: The buyer's bank (issuing bank) issues the letter of credit in favor of the seller (beneficiary) based on the buyer's request. The letter of credit outlines the terms and conditions for payment.
Red Clause Provision: The letter of credit contains a special provision, often printed in red ink, allowing the beneficiary to receive an advance payment before the shipment of goods. This advance is typically for costs associated with preparing and packaging the goods for shipment.
Advance Payment: Once the red clause letter of credit is activated, the beneficiary can present a written request, along with supporting documents (such as a draft or invoice), to the issuing bank. The bank then provides an advance payment to the beneficiary.
Shipment of Goods: After receiving the advance payment, the seller prepares and ships the goods to the buyer. The shipping documents, such as the bill of lading and other required paperwork, are sent to the issuing bank.
Payment at Maturity: The buyer's bank pays the full face value of the letter of credit to the seller upon presentation of the required shipping documents. Any advance payment made under the red clause is deducted from the total payment.
What are the types of "Red Clause"?
There are two types of Red Clause:
A. Unsecured Red Clause: When the importer does not have to show proof of purchase.
B. Secured Red Clause: When the exporter is required to submit the proof of shipment.
What are the documents required to attain the Red Clause LC?
Shipping bill of lading
Airway bill
Commercial invoice
Insurance certificate
Certificate of origin
Packing list
Certificate of inspection
Transport document
Here's a simplified example of the red clause provision in a letter of credit:
"Red Clause: The beneficiary is authorized to receive an advance payment of [specified amount] from the issuing bank upon presentation of a written request along with supporting documents. This advance payment shall be deducted from the face value of this letter of credit, which will be paid to the beneficiary upon presentation of the required shipping documents."
In this example:
The red clause provision allows the beneficiary to receive an advance payment.
The specified amount of the advance is mentioned.
The advance payment is later deducted from the total face value of the letter of credit upon the presentation of the required shipping documents.
Red clause letters of credit provide a financing option for sellers, especially when they need funds to prepare and ship goods. However, it's important for both buyers and sellers to carefully review and understand the terms of the red clause and ensure compliance with the agreed-upon conditions.
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