Transferable Letters of Credit Work

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Transferable Letters of Credit

A transferable letter of credit (LC) is a bank guarantee that lets the initial beneficiary (the first beneficiary) transfer some or all of the credit to one or more secondary beneficiaries. It is commonly used when the first beneficiary acts as an intermediary—such as a retailer, broker, or reseller—and relies on suppliers or manufacturers to fulfill the order.

Key points

  • The applicant (buyer) asks a bank to issue the LC to a first beneficiary (seller or middleman).
  • The LC guarantees payment to the beneficiary provided the documents and conditions specified in the LC are met.
  • If the LC is transferable, the first beneficiary can pass part or all of the credit to secondary beneficiaries (e.g., suppliers).
  • Transferable LCs are used in domestic and international trade to secure payments and reduce advance-payment requirements.

How transferable letters of credit work

  1. Buyer (applicant) arranges a transferable LC with their bank and pays any fees.
  2. The issuing bank issues the LC in favor of the first beneficiary.
  3. The first beneficiary, if permitted by the LC, transfers the credit (fully or partially) to one or more secondary beneficiaries.
  4. Secondary beneficiaries present the required documents to claim payment under the transferred portion, subject to the terms of the LC.
  5. If the buyer fails to pay, the bank is obligated to honor the LC per its terms.

Transferable LCs protect sellers and their suppliers by ensuring payment when the required documents (e.g., bill of lading, commercial invoice) comply with the LC’s conditions. They are particularly useful when the buyer’s creditworthiness is uncertain but the seller trusts the buyer’s bank.

Parties involved

  • Applicant — the buyer who requests the LC.
  • Issuing bank — the bank that issues the LC and guarantees payment.
  • First (primary) beneficiary — the party in whose favor the LC is originally issued.
  • Second (secondary) beneficiary — the party (or parties) to whom the first beneficiary transfers the credit.

Obtaining a transferable letter of credit

  • Apply to a bank (often one with international trade experience).
  • Submit a credit application and documentation about income, assets, debts, and the transaction.
  • The bank underwrites the request, assessing risk and determining fees and terms.
  • The LC itself is a guarantee; the applicant doesn’t receive a loan unless the bank must fund payment under the LC.

Fees typically range from about 0.75% to 2% of the guaranteed amount, depending on transaction size and the applicant’s creditworthiness.

Related types of letters of credit

  • Confirmed letter of credit — a second bank (usually trusted by the seller) adds its guarantee to the LC, offering extra security if the issuing bank might default.
  • Commercial letter of credit — the bank pays the beneficiary when conditions are met; used for standard trade payments.
  • Standby letter of credit — serves as a backup commitment; the bank pays only if the applicant fails to perform.
  • Back-to-back letter of credit — two separate LCs used when a middleman needs to issue an LC to their supplier based on the LC they received from the buyer.
  • Revolving letter of credit — provides repeating credit availability for a series of transactions without issuing a new LC each time.

When to use a transferable LC

  • When a middleman needs to guarantee payment to upstream suppliers without exposing their own cash flow.
  • When a buyer and a first beneficiary have a relationship but the beneficiary must pay suppliers.
  • In transactions where reducing upfront payments or ensuring pay-through to multiple parties is important.

Summary

Transferable letters of credit are a flexible trade-finance tool that enable the initial beneficiary to pass guaranteed credit to secondary beneficiaries. They help facilitate complex supply chains and international trade by ensuring payment to suppliers while limiting the need for advance payments. Buyers pay fees for the assurance provided, but transferable LCs often make transactions feasible that might otherwise be too risky.

Sources

  • Export-Import Bank of the United States — guidance on letters of credit
  • U.S. Department of Commerce, International Trade Administration — Trade Finance Guide
  • Cornell Law School, Legal Information Institute — definition of credit facility