Legal Definitions - revocable letter of credit

A revocable letter of credit is a financial commitment issued by a bank (the "issuing bank") on behalf of a buyer (the "applicant") to guarantee payment to a seller (the "beneficiary") once specific conditions, usually related to the shipment of goods or provision of services, are met. The defining characteristic of a revocable letter of credit is that the issuing bank can modify or cancel this payment guarantee at any time without needing the consent of the beneficiary. This makes it a less secure form of payment for the seller compared to an irrevocable letter of credit, as the promise of payment can be withdrawn unilaterally by the bank.

Here are some examples illustrating how a revocable letter of credit might be used:

• Domestic Transaction with Established Trust: A large retail chain in the United States regularly purchases seasonal clothing from a long-term, trusted manufacturer. For a new order, the retail chain's bank issues a revocable letter of credit to the manufacturer. This arrangement provides some assurance to the manufacturer, but also allows the retail chain's bank to adjust the terms or even cancel the credit if, for example, there's a sudden, unexpected change in market demand that requires the order to be significantly altered or terminated before production is complete. The manufacturer, due to the strong existing relationship, accepts this flexibility.

  How it illustrates the term: The bank, acting for the retail chain, can unilaterally change or cancel the payment guarantee without needing the clothing manufacturer's agreement, demonstrating the "revocable" nature of the instrument.

• Project with Evolving Scope: A technology startup is commissioning a custom software module from a development firm. The project's exact specifications are still somewhat fluid, with the possibility of features being added or removed based on early user feedback. To provide initial financial assurance to the development firm while maintaining flexibility, the startup's bank issues a revocable letter of credit for the first phase of the project. If the project's direction significantly shifts or if the startup decides to pivot to a different solution, the bank can modify or cancel the letter of credit to align with the new terms or terminate the arrangement, without requiring the development firm's consent.

  How it illustrates the term: The ability of the issuing bank to alter or withdraw the payment commitment without the development firm's approval highlights the revocable nature, which is beneficial when the underlying contractual terms are not yet fully solidified.

• Expedited Trade with Accepted Risk: An importer in Europe needs to quickly secure a shipment of specialized components from a new supplier in Asia. To expedite the process and potentially negotiate a slightly better price, the supplier agrees to accept a revocable letter of credit, acknowledging the inherent risk. The European importer's bank issues the revocable letter of credit. While the supplier receives a promise of payment, they understand that the bank could withdraw this promise before the components are shipped, especially if there are unforeseen market fluctuations or changes in the importer's financial standing that make the transaction too risky for the issuing bank.

  How it illustrates the term: The supplier accepts the risk that the payment guarantee can be unilaterally withdrawn by the issuing bank, emphasizing the "revocable" aspect. This choice might be made to gain other advantages like speed or cost savings in the transaction.