Legal Definitions - revolving letter of credit

A revolving letter of credit is a specialized financial guarantee issued by a bank that provides ongoing assurance of payment for a series of transactions, rather than just a single one. Similar to a standard letter of credit, it guarantees that a seller (beneficiary) will receive payment from a bank on behalf of a buyer (applicant), provided certain conditions are met. The key difference is that a revolving letter of credit automatically renews or replenishes itself after each payment or over a specified period (e.g., monthly, annually), up to a pre-determined maximum amount. This eliminates the need to establish a new letter of credit for every transaction, making it ideal for regular, repeated business dealings.

Here are some examples illustrating how a revolving letter of credit works:

• International Trade for Regular Shipments:

  Imagine a large electronics distributor in the United States (the buyer) that regularly imports a specific component from a manufacturer in Vietnam (the seller). Instead of arranging a new letter of credit for each monthly shipment, the distributor's bank issues a revolving letter of credit for $750,000, valid for one year. Each month, when the Vietnamese manufacturer ships the components and presents the required documents to the bank, the bank pays the manufacturer for that shipment (e.g., $200,000). Once that payment is made, the available credit under the letter of credit automatically resets to the full $750,000 for the next month's transaction, allowing for continuous, secure trade without constant re-application, as long as the total payments over the year do not exceed an agreed aggregate limit.

• Construction Project Material Procurement:

  Consider a construction company (the buyer) undertaking a multi-year infrastructure project, requiring consistent deliveries of specialized building materials from a particular supplier (the seller). To ensure the supplier is confident in receiving payment for staggered deliveries over the project's duration, the construction company's bank establishes a revolving letter of credit for $2 million. As different phases of the project commence, the supplier delivers materials and submits invoices. The bank then pays the supplier against this letter of credit. After each payment, the available credit amount replenishes, allowing the supplier to continue providing materials and receive payment for subsequent orders, up to the $2 million limit, without the construction company needing to secure new financial guarantees for every single material order.

• Franchise Royalty and Inventory Assurance:

  A national restaurant franchisor (the beneficiary) might require its new franchisees (the applicants) to maintain a revolving letter of credit with their bank. This is often to cover potential shortfalls in monthly royalty payments or to guarantee payment for mandatory inventory purchases from the franchisor's approved suppliers. For instance, a new franchisee might establish a revolving letter of credit for $100,000. If the franchisee's monthly royalty payment is late or if they fail to purchase required inventory, the franchisor can draw funds directly from this letter of credit. Once a draw is made and the issue is resolved (e.g., the franchisee repays the drawn amount to their bank), the letter of credit automatically replenishes to its original $100,000 limit, ensuring continuous financial security for the franchisor against future potential defaults or non-compliance by the franchisee.