What is a Transferable Letter of Credit?

A transferable letter of credit is a document that is issued to a specific party, and can be reassigned to another individual or entity under certain circumstances. Like a sight letter of credit, a synthetic letter of credit, and all other forms of the letter of credit, the transferable type originates from a financial institution and is used to guarantee that if the holder of the letter is unable to meet his or her obligations to a seller, the institution will complete the purchase. What is different with the transferable letter of credit is that the seller, as the recipient, has the ability to assign the proceeds to a third party.

One of the more common situations where a transferable letter of credit may be employed is when the seller has obligations to his or her creditors that must be honored. As a way of guaranteeing that they will receive payment, even if the seller is unable to pay, the seller transfers some or all of those proceeds to the vendors. In some countries, laws prohibit allow this to take place with only one vendor. In other nations, it is legal to issue portions of an existing letter of credit to more than one vendor.

The use of a transferable letter of credit is often found in situations involving the import and export of goods. The buyer obtains the line of credit from his or her banker as a means of ensuring that the seller will be paid in full for the order. Once the bank is provided with confirmation that the order has arrived and is in the possession of the buyer, funds are released to the seller’s bank. Should the seller wish all or part of those funds to be redirected to a third party, usually a supplier who works with the seller in some capacity, the payment is forwarded to whatever bank and bank account that the seller requests.

While this type of financial arrangement is helpful in a number of business situations, it is important to note that the seller cannot choose to exercise this option with a transferable letter of credit without the express permission of the buyer. This means that the seller must approach the buyer, outline the reasons behind the transfer, and discuss exactly how the transfer will take place. Assuming that there are no objections, the transfer is executed in accordance with any federal or state laws that apply to this type of transaction.