A letter of credit is an undertaking by a bank to pay a beneficiary on presentation of specified documents. It is used to shift credit risk from a counterparty to a bank.

Independence. The bank’s obligation is separate from the underlying contract. A dispute between buyer and seller is not a reason for the bank to refuse payment, and this independence is the entire point — a beneficiary takes a bank’s credit rather than a trading partner’s.

Strict compliance. The bank pays against documents, and the documents must conform to the credit on their face. Minor discrepancies — a misspelling, a date outside the presentation window, a missing signature — justify refusal. Most disputes are about whether a presentation conformed.

Standby versus commercial. A commercial credit is a payment mechanism for goods. A standby functions as a guarantee, payable on the beneficiary’s statement that the applicant has defaulted, and is common in construction and lease security.

Fraud is the narrow exception to independence: where the presentation is fraudulent and there is no colorable basis for payment, a court may enjoin it. The standard is deliberately high, and applications usually fail.

Practical guidance. For a beneficiary, negotiate the required documents so they are within your control to produce. For an applicant, the corollary — a credit payable on a bare statement of default offers little protection.