Back-to-back letter of credit
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A trader in the middle uses the LC from its buyer to get its own bank to open a second LC for its supplier.
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01 · In plain words
A trader in the middle uses one LC to support a second LC for its supplier
A , or LC, is a bank's promise to pay a seller who hands in the right documents. A , or back-to-back LC, uses two separate LCs (ICC Academy).
The first is the , which we call the master LC. The final buyer's bank opens it in favor of a trader in the middle, the middleman. The second is the back-to-back LC. The middleman's own bank opens it in favor of the supplier who makes or sells the goods (ICC Academy).
Traders who act as middlemen between a supplier and a final buyer commonly use this setup (ICC Academy). The middleman's bank looks to the money paid under the master LC as its main way to get repaid (ICC Academy).
The two LCs are likely to have the same terms. Five things can differ: the amount, the price per unit, the last day the LC is valid, the last day to ship, and the time allowed to hand in documents (ICC Academy).
Who is involved
- The final buyer asks its bank for the master LC. It is the of the master LC.
- For the final buyer, the master LC works like any other LC. Its bank promises to pay the middleman if the terms are met.
- The final buyer's bank, the of the master LC, makes the first promise to pay.
- The middleman, a trader, is the of the master LC and the applicant for the back-to-back LC.
- The middleman's bank opens the back-to-back LC and makes the second promise to pay.
- The supplier is the beneficiary of the back-to-back LC.
02 · How it works
Six steps link the buyer's LC, the supplier's LC and the repayment of the middleman's bank
Figure 1 · Interactive
A back-to-back LC, step by step
Read down the steps. The last step is where the middleman's bank is repaid.
Source: ICC Academy, Types of documentary credit: a comprehensive guide on the two credits, their terms and repayment; US International Trade Administration, Trade Finance Guide, July 2022 on payment against matching documents.
03 · What it means for you
The middleman gets a bank promise for its supplier, and the supplier gets its own separate LC
Figure 2 · Interactive
What a back-to-back LC means for each side
Choose your side of the trade.
04 · Worked example
On a $1 million master LC, an illustrative middleman keeps $94,250 after the second LC's costs
This example uses round, made-up numbers. The master LC from the buyer is $1,000,000. The back-to-back LC to the supplier is $900,000, which can be a lower amount than the master LC. The back-to-back LC stays open for 120 days. The middleman's bank charges 0.25% for every 90 days, so 2 periods. The supplier gets paid 10 days before the money from the master LC arrives. The middleman pays for those 10 days at 5.00% a year, counted on a 360-day year. Real fees and rates vary by bank, country and deal.
Figure 3 · Illustrative
A middleman's position on a $1,000,000 master LC and a $900,000 back-to-back LC
Illustrative inputs. The amount the middleman keeps is highlighted.
Made-up rates, worked out by our checking script. Your bank's fees and rates will differ by bank, country and deal.
05 · When to use it
A back-to-back LC suits a trader in the middle whose buyer's LC cannot simply be passed on
Good fit when
- You trade as a middleman between a supplier and a final buyer (ICC Academy).
- The master LC from your buyer does not state that it is transferable, so it cannot be passed on to your supplier (ICC Academy).
- Your bank is ready to open a second LC and look first to the money from the master LC for repayment.
Another tool may suit better when
- The master LC states that it is transferable, and one transfer to your supplier meets the need. Look at a transferable letter of credit. A transferred LC cannot be transferred on again at the supplier's request (ICC Academy).
- You want low paperwork and low cost. An LC takes work and is relatively expensive, and this setup uses two (US ITA). Look at a documentary collection or open account.
- You sell your own goods straight to the buyer, so one LC between you is enough. Look at a sight letter of credit.
06 · Rules and a real case
Each LC follows the ICC rules it names, and a court has treated the two LCs as separate
The master LC and the back-to-back LC are two separate LCs (ICC Academy). When an LC says it follows , those ICC rules apply to that LC. They have been in force since July 1, 2007 (ICC). , 2023 edition, sets out how banks check documents (ICC). The , version 2.1, covers documents sent electronically (ICC). If the master LC states it is a , a transfer may be an option instead.
A real case. In PT Adaro Indonesia v Rabobank, decided by the High Court of Singapore on May 28, 2002, Bank of Ayudhya issued an export LC on September 7, 2000 in favor of a Singapore trader, G Premjee Trading. The trader then asked Rabobank for an import LC in favor of the supplier, PT Adaro, and Rabobank issued it the next day. The cargo was coal, loaded on the MV Cielo Lucia for delivery to TPI Polene in Thailand. The court held that the two LCs were back-to-back only in that they dealt with the same cargo. They remained two separate transactions and two separate LCs. The court entered judgment for the plaintiffs, who brought the claim, for US$1,297,255.06, with interest at 6% a year. Those LCs followed UCP 500, the rules in place before UCP 600 (High Court of Singapore judgment).
Summary
A back-to-back LC lets a middleman pay its supplier with a bank promise, backed by its buyer's LC
Two banks make two separate promises. The supplier is paid on documents that match its LC. The middleman's bank looks first to the master LC to get its money back, so the middleman must make its own documents match the master LC. The trade-off is two sets of paperwork and two sets of fees.
Related guides: Letters of credit; The payment terms spectrum; The trade documents checklist. Related cards: Transferable letter of credit; Letter of credit (sight); Confirmed letter of credit. Every term is in the Trade Finance Glossary.
Sources
- ICC Academy (David Meynell, ICC Banking Commission), Types of documentary credit: a comprehensive guide, October 21, 2024. Supports: the two separate credits, who uses them, matching terms, repayment from the master credit, differing interpretation, transferability
- US International Trade Administration, Trade Finance Guide: A Quick Reference for US Exporters (2022 edition), Chapter 4, July 2022. Supports: payment against matching documents, discrepancies, costs and effort of LCs
- High Court of Singapore, PT Adaro Indonesia v Rabobank [2002] SGHC 114, May 28, 2002. Supports: the real case
- International Chamber of Commerce, UCP 600, Uniform Customs and Practice for Documentary Credits, in force July 1, 2007. Supports: the rules an LC can follow
- International Chamber of Commerce, International Standard Banking Practice (ISBP), 2023 edition, 2023. Supports: document checking practice
- International Chamber of Commerce, eUCP Version 2.1, June 29, 2023. Supports: electronic presentation
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