Back to Back Letters of Credit – Definition

Cite this article as:"Back to Back Letters of Credit – Definition," in The Business Professor, updated June 8, 2019, last accessed October 23, 2020, https://thebusinessprofessor.com/lesson/back-to-back-letters-of-credit-definition/.

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Back-To-Back Letters Of Credit Definition

A letter of credit is often written by a bank or an institutional intermediary promising that it will be responsible for a holder’s payment to a beneficiary if the holder does not make the payment.

Back-to-back letters of credit is used when an intermediary is involved in a financial transaction between a buyer and a seller. A broker or a financial institution can act as an intermediary between the buyer and seller. Two letters of credit (LCs) are involved in a back-to-back letter of credit transaction.

A Little More on what is a Back-To-Back Letter Of Credit

Back-to-back letters of credit occurs in transactions wherein the seller is guaranteed to receive payment once the proof of completing the terms of the transaction is presented to the bank (intermediary’s bank). In most cases, no direct interaction occurs between the buyer and the seller, arrangements are made by the intermediary on behalf of the buyer.

Two distinct letters of credit (LCs) are used in back-to-back letters of credit, one is given to the intermediary and issued by the buyer’s bank while the other is issued by the intermediary’s bank to the seller where the seller is a beneficiary. The first LC serves as the collateral for the second LC, back-to-back LCs are mostly used in international trade.

Example of a Back-to-Back Letter of Credit Transaction

Qualified Intermediaries, mostly brokers can facilitate transactions between buyers and sellers regardless of the location of both parties. Here is an example;

A back-to-back letter of credit can be used if company A which is based in the United States wants to sell an equipment to Company C which is based in Japan. Due to risk of default of payment, Company A might be reluctant to sell the equipment to Company C.

A broker firm serving as an intermediary between these two parties can facilitate and manage the business deal. Using the back-to-back LCs, brokers ensure that this business deal falls in place while they also get their commission from it.

References for Back to Back Letter of Credit

Academic Research on Back to Back Letter of Credit

How to Handle Letters of Credit, Mentschicoff, S. (1963). Bus. Law., 19, 107.

Letters of Credit, Harfield, H. (1959). Banking LJ, 76, 93.

How to Use Letters of Credit in Financing the Sale of Goods, Wiley, R. A. (1964). Bus. Law., 20, 495.

Letter of Credit Transactions: The Banks’ Position in Determining Documentary Compliance-A Comparative Evaluation under US, Swiss and German Law, Grassi, P. S. (1995). Pace Int’l L. Rev., 7, 81.

Enjoining Letter of Credit Transactions, Harfield, H. (1978). Banking LJ, 95, 596.

The Uniform Commercial Code in Minnesota: Article 5–Letters of Credit, Halls, J. A. (1965). Minn. L. Rev., 50, 453.

The Law Merchant and the Letter of Credit, Trimble, R. J. (1948). Harvard Law Review, 61(6), 981-1008.

Letters of Credit: The Developing Concepts and Financing Functions, Joseph, C. E. (1977). Banking Lj, 94, 816.

Letters of Credit: A Primer, Leon, C. (1986). Md. L. Rev., 45, 432.

Letters of Credit–Article 5 of the Uniform Commercial Code, Rowland, L. H. (1965). Mo. L. Rev., 30, 288.

Enjoining Payment on a Letter of Credit in Bankruptcy: A Tempest in a Twist Cap, Chaitman, H. D., & Sovern, J. (1982). Bus. Law., 38, 21.

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