Letter of Credit Forum

This type of Letter of Credit was introduced to provide pre-shipment finance to the exporter. A clause was added to the Letter of Credit to the effect that a certain amount, or percentage of the Letter of Credit value, was available for immediate drawdown against an invoice and simple receipt. These funds would be used by the exporter for costs
associated with manufacturing/delivery the goods to the load port.

 It is normally used only where the buyer and seller have close working relationship because, in effect, the buyer is extending an unsecured loan to the seller (and bears the financial risk and the currency risk).

The Red Clause Letter of Credit was originally used by sheep farmers in Australia who faced the high cost of shipping their sheep from the Australian interior to the load port on the coast. By drawing the advance funds from the Letter of Credit they were able to finance this part of the shipment and allow the sheep to be exported. The reason it is called a Red Clause Letter of Credit is simply that, originally, the clause relating to the advance funds was written in red ink.