What Is a Red Clause Letter of Credit? Meaning, Types, and Process

Before you can ship goods to an overseas buyer, you often need funds to get production moving. Raw materials, packaging, labour, and logistics costs arise well before the buyer releases payment. For many exporters, this timing gap puts immediate strain on working capital. A Red Clause Letter of Credit (LC) helps solve this problem. It is a special type of documentary credit that allows you, as the exporter, to receive an advance from the buyer’s bank before shipment. 

In simple terms, it works like an unsecured pre-shipment advance backed by the buyer’s credit standing, not your collateral. The name comes from early banking practice, where the advance clause was printed in red ink so it stood out clearly from the rest of the credit terms. 

Read on this guide to understand how a Red Clause LC works, how it differs from a green clause, and what modern alternatives exporters use today.

What Is a Red Clause Letter of Credit?

A Red Clause Letter of Credit is a type of documentary credit that includes a specific clause allowing the exporter to receive an advance before shipping the goods. This clause authorises the bank to release funds ahead of shipment, unlike a standard LC where payment happens only after documents are presented.

• It allows you to access a pre-shipment advance based on the buyer’s letter of credit, not on your own collateral.
• The advance functions like an unsecured loan from the buyer to you, routed through the advising or nominated bank.
• Once you ship the goods and submit compliant export documents, the advance amount gets adjusted against the final payment.
• The main objective is to fund upfront costs such as raw material purchases, processing, packaging, and other pre-shipment expenses.

Why Is It Called a “Red Clause”?

• The term comes from early banking practice, when letters of credit were issued as physical documents rather than digital messages.
• The clause that authorised the bank to release an advance to the exporter was written or printed in red ink to ensure it stood out and received immediate attention from the advising bank.
• Today, letters of credit are issued electronically and no longer use coloured ink, but the name Red Clause LC continues as the accepted industry term for this type of advance-linked LC.

Key Features of a Red Clause LC

• The advance amount is usually 20–25% of the LC value, though buyers and sellers can negotiate a higher or lower percentage based on trust and transaction history.
• You, as the exporter, receive the advance as the beneficiary of the letter of credit, while the importer ultimately bears the repayment risk.
• Compared to other trade finance options, a Red Clause LC is largely unsecured, relying on the buyer’s creditworthiness rather than security from the exporter.

How Does a Red Clause Letter of Credit Work?

A Red Clause Letter of Credit follows a defined sequence, beginning with the commercial agreement between buyer and seller and concluding with settlement after shipment. What sets it apart from a standard letter of credit is the early release of funds, where the advising bank pays you an advance before the goods are shipped, acting on the issuing bank’s authorisation.

Step 1: Agreement and Application

• You and the overseas buyer first agree to use a Red Clause LC to support pre-shipment funding.
• Both sides decide the advance amount, usually expressed as a percentage of the total contract value.
• The buyer then applies to their bank and specifically requests inclusion of the red clause in the LC.

Step 2: Issuance and Confirmation

• The issuing bank reviews the buyer’s credit profile and ability to honour the full payment.
• After approval, the bank issues the Letter of Credit with the red clause clearly stated.
• This clause authorises the advising bank to release an advance to you before shipment.

Step 3: Availing the Advance Payment

• Once the LC is advised, you approach your local advising bank to claim the advance.
• You submit a simple receipt along with a Letter of Indemnity (LOI), confirming your obligation to ship the goods.
• Based on the LC terms, the advising bank releases the advance, typically around 20–25% of the LC value.

Step 4: Shipment and Settlement

• You use the advance to manufacture, source, and ship the goods as agreed.
• After shipment, you present the complete set of shipping documents to the bank.
• The bank adjusts the advance and applicable interest from the final payment and releases the remaining balance.

What Are the Types of Red Clause LCs?

Red Clause LC are broadly classified based on whether the buyer requires any proof of goods before releasing the advance. In practice, exporters encounter two main variants, each carrying a different level of risk for the importer.

Unsecured (Clean) Red Clause

• An Unsecured Red Clause LC allows you to receive the advance without submitting any proof of goods or inventory.
• To access the funds, you usually provide a simple receipt along with a letter of indemnity to the advising bank.
• This structure exposes the buyer to the highest risk, as the advance relies entirely on trust in the exporter.

Secured (Documentary) Red Clause

• In a Secured Red Clause LC, the bank releases the advance only after you submit limited supporting documents.
• These typically include warehouse receipts or similar proof showing that raw materials have been purchased or set aside for the order.
• While not fully risk-free, this version offers the buyer more comfort than a clean red clause arrangement.

Red Clause vs. Green Clause Letter of Credit

Red Clause and Green Clause Letter of Credit are often mixed up because both allow you to access funds before the final settlement. In simple terms, a Green Clause LC is an extension of a Red Clause LC, but with added safeguards for the buyer.

Difference Between Red and Green Clause LC

What Are the Advantages of a Red Clause LC?

A Red Clause LC offers practical advantages to both sides of a trade transaction. It aligns the buyer’s need for timely delivery with the seller’s need for early funds, making it a strategic tool rather than just a payment instrument.

Benefits for the Exporter (Seller)

• Gives you access to pre-shipment working capital without arranging a separate bank loan.
• Keeps pressure off your own cash reserves, especially for large or repeat orders.
• Enables you to procure raw materials and start production as soon as the order is confirmed.
• Improves order execution by removing funding delays at the early stages of the export cycle.

Benefits for the Importer (Buyer)

• Strengthens your negotiating position, often helping secure better pricing or favourable terms.
• Allows you to work with smaller or newer exporters who may not have strong balance sheets.
• Ensures production begins on schedule, lowering the risk of delayed or missed shipments.
• Improves supply chain reliability by financially supporting critical suppliers upfront.

What Are the Risks and Disadvantages?

Since a Red Clause LC allows funds to be released before shipment, it brings certain risks that both parties need to understand and manage. The early movement of funds increases financial and execution exposure, which is why banks issue red clause LCs only when there is a strong level of trust between the buyer and the seller.

Risks for the Buyer

• The main risk is bad debt, where the seller receives the advance but fails to ship the goods.
• Since the advance is unsecured, the issuing bank will still recover the amount from you if the seller defaults.
• Your ability to recover funds directly from the seller may be limited, especially in cross-border disputes.
• There is also a risk that the advance is used for purposes unrelated to production or shipment.

Cost and Complexity

• Red Clause LCs usually attract higher bank charges than standard LCs due to additional monitoring and administration.
• Interest on the advance is generally charged to the seller, though the cost can be passed to the buyer depending on the agreed terms.
• The paperwork and compliance requirements can feel heavy, particularly for smaller exporters or first-time users.

Documents Required for a Red Clause LC

A Red Clause Letter of Credit involves two separate documentation stages. One set of documents is used to obtain the pre-shipment advance, while a different set is required after shipment to receive the final payment. Understanding this distinction upfront helps you prepare correctly and prevents delays during bank processing.

For Availing the Advance

• A written request asking the advising bank to release the advance as permitted under the red clause.
• A simple receipt signed by you, acknowledging the amount received as an advance.
• A Letter of Indemnity confirming that you will ship the goods as agreed or refund the advance if shipment does not take place.

For Final Settlement

• A commercial invoice reflecting the actual shipment value and buyer details.
• The transport document, such as a Bill of Lading or Airway Bill, proving dispatch of goods.
• A packing list detailing quantity, weight, and packaging.
• A certificate of origin and insurance certificate, wherever required under the LC terms.

Alternatives to Red Clause Letters of Credit

Because Red Clause Letters of Credit expose buyers to high risk, they are rarely used in modern trade. Today, exporters prefer simpler and safer ways to access pre-shipment funds, including structured finance options and digital payment methods that reduce paperwork and improve cash flow visibility.

Export Factoring and Forfaiting

• Export factoring allows you to sell your accounts receivable to a third party in exchange for immediate cash.
• It gives you access to working capital without setting up a complicated Red Clause Letter of Credit.
• It is usually easier to use if you already have regular orders and a proven export track record.

Standby Letter of Credit (SBLC)

• An SBLC acts as a safety net rather than a direct payment instrument.
• You can use it to secure a separate working capital loan from your local bank.
• This structure avoids embedding unsecured lending risk directly into the trade transaction.

Modern International Payment Solutions

• For smaller or faster transactions, digital payment platforms increasingly replace complex LC structures.
• Platforms such as Razorpay International Payments enable streamlined cross-border collections.
• You benefit from lower fees, real-time payment tracking, and significantly less paperwork compared to traditional bank-led LCs.

How Razorpay International Payments Simplifies Global Trade

While trade finance instruments help manage risk before shipment, exporters still need a reliable way to receive overseas payments after delivery. Razorpay International Payments addresses this gap by giving Indian exporters, freelancers, and global sellers a compliant and simplified way to collect foreign payments without operational complexity.

With Razorpay you can:

• Accept Payments from Over 180 Countries: Razorpay lets you receive payments from buyers across key markets including the US, UK, EU and more, increasing your global reach.
• Support for 135+ Currencies: You can collect funds in multiple foreign currencies, making it easier for international clients to pay you in their preferred denomination.
• Bank transfers Without Hidden Costs: Through global bank transfer methods such as SWIFT, ACH and SEPA, you receive overseas remittances with no forex markup and no hidden charges, helping you save on transfer costs compared with traditional bank routes.
• Unified Dashboard for All Collections: Track international card payments, bank transfers and payment links from a single dashboard, simplifying reconciliation and reporting.
• Effortless Compliance and FIRC Generation: Razorpay provides automated digital FIRCs (Foreign Inward Remittance Certificates) with payments, easing RBI and tax compliance in India.

Conclusion

A Red Clause Letter of Credit can help you access cash before shipment, easing pressure on your working capital during production. At the same time, it carries higher risk for the buyer and requires you to follow the terms carefully. Because of this balance, it works best when you have an established relationship and a high level of trust with the overseas buyer. 

Before choosing this route, you should carefully weigh the benefit of receiving advance cash against the strict documentation and compliance requirements. If the process feels complex or restrictive, exploring simpler and more modern funding or payment options may be a better fit for your business.

FAQs

1. Is a Red Clause Letter of Credit secured or unsecured?

A Red Clause LC is primarily an unsecured facility, as the advance is released based on the buyer’s authorisation rather than against collateral by the exporter.

2. Who bears the financial risk in a Red Clause LC transaction?

The importer bears the financial risk. Even if the exporter fails to ship the goods after receiving the advance, the issuing bank can recover the amount from the buyer.

3. How does a Red Clause LC differ from a Green Clause LC?

A Red Clause LC usually provides a smaller advance of around 20–25% to cover production costs and does not require security. A Green Clause LC offers a much higher advance, often up to 80%, and is backed by warehouse receipts for stored goods.

4. What documents are required to claim the advance payment?

To receive the advance, you generally submit a written request along with a simple receipt and a Letter of Indemnity confirming that you will ship the goods or repay the amount.

5. Why is it called a “Red Clause” Letter of Credit?

The term comes from traditional banking practice, where the clause authorising the advance was printed in red ink to clearly draw the advising bank’s attention.

6. Can the advance amount be deducted from the final payment?

Yes. After you present the final shipping documents, the bank deducts the advance and any applicable charges from the final settlement amount.