Explained: The Red Clause and Green Clause Letters of Credit

Red Clause Letters of Credit and Green Clause Letters of Credit are specialized types of Letters of Credit (LCs) used in trade finance to provide advance payment to sellers (exporters) before shipping goods. These clauses are included in LCs to address the seller’s need for working capital or pre-shipment expenses, making them particularly useful in industries with high production or storage costs.

---

What Is a Red Clause Letter of Credit?

A Red Clause Letter of Credit allows the seller to receive an advance payment before shipping goods. This advance is typically used to finance production, procurement, or other pre-shipment activities. The term “Red Clause” originates from the practice of printing this clause in red ink on the LC.

How It Works:

1. The buyer’s (importer’s) bank issues the LC with a Red Clause, authorizing an advance payment to the seller.
2. The seller provides a receipt or undertaking to the bank in exchange for the advance.
3. The advance payment is deducted from the final amount when the seller submits the required trade documents.

Key Features:

• Advance Payment: Funds are provided before shipment.
• Security for the Bank: Banks typically require a receipt or written undertaking to recover the advance in case of default.
• Seller’s Benefit: Helps the seller manage working capital for production or procurement.

Use Cases:

• For exporters needing liquidity to fulfill large or resource-intensive orders.
• Common in industries like agriculture or textiles, where upfront costs are significant.

---

What Is a Green Clause Letter of Credit?

A Green Clause Letter of Credit extends the functionality of a Red Clause LC by providing advance payment not only for production or procurement but also for storage, warehousing, or freight-related costs. The term “Green Clause” comes from the clause traditionally being printed in green ink.

How It Works:

1. The buyer’s bank issues an LC with a Green Clause, specifying the conditions for advance payment.
2. The seller receives an advance for storage or transportation expenses in addition to production costs.
3. Like a Red Clause LC, the advance is deducted from the final payment upon submission of compliant documents.

Key Features:

• Comprehensive Advances: Includes pre-shipment storage and freight costs in addition to production.
• Documentation Requirement: Sellers often need to provide proof of warehousing or storage agreements to access the advance.
• Enhanced Seller Support: Offers additional financial flexibility compared to a Red Clause LC.

Use Cases:

• For exporters requiring funds for both production and storage or transportation.
• Suitable for goods requiring extensive storage before shipment, such as agricultural produce or bulk commodities.

---

Key Differences Between Red Clause and Green Clause Letters of Credit

Feature	Red Clause LC	Green Clause LC
Purpose	Advance for production or procurement	Advance for production, storage, or freight
Scope of Advance	Limited to working capital	Includes storage and transportation costs
Documentation	Receipt or undertaking required	Additional proof of storage or warehousing
Use Case	High-production-cost industries	Goods requiring extensive storage or transport

---

Benefits of Red Clause and Green Clause LCs

For Sellers (Exporters):

1. Improved Cash Flow:
   • Provides upfront funds for production, storage, or logistics.
2. Enhanced Trade Flexibility:
   • Enables sellers to fulfill large or complex orders.
3. Risk Mitigation:
   • Advance payments reduce the risk of production delays.

For Buyers (Importers):

1. Secure Transactions:
   • Payment advances are tied to specific terms and documentation.
2. Supports Reliable Supply Chains:
   • Ensures sellers have the resources to meet contract terms.

---

Risks and Considerations

For Buyers:

1. Risk of Seller Default:
   • If the seller fails to ship the goods, recovering the advance can be challenging.
2. Additional Costs:
   • Banks may charge higher fees for issuing Red or Green Clause LCs.

For Sellers:

1. Stringent Documentation:
   • Requires precise records to access advances and avoid disputes.
2. Repayment Obligations:
   • Advances are deducted from final payments, reducing immediate cash inflows upon shipment.

---

Example Scenarios

Red Clause LC:

• Scenario: A textile exporter in India receives an order from a US buyer. The buyer issues a Red Clause LC, enabling the exporter to access funds for purchasing raw materials before shipment.

Green Clause LC:

• Scenario: An agricultural exporter in Brazil needs funds to store coffee beans in a warehouse before shipment to Europe. The buyer issues a Green Clause LC, covering both production and storage costs.

Red Clause and Green Clause Letters of Credit provide crucial financial support for exporters, facilitating smooth trade transactions and reducing the risk of production or shipping delays. While both types of LCs are designed to address sellers’ working capital needs, Green Clause LCs offer broader financial assistance, making them suitable for complex trade scenarios involving significant storage or transportation costs. Both instruments enhance trust and efficiency in international trade but require careful management to mitigate associated risks.

Different Types of Letters of Credit Explained: Sight, Usance, and More