Standby Letter Of Credit

Introduction to
Standby Letter of Credit

A Standby Letter of Credit (called “SBLC“ or “LC”) are written obligations of an issuing bank to pay a sum of money to a beneficiary on behalf of their customer in the event that the customer does not pay the beneficiary. It is important to note that standby letters of credit apply only whenever the issuing bank’s commitment to pay is not contingent on the existence, validity, and enforceability of its customer’s obligation; this is called an “abstract” guarantee; that is, the bank’s obligation is to pay regardless of any disputes between its customer and the beneficiary. The issuance of letters of credit is a private transaction and does not result in the issuance of any public trading securities.

Key Benefits

  • Improves your cash flow
  • Eliminates or reduces the need to give a beneficiary, with whom you have entered into a contract, cash collateral or other security to support the performance obligations under the contract
  • May eliminate the need for you to prepay for products or services, which allows you to use your funds for alternate purposes before payments become due
  • A bid or performance guarantee may help you win contracts by providing the company with financial security of payment

Who are the parties to the standby letter of credit?

  • The Applicant. This is the customer of the bank who applies to the bank for the standby letter of credit. He must provide collateral to the bank or have sufficient credit to induce the bank to issue the instrument. He also must pay the bank a fee for issuing the instrument.
  • The Issuing Bank. This is the applicant’s bank that issues the standby letter of credit.
  • The Beneficiary. This is the party in whose favour the instrument is issued.
  • Confirming Bank. This is a bank (usually located near the beneficiary) that agrees (confirms) to pay the beneficiary rather than have the issuing bank pay the beneficiary. The beneficiary pays the Confirming Bank a fee for this convenience. The Confirming Bank then collects from the Issuing Bank the amount paid to the beneficiary.
  • Advising Bank. This is the bank that represents the beneficiary. It may accept the letter of credit on behalf of the beneficiary and collect on it on behalf of the beneficiary. In order for the transaction to be a bank-to-bank transaction, the advising bank works for the beneficiary to keep the instrument in the banking system. Sometimes the Advising Bank also is the Confirming Bank, but not always.

What is the purpose of the standby letter of credit?

The standby basically fulfils the same purpose as a bank guarantee: it is payable upon first demand and without objections or defences on the basis of the underlying transaction between the applicant and the beneficiary. It is up to the beneficiary to decide whether he may accept a standby.

What are the types of standby letters of credit?

  • Performance Standby: This instrument supports an obligation to perform other than to pay money including the purpose of covering losses arising from a default of the applicant in completion of the underlying transaction.
  • Advance Payment Standby: This instrument supports an obligation to account for an advance payment made by the beneficiary to the applicant.
  • Bid Bond/Tender Standby: This standby supports the obligation of the applicant to execute a contract if the applicant is awarded a bid.
  • Counter Standby: This instrument supports the issuance of a separate standby or other undertakings by the beneficiary of the counter standby.
  • Direct Pay Standby: This instrument serves to support payment when due to an underlying payment obligation typically in connection with a financial standby without regard to default. This standby is also used to directly pay an obligation where the only conditions of payment are the passage of the term and the presentment of payment.
  • Insurance Standby: This instrument is an insurance or reinsurance obligation of the applicant.
  • Commercial Standby: This is the most used standby and it supports the obligations of an applicant to pay for goods or services in the event of non-payment by a business debtor.

Are standby letter of credits transferable?

Assignment of Standby letter of credit proceeds -The beneficiary can assign the proceeds of a standby letter of credit. But this assignment does not assign the rights of the beneficiary as “drawer” on the standby letter of credit, and only the beneficiary may exercise the “drawer” rights and present the demand for payment under the terms of the standby letter of credit unless the terms of the instrument provide otherwise. This means that the assignee may receive the proceeds of the standby, but in order to obtain those proceeds, the beneficiary must first make the demand for payment. This also means that the beneficiary can sell by assignment, at discount, the benefits of the standby. An assignment of proceeds requires notice to the issuing bank of this action; otherwise, the issuing bank would pay the beneficiary rather than the assignee.

Transfer of Standby letter of credits. Standby letter of credits can be transferred to a third party ONLY with the written consent of the issuing bank AND the beneficiary. Are standby letter of credits the subject of trading?

There is no public market for the trading of standby letters of credits. Standby letters of credits can only be transferred or the proceeds assigned in private transactions (as previously noted above).

Standby letters of credit do not have CUSIP or ISIN numbering. Standby letters of credit are not trading securities, trading debt instruments, or trading investment funds, and therefore are not subject to the rules and regulations of the Security and Exchange Commission.