Standby Letters of Credit in business negotiations
A Standby Letter of Credit is a written obligation of a bank to ensure payment of a third party. I used the verb “guarantee” since a standby letter of credit is a bank guarantee under another name. Until 1996 banks were not permitted to issue guarantees but only letters of credit. Judges originally came up with this no-guaranty rule for banks based on how banks were chartered.
Under a letter of credit, a bank makes payment against presentation of certain documents. To turn a letter of credit into a guarantee, the beneficiary of the standby only had to present a document availing himself of the guarantee (“Pay me, now! ”).
In 1996 the US Office of the Comptroller of the Currency released Federal Register / Vol. 61, No. 28 § 7. 1016 Independent undertakings to pay against documents and § 7. 1017 National bank as guarantor or surety on indemnity bond, thus allowing banks to issue guarantees. However, customers were so much used to their standbys that they only cautiously used this new-fangled offering called “bank-guarantee”.
Who ‘ re the parties to the standby letter of credit?
(1) The Applicant: The customer of a bank who applies for a standby letter of credit.
(2) The Issuing Bank: This is the bank that issues the standby letter of credit.
(3) The Beneficiary: The party in whose favor the bank issues the standby or guarantee.
Following the rules about letters of credit sometimes further banks are involved in the transaction.
(4) Confirming Bank: A bank (usually located near the beneficiary) that agrees (confirms) to pay the beneficiary rather than have the issuing bank pay the beneficiary. The obligation of the confirming bank is independent of the Issuing Bank, that means that the Confirming Bank is unable to refuse payment claiming it has not received payment from the Issuing Bank.
(5) Advising Bank: This bank can be a well-paid mailman which advises the Beneficiary that Issuing Bank has written a standby to their benefit.
What are standbys typically used for?
(1) Performance Guarantee. This instrument supports an obligation to perform other than to pay money, e. g. obligation to maintain or repair an commercial installation.
(2) Advance Payment Standby. This instrument supports an obligation to account for an advance payment made by the beneficiary to the applicant.
(3) Bid Bond/Tender Standby. This standby supports an obligation of the applicant to execute a contract if the applicant is awarded a bid.
(4) Insurance Standby. This instrument is an insurance or reinsurance obligation of the applicant.
(5) 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.
According to which rules are standbys processed?
The ICC issued the International Standard Practices in 1998 (ISP 1998, ICC-Publ. Nr. 590). These rules however have never really been accepted by the banking community. Furthermore, standbys can still be issued according to the ICC issued UCP 600 (Uniform Customs and Practices for Documentary Credits, ICC-Publ. Nr. 600). Article 1 UCP 600 states in this regard:
“The Uniform Customs and Practice for Documentary Credits, 2007 Revision, ICC Publication no. 600 (“UCP”) are rules that apply to any documentary credit (“credit”) (including, to the extent to which they may be applicable, any standby letter of credit). ”
The limited applicability stems from the fact that rules regarding stale shipping documents are extraneous to a guarantee transaction. In fact, the majority of the UCP 600, which deals mostly with the issuance of shipping documents, is not applicable to standby letters of credit.
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