Standby Letter of Credit, Irrevocable Standby Letter of Credit
A Standby Letter of Credit includes a guarantee of payment. A Standby Letter of Credit is a written undertaking by a Bank to pay on demand against required documents up to a maximum amount, by an established expiry date. A SBLC is issued by the Issuing bank in favor of the Beneficiary at the request of and in accordance with instructions of the Applicant. The SBLC is designed to be used if the Applicant fails to carry out on their financial or performance obligations to the Beneficiary. A SBLC serves essentially the same function as a Demand Guarantee. SBLCs are used in America. Demand Guarantees are issued most of the rest of the world.
A Standby Letter of Credit serves a somewhat different function than a Documentary Letter of Credit. A Commercial or Documentary L/C serves as the primary payment mechanism for a transaction. A Standby L/C is a secondary payment mechanism. A bank will issue a Standby Letter of Credit on behalf of a customer to provide assurances of its ability to pay a creditor. Normally, neither the seller nor the buyer expects that a Standby Letter of Credit will be drawn upon. A Standby L/C includes a promise by a bank or financial institution to pay the debt owed to the buyer in the event that the customer / buyer defaults on payment. The seller/beneficiary is able to draw under a standby L/C by presenting a draft, and other documentation indicating that the customer has not performed its obligation.
Standby L/Cs are issued to:
- Stand behind monetary obligations,
- To insure the refund of advance payment Funds given by the buyer of goods to the seller prior to shipment, often just a percentage of the value of the goods with the remainder paid after shipment,
- To support performance and bid obligations, and
- To insure the completion of a sales contract.
A standby letter of credit is often used to guarantee payment performance of a customer. If payment is made in accordance with the suppliers' terms, the letter of credit would not be drawn on. Under these provisions, the bank is given until the close of the third banking day after receipt of the documents to honor the draft. One final comment: Letters of Credit of any kind are not used frequently in domestic sales transactions for one basic reason: A customer can usually find a less expensive and less complicated alternative such as open account terms rather than having to deal with the complexities associated with arranging for a Letter of Credit to be issued.
© 2012. Michael C. Dennis. All Rights Reserved. Michael is a consultant with extensive experience helping companies manage letters of credit and L/C related problems.
Edited by Michael Zininberg