Standby Letter of Credit

What is a standby letter of credit?

A Standby Letter of Credit (called“SBLC) are written obligations of an issuing bank to pay a sum of money to a beneficiary on behalf of their customer in the event of NON PERFORMANCE OF APPLICANT.  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 it’s customer’s obligation; 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.

Requirement of standby letters of credit?

The standby letter of credit comes from the banking legislation of the United States, which forbids US credit institutions from assuming guarantee obligations of third parties.  (Most other countries outside of the USA continue to allow bank guaruntees.)  To circumvent this US banking rule, the US banks created the standby letter of credit, which is based on the uniform customs and practice for documentary credits.  In 1998 the International Chamber of Commerce (ICC) added ISP98 (International Standby Practices 98) as the rules to guide standby letters of credit.  These rules are slowly being adopted; however, many of the standby letters of credit continue to rely on the ICC’s older guide, Uniform Customs and Practices for Documentary Credits, ICC Publication 600.

Now most of the banks across globe has preferred SBLC over conventional guarantees due to its operational benefits to all parties.

Parties to the standby letter of credit-

This is same as parties to commercial Letter of Credit.

There are only two parties to any credit. the one - who issues it and the other who is the beneficiary. Rest all are just facilitators.

(1) The Issuing Bank.  This is the applicant’s bank that issues the standby letter of credit.
(2) The Beneficiary.  This is the party in whose favor the instrument is issued.

  
Facilitator to Standby Letter of Credit:

(1) 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.
(2) 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.
(3) 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.

 
Purpose of the standby letter of credit

The standby basically fulfills the purpose as a bank security, FAR BETTER THAN A BANK GUARANTEE: it is payable upon first demand and without objections or defenses 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.
  
 
Various types of standby letters of credit

(1) 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.
(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) Counter Standby.  This instrument supports the issuance of a separate standby or other undertaking by the beneficiary of the counter standby.
(5) Direct Pay Standby.  This instrument serves to support payment when due of 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 presentment of payment.
(6) Insurance Standby.  This instrument is an insurance or reinsurance obligation of the applicant.

(7) 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.
  
 
Transferable standby letter of credits

Transfer of any SBLC shall be as per applicable rules. if its under UCP600, article 38 of UCP shall be applicable.

Standby letter of credits can be transferred to a third party ONLY with the written consent of the beneficiary. If issuing bank wants, they may add that thier consent should be taken prior to any transfer. Issuing bank may also request for pre-intimation of transfer.