Standby Letter of Credit
What is a Standby Letter of Credit?
A standby letter of credit ("Standby") is an irrevocable, binding undertaking by an Issuer (generally, a bank), made at the request of an Applicant (generally, a bank's customer), for the benefit of a Beneficiary, to ensure payment or performance of an underlying obligation. Its commercial value lies in its being totally independent of any agreement between the Beneficiary and the Applicant or the Applicant and the Issuer. Once issued, the issuer must honor the terms of the standby if the beneficiary presents documents, such as a draft (bill of exchange) or written demand for payment, that strictly comply with the terms of the standby letter of credit.
Standbys are most frequently issued in the United States and until relatively recently, were less commonly used in the UK and Europe, where bank guarantees were more likely to be used to achieve similar purposes. In fact, because certain American banks were prohibited from issuing guarantees, standby letters of credit were developed as a substitute and became the primary means by which American banks ensured payment or performance.
Typically, a standby is used to ensure payment of an obligation (such as a contract or lease calling for payment at a future time) or performance of an obligation (such as completion of a construction project). In the case of the performance standby, the beneficiary would seek to provide sufficient funds to enable another contractor to complete the project. Demand guarantees issued by banks or performance bonds issued by insurance companies would provide similar assurances.
As standbys are often used internationally, a body of international custom and practice has developed to promote uniformity in handling standbys. It is embodied in the Uniform Customs and Practice for Documentary Credits (International Chamber of Commerce Publication 500) ("UCP"), which covers commercial letters of credit as well as standbys, and the International Standby Practices ("ISP"), which covers only standbys and was developed by the International Financial Services Association.
Although proceeds of a standby may be assigned, the standby itself is usually not transferable unless the standby so provides. If the standby provides that it is transferable, the UCP and ISP differ on the consequences. Under UCP Art. 48(b), it may be transferred only once. Under ISP Rule 6.02, however, it may be transferred more than once, but the issuer must agree to the transfer requested by the beneficiary. In either case, the restrictions would effectively destroy the ability to trade the instrument quickly.
Can Standby Letters of Credit be traded or sold?
Legitimate standbys are not intended to be investment instruments and there is no established market for trading them. You would need to see the non-operative SLC and verify its authenticity. Who is the beneficiary? Who is the applicant? And what is the contact or performance being guaranteed?
There are many Letter of Credit scams going around. These scams usually involve selling or trading Standby Letters of Credit. Legitimate LOCs are not intended to be investment instruments and there is no established market for trading them. Although an active Letter of Credit, depending its terms and conditions, can usually be hypothecated, discounted, or forfeited (the financial equivalent to factoring) for quicker access to funds, this is not a procedure to be embarked upon by the inexperienced. A Letter of Credit may be written for a short period of time, covering one shipment of goods, or may be written for a greater amount and for a longer period of time in order to cover say, a year's worth of shipments. But legitimate
SLOCs virtually never carry the term "one year and one day."
Educate yourself before getting involved in the trading of any Letter of Credit and verify all terms and conditions, parties involved, and the nature of the investment with an independent party. See Fraudaid.com, the FBI web site, or for more LOC scam info, or contact us and we would be happy to discuss any Letter of Credit transaction.
Need fast cash for your active Letter of Credit? High Falls Funding can discount or forfeit certain types of Letters of Credit for fast cash. Contact us to discuss.
Fraudsters or those dealing in Letter of Credit Scams beware, we contact the US Treasury Department when such scams are made aware to us. Please do not contact us with any such fraudulent schemes.
See the following information links, compliments of the Credit Research Foundation, a non-profit organization.
Understanding and Using Letters of Credit, Part I
Understanding and Using Letters of Credit, Part II
Sample Procedure for Letter of Credit Administration
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