LETTER OF CREDIT
A Letter of Credit is issued on your behalf to provide a secure means of payment to your overseas suppliers. The beneficiary of the Letter of Credit, your suppliers, will only receive payment if they present documents that comply exactly with the terms and conditions of the Letter of Credit.
Letters of Credit are the safest and often most convenient means of financing trade related transactions. An LC (Documentary or Standby) is a written undertaking given by a bank (Issuing Bank) to a beneficiary on instruction from an applicant (issuing Bank’s client) to pay the beneficiary at sight, or at a determinable future date, a stated amount of money within a defined time period. This undertaking is conditional upon the beneficiary’s documentary compliance with the terms and conditions in the LC.
Some situations require that a third party (often a bank) guarantees to pay a sum of money to one party if the counterparty defaults, for example if the counterparty fails to deliver a project within the agreed timelines. As such, the guarantee transfers the creditworthiness of the applicant/instructing party of the guarantee to the bank (the guarantor).
It is important to understand that what the guarantor guarantees is to pay an amount of money to the beneficiary, not to complete the project, fix the machine, deliver the goods or whatever else may be the subject of the guarantee. In fact, the guarantor does not guarantee that the applicant/instructing party will fulfil its obligation; it only commits itself to pay, in whole or in part, the amount stated in the guarantee.
STANDBY LETTER OF CREDIT
As the name indicates, a standby takes the form of a documentary credit, while its function and content are that of a guarantee. It was developed in the US around a half a century ago when US banks were not allowed under US law to issue guarantees. By issuing a standby, banks were able to accommodate customers’ needs for products that naturally belonged to the banking business.
A standby can be defined as a demand guarantee assuming the shape of a documentary credit. As with the documentary credit, the beneficiary under a standby is to present documents in accordance with the stipulations of the standby (and UCP 600 or ISP98 as the case may be) to obtain payment.
Instead of requiring the presentation of shipping documents, the beneficiary under a standby must present a document stipulated in the standby, declaring that the applicant/instructing party has failed to fulfil its payment obligation, to perform a job or to meet some other commitment called for in the commercial contract and sometimes has also failed to state the manner in which the applicant/instructing party has not fulfilled its obligation.