CDCS study materials-Standby letters of credit

Chapter-21
Learning objectives
This chapter provides an overview of standby letters of credit and the content of ISP98.
By the end of this chapter, you should be able to:
◆◆ describe the origins and use of a standby letter of credit; and
◆◆ understand the content of ISP98 as the rules specifically developed for use with a standby letter of credit.

21.1 Introduction:

Standby letters of credit were initially developed because banks in the United States had limited legal authority to issue guarantees. Today, except under limited circumstances, that restriction on the issuance of guarantees no longer exists.
Standby letters of credit are used to underwrite a wide variety of commercial and financial operations.
Standby letters of credit are not legally distinct from demand guarantees, which also require the presentation of stipulated documents and compliance with the terms and conditions of the guarantee. The distinction lies in
practice and terminology.
A standby letter of credit acts as a guarantee if there is a failure to perform a contractual undertaking, such as the obligation of a buyer to pay or that of a seller to deliver. It has the same basic form as a commercial documentary credit. However, the intention is often that a beneficiary, in whose favour a standby letter of credit is issued, draws only in case of default on the transaction to which the standby letter of credit relates.

21.2 Types of standby letter of credit

Standby letters of credit (or simply ‘standbys’) can be extremely flexible and are therefore a suitable product in a wide range of payment scenarios.
The following are the types most commonly used.
◆◆ A performance standby supports an obligation to perform other than to pay money and includes an obligation to pay for losses arising from a default of the applicant in the completion of the underlying transaction.
◆◆ An advance payment standby supports an obligation to account for an advance payment made by the beneficiary to the applicant.
◆◆ A bid-bond, or tender bond, standby supports an obligation of the applicant to execute a contract if it is awarded a bid.
◆◆ A counter-standby supports the issuance of a separate standby letter of credit or other undertaking by the beneficiary of the counter standby.
◆◆ A financial standby supports an obligation to pay money, including any instrument evidencing an obligation to repay borrowed money.
◆◆ An insurance standby supports an insurance or reinsurance obligation of the applicant.
◆◆ A commercial standby supports the obligations of an applicant to pay for goods or services in the event of non-payment by other methods.
◆◆ A direct-pay standby is intended to be the primary means of payment and may or may not be linked to a default in performance or payment.

Source: Guide to Documentary Credits By Gary Coller
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