A Standby Letter of Credit (SBLC) is a guarantee of payment issued by a bank on behalf of a client that is used as “payment of last resort” should the client fail to fulfill a contractual commitment with a third party. The Standby letter of credit is never intended to be utilized, however, it keeps contracts from going unfulfilled in the occasion your organization shuts down, declares bankruptcy, or can’t pay for products or services given. It helps prove a business’s credit value and repayment abilities.

Very much like Bank Guarantee, a Standby Letter of Credit can be used by Buyer as collateral to secure a Loan or Credit Facility or to make purchases in foreign business transactions. SBLCs are very flexible instruments for all types of business.  It can cover anything from an ordinary guarantee commitment to a more sophisticated financial instrument.

Example of Standby Letter of Credit (SBLC):

Lam Tang Limited, a Chinese exporter, received an order to supply goods to Johnson Ltd., a British company.  Lam Tang Limited wants an assurance from Johnson Ltd. that it will make timely payment for the goods. Obliging to the request of  Lam Tang Limited, Johnson Ltd. issued a Standby Letter of Credit in favor of Lam Tang Limited. In this case, if due to any circumstances Johnson Ltd. fails to make the payment to  Lam Tang Limited, the Chinese company can claim the credit on the Standby Letter of Credit. Thus, the Standby Letter of Credit acts as an assurance to the exporter that he will be paid for the export of goods.

Standby Letter of Credit (SBLC) Providers – Who Are They?

Standby letters of credit are often used in international trade transactions, such as the purchase of goods from another country. The seller will ask for a standby letter of credit.

A standby letter of credit shows a company’s credit quality and ability to repay loans. Although SBLC/BG is not intended for use as a replacement for immediate cash payment obligation, it helps fulfill business obligations in case the business stops operations, cannot pay its vendors or becomes insolvent.
Small businesses often face difficulty when securing financing. For this reason, Standby Letters of Credit may be especially beneficial for encouraging investors to lend money to such a company. In case of default, investors are assured they will be paid the principal and interest from the bank through which the SBLC/BG is secured.

Standby Letters of Credit are issued for use in a wide variety of commercial and financial operations. Standby Letters of Credit are very much alike Documentary Letters of Credit (DLC). Their main difference is that unlike DLCs, SBLCs only become operative in case the applicant defaults. In case of default, the beneficiary in whose favor the SBLC was issued, can draw on the SBLC and demand payment.

Historically, Standby Letters of Credit were developed because the US regulator legally limited the US bank’s authority to issue Bank Guarantees.
SBLCs are also very similar to Bank Guarantees (BG), which too require that the presentation of stipulated documents be compliant with the terms and conditions of the Bank Guarantee. Standby Letter of Credit (SBLC) and Bank Guarantees are different in terms of protection, they both serve the primary purpose of making sure that sellers get paid, but while a Standby Letter of Credit protects the seller, a Bank Guarantee (BG) protects both sides, since it also protects the buyer in case the supplier never ships the goods or ships them in a damaged condition.

An SBLC is similar to a standard letter of credit: A bank promises to pay a beneficiary as long as the beneficiary provides documents and meets the requirements of the letter of credit. Still, there are key differences:

• Backup plan: An SBLC is a safety net. Like most safety nets, the goal is to avoid using it. When somebody gets paid with an SBLC, it means something went wrong. With a standard letter of credit, on the other hand, everybody involved hopes and expects that payment will occur. For example, those letters pay when an exporter successfully delivers a shipment to an importer.
• Performance aspect: SBLCs also are unique because they can include a performance component—or negative performance, if you prefer. If a service is not performed, the beneficiary gets paid.
• In-country: SBLCs are used frequently for domestic transactions. Those might include everything from building projects to receiving electricity services. Commercial letters of credit are more common in international trade.

Standby Letter of Credit (SBLC) Description:

SBLC COST- How Much Does It Cost To Obtain a Standby Letter of Credit (SBLC)?

SBLC costs include account opening fee, processing fee, leasing fee and bank transmission fee. Generally speaking, the cost to obtain a standby letter of credit varies from bank to bank and from company to company. Some banks charge up to 10% of the SBLC face amount annually, but our company (Grand City Investment Limited) charges only 4% of the SBLC face value and the SBLC can be canceled as soon as the terms of the contract have been met by the buyer or lessee. That’s one of the advantages of working with genuine SBLC providers like Grand City Investment Limited.

SBLC/BG FACTS:

• All SBLC/BG are Asset/Cash backed. A newly created SBLC/BG is called “Fresh Cut” whereas an already existing SBLC/BG is called “Seasoned”

• ​​Whether purchased of leased, SBLC / BG is issued for a “term” having validity normally for 1 year and 1 day which may extend up to multiple years depending on the Provider’s own discretion and Provider’s level of comfort with the Beneficiary.

• Banks will issue an SBLC/BG to any of its customers if they have sufficient cash in their bank account or available balance in their credit line (if they are already availing a credit line from the bank). It’s a complete myth that “Banks Do Not Issue SBLC/BG). This is the “Primary Market” transaction.

• Providers of SBLC/BG are a part of the “Secondary Market” transactions. SBLC/BG Providers are high net worth corporations or individuals who hold bank accounts at the issuing bank that contain significant cash sums (assets). SBLC/BG Providers would often be a collateral management firm, a hedge fund, or private equity company. SBLC/BG Provider instructs its issuing bank to secure and encumber cash in his own account and authorizes the bank to “cut” (an industry term meaning to create a financial instrument such as SBLC/BG ). Effectively, the SBLC/BG is “leased” or “sold” to the Beneficiary as a form of investment since the Provider receives a return on his commitment.

• SBLC/BG is issued under ICC/URDG758 (UPC 600) protocol and is readily accepted by almost all International as well as Private Banks.

• SBLC/BG is supplied by the Issuing Bank of the Provider to the Beneficiary’s bank account at the Receiving Bank and is transmitted inter-bank via the appropriate SWIFT platform alone (MT-760).

• The Provider and the Beneficiary agree to enter into a Collateral Transfer Agreement (CTA) which governs the issuance of the SBLC/BG. The SBLC/BG is specifically issued to the Beneficiary for a defined purpose and each contract is bespoke. It is effectively a form of “Securities Lending” and often a derivative of “re-hypothecation”. The fact that there is an underlying agreement (the CTA) has no bearing on the wording or construction of the Guarantee (SBLC/BG). This allows the Beneficiary to use the SBLC/BG to raise credit, to guarantee credit lines and loans or to enter trade positions or buy/sell contracts.

• SBLC/BG is valuable in the secondary and tertiary markets, and this also creates an environment for Intermediaries to profit on the leasing and selling of SBLC/BG. Unfortunately, this also creates misunderstandings and opportunities for fraud. Scammers keep trying, by imposing their “procedures” which in general, involve rushed deals with no hard copies to follow, advanced payments, and so on.

• By its own nature and definition, only banks can legally issue SBLC (Stand-By Letters of Credit) or BG (Bank Guarantee). This is not only common sense, but actually regulated by banking laws in most countries since these are debt obligations issued by banks.

• SBLC/BG must be UCP-600 compliant and hence it must be issued by a licensed bank alone. Otherwise, it will not be UCP-600 compliant, regardless of the wording of the document. If it is not UCP-600 compliant, no bank will ever accept it as collateral or even as a documentary credit. While it is true that URDG-758 changed this from banks to “a bank, other institution or person” may act as a guarantor, the fact is that URDG-758 rules implied that financial stability of the guarantor is obligatory, and that the issuance of said documents shall be governed by the internal legislation of each country. Regardless, most banks will only accept documentary credit from other banks, due to their financial stability and their full compliance with local laws.

• Banks, in general, will monetize only an “owned/purchased” SBLC/BG. They will not monetize a “leased” SBLC/BG. In contrast to a purchased or owned SBLC where the buyer becomes the official owner of the instrument and in turn would be able to lease the SBLC out to a Third Party, a “leased SBLC” cannot be “leased out” any further.

• There are private Monetizers who would monetize a “leased” SBLC/BG. Some Monetizers will, however, only accept SBLC/BG with CUSIP or ISIN Numbers. This means they will NOT accept a fresh cut bank guarantee, ONLY seasoned instruments. Seasoned BG’s cost more and generally are only available to be purchased from secondary owners not banks.

• Although a leased SBLC/BG is not considered an “asset” (a leased SBLC/BG is not trading securities, trading debt instruments, or trading investment funds. There is no public market for the trading of SBLC/BG. All SBLC/BG transactions are private transactions), it can still be monetized, discounted or funded (whereby the SBLC/BG is turned into usable cash) by a resourceful Monetizer. Remember, SBLC/BG is after all a written obligation of the issuing bank to pay a sum to a beneficiary on behalf of their customer in the event that the customer himself does not pay the beneficiary. The Instrument/ Security remains valid during the term before the Expiry Date. Such resourceful Monetizers possess the capacity to a draw a line of credit against “leased” SBLC/BG and use part of the cash to pay the client his “Non Recourse Monetization Payment” (often 40% to 65% of the value of the Leased Bank Instrument known as “Loan To Value” (LTV). The Monetizer then takes the balance of the money from the Line of Credit and places these funds into Trade / PPP using a proprietary trading platform. This platform is often a group of experienced bank traders who use the Monetizers cash and trade it generating significant profit returns on a weekly or monthly basis. Often the Platform uses normal trading risk protection strategies to ensure the Monetizers funds receive significant protection from all trading downside risk.

• Most people often confuse the term NOT RATED with the fact that some SBLC/BG issuing entities are not real banks, but private companies offering consulting services, and sometimes, issuing documents that are beyond their legal and financial capacity, hiding themselves behind the excuse that because they are an “offshore bank” or a foreign corporation or because they only deal with foreigners, they do not need to hold a banking license or comply with reserve deposits with the Central Banks of the jurisdictions from where they operate. The reality is, a rating is just an opinion given by one person or company, about the credibility of the bank or institution what the rating is about; but this has almost nothing to do with the truth, that the documents in question are worthless not because of the credit rating of the issuer, but because the issuer is not a bank.

• For political reasons, most Eurozone regulated banks avoid, as much as they can, to work with banks of certain countries. Trying to monetize an instrument issued by a Latin American country, or even China is almost impossible!! Even Europe is not free of that problem; for example, while the list of embargo banks from Russia and Ukraine is very small, most Eurozone regulated banks prefer to not accept as collateral instruments issued by any Russian or Ukraine based banks, they say it is to reduce their risks as much as possible, and to avoid working with banks that while not currently on the embargo list, can be included in said list at any time. Some other countries have strong, reliable and highly praised banks with excellent credit ratings, like Azerbaijan, yet almost no Eurozone regulated bank wants to work with instruments issued by them; this limits the ability of most monetizers to work with instruments from banks of these countries regardless of the credit rating of the bank.

• To determine if a borrower is worthy of an SBLC/BG, many banks will undertake a credit analysis. Credit analyses focus on the ability of the organization to meet its debt obligations, focusing on default risk. Lenders will generally work through the five C’s to determine credit risk: the applicant’s credit history, capacity to repay, its capital, the loan’s conditions, and associated collateral. This form of due diligence can revolve around liquidity and solvency ratios. Liquidity measures the ease with which an individual or company can meet its financial obligations with the current assets available to them, while solvency measures its ability to repay long-term debts. Specific liquidity ratios a credit analyst may use to determine short-term vitality are current ratio, quick ratio or acid test, and cash ratio. Solvency ratios might entail the interest coverage ratio.

• SBLC/BG denotes an irrevocable obligation assumed by banks. The principle that if a compliant demand is made under a standby letter of credit, an issuing bank must pay, subject to only very limited exceptions.
• A key purpose of the widespread use of standby letters of credit to finance commodity transactions is the comfort it gives to the seller that it will receive payment.

• The drafting of the SBLC/BG should provide that the presentation of a demand would be conclusive evidence that the amount claimed was “due and owing” to the Beneficiary of the SBLC/BG. The beneficiary’s belief that payment was “due and owing” should activate payment.

• The meaning of the words “obligated to pay” has to be considered in the context of the certificate to be tendered under the SBLC/BG.

• Exceptions to the rule that an issuing bank must pay under an SBLC/BG are limited and difficult to prove. If you have concerns about the reliability of your counterparty, requiring them to provide an SBLC from a reliable bank and governed particularly by English law remains a good way of securing payment.

• If you are the beneficiary of an SBLC/BG, you should insist that it contains clear wording to the effect that presentation of a demand by you will be conclusive evidence that the amount claimed will be “due and owing”. In order to rely on the strength of these decisions, you should also ensure that English law governs the SBLC/BG, even if it does not govern the underlying contract.

• The great utility of the standby letter of credit is reflected in the fact that it can be used in practically any situation in which one party to a contract is concerned with the other party’s ability to perform. Some of the many ways in which a standby letter of credit can be used are: to ensure payment or performance in construction financing, corporate consolidations, real estate transactions, management contracts, leases on real and personal property, stock transfers and purchases, and bid and performance bonds; to ensure payment of salaries to highly paid individuals such as professional athletes and entertainers; and to ensure payment of professional services such as attorney’s fees.​

• The standby letter of credit is neither a contract nor a negotiable instrument and if it is not properly drafted, it will not be considered a guarantee at all. The standby letter of credit or SBLC/BG is a distinct legal instrument, unlike any other. The obligation of the issuer of the SBLC/BG is independent of the underlying contract between the issuer’s customer and the beneficiary of the SBLC. The standby letter of credit enables a businessman to enter into business ventures with minimal fear of loss. By substituting the credit of a third party, usually a bank, for that of the debtor, the businessman can help to protect his investment. Finally, the standby letter of credit is particularly well suited for preventing loss or delay of payment caused by the debtor’s bankruptcy. Because the standby letter of credit and its proceeds are not part of the bankruptcy estate, the beneficiary of a standby letter of credit should receive payment from the bank without delay. The low cost and adaptability to a wide range of business transactions make the standby letter of credit very attractive to the business community and to business lawyers.

• ​​Standby letters of credit frequently involve negotiated, complex agreements and larger dollar amounts where lawyers tend to be more involved. Examples include standbys supporting or securing municipal bond issues, construction contracts, subdivision and municipal improvements, commercial real estate leases, equipment leases, cable installations, reinsurance requirements of nonadmitted reinsurers, power purchase contracts, SWAP agreements, securitizations, self-insured retention amounts in insurance fronting arrangements, indemnification obligations for surety bonds, supersedeas bonds to stay execution of a judgment pending an appeal, prejudgment attachments bonds, government contracts or privileges, clearing obligations of brokers and dealers, advance payment guarantees, and open account sales.

• Commercial letters of credit customs and practice carry over and are applied to standby letters of credit because standby letters of credit evolved from and have many characteristics in common with commercial letters of credit. Commercial letters of credit customs and practice were established well before standby letters of credit gained usage and popularity. Until 1998, when the International Standby Practices or “ISP”5 was promulgated, almost all letters of credit were issued subject to the Uniform Customs and Practice for Documentary Credits (the UCP).The UCP is specifically geared to examining documents presented in international trade such as drafts, bills of lading, other types of shipping documents, insurance certificates, inspection certificates, commercial invoices, and packing lists. The UCP also provides for the “negotiation” of drafts and documents presented to banks other than issuers that are “nominated” in letters of credit to purchase and present the drafts and documents. Both of these situations — live commercial documents and negotiation of drafts and documents — are seldom relevant to or found in standby letter of credit practice.

• ​​The UCP governs standby letters of credit to the extent that its articles are applicable.The UCP does not explain when and how its articles should be applied to standby letters of credit.Even preparing a draft to be presented under a standby letter of credit can present challenges for those who do not have a working knowledge of how banks expect drafts to be worded and presented. Yet every regime that governs letters of credit provides that standard banking practices or international standard banking practices are to be used to determine whether documentary presentations and other aspects of letter of credit transactions are proper and compliant.

• Much of the lack of familiarity with or transparency of standby letter of credit practices has been overcome by the International Standby Practices, or ISP. The ISP’s rules specifically address standby letters of credit practice separate from commercial letter of credit practice. The ISP’s rules are well written and for the most part are clear, even-handed, and straightforward. They avoid significant pitfalls of using the UCP in standby letters of credit, such as presentation of stale documents, installment drawings, force majeure, and the requirement that documents and data in documents be consistent. Unfortunately, the UCP is still used in almost half of the standby letters of credit issued in this country and probably in more than half issued by foreign banks in other countries. Additionally, even the ISP’s rules are not all-encompassing. Resort to standard banking practices outside the ISP, caselaw, and the UCC is necessary to fill in the gaps. Finally, there are several rules or provisions of the ISP, the UCP or the UCC that govern standby letters of credit that lawyers and their letter of credit applicant or beneficiary clients may not be familiar with, overlook, or miscomprehend their import. Many letters of credit customs, practices and rules are counter-intuitive and cannot be predicted by resort to simple contract law principles or even other articles of the UCC.

Contact us today to see how a Standby Letter of Credit from rated banks can help you conclude worthy deals with your suppliers and contractors.

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