So sánh standby credit và credit

Standby letters of credit are irrevocable agreements for the payment of money. They function like guarantees of obligations and are usually provided by a bank for the benefit of a beneficiary. Standby letters of credit are governed by Article 5 of the Uniform Commercial Code (UCC), which in California is found at Division 5 of the California Commercial Code.

Standby letters of credit should not be confused with commercial letters of credit (not discussed in this blog) which are used as primary payment mechanisms in trade.

Standby letters of credit are generally used to provide third-party support for specific obligations. Where a specific payment obligation is being supported by a standby letter of credit, the standby letter of credit is usually drawn only if and to the extent the applicant fails to satisfy the specific payment obligation. As it involves an extension of credit by the issuing bank, the application process is similar to the process of obtaining any loan. Moreover, as the standby letter of credit involves a possible contingent payment in the future, many issuers require that the standby letter of credit be cash collateralized.

The issuing bank will usually have its own requirements for what a standby letter of credit will contain. Examples of what a standby letter of credit may include are:

• The amount of the letter of credit.
• When drawings are permitted under the letter of credit.
• The drawing conditions under the letter of credit. For example:
  • the conditions under which drawings can be made.
  • the documents that must be presented for a drawing to occur.
  • whether partial draws are allowed, and if so, any limits that may exist on such draws.
  • the timeframes for drawing.

The issuing bank pays the beneficiary under a standby letter of credit if and when the beneficiary submits a proper draw request to the issuing bank. Once drawn upon, the individual and/or entity that applied for the standby letter of credit must also reimburse in full the issuer of the standby letter of credit for the amount paid out.

Drawing on a standby letter of credit usually requires delivery of a draft and specified documents to the issuing bank in order to receive payment. Such documents usually include submission of the original standby letter of credit and a separate statement. The letter of credit itself will specify drawing requirements.

Standby letters of credit are unique instruments which are governed by their own distinct rules. As an applicant for a standby letter of credit, one should make sure that they speak to their banker, attorney, or other professional advisor to make sure they are comfortable with all of the requirements for obtaining a standby letter of credit before moving forward with it.

All blogs on this site are for educational purposes only, do not constitute legal advice or opinion, and should not be applied to your situation, or any specific situation, without consultation with counsel. Strategy Law, LLP does not provide any legal advice concerning any matter discussed in a blog except upon formal engagement including, without limitation, execution of Strategy Law, LLP’s formal legal services agreement, and with respect to specific factual situations. No blog constitutes a guaranty, warranty, or prediction regarding the result of any legal matter discussed in the blog or any representation.

A legal instrument issued by a bank on behalf of its client, providing a guarantee of its commitment to pay the seller if its client (the buyer) defaults on the agreement

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What is a Standby Letter of Credit (SBLC)?

A standby letter of credit, abbreviated as SBLC, refers to a legal document where a bank guarantees the payment of a specific amount of money to a seller if the buyer defaults on the agreement.

An SBLC acts as a safety net for the payment of a shipment of physical goods or completed service to the seller, in the event something unforeseen prevents the buyer from making the scheduled payments to the seller. In such a case, the SBLC ensures the required payments are made to the seller after fulfillment of the required obligations.

A standby letter of credit is used in international or domestic transactions where the seller and the buyer do not know each other, and it attempts to hedge out the risks associated with such a transaction. Some of the risks include bankruptcy and insufficient cash flows on the part of the buyer, which prevents them from making payments to the seller on time.

In case of an adverse event, the bank promises to make the required payment to the seller as long as they meet the requirements of the SBLC. The bank payment to the seller is a form of credit, and the customer (buyer) is responsible for paying the principal plus interest as agreed with the bank.

Summary

• A standby letter of credit (SBLC) refers to a legal instrument issued by a bank on behalf of its client, providing a guarantee of its commitment to pay the seller if its client (the buyer) defaults on the agreement.
• An SBLC is frequently used in international and domestic transactions where the parties to a contract do not know each other.
• A standby letter of credit serves as a safety net by assuring the seller that the bank will make payment for the goods or services delivered if the buyer fails to make the payment on time.

Standby Letter of Credit Explained

A standby letter of credit is often required in international trade to help a business obtain a contract. Since the parties to the contract do not know each other, the letter promotes the seller’s confidence in the transaction. It is seen as a sign of good faith since it shows the buyer’s credit quality and ability to make payment for goods or services even if an unforeseen event occurs.

When setting up an SBLC, the buyer’s bank performs an underwriting duty to verify the credit quality of the buyer. Once the buyer’s bank is satisfied that the buyer is in good credit standing, the bank sends a notification to the seller’s bank, assuring its commitment of payment to the seller if the buyer defaults on the agreement. It provides proof of the buyer’s ability to make payment to the seller.

How an SBLC Works

The process of obtaining an SBLC is similar to a loan application process. The process starts when the buyer applies for an SBLC at a commercial bank. The bank will perform its due diligence on the buyer to assess its creditworthiness, based on past credit history and the most recent credit report. If the buyer’s creditworthiness is in question, the bank may require the buyer to provide an asset or the funds on deposit as collateral before approval.

The level of collateral will depend on the risk involved, the strength of the business, and the amount secured by the SBLC. The buyer will also be required to furnish the bank with information about the seller, shipping documents required for payment, the beneficiary’s bank, and the period when the SBLC is valid.

After review of the documentation, the commercial bank will provide an SBLC to the buyer. The bank will charge a service fee of 1% to 10% for each year when the financial instrument remains valid. If the buyer meets its obligations in the contract before the due date, the bank will terminate the SBLC without a further charge to the buyer.

If the buyer fails to meet the terms of the contract due to various reasons, such as bankruptcy, cash flow crunch, dishonesty, etc., the seller is required to present all the required documentation listed in the SBLC to the buyer’s bank within a specified period, and the bank will make the payment due to the seller’s bank.

Types of Standby Letter of Credit

The two main types of SBLC are:

1. Financial SBLC

The financial-based SBLC guarantees payment for goods or services, as stipulated in the agreement. For example, if a crude oil company ships oil to a foreign buyer with an expectation that the buyer will pay within 30 days from the date of shipment, and the payment is not made by the required date, the crude oil seller can collect the payment for goods delivered from the buyer’s bank. Since it is a credit, the bank will collect the principal plus interest from the buyer.

2. Performance SBLC

A performance-based SBLC guarantees the completion of a project within the scheduled timelines. If the bank’s client is unable to complete the project outlined in the contract, then the bank promises to reimburse the third party to the contract a specific sum of money.

Performance SBLCs are used in projects that are scheduled for completion within a specific timeline, such as construction projects. The payment serves as a penalty for delays in the project’s completion, and it is used to compensate the customer for the inconvenience caused or to pay another contractor to take over the project.

Related Readings

Thank you for reading CFI’s guide to Standby Letter of Credit. In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful: