What
is a standby letter of credit?
“A
standby letter of credit (or simply
“standby” in trade finance jargon) is
an irrevocable, independent, documentary, and binding undertaking
when issued and need not so state.”
This
nice and official definition is a bit complex. In addition, the most
important element is missing: Undertaking to do what?
- With “undertaking”, we mean the undertaking to pay a certain amount of money. This undertaking is usually issued by a bank to support a payment obligation of its client.
- “Irrevocable” signifies the Issuer cannot cancel it.
- “Independent” indicates that the standby does not depend on the issuer’s ability to obtain reimbursement from the applicant or on the underlying transaction.
- “Documentary” means that the standby depends on the presentation and examination of documents.
Standby
letters of credit come from the United States where they are most
widely used. In Europe, we usually issue guarantees instead.
Standby
schema
Additional
parties can complement this basic schema:
- A Confirmer adds, upon the issuer’s request, its confirmation to honor the standby.
- A Presenter presents a claim on behalf of a Beneficiary or nominated person.
- An Advisor checks the apparent authenticity of messages in accordance with standby letter of credit practice.
- A Nominated Person can receive a presentation of a standby and act as Confirmer or Issuer but is not obliged to do so.
What
are ISP 98?
ISP
stands for “International Standby Practices”. 98 refers to the
year where the International Chamber of Commerce (ICC) has approved
the ISP. The rules intend to simplify, standardize, and streamline
the drafting of standbys. They reflect generally accepted practice,
custom, and usage of standby letters of credit.
The
ISP 98 apply to any independent undertaking (whatever its name) that
refers to them.
Types
of standbys
- A performance standby supports an obligation to perform other than to pay money.
- An advance payment standby supports an obligation to account for an advance payment made by the beneficiary to the applicant.
- A bid bond / tender standby supports an obligation of the applicant to execute a contract if the applicant is awarded a bid.
- A counter standby supports the issuance of a separate standby or other undertaking by the beneficiary of the counter standby.
- A financial standby supports an obligation to pay money.
- A direct pay standby supports payment of an underlying payment obligation typically in connection with a financial standby but without regard to a default.
- An insurance standby supports an insurance or reinsurance obligation of the applicant.
- A commercial standby supports the obligation of an applicant to pay for goods or services in the event of non-payment by other methods.
Main
features of standbys
- By default, the issuer honors a standby at sight. However, the parties can also expressly agree on deferred payment.
- A presentation must be made in paper form unless another medium is fixed. Documents must be presented in their original form. (ISP 98, when the Internet was still in its infancy!!)
- Partial presentations are possible unless expressly prohibited by the standby. The same applies to multiple presentations.
- A presentation must be made at the right time (= on or before the expiry date) and location. If no location is fixed, the location of the Confirmer applies.
- Transfer of a standby means that the Beneficiary will shift the benefit of a standby to a third party. By default, a standby is not transferable. Indeed, any transfer of a standby requires the consent of the Issuer or Nominated Person. The only exception is that the applicable law itself does not require such consent.
- Upon expiration, the Beneficiary of a standby can ask the Issuer to extend it or, if the Issuer does not accept, to pay the amount available under it. This is commonly referred to as “extend or pay”.
A
final word about legal definitions
Here
is my favorite definition of the ISP 98:
“A
or B” means “A or B or both”; “either A or B” means “A or
B, but not both”; and “A and B” means “both A and B”.
You
can think a long time about it. But in the end, isn’t that pretty
obvious? Why do legal people have to complicate artificially normally
pretty straightforward language? There has certainly been lots of
litigation about the roles that various parties assume in standbys.
But does this type of definition really help avoiding future
disputes? I doubt.
Resource:
ICC
International Standby Practices – ISP 98
