Since things may go wrong with any type of transaction, it is wise to always keep a backup plan. Regardless of whether the acquisition is for an accomplished service or shipment of any physical goods, the standby letter of credit will ensure protection.
Standby Letter of Credit – What is it?
SBLC is a document issued by a bank. It serves as a guarantee wherein the issuing bank assures to pay a “beneficiary” in case, things fail to occur. Similar to the traditional letters of credit, Standby letters of credit may be used for both domestic transactions and international trade. It offers ample security from the bank. In the event, customer of bank fails to do certain things such as fails to make payments on time, accomplish projects in a timely manner, or satisfy any specific terms of an agreement, the bank will pay the beneficiary.
When the bank is placed on the hook for payment, the beneficiary can rest assured about getting paid. There may be several reasons behind a buyer not being able or willing to pay. These include:
- A cash-flow crunch suffered by the buyer. As a result, the buyer waits for payment from his own customers.
- The buyer goes out of business.
- Assets of buyer get frozen in political unrest.
- Buyer is not happy with the seller.
- The buyer is not trustworthy.
A bank is always more stable financially as compared to buyers. Also the bank has no concern with disputes existing between buyers and sellers. So, the SBLC bank guarantee will be paid until the beneficiary meets requirements of letters and the bank is still in business. In case, the beneficiary has a concern related to bank’s stability, he/she can use a confirmed letter of credit. However, it is very important that the beneficiary puts complete faith in the bank that confirms letter.
Standby Letter of Credit Vs Letter of Credit
SBLC or standby letter of credit is quite similar to a standard letter of credit or its “commercial” version. Here, the bank assures beneficiary to pay as long as the beneficiary produces documents. It is also important that the beneficiary meets all requirements of the letter of credit. SBLC can be considered as a safety net. Similar to most safety nets, its main aim is to avoid using it. Once an individual gets paid with a standby letter of credit, it indicates that something went wrong. However, in case of a commercial letter of credit, everybody involved expects payment.
SBLC is unique as it may include a performance component or even a negative performance. When the service is not performed, payment is received by the beneficiary. These letters of credit are mainly used for domestic transactions. On the other hand, commercial letters of credit are used in international trade.
Standby Letters of Credit and Commercial LC: Some Common Characteristics
- Both commercial and standby letters of credit are conditional and irrevocable assurances for payment made by trustworthy financial organizations customarily by banks.
- Both commercial and standby letters of credit are not dependent instruments. These are independent instruments for payment regardless of the contract they get used in.
- Both commercial and standby letters of credit are directed by ICC’s rules.
- Both commercial and standby letters of credit proceed through documents. Both of these financial instruments are documentary by nature.
Presentation Complexity of Standby and Commercial Letters of Credit
The standby letter of credit will require fairly simple documentary requirements so as to reach the payment. On the other hand, commercial letter of credit needs very detailed and highly complicated documentary requirements for reaching the payment. Commercial letters of credit are chief method for payment in global sales. Hence, when you open this letter of credit to a supplier for making payment for goods, you are actually purchasing directly through letter of credit. The supplier will get payment from your bank soon after he creates a conforming presentation under the LC.
Standby Letter of Credit – How to Get One?
The best way to get one is to ask your bank to issue it. Get in touch with someone in the commercial division of the bank or the department for international trade. You must keep ample spare time in hand to understand its functioning and the circumstances under which you will be responsible for making payments.
In case, you want someone else to use SBLC, acquire it as a part of your agreement. You should also demand for an irrevocable LC (letter of credit). Make sure you work closely with the attorneys and bank. This is important to get a detailed understanding on what you require doing for collecting payments. Remember that letters of credit may get extremely complex. It is quite tough to meet all of the requirements. In case, you fail to meet all of the requirements, you will not get paid.