SBLC – Stand-By Letter of Credit

The stand-by letter of credit is a hybrid technique which brings together documentary credit by the obligatory remittance of documents complying with what is produced, and the guarantee on request in the fact that it is only carried out in the case of the purchaser failing to pay.

However, despite the connections which can be made with documentary credit, it cannot be confused with this latter as it does not fulfill the same functions. In fact, the stand-by letter of credit, if it is a good protection technique against the risk of non-payment, does not constitute a payment mechanism.

To find out more on the stand-by letter of credit:

Technique

In a commercial sense, the stand-by letter of credit guarantees the obligations of a purchaser to pay for goods or services. It consists of the irrevocable engagement of a bank to compensate its beneficiary when the order giver proves to be inefficient. Stand-by letters of credit are used against the remittance of documents which can sometimes limit themselves to the declaration made by the credit or that the debtor has not settled his obligations.

The seller will only produce the contract when he has received notification of his payment guarantee being issued through the stand-by letter of credit. The notification either reaches him via the issuing bank, or a second bank situated in his country and plays the same role as documentary credit. Once the goods are ready, they are sent to the purchaser. Normally, payment follows. The vast majority of commercial transactions, furthermore function without incident.

If payment does not however occur, then the stand-by letter of credit comes into play. The unpaid seller asks for the guarantee in the form of a request signed by him and certifying that the purchaser has not fulfilled his payment obligations. He will enclose the documents declaring when the stand-by letter of credit was issued, proving that, for his part, he has fulfilled his obligations properly. It results in payment by the issuing bank.

Legal Control

Stand-by letters of credit (SBLC) form an integral part of the Uniform Rules and Usages of the ICC, relating to documentary credit. Only articles 1 and 2 of the URU 500 mention them. Notably, article 1 stipulates “that rules and usages…apply themselves to all documentary credit (including to the extent where they are applicable to stand-by letters of credit)…”.

However, to take into account the greater and greater importance which stand-by letters of credit take, rules and international practices relating to stand-by (RPIS 98) have been specially drafted..

Thus, two coexisting texts govern the same problem! Therefore, how do you choose one? To which is it best to refer?

The RPIS 98 are more liberal and less restrictive rules than the URU 500, principally on the subject of documentary obligations. Therefore, using them can simplify the technique of SBLC. However, the difficulty in relation to their usage is in the fact that they still do not have the international audience that has been acquired for URU 500 by hard work. Moreover, the combination of their more liberal character and the lack of practice which, due to their newness, they are subject to, makes their use more unpredictable. However, many think that URUs will only be confined to documentary credit in the near future. It is therefore preferable to choose RPIS 98, which despite its newness, remains the best suited for stand-by letters of credit.

For the moment, international operators must precisely check to see whether their SBLCs are subject to URU 500 or RPIS 98 as these two sets of rules are noticeably different, and therefore, the bank’s treatment of SBLC is not the same depending on whether they depend on the former or latter.

Role of Documents

The documents to be produced for using a commercial SBLC are neither complicated nor numerous. It can be required to produce:

• the original of the non-payment declaration, drawn up on the seller’s headed notepaper and signed by him;
• a copy of the commercial invoice ;
• a copy of the delivery note.

Often, and notably in Anglo-Saxon countries, the documentary presentation is limited to the single declaration of non-payment.

Advantages and Drawbacks

With regard to document circulation, SBLCs improve operations in a very sensible way in comparison to documentary credit. In SBLCs the originals of the documents, and in particular transport documents, such as the marine bill of lading are sent directly from the exporter to the importer, enabling them to use them from the arrival of the goods. The verification of documents produced in one go is less strict and more rapid. The documents to be produced by the beneficiary are mainly very simple.

In documentary credit, circulating the documents is more complicated. The originals must be retained by the notifying bank, who send them, after verification, to the emitting bank, who then, after re-verification returns them to the order giver. These operations generally take about 10 days. For short marine journeys, (such as those in the Mediterranean) the goods arrive at the destination port, in the majority of cases before the documents. And yet, it is necessary to present an original bill of lading to the shipping company in order for it to deliver the goods!

However, this advantage of SBLCs in relation to documentary credit is only worth it if you re interested in these two devises as means of protection against the risk of non-payment. Do not forget that documentary credit is also a payment technique (even financing in certain circumstances), which the SBLC is not and therefore it is henceforth misleading to compare two devises which do not exactly fulfill the same functions.

From the point of view of drawbacks, the SBLC does not protect the purchaser very well, while documentary credit brings a correct balance between the interests of the two parties. To take several concrete examples, RPIS 98 grants three to seven days to verify all the anomalies in the documents. This delay can prove to be thus extremely short, favourable to the seller. Similarly, the purchaser finds himself less protected if there are typing errors, for example in the delivery address. And yet, this can be important. Some people do not hesitate to compare a SBLC produced on the order of the purchaser to giving a blank cheque. However, the improper resorting to guarantees remains very rare…

Another failing is directly connected to the “newness” of the SBLC. The judicial precedent concerning it is rare and uncertain, and it universality is worse than what documentary credit benefits from.

However, if the advantages and drawbacks of the SBLC are placed as a protective tool against the risk of non-payment, on balance the advantages can outweigh the drawbacks in the case of re-occurring repetitive standard business, such as within commercial relations with exclusive representatives or licensees. For limited operations, documentary credit remains advantageous.