How To Use The Standby Letter Of Credit As Guarantee

By Kerri Stout

Financial and contractual agreements are safer when you have a guarantee. This is the safety net you require to recover your money in case the agreement is not honored. A standby letter of credit is a perfect guarantee when handling project and transactions of any magnitude. It helps you avoid reliance on goodwill when doing business.

Service delivery, shipment and construction industry players are the greatest beneficiaries of this guarantee. The guarantee is issued by a bank by stating that it will release an amount worth of the contract in case anything happens. They provide a cushion that you are covered in case of breach of contract. For international transactions, the letter should come from a bank operating in both jurisdictions.

The financial institution of bank that provides the guarantee knows the client and his credit worth. This makes it easy to recover money through attaching assets or his accounts in case payments need to be made. It is an effective way to ensure that your client does not default.

A perfect example is a contractor working in Dubai. The project is supposed to be completed within a set time frame. The letter of credit is issued as a guarantee that the deadline will be met. When this does not happen, the client collects money from the guarantor as compensation for lost time and revenue. This money is used to cover for the cost of hiring another contractor or loss of business.

Contractors and suppliers are likely to breach trust by failing to fulfill their obligation. There are other factors that might lead to breach of contract that are beyond the supplier. A financial crunch or delayed payment by his customers will cause failure. You are cushioned by the bank in such cases.

There are cases where suppliers or contractors go out of business before fulfilling their contractual agreements. As a client, you do not have the mandate or capacity to attach their assets and recover your money. It is likely that you do not have the resources either. The process of recovery is also likely to cost you a lot of money and time. Banks have the infrastructure, mandate and the network to make such a recovery.

The assets of your contractor or supplier may be frozen because of political unrest. There are disagreements that may arise midway through the project and cause it to stall. Such circumstances would make it difficult to recover your funds. This is also the best way to deal with dishonest contractors who have no intention of fulfilling their contractual agreements.

The client has to fulfill certain obligations before the letter is granted. His creditworthiness must be to the tune of the contract or more. When claiming reimbursement, you must show proof that the contract was not fulfilled and thus you deserve payment. Such a guarantee is only executed in extreme and very rare cases.

Most of the cases that require a standby letter involved domestic trade. International transactions use commercial letters. The bank has its own conditions of issuing the guarantee. This is the best safety net in business instead of relying on goodwill which could lead to losses once breached. It reduces your exposure to losses regardless of your trading environment.

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