Standby Letter of Credit

Even though the standby letter of credit (hereafter “standby”) has been known for many years, its use has gained ground only in recent years in Europe. As the name indicates, a standby takes the form of a documentary credit, while its function and content is that of a guarantee. It was developed in the US around a half a century ago when US banks were not allowed under US law to issue guarantees.

By issuing a standby, banks were able to accommodate customers’ needs for products that naturally belonged to the banking business. Today, however, standbys have gained popularity worldwide to the extent that the issuance of standbys by non-US banks is believed to outnumber issuance by US banks.

A standby can be defined as a demand guarantee assuming the shape of a documentary credit. As with the documentary credit, the beneficiary under a standby is to present documents in accordance with the stipulations of the standby in order to obtain payment.

Instead of requiring the presentation of shipping documents, the beneficiary under a standby must present a document stipulated in the standby, declaring that the applicant/instructing party has failed to fulfil its payment obligation, to perform a job or to meet some other commitment called for in the commercial contract and sometimes has also failed to state the manner in which the applicant/instructing party has not fulfilled its obligation.

The standby occasionally stipulates that the beneficiary’s declaration must be accompanied by other documents supporting the demand, such as copies of invoices, transport documents or a statement of account. In most cases, these copies will not be examined for their correctness, they may only need to be presented.

Like a guarantee, a standby is a very flexible instrument that can be used for all types of business. It can cover anything ranging from an ordinary guarantee commitment to more sophisticated financial instruments.

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