Other types of letters of credit
Standby letters of credit
A standby letter of credit, is a guarantee that a bank or a financial institution provide. This is an undertaking which is activated only if something goes wrong between the buyer and the seller such as the buyer defaulting and the expected payment does not take place. It therefore allows the seller to enforce a claim.
A standby letter of credit is similar to a bank financial guarantee, with the main difference being that they are governed by UCP600 or ISP98 rules.
Transferable letters of credit
If a letter of credit is issued as a transferable credit, the beneficiary may ask the bank that is authorised to carry out the transfer (usually the advising bank) to transfer the letter of credit, completely or in part, to a subcontractor. When a letter of credit is transferred, a number of conditions can be changed.
- The amount and any unit price may be reduced
- Validity, shipment and presentation can be shortened
- Any insurance percentage rate can be raised.
Documents presented under a transferred letter of credit
When documents are presented under a transferred letter of credit, it is possible for the beneficiary to replace the invoices and any bills of exchange with his own. If the terms of the letter of credit have been met, the beneficiary will receive the difference between the two invoices (less the bank’s commission, if applicable) and the balance is then paid to the subcontractor.
Pros and cons of transferable letters of credit
One of the main advantages of a transferable letter of credit is that the credit exposure lies with the subcontractor. One of the main risks with transferring a letter of credit is that the beneficiary is forced to use the other documents presented by the subcontractor. Consequently, any mistakes in these documents might be repeated under the original letter of credit, possibly resulting in some of the security provided by using a letter of credit being lost.