Legal Perspective: Commercial documentary credit and standby LCs

The terms letter of credit (LC) or standby LCs are frequently used in commercial documents. It is important to highlight the difference between these terms.

Since many years now, standby LC has become a self-instituted instrument which is currently used by banks and commercial parties in the same range as banker 's guarantees and indemnities.

Historically speaking, and because of the prohibition enforced on U.S. banks by U.S. Federal laws - preventing them from issuing guarantees or indemnities and making this kind of securities within the exclusive scope of the U.S. insurance companies and bonded companies - banks there have turned the guarantees and indemnities into a new concept called Standby LC.

This is how this term came into use among bankers.

One may be interested to know the reason for which these federal laws were imposed on American banks - it is necessary to bear in mind that the main reason was to prevent these banks from issuing guarantees or counter guarantees, during the course of their international trade business, subject to foreign laws and usage.

After spreading among American banks, the usage of Standby LC has expanded to the South-east Asian countries, ie., those which have normal business trade mainly directed to and from the U.S.

In Europe, it was introduced in 1983 after the International Chamber of Commerce included this type of credit in the UCP400 1983. In Arab countries, standby LC is widely used in the course of international trade with South Asia as well as the U.S.

The standby LC enjoys the same features of the commercial LC, but instead of being based on commercial shipping documents, it usually calls for documents confirming non-compliance of an obligation or a duty by a commercial party.

While a commercial credit has the aim to settle a movement and a sale of goods, the standby LC is mainly targeted to indemnify the breach of the commercial parties in their contractual obligations, same as the ordinary bank guarantee.

Taking into consideration what has been stated above, the following comparison can be said in relation to the standby LC and the commercial documentary credit.

Standby LC is a guarantee and an indemnity instrument. It is claimed in settlement by its beneficiary in order to get indemnified only, if and when, the applicant for such credit has made a breach of his contractual obligations. The negotiation of such credit is not always a rule, but an exception.

On the other hand, the commercial documentary credit is mainly targeted to settle the value of goods sold and shipped by the seller to the buyer.

It is therefore a guarantee and payment instrument, which offers to the seller the insurance that if he ships the goods he will be paid by the bank who has issued this credit in his favour.

The author is a legal consultant on banking and stock market laws.