Standby Letter of Credit and Independent Guarantee
When a business needs to prove that they have adequate financial resources to guarantee payment, they may opt to provide a Standby Letter of Credit or an Independent Guarantee. Both of these instruments are available to and used by businesses of all sizes, from small local companies to large multinational corporations. In this article, well take a look at how Standby Letters of Credit and Independent Guarantees work and how they are used.
A Standby Letter of Credit (SBLC) is a financial instrument issued by a bank, and guaranteed by that bank, to back the financial obligation of a customer. In other words, should the customer default on their obligation, the bank is required to make payment in accordance with the terms of the Standby Letter of Credit. The purpose of the Standby Letter of Credit is to provide assurance to the beneficiary that they will be paid should the customer not honor their obligation.
A Standby Letter of Credit is also commonly used when a company needs to demonstrate financial ability to fulfill a contract, export/import goods, or even to secure a loan. Generally, in order to open a Standby Letter of Credit, the bank will require the company to provide some form of collateral. This collateral can take various forms, from funds held in an account at the bank, to corporate bonds or other securities. The terms of the Standby Letter of Credit will depend on the arrangement between the bank and the customer, but typically payment will be due within ten to thirty days.
An Independent Guarantee is another form of financial instrument used to guarantee payment of an obligation. This is different from a Standby Letter of Credit in that it is not issued by or backed by a bank. Instead, an Independent Guarantee is a guarantee issued by an individual or firm to guarantee the performance of an undertaking or commitment by a third party. The guarantor may agree to pay the full amount of the debt in the event of a default, or may agree to pay a specific portion of the debt.
There are several types of Independent Guarantees available, depending on the underlying obligation that is being secured. These include Performance Guarantees, Completion Guarantees, Security Guarantees and Advance Payment Guarantees. Performance Guarantees are typically used to guarantee that a contractor will perform according to the terms of the contract. Completion Guarantees are used to guarantee that a contractor will complete a specific project in accordance with the agreed upon terms. Security Guarantees are typically used to guarantee a loan or to guarantee that a third party will honor their obligations under a contract. Finally, Advance Payment Guarantees are used to guarantee payment for goods or services that are made in advance of delivery.
Standby Letters of Credit and Independent Guarantees can be invaluable tools for businesses of all sizes as they provide assurance to vendors, contractors and creditors that any financial obligations will be met. A Standby Letter of Credit is a much more secure form of guarantee than an Independent Guarantee, as it is backed by a bank, while an Independent Guarantee is only as reliable as the guarantor. Ultimately, the choice of which instrument to use depends on the amount of risk that the issuer is willing to take on, and their ability to provide suitable collateral in order to secure a Standby Letter of Credit.
