Law Offices of Robert Townsend
Hampshire House
11944 Mayfield, Suite 301
Brentwood, CA 90049
Voice: (310) 207-0180
E-mail: bob@townsend.net
Primary Robert Townsend Web Site: http://www.bob.townsend.net/
(Also called “SLC”, “LC’s”, and “Standbys”)
Robert Townsend
Attorney
at Law
Warning! This is not intended to be
legal advice; it is information and opinion only. Do NOT rely on this information as legal advice. You must first
see your own attorney and apply the facts of your particular situation to the law
of your state and country. Do not engage in any area of the subject of this
article without first seeing an attorney.
You may be subject to severe investment losses, or as a broker to
civil and criminal penalties.
These opinions are based upon the 20+ years of experiences
and observations of the author in 33 countries as an attorney to investors,
financial institutions, and others involved in international transactions. He has also served as an expert witness in
this area of the law.
a.
Bank Obligation.
Standby Letters of Credit (called “SLC’s or “LC’s” or “Standbys”) are
written obligations of the issuing bank to pay a sum on to a beneficiary on
behalf of their customer in the event that the customer himself does not pay
the beneficiary. It is important to
note that these standby letters of credit apply only whenever the issuing
bank's commitment to pay is not contingent on the existence, validity
and enforceability of it’s customer’s obligation; this is called an “abstract”
guarantee (i.e. the bank’s obligation is to pay regardless of any disputes
between its customer and the beneficiary).
The issuance of letters of credit is a private transaction and does not
result in the issuance of any publicly tradable instruments.
b. Rules of Standbys. The standby letter of credit comes from the banking legislation of the United States, which forbids US credit institutions from assuming guarantee obligations vis-à-vis third parties. To circumvent this rule, the US banks created the standby letter of credit, which is based on the uniform customs and practice for documentary credits (infra). In 1998 the International Chamber of Commerce (ICC) added ISP98 (International Standby Practices 98) as the rules to guide standby letters of credit. These rules are slowly being adopted; however, many of the standby letters of credit continue to rely on the ICC’s older guide, Uniform Customs and Practices for Documentary Credits, 1993 revision, ICC Publication 500.
a.
The Applicant. This is the
customer of the bank who applies to the bank for the standby letter of
credit. He must provide collateral to
the bank or have sufficient credit to induce the bank to issue the instrument. He also must pay the bank a fee for issuing
the instrument.
b. The Issuing Bank. This is the applicant’s bank that issues the
standby letter of credit.
The Beneficiary. This is the party in
whose favor the instrument is issued.
c.
Confirming Bank. This is a bank (usually located near the beneficiary) that agrees
(confirms) to pay the beneficiary rather than have the issuing bank pay the beneficiary. The beneficiary pays the Confirming Bank a
fee for this convenience. The
Confirming Bank then collects from the Issuing Bank the amount paid to the
beneficiary.
d.
Advising Bank. This is the bank
that represents the beneficiary. It may
accept the letter of credit on behalf of the beneficiary and collect on it on
behalf of the beneficiary. In order for
the transaction to be a bank-to-bank transaction, the advising bank works for
the beneficiary to keep the instrument in the banking system. Sometimes the Advising Bank also is the
Confirming Bank, but not always.
The standby basically fulfills the same purpose as a bank guarantee: it is payable upon first demand and without objections or defenses on the basis of the underlying transaction between the applicant and the beneficiary. It is up to the beneficiary to decide whether he may accept a standby.
Like the bank guarantee, the standby
letter of credit is of abstract in nature, i.e. it is legally separated
from the underlying transaction.
a.
Performance Standby.
This instrument supports an obligation to perform other than to pay
money including the purpose of covering losses arising from a default of the
applicant in completion of the underlying transactions.
b.
Advance Payment Standby. This instrument support an obligation to account for an advance
payment made by the beneficiary to the applicant.
c.
Bid Bond/Tender Standby. This standby supports an obligation of the applicant to execute a
contract if the applicant is awarded a bid.
d.
Counter Standby.
This instrument supports the issuance of a separate standby or other
undertaking by the beneficiary of the counter standby.
e.
Direct Pay Standby.
This instrument serves to support payment when due of an underlying
payment obligation typically in connection with a financial standby without
regard to default. This standby is also
used to directly pay an obligation where the only conditions of payment are the
passage of the term and presentment of payment.
f.
Insurance Standby.
This instrument is an insurance or reinsurance obligation of the
applicant.
g. Commercial Standby. This is the most used standby and it supports the obligations of an applicant to pay for goods or services in the event of non-payment by other methods.
a.
Assignment of Standby letter of credit Proceeds. The beneficiary can assign the proceeds of a
standby letter of credit. But this
assignment does not assign the rights of the beneficiary as “drawer” on the
standby letter of credit, and only the beneficiary may exercise the “drawer”
rights and present the demand for payment under the terms of the standby letter
of credit unless the terms of the instrument provide otherwise. This means that the assignee may receive the
proceeds of the standby, but in order to obtain those proceeds the beneficiary
must make the demand for payment. This
also means that the beneficiary can sell by assignment at discount the
benefits of the standby. An assignment
of proceeds requires notice to the issuing bank of this action; otherwise the
issuing bank would pay the beneficiary rather than the assignee.
b. Transfer of Standby letter of credits. Standby letter of credits can be transferred to a third party ONLY with the written consent of the issuing bank AND the beneficiary.
a.
No Public Market. There
is no public market for the trading of standby letters of credits. Beware!
Fraudsters or naïve brokers are always erroneously representing that
there is a public market for the trading of standby letters of credits (and
bank guarantees). This is not to be
confused with the trading of other bank issued instruments such as medium term
notes, etc. Standby letters of credits
can only be transferred or the proceeds assigned in private transactions (See
above). Sometimes these instruments are
used in Ponzi Schemes. See more on Ponzi Schemes.
b. No CUSIP or ISIN Numbering. Standby letters of credits are not trading securities, trading debt instruments, or trading investment funds, and therefore are not subject to the settlement procedures offered through Eruoclear or DTC and most other settlement firms. Obviously, therefore, they also are not issued CUSIP or ISIN numbers for trading purposes. However, Euroclear may accept such standby letters of credits for “safekeeping” purposes only. So one has to be careful in understanding the particular legal relationship of a standby letter of credit to Euroclear or other settlement entities, especially as to issues of authenticity. A standby letter of credit held in safekeeping does not serve to authenticate the instrument. Anything can be the subject of a safe keeping situation. Mixing a metaphor, you can get a safe keeping receipt for a ham sandwich.
a.
Fraudulent Instruments. There are many fraudulent standby letters of credits; i.e. they
are NOT issued by the bank that is represented as the issuer. The authenticity should always be checked (See Paragraph d. below for very important
warning). The fake financial instrument may have a face value of anything from $5
million to $600 million or even billions of dollars (or other currencies), and
they usually give the appearance of being tied to a major international bank. The scheme involves investors being
persuaded to buy these Standby letters of credits after being offered discounts
of over 40%, more or less. The investor
would then look forward to redeeming the full face value on maturity (e.g. one
year's time), thereby securing a healthy profit. Of course no profit is forthcoming; the investor only suffers
the loss of the price paid for the bogus instruments. Banks do not issue standbys for this type of
proposition. Standby letter of credits
are NOT investment products. Standby
letter of credits are issued by banks to cover the liability of its customer to
a third party that the bank agrees to pay.
Sometimes fraudsters use the discounted Standby letter of credit as bait
to secure an advance fee (e.g. 1% of the SLC’s face value). The advance fee is
represented to pay for alleged due diligence and administration procedures, but
is merely pocketed by the perpetrators resulting in a fraud loss to the
investor.
b.
Fraudulent Leasing of standby letter of credits. Leasing of standby letters of credits for an
upfront fee is invariably a fraud.
These standby letters of credits can either be legitimate or bogus, so
checking out the authenticity in the long run is not really important (See
Warning below on going to the bank to check authenticity of standby letters of
credits!). The problem is that after
paying an upfront fee there is nothing in the real world that the lessee can do
with a leased standby, and the lessor knows it; i.e. the lessor knows that the
standby letter of credit will never be called upon. The lessor does this by making the terms of the lease such that
the standby letter of credit can never be called up. The lease may provide that
the leased SLC may not be used as collateral without the consent of the lessor
(which is never given); thus it may not be borrowed against. Or the lease may provide a time limit for
use by the lessee that the lessor knows cannot be met (e.g. See c. below
“leasing for HYIP).
c.
Leasing For Credit Enhancement. An important warning to potential lessees is
that if one leases a standby letter of credit for “credit enhancement” and the
standby letter of credit cannot be called upon by the lessee, then any credit
or loan issued to the lessee is based on a bank fraud committed by
the lessee on the lending bank unless the lessee fully discloses to the
lending bank the non-callability element of the standby letter of credit. At that point, the lending bank will not
consider the standby letter of credit as a “credit enhancer”, so the whole idea
does not work. Leasing for this purpose
is a usually a bad idea.
(It is, however, important to note that this author has been involved in
situations where a standby letter of credit is leased as part of a “financing for
investment” structure; however, the instrument is always “at risk”, though
there are several legal techniques for substantially diminishing the risk (but
not eliminating the risk) of the standby to be called upon for payment. The remaining risks are worth the rewards
the owner of the standby letter of credit receives for its involvement.)
d.
Leasing for HYIP.
There is the leasing of standby letter of credits that are issued by
legitimate banks and with callable terms; however, the short term of the lease
of the SLC is such that the lessee cannot possibly perform (or never perform)
within the time limits of the SLC.
Thus, the lessee does not timely perform and the lessor pockets a large
fee. An example of this situation is
where a party agrees to lease a standby letter of credit with the agreement
that the lessee will place the standby in a performing high yield investment
program approved by lessor. The lessee cannot find a performing HYIP within the
time limit, because such HYIP’s do not exist.
The investor loses his fee. For more on HYIP’s see the article “HYIP’s In A 7 Minute Nutshell”.
e.
Checking Authenticity.
Checking authenticity of standby
letters of credits. The ICC states:
“Anyone offered an investment opportunity supported by a financial instrument
can have it checked out by the CCB for a
nominal cost. Call +44(0) 208 591 3000 or e-mail ccb@icc-ccs.org.uk for
details.” Big
warning! What one (other than a very careful and knowledgeable attorney) must NOT
due is to walk into a bank (including branch offices) with a standby letter of
credit (or bank guarantee or other instrument) to check on its
authenticity. There is a high
probability (a) the instrument is fraudulent, and (b) therefore one will be
arrested “on the spot”, and that probability substantially increases if one is
a minority; e.g. African-American, Hispanic, from the Mideast, etc.
f.
Standby letters of
credits From Offshore Small Banks. Usually standby letters of
credits from tax haven banks (unless an affiliate of a major bank) have little
or no value. Often there is talk about
having these standby letters of credits “confirmed” (i.e. accept liability for
the instrument) by a major bank, but in reality, this does not happen for the
most part. This is particularly true
with U.S. banks, as under the Patriot Act in essence they cannot lawfully do
business with these small offshore banks.
g.
London Short Form 3034
(or any other number). If you
see this term mentioned, rest assured that you are dealing with a fraudulent
situation. Such a form does not
exist. This is an easy tip-off that
this is a transaction with which you should not waste your time…and
particularly your money.
The primary problem of the applicant is getting the bank to understand the transaction AND then getting the wording right on the instrument. This author has spent many a day trying to get a bank to prepare a letter of credit with the desired terms. Do not leave the preparation of the letter of credit solely to the “SLC people” at the bank; if you are dealing with an American bank 90% of the time they get it wrong, particularly if it something other than a goods or service import-export transaction.
The terms of the standby letter of credit itself will advise the
beneficiary on the precise terms that must be followed for presentment of the
demand and the collection thereof.
These terms usually must be precisely followed. Read the instrument carefully!
Usually absent visible obvious fraud, the bank will pay according to
the terms of standby letter of credit without regard to looking at the actual
performance by the beneficiary of the underlying agreement. If the applicant (bank’s customer) feels
that the bank should not pay because of non-performance or fraud by the
beneficiary, then he should sue the beneficiary and interplead the bank seeking
an injunction to prevent the bank from paying.
The bank will then stand on the sidelines until a court tells it what to
do.
(Bank Letterhead with Bank
Address)
Name and Address Date_____
of Beneficiary
Amount: $1,000.00
One Thousand Dollars
We hereby issue our irrevocable
Standby Letter of Credit as per following
specifications:
Form of Credit: Irrevocable
Credit number: __________
Date of issue of credit: __________
Date and place of expiry: ___________/__________
Applicant: ____________________
Beneficiary: ____________________
Amount: The
above mentioned
Maximum amount.
Available with: (issuing
bank)
By: Payment. We shall effect
Payment with a deferred
value date of 3 (three)
banking days after receipt
of documents strictly
complying with the terms
and conditions of this
Standby Letter of Credit.
Partial drawings: ____________________
Covering/relating to: ____________________
Documents: Beneficiary’s
written state-
ment purportedly signed by
2 (two) authorized officers,
that applicant _________
(e.g. has failed to fulfill his
contractual obligations)
Additional Conditions: _______________________
Commission and Charges: All commission and
Charges outside Switzerland
are for applicant/beneficiary’s
account.
Period for presentation
Of Documents: Within
credit validity
We hereby undertake that
payment will be effected if documents tendered
Comply with the credit
terms and if all other conditions of this credit are
fulfilled.
This credit is issued
subject to Uniform Customs and Practice for
Documentary Credits,
1993revision, ICC Publication No. 500.
Documents to be sent to us
by registered airmail/by Courier service in
one lot to the following address”
_____________________________
___________________
Bank
For “Bank
Guarantees a Nutshell” see http://townsend-law.netfirms.com/bankguarantees.htm
If you have any questions concerning standby letters of credit or bank guarantees, please call the Law Offices of Robert Townsend for a complimentary discussion of the matter.
Law Offices of Robert Townsend
Hampshire House
11944 Mayfield, Suite 301
Brentwood, CA 90049
Voice: (310)
207-0180
Fax: (310)
388-5690
E-mail: bob@townsend.net
Main Law Office Site of Robert Townsend: www.bob.townsend.net