Stand By Letter: what is and how it works

What is Stand By Letter of Credit

When we talk about Stand-by Letter of Credit (SLOC), we refer to a pledge of payment, born in the common law system (in particular, USA), but now generally used in all country.

SLOC is a particular type of documentary credit, a simpler one with all its characteristics, but used like a sort of contract of guarantee.

From the point of view of the Italian jurisdiction, SLOC belongs to the area of the atypical new guarantee, like, for example, the patronage letter.

Those tools are “atypical”, because even if they share similarities with some Italian institutions, they still cannot be compared or identified with none of existing classic institution.

SLOC is usually used in international business, especially for international supply contracts, when the goods must be transported by air: goods and documents are sent together, and there is no need to keep the goods in storage waiting for the documents (that usually happens with documentary credit).

Stand By Letter: how it works

Usually, a documentary credit works this way: the bank (issuing bank), by request of the applicant, promises to make a payment to a subject (the recipient), when it receives the documents regarding the credit.

With the stand-by letter, instead, the documents are presented only if the principal has not fulfilled his duty. So, among the documents necessary there always are the statement of non-fulfillment of the applicant, the invoice, and the document of transport.

In the first case, the documentary credit is used like a payment; in the second, the SLOCs it is a guarantee.

Taking as example the supplying contract, the scheme is the following: the exporter sends the goods and documents, sure that he will we paid one way or another, by the importer o by the bank if the importer does not pay. Then, if that happens, the exporter asks to the issuing bank to pay him, using the letter of credit.

There are some limitations of responsibility for the issuing bank, concerning the authenticity of the documents, and the verification of the identity of who is demanding the payment.

Types of Stand By Letter

There are some different types of SLOCs. All SLOCs, as seen, implicate the permanent obligation of the issuing bank to pay on demand of the recipient in case that the applicant cannot.

That scheme is the one of the performance standby, but is also the structure of the advance payment standby and of the bid bond standby.

The first one guarantee the payment of a down payment, while the second is used to guarantee the execution of a contract after the approval of the bid.

The duty of payment is binding from the date of issue; the only conditions are the submission of the documents and the statement by the recipient that he has not been paid.

Legislation about Stand By Letter

Even though SLOCs are very common and utilized all around the world, they have not a very standard regulation.

SLOCs are regulated by International Standby Practice (ISP) 98 of ICC, but those regulations are not very common, because ICC rules about documentary credit are more likable to be used, even in case of SLOC.

This happens, mostly in the civil law system, because, as said before, those instruments don’t fit the canonic institution, and civil law country (as Italy) prefer to trat them the same way they use for the most similar yet existing instrument.

There is also a UNCITRAL (United Nations Commission on International Trade Law) convention of 2000 about SLOC which is anyway not effective in none of G20 members (Italy neither).

Even in the USA, were SLOCs are born, the regulation in this subject only talks about “letters of credit”, without mentioning the “standby” characteristic (this may depend by the fact that SLOCs were born to bypass the USA prohibition for the banks to give accessories guarantee).

So, until all the countries will agree on the regulation to apply to the SLOCs, the principal international regulation stays in the practices.

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