Fidic Letters By Contractor.pdfl
Parties to commercial transactions have for years argued over the forms of security providing credit support to their deals. Beneficiaries, known as "obligees," prefer letters of credit over surety bonds because letters of credit generally are easier to collect upon, usually merely by presentation of certain documentation. Payment under surety bonds is usually a more drawn-out process and involves a greater risk of litigation on the underlying commercial transaction and any other defenses that may be available to the surety company.
Fidic Letters By Contractor.pdfl
Two types of letters of credit are frequently used in commercial transactions: documentary letters of credit and standby letters of credit. A documentary letter of credit, which is usually governed by the UCC, is one in which the beneficiary must present specified documents to the issuer in order to draw funds from the letter of credit. Documentary letters of credit are primarily used as direct payment devices to facilitate sales-of-goods transactions. The typical documents that a seller of goods (the beneficiary) must produce in order to draw from the letter of credit include a bill of lading, commercial invoice, certificate of insurance covering transport or import-export documentation.
In a standby letter of credit, the issuer must honor the letter of credit after it receives a statement (usually in the form of a properly completed draw certificate) from the beneficiary that the other party to the underlying contract is in default under the terms of the contract or that the conditions to a draw have otherwise been satisfied. Standby letters of credit are the prevalent security instruments supporting obligations under construction contracts for thinly-capitalized construction companies, special-purpose project companies or owners, power offtakers with shaky credit ratings or any other entity that may need some credit support for its obligations.
All letters of credit operate under the doctrine of independent contracts, which says that the issuing bank's obligation to honor or pay upon a properly presented draft is independent of the underlying contract or commercial relationship between the account party and the beneficiary presenting the draft.
Because letters of credit are independent from the underlying transactions, they are often more attractive to beneficiaries because there is no need to prove a breach of the underlying contract or the extent to which the beneficiary suffered damages. Further, traditional defenses and claims in contract law do not apply to letter-of-credit transactions because a letter of credit is governed by its own set of legal principles. Thus, from the point of view of a beneficiary, letters of credit are enforceable against an issuer regardless of the bankruptcy of the applicant.
An obligee may see surety bonds as less desirable because they are not demand instruments like letters of credit. They involve a "claim adjustment process" in which the surety investigates the underlying default. This slows down the reimbursement process. Sureties will deny claims they believe are without merit.
In general, security instruments that impose autonomous obligations are often labelled on-demand bonds or guarantees, first-demand bonds or guarantees, demand bonds or guarantees or standby letters of credit.
An on-demand bond or guarantee will usually stipulate what documents have to be presented to the issuer in order to receive payment. The beneficiary need only issue a demand in accordance with the terms of the instrument and present the required documents. Unlike a conditional bond, there is no requirement to establish breach and quantum of loss. An on-demand bond operates independently of performance or non-performance of the underlying contract terms (hence, it is "autonomous"). These instruments operate like standby letters of credit by creating an autonomous payment obligation essentially in the nature of a standby letter of credit rather than a guarantee of a third party's performance.
Despite the name, English-law standby letters of credit have more in common with on-demand instruments than with letters of credit. They enable the beneficiary to obtain payment from the issuer of the standby credit when the other contracting party has failed or is alleged to have failed to perform the contract.
The two key factors seem to be practice and location. The fact that US banks may only issue letters of credit has clearly led to the prevalence of standby letters of credit in international transactions involving American banks and in sectors where their use is the norm. In addition, standby letters of credit tend to be more widely used in connection with long-term contracts, such as project finance loans, and projects involving multilateral agencies. They are also found in oil and gas projects in the Middle East. On the other hand, in UK domestic construction and infrastructure projects, bonds and guarantees prevail.
At present the letters are not available for general download. They will be added shortly to the Contractors resources section together with Red Book 1999, PAM and Yellow Book 1999. Those that responded to the event on Facebook received advanced copies. Please bear with us and you will be informed when they are available.