Standby letters of credit come in two primary forms: the performance standby letter of credit and the financial standby letter of credit. The performance standby letter of credit works to ensure that work you have agreed to perform is performed in a timely and satisfactory manner. For example, if you own an architectural firm and are contracted to build a museum, you may be asked to provide a performance SBLC that guarantees that you will finish the plans by the end of your contract term, and that the structure you design is sound and meets all requirements. If, for some reason, you are unable to finish, or your design is deemed unsafe or unbuildable, the SBLC will take effect and pay the museum a preset amount.
GET STARTED WITH A STANDBY LETTER OF CREDIT
A financial letter of credit generally works on the other party in the exchange—example, the museum can be asked to provide a financial SBLC to your firm for the total amount of the project. If they fail to pay you after work is finished, the bank will issue payment to your business on behalf of your client. These types of SBLC are often required when performing international trade or other large purchase contracts where other forms of payment protections (such as litigation in the event of non-payment) can be difficult to obtain.
HOW TO OBTAIN A STANDBY LETTER OF CREDIT
Obtaining a standby letter of credit is similar to obtaining a commercial loan, though with a few key differences. As with any business loan, you will need to provide proof of your creditworthiness to the bank. Unlike a loan, the process for approval for a SBLC is much quicker, with letters often being issued within a week of all paperwork being submitted. Also unlike traditional loans, the bank will require a fee of between one and ten percent of the SBLC amount before issuing the letter. This fee is usually charged per year that the letter of credit is in effect. If the terms of the contract are fulfilled early, you can cancel the SBLC and not incur additional charges. For small business owners, the standby letter of credit can be a powerful tool for establishing trust with suppliers and vendors. Obtaining an SBLC is proof that you and your company have good credit, and can put many suppliers at ease about providing you favorable financing terms. Furnishing a financial SBLC can often allow you to negotiate payment and financing terms with suppliers from a position of strength in order to get the best interest rates and payment schedule, while maintaining a good relationship with your suppliers. If you provide services, on the other hand, offering to furnish performance standby letters of credit can be extremely useful to helping your business secure large contracts. Putting your clients at ease by being willing to guarantee your work financially can overcome many of the objections business owners face in the selling process.
WHAT CAN A SBLC BE USED FOR?
SBLC and BG can be used to enhance your ability to apply for a line of credit with your bank; in other words, it can be used as collateral when your bank is asking for additional comfort when you ask them to fund your project. The SBLC we deal in are genuinely 100% cash-backed and therefore usable as collateral. Our issuers only use top 25 World Banks – mainly from Europe like HSBC, Deutsche, UBS etc. This guarantees world wide acceptance of your SBLC. These SBLC are generated by “someone” blocking their funds on your behalf, so we speak of a “leased” SBLC. In other words the SBLC is owned by the issuer and you are the beneficiary. The SBLC is generally issued for 1 year and 1 day, but can easily be extended up to 5 years. (It is possible to get an SBLC for only 6 months). Once issued the SBLC is transferred to your bank via the Swift protocol of MT760. Leasing of an SBLC comes at a cost. And to be very honest: at a high cost. Financing your project by using an SBLC is very expensive. First you need to pay money to the issuer of the SBLC plus commission to the consultants facilitating the process, Then you need to give the SBLC to your bank, who are providing a Line of Credit against the SBLC, which may only be up to 90% LTV or less. And usually, your bank will charge a one off fee to ‘monetise’ the instrument and also charge interest on the drawn down loan amount.
To successfully apply for an SBLC you need to be aware of four vital points:
a) You need to have a good project
b) You need to have a bank funding your project based on the supporting collateral of an issued SBLC
c) You need to have the money to pay for the leasing of the SBLC
d) You need to have a believable and realistic exit strategy to repay the loan and return the SBLC at the end of the term
All the SBLC we deal with are callable, assignable, fully transferable and lienable. If you are thinking of using an SBLC to participate in a High Yield Trade Program, we are more than happy to assist you in acquiring the SBLC and placing it into trade. However, you need to be very sure you are able to pay the leasing fees of the SBLC before issue, as most providers will not allow the instrument to be taken into a Trade Program unless and until the fee is paid. You cannot pay the lease fee from the program returns. It is also not possible to use an SBLC to secure a commodity trade and pay for the SBLC out of the profits from the transaction. When paid for and used correctly, these instruments provide numerous lucrative options. v-funding can provide BG, SBLC and CD, which can be blocked or delivered via SWIFT or Euroclear.
LETTERS OF CREDIT CAN BECOME WORTHLESS
The deep and prolonged crisis in the financial services industry will result in numerous FDIC insured banks facing receivership or conservatorship. Undrawn letters of credit issued by these institutions are likely to be worthless. Parties to letter of credit transactions are advised to look carefully at their letters of credit and related documentation and enforce their right to require certain letters of credit to be replaced or, where possible, revise documents to require replacement of letters of credit issued by troubled institutions. At the end of this Alert, we have provided several suggested courses of action.
ABOUT LETTERS OF CREDIT
The parties to a letter of a credit are as follows:
Issuer – the bank or thrift issuing the letter of credit is the Issuer.
Account Party – the party who obtains the letter of credit from the Issuer is the Account Party. Often, the Account Party arranging for a standby letter of credit delivers cash or other collateral to the Issuer to secure repayment of any draws on the letter of credit.
Beneficiary – the party who holds the standby letter of credit and who is authorized to draw under the letter of credit on the conditions stated in the letter of credit is the Beneficiary.
A standby letter of credit is issued by the Issuer to the Beneficiary at the request of the Account Party, and requires the Issuer to pay a specified sum to the Beneficiary upon satisfaction of the conditions of drawing specified in the standby letter of credit. The standby letter of credit will specify the maximum amount that may be drawn, the expiration date, the place where drafts must be presented and what certifications or deliveries must be made in connection with the draw request. Virtually all letters of credit utilized in real estate transactions are “sight draft” letters of credit, which means that the Beneficiary can require payment under the letter of credit upon delivery of a simple sight draft, which looks very much like a bank check, together with any other required certifications. Letters of credit are governed by Article 5 of the Uniform Commercial Code (the “UCC”), which has been enacted in every state and the District of Columbia. In addition, parties generally agree that the letter of credit will be governed by the Uniform Customs and Practice for Documentary Credits (the “UCP”) or the International Standby Practices 98 (the “ISP”), both of which are promulgated by the International Chamber of Commerce. Standby letters of credit issued by US financial institutions are also subject to regulation by one or more of the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, the Federal Reserve Board and the Office of the Comptroller of the Currency.
Standby letters of credit are generally issued and held pursuant to a separate contract between the Account Party and the Beneficiary – such as a lease, loan agreement, purchase agreement or public improvement agreement. The “underlying contract” between the Account Party and the Beneficiary is separate and independent of the letter of credit as a legal matter, but it will specify the requirements that the letter of credit must satisfy and when it can be drawn. If these documents are drafted properly, they will generally contain language that requires the Issuer to meet certain specified standards as to its financial strength.
Following is some typical lease language (although any actual language you use should be crafted to fit the particular case):
The Letter of Credit shall be issued by a commercial bank acceptable to [Landlord] and (1) that is chartered under the laws of the United States, any State thereof or the District of Columbia, and which is insured by the Federal Deposit Insurance Corporation; (2) whose long-term, unsecured and insubordinate debt obligations are rated in the highest category by at least two of Fitch Ratings Ltd. (Fitch), Moody’s Investors Service, Inc. (Moody’s) and Standard & Poor’s Ratings Services (S&P) or their respective successors (the Rating Agencies) (which shall mean AAA from Fitch, AAA from Moody’s and AAA from Standard & Poor’s); and (3) which has a short term deposit rating in the highest category from at least two Rating Agencies (which shall mean F1 from Fitch, P-1 from Moody’s and A-1 from S&P) (collectively, the LC Issuer Requirements). If at any time the LC Issuer Requirements are not met, or if the financial condition of such issuer changes in any other materially adverse way, as determined by [Landlord] in its sole discretion, then [Tenant] shall within [five (5)] days of written notice from [Landlord] deliver to [Landlord] a replacement Letter of Credit which otherwise meets the requirements of this [Lease] and that meets the LC Issuer Requirements (and [Tenant]’s failure to do so shall, notwithstanding anything in this [Lease] to the contrary, constitute an Event of Default for which there shall be no notice or grace or cure periods being applicable thereto other than the aforesaid [five-day] period). Among other things, [Landlord] shall have the right under such circumstances to immediately, and without further notice to [Tenant], present a draw under the letter of credit for payment and to hold the proceeds thereof.
Following is some typical language for the governing documents (and once again, any actual language you use should be crafted to fit the particular case):
In the event the issuer of any letter of credit held by [Landlord] is insolvent or is placed into receivership or conservatorship by the Federal Deposit Insurance Corporation, or any successor or similar entity, or if a trustee, receiver or liquidator is appointed for the issuer, then, effective as of the date of such occurrence, said Letter of Credit shall be deemed to not meet the requirements of this Section, and then [Tenant] shall within [five (5)] days of written notice from [Landlord] deliver to [Landlord] a replacement Letter of Credit which otherwise meets the requirements of this [Lease] and that meets the LC Issuer Requirements (and [Tenant]’s failure to do so shall, notwithstanding anything in this [Lease] to the contrary, constitute an Event of Default for which there shall be no notice or grace or cure periods being applicable thereto other than the aforesaid [five day] period); or, alternatively, [Tenant] shall, within such [five-day] period deliver cash to [Landlord] in the amount required above.
Letters of credit typically follow a fairly predetermined format. However, the Issuer will often agree to include customized language which might include, among other things, the Beneficiary’s automatic right to draw in the event the letter of credit is due to expire without being renewed or replaced, or if the Issuer’s credit rating drops below a specified level. It is obvious that a Beneficiary is in a much better position if it draws upon a letter of credit for payment, and retains the proceeds, before the Issuer is subject to a receivership or conservatorship order by FDIC. Failure to do so could render the letter of credit worthless and leave the Beneficiary without a viable course of action to re-establish the deposit or other security. While beyond the scope of this article, the type of account in which the proceeds are held, in the case of a tenant security deposit, should be carefully considered in order to minimize potential bankruptcy risks.
FDIC MAY REPUDIATE LETTERS OF CREDIT FROM BANKS IN RECEIVERSHIP
US banks and thrifts are failing at an alarming pace, and the Rating Agencies have dramatically downgraded the credit ratings for numerous institutions whose financial strength would have been unquestioned just a year or two ago. For banks, 2008 was a very painful year. In 2007, only three banks were placed into receivership; in 2008, 25 failed, an increase of more than 800 percent.
2015 is looking ominous for the banking industry, and many experts predict that large numbers of banks and thrifts will be placed under government control throughout the year. Meanwhile, the Rating Agencies will downgrade ratings as institutions’ prospects dim. While the government agencies often transfer assets and liabilities of a failed institution to a successor, the government has the statutory right to repudiate all “burdensome” contracts – including letters of credit – when it places a bank or thrift under government control.
FDIC has recently reminded letter of credit Beneficiaries – most notably commercial landlords – that FDIC may not honor undrawn standby letters of credit issued by banks that have been placed under government receivership or conservatorship. In other words, the FDIC has announced that it can repudiate undrawn letters of credit, and that no damages against the Issuer will be available to the Beneficiary, unless the conditions for drawing were fully satisfied before the receivership or conservatorship occurred. Because the United States Supreme Court has held that letters of credit are typically not deposits, the Beneficiary is not protected up to the FDIC insurance limit for deposit accounts – currently 250,000 – if a letter of credit is repudiated. Letters of credit can, of course, be assumed by any bank that accepts the obligations of a failed institution, but the critical message here is that this may occur at the sole discretion of the FDIC and the acquiring bank.
FDIC has wide latitude in the way it structures the transfer of assets of a failed institution, so even if a failed bank “merges” into a healthy institution, letters of credit may still be at risk.
Meanwhile, in the event the Issuer is placed under FDIC control, any cash deposited with the Issuer by the Account Party as collateral for a letter of credit will likely be considered a deposit account that is insured only up to 250,000.
WHAT TO DO IF YOU ARE A LETTER OF CREDIT BENEFICIARY
First, check all agreements between you and the Account Party to identify the requirements that the standby letter of credit and the Issuer must satisfy.
Second, frequently check all standby letters of credit you may be holding to confirm maturity dates, conditions for draws and, most importantly, the identity of the Issuer. To determine whether the Issuer meets the standards appearing in your agreements with the Account Party, you can easily check the ratings on the rating agencies’ websites, as applicable – www.standardandandpoors.com; www.moodys.com, and www.fitchratings.com. If it appears that the Issuer’s rating has fallen below the specified standard, consider advising the party who is required to maintain the letter of credit of such failure in light of its contractual duties. Be sure to follow the document’s notice requirements, and check the default provisions to determine whether the party is entitled to notice and a right to cure. FDIC does not publish its FDIC Watchlist; if you have concerns about any particular institution, please note it is unlikely the FDIC will either confirm or deny that institution’s status.
Third, as noted above, many standby letters of credit permit a drawing in full in the event that the Issuer fails to meet the requirements of the underlying contract and no replacement letter of credit has been delivered within a specified time period. When a Beneficiary holds a standby letter of credit with such language, the beneficiary should consider presenting a draw before the Issuer is placed under receivership or conservatorship. Look carefully at notice and cure provisions in the underlying document (such as the lease), and the letter of credit itself, to ensure that no liability will arise from such an action. Under applicable law, the Issuer may have as long as five business days to honor a draft for payment, so quick and decisive action will be imperative.
Fourth, in some instances, letters of credit are held in an escrow arrangement by a title company, bank or other entity. Because you should never assume that the escrow agent will be monitoring the Issuer’s financial condition (even if the escrow holder has agreed to do so), review the applicable terms and conditions to ensure that the appropriate protections are in place. Fifth, to the extent that you are involved in documenting a new transaction, review carefully how the letter of credit provisions in your documents work, and be mindful of the fact that bank ratings can change dramatically in the course of a day. In addition, from a drafting standpoint, counsel will want to ensure that the documents do not grant back-to-back notice and grace periods that could make decisive action impossible. A tenant may be unable, as a practical matter, to replace a repudiated letter of credit if the Issuer is subject to a receivership or conservatorship action and the FDIC does not transfer the Issuer’s obligations to a successor bank.
GET STARTED WITH A STANDBY LETTER OF CREDIT
A financial letter of credit generally works on the other party in the exchange—example, the museum can be asked to provide a financial SBLC to your firm for the total amount of the project. If they fail to pay you after work is finished, the bank will issue payment to your business on behalf of your client. These types of SBLC are often required when performing international trade or other large purchase contracts where other forms of payment protections (such as litigation in the event of non-payment) can be difficult to obtain.
HOW TO OBTAIN A STANDBY LETTER OF CREDIT
Obtaining a standby letter of credit is similar to obtaining a commercial loan, though with a few key differences. As with any business loan, you will need to provide proof of your creditworthiness to the bank. Unlike a loan, the process for approval for a SBLC is much quicker, with letters often being issued within a week of all paperwork being submitted. Also unlike traditional loans, the bank will require a fee of between one and ten percent of the SBLC amount before issuing the letter. This fee is usually charged per year that the letter of credit is in effect. If the terms of the contract are fulfilled early, you can cancel the SBLC and not incur additional charges. For small business owners, the standby letter of credit can be a powerful tool for establishing trust with suppliers and vendors. Obtaining an SBLC is proof that you and your company have good credit, and can put many suppliers at ease about providing you favorable financing terms. Furnishing a financial SBLC can often allow you to negotiate payment and financing terms with suppliers from a position of strength in order to get the best interest rates and payment schedule, while maintaining a good relationship with your suppliers. If you provide services, on the other hand, offering to furnish performance standby letters of credit can be extremely useful to helping your business secure large contracts. Putting your clients at ease by being willing to guarantee your work financially can overcome many of the objections business owners face in the selling process.
WHAT CAN A SBLC BE USED FOR?
SBLC and BG can be used to enhance your ability to apply for a line of credit with your bank; in other words, it can be used as collateral when your bank is asking for additional comfort when you ask them to fund your project. The SBLC we deal in are genuinely 100% cash-backed and therefore usable as collateral. Our issuers only use top 25 World Banks – mainly from Europe like HSBC, Deutsche, UBS etc. This guarantees world wide acceptance of your SBLC. These SBLC are generated by “someone” blocking their funds on your behalf, so we speak of a “leased” SBLC. In other words the SBLC is owned by the issuer and you are the beneficiary. The SBLC is generally issued for 1 year and 1 day, but can easily be extended up to 5 years. (It is possible to get an SBLC for only 6 months). Once issued the SBLC is transferred to your bank via the Swift protocol of MT760. Leasing of an SBLC comes at a cost. And to be very honest: at a high cost. Financing your project by using an SBLC is very expensive. First you need to pay money to the issuer of the SBLC plus commission to the consultants facilitating the process, Then you need to give the SBLC to your bank, who are providing a Line of Credit against the SBLC, which may only be up to 90% LTV or less. And usually, your bank will charge a one off fee to ‘monetise’ the instrument and also charge interest on the drawn down loan amount.
To successfully apply for an SBLC you need to be aware of four vital points:
a) You need to have a good project
b) You need to have a bank funding your project based on the supporting collateral of an issued SBLC
c) You need to have the money to pay for the leasing of the SBLC
d) You need to have a believable and realistic exit strategy to repay the loan and return the SBLC at the end of the term
All the SBLC we deal with are callable, assignable, fully transferable and lienable. If you are thinking of using an SBLC to participate in a High Yield Trade Program, we are more than happy to assist you in acquiring the SBLC and placing it into trade. However, you need to be very sure you are able to pay the leasing fees of the SBLC before issue, as most providers will not allow the instrument to be taken into a Trade Program unless and until the fee is paid. You cannot pay the lease fee from the program returns. It is also not possible to use an SBLC to secure a commodity trade and pay for the SBLC out of the profits from the transaction. When paid for and used correctly, these instruments provide numerous lucrative options. v-funding can provide BG, SBLC and CD, which can be blocked or delivered via SWIFT or Euroclear.
LETTERS OF CREDIT CAN BECOME WORTHLESS
The deep and prolonged crisis in the financial services industry will result in numerous FDIC insured banks facing receivership or conservatorship. Undrawn letters of credit issued by these institutions are likely to be worthless. Parties to letter of credit transactions are advised to look carefully at their letters of credit and related documentation and enforce their right to require certain letters of credit to be replaced or, where possible, revise documents to require replacement of letters of credit issued by troubled institutions. At the end of this Alert, we have provided several suggested courses of action.
ABOUT LETTERS OF CREDIT
The parties to a letter of a credit are as follows:
Issuer – the bank or thrift issuing the letter of credit is the Issuer.
Account Party – the party who obtains the letter of credit from the Issuer is the Account Party. Often, the Account Party arranging for a standby letter of credit delivers cash or other collateral to the Issuer to secure repayment of any draws on the letter of credit.
Beneficiary – the party who holds the standby letter of credit and who is authorized to draw under the letter of credit on the conditions stated in the letter of credit is the Beneficiary.
A standby letter of credit is issued by the Issuer to the Beneficiary at the request of the Account Party, and requires the Issuer to pay a specified sum to the Beneficiary upon satisfaction of the conditions of drawing specified in the standby letter of credit. The standby letter of credit will specify the maximum amount that may be drawn, the expiration date, the place where drafts must be presented and what certifications or deliveries must be made in connection with the draw request. Virtually all letters of credit utilized in real estate transactions are “sight draft” letters of credit, which means that the Beneficiary can require payment under the letter of credit upon delivery of a simple sight draft, which looks very much like a bank check, together with any other required certifications. Letters of credit are governed by Article 5 of the Uniform Commercial Code (the “UCC”), which has been enacted in every state and the District of Columbia. In addition, parties generally agree that the letter of credit will be governed by the Uniform Customs and Practice for Documentary Credits (the “UCP”) or the International Standby Practices 98 (the “ISP”), both of which are promulgated by the International Chamber of Commerce. Standby letters of credit issued by US financial institutions are also subject to regulation by one or more of the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, the Federal Reserve Board and the Office of the Comptroller of the Currency.
Standby letters of credit are generally issued and held pursuant to a separate contract between the Account Party and the Beneficiary – such as a lease, loan agreement, purchase agreement or public improvement agreement. The “underlying contract” between the Account Party and the Beneficiary is separate and independent of the letter of credit as a legal matter, but it will specify the requirements that the letter of credit must satisfy and when it can be drawn. If these documents are drafted properly, they will generally contain language that requires the Issuer to meet certain specified standards as to its financial strength.
Following is some typical lease language (although any actual language you use should be crafted to fit the particular case):
The Letter of Credit shall be issued by a commercial bank acceptable to [Landlord] and (1) that is chartered under the laws of the United States, any State thereof or the District of Columbia, and which is insured by the Federal Deposit Insurance Corporation; (2) whose long-term, unsecured and insubordinate debt obligations are rated in the highest category by at least two of Fitch Ratings Ltd. (Fitch), Moody’s Investors Service, Inc. (Moody’s) and Standard & Poor’s Ratings Services (S&P) or their respective successors (the Rating Agencies) (which shall mean AAA from Fitch, AAA from Moody’s and AAA from Standard & Poor’s); and (3) which has a short term deposit rating in the highest category from at least two Rating Agencies (which shall mean F1 from Fitch, P-1 from Moody’s and A-1 from S&P) (collectively, the LC Issuer Requirements). If at any time the LC Issuer Requirements are not met, or if the financial condition of such issuer changes in any other materially adverse way, as determined by [Landlord] in its sole discretion, then [Tenant] shall within [five (5)] days of written notice from [Landlord] deliver to [Landlord] a replacement Letter of Credit which otherwise meets the requirements of this [Lease] and that meets the LC Issuer Requirements (and [Tenant]’s failure to do so shall, notwithstanding anything in this [Lease] to the contrary, constitute an Event of Default for which there shall be no notice or grace or cure periods being applicable thereto other than the aforesaid [five-day] period). Among other things, [Landlord] shall have the right under such circumstances to immediately, and without further notice to [Tenant], present a draw under the letter of credit for payment and to hold the proceeds thereof.
Following is some typical language for the governing documents (and once again, any actual language you use should be crafted to fit the particular case):
In the event the issuer of any letter of credit held by [Landlord] is insolvent or is placed into receivership or conservatorship by the Federal Deposit Insurance Corporation, or any successor or similar entity, or if a trustee, receiver or liquidator is appointed for the issuer, then, effective as of the date of such occurrence, said Letter of Credit shall be deemed to not meet the requirements of this Section, and then [Tenant] shall within [five (5)] days of written notice from [Landlord] deliver to [Landlord] a replacement Letter of Credit which otherwise meets the requirements of this [Lease] and that meets the LC Issuer Requirements (and [Tenant]’s failure to do so shall, notwithstanding anything in this [Lease] to the contrary, constitute an Event of Default for which there shall be no notice or grace or cure periods being applicable thereto other than the aforesaid [five day] period); or, alternatively, [Tenant] shall, within such [five-day] period deliver cash to [Landlord] in the amount required above.
Letters of credit typically follow a fairly predetermined format. However, the Issuer will often agree to include customized language which might include, among other things, the Beneficiary’s automatic right to draw in the event the letter of credit is due to expire without being renewed or replaced, or if the Issuer’s credit rating drops below a specified level. It is obvious that a Beneficiary is in a much better position if it draws upon a letter of credit for payment, and retains the proceeds, before the Issuer is subject to a receivership or conservatorship order by FDIC. Failure to do so could render the letter of credit worthless and leave the Beneficiary without a viable course of action to re-establish the deposit or other security. While beyond the scope of this article, the type of account in which the proceeds are held, in the case of a tenant security deposit, should be carefully considered in order to minimize potential bankruptcy risks.
FDIC MAY REPUDIATE LETTERS OF CREDIT FROM BANKS IN RECEIVERSHIP
US banks and thrifts are failing at an alarming pace, and the Rating Agencies have dramatically downgraded the credit ratings for numerous institutions whose financial strength would have been unquestioned just a year or two ago. For banks, 2008 was a very painful year. In 2007, only three banks were placed into receivership; in 2008, 25 failed, an increase of more than 800 percent.
2015 is looking ominous for the banking industry, and many experts predict that large numbers of banks and thrifts will be placed under government control throughout the year. Meanwhile, the Rating Agencies will downgrade ratings as institutions’ prospects dim. While the government agencies often transfer assets and liabilities of a failed institution to a successor, the government has the statutory right to repudiate all “burdensome” contracts – including letters of credit – when it places a bank or thrift under government control.
FDIC has recently reminded letter of credit Beneficiaries – most notably commercial landlords – that FDIC may not honor undrawn standby letters of credit issued by banks that have been placed under government receivership or conservatorship. In other words, the FDIC has announced that it can repudiate undrawn letters of credit, and that no damages against the Issuer will be available to the Beneficiary, unless the conditions for drawing were fully satisfied before the receivership or conservatorship occurred. Because the United States Supreme Court has held that letters of credit are typically not deposits, the Beneficiary is not protected up to the FDIC insurance limit for deposit accounts – currently 250,000 – if a letter of credit is repudiated. Letters of credit can, of course, be assumed by any bank that accepts the obligations of a failed institution, but the critical message here is that this may occur at the sole discretion of the FDIC and the acquiring bank.
FDIC has wide latitude in the way it structures the transfer of assets of a failed institution, so even if a failed bank “merges” into a healthy institution, letters of credit may still be at risk.
Meanwhile, in the event the Issuer is placed under FDIC control, any cash deposited with the Issuer by the Account Party as collateral for a letter of credit will likely be considered a deposit account that is insured only up to 250,000.
WHAT TO DO IF YOU ARE A LETTER OF CREDIT BENEFICIARY
First, check all agreements between you and the Account Party to identify the requirements that the standby letter of credit and the Issuer must satisfy.
Second, frequently check all standby letters of credit you may be holding to confirm maturity dates, conditions for draws and, most importantly, the identity of the Issuer. To determine whether the Issuer meets the standards appearing in your agreements with the Account Party, you can easily check the ratings on the rating agencies’ websites, as applicable – www.standardandandpoors.com; www.moodys.com, and www.fitchratings.com. If it appears that the Issuer’s rating has fallen below the specified standard, consider advising the party who is required to maintain the letter of credit of such failure in light of its contractual duties. Be sure to follow the document’s notice requirements, and check the default provisions to determine whether the party is entitled to notice and a right to cure. FDIC does not publish its FDIC Watchlist; if you have concerns about any particular institution, please note it is unlikely the FDIC will either confirm or deny that institution’s status.
Third, as noted above, many standby letters of credit permit a drawing in full in the event that the Issuer fails to meet the requirements of the underlying contract and no replacement letter of credit has been delivered within a specified time period. When a Beneficiary holds a standby letter of credit with such language, the beneficiary should consider presenting a draw before the Issuer is placed under receivership or conservatorship. Look carefully at notice and cure provisions in the underlying document (such as the lease), and the letter of credit itself, to ensure that no liability will arise from such an action. Under applicable law, the Issuer may have as long as five business days to honor a draft for payment, so quick and decisive action will be imperative.
Fourth, in some instances, letters of credit are held in an escrow arrangement by a title company, bank or other entity. Because you should never assume that the escrow agent will be monitoring the Issuer’s financial condition (even if the escrow holder has agreed to do so), review the applicable terms and conditions to ensure that the appropriate protections are in place. Fifth, to the extent that you are involved in documenting a new transaction, review carefully how the letter of credit provisions in your documents work, and be mindful of the fact that bank ratings can change dramatically in the course of a day. In addition, from a drafting standpoint, counsel will want to ensure that the documents do not grant back-to-back notice and grace periods that could make decisive action impossible. A tenant may be unable, as a practical matter, to replace a repudiated letter of credit if the Issuer is subject to a receivership or conservatorship action and the FDIC does not transfer the Issuer’s obligations to a successor bank.
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