Export Contracts and Standby Letters of Credit: Drawing Conditions and Expiry Design

Linking payment terms with demand documents and the expiry of the standby letter of credit

In export transactions on open account terms, a standby letter of credit (SBLC) is used to protect against the risk that the buyer fails to pay. However, a sufficient guarantee amount or the name of an issuing bank alone does not guarantee recovery of payment in each transaction.

Companies should check whether the payment requirements, demand documents, and expiry in the export contract and the standby document are consistent. This article summarizes the key points to review at the first shipment of a new transaction and when transaction terms change.

1. Distinguishing the Export Contract from the Standby Letter of Credit

A standby letter of credit is distinct from a commercial letter of credit, which is used as an ordinary means of paying for goods. The U.S. Department of Commerce describes it as an instrument that can be drawn upon in the event of a contractual default, such as an importer's failure to pay an invoice.

The specific payment obligation must be determined by the wording of the standby, the applicable rules, and the governing law. Simply stating in the contract that the buyer will provide a payment guarantee does not create a payment obligation on the part of a bank.

Companies should verify the issuing bank, beneficiary, applicant, and amount, and check the authenticity of the standby and the advising route with their own bank. The existence of an advising bank alone should not be taken to mean that the bank bears a separate payment obligation.

2. Payment Default and Consistency of Demand Documents

First, determine when payment falls due under the export contract. The time at which a default occurs may differ depending on whether the reference point is the shipment date, the arrival date, the date inspection is completed, or the date the invoice is received.

In addition to a demand, a standby letter of credit may require a statement of non-payment, a copy of the invoice, transport documents, or other evidence. If a drawing requires the buyer's confirmation or consent, the seller may be unable to obtain the documents precisely when the buyer refuses to pay.

Companies should confirm who must prepare the required documents, what wording must be used in signing, and whether originals or copies are required. To avoid confusing the determination of a contractual breach with the bank's examination of documents, the technical documentary requirements should be reviewed with the company's bank.

3. Linking the Payment Due Date and Standby Expiry

If the expiry of the standby is the same as or too close to the last shipment date, the standby may expire before the open account payment falls due. The expiry should be set to allow time after the due date for notice, document preparation, and presentation.

The place of presentation, cut-off times, holidays, whether electronic presentation is permitted, and the applicable rules should also be checked. Whether mailing documents before the expiry date is sufficient or whether they must actually reach the designated place depends on the wording and the rules.

Even with an automatic extension clause, the standby is not always maintained. The export contract should address when the seller will receive a notice of non-extension and whether, upon such notice, the seller may suspend further shipments or demand other security.

4. Amending the Standby for Partial Shipments and Contract Changes

If partial shipments are repeated, companies should check whether the standby amount covers the entire outstanding balance. They should also check whether the available amount is reduced after each drawing or whether it can be reinstated.

An increase in the transaction amount, an extension of the payment date, or a change of buyer does not automatically change the terms of the standby. Amendments to the export contract and the bank's acceptance of an amendment to the standby must be managed as separate procedures.

Gaps in security can be reduced by specifying the obligation to make further shipments before an amendment to the standby is confirmed, the costs of issuing the standby and bank fees, and the timing of releasing the existing standby.

5. Pre-Shipment Review and Preservation of Records After Non-Payment

Before signing, prepare the export contract, the draft standby letter of credit, purchase orders, the expected shipment schedule, the invoice form, and the payment schedule together. The governing law and dispute resolution clauses should be checked separately in the main contract and the standby.

If non-payment has already occurred, check the expiry and presentation requirements first, and preserve invoices, shipment and delivery evidence, notices to the customer, and bank responses in original form. A drawing under the standby and a contractual claim against the buyer may involve different procedures and counterparties.

A legal review does not replace a bank's credit assessment or sanctions screening. The legal effect of the standby wording and the possibility of drawing should be confirmed with a lawyer, while the actual issuance and presentation procedures should be confirmed with the company's bank.

6. Implications for Businesses

A standby letter of credit should be managed together with the payment schedule of the export contract. Companies should record the outstanding balance per invoice, the final payment due date, the standby expiry, and the amendment history, and check whether a gap in security will arise before making further shipments.

Companies should not assume that a change to the main contract automatically leads to an amendment of the bank's standby. The legal payment undertaking and drawing conditions should be confirmed in the wording of the documents, and the actual issuance, presentation procedures, and bank credit should be confirmed with the company's bank, to build an enforceable payment security structure.

Related Laws and References

U.S. Department of Commerce — Trade Finance Guide

ICC — International Standby Practices (ISP98)