Documentary and Standby Letters of Credit

Effective January 1, 1999, banks may incorporate, by reference, the International Standby Practices, referred to as ISP 98, into their standby letters of credit.1 In doing so, banks will supplement and vary Article 5 of the Uniform Commercial Code ("UCC"),2 which governs letters of credit in most of the United States, and replace, as to such credits, the Uniform Customs and Practices ("UCP"),3 a statement of practices published by the International Chamber of Commerce ("ICC") that is nearly universally incorporated by reference into letters of credit. The purpose of this article is to describe when ISP 98 applies and how certain of its rules follow or vary from the UCC and the UCP.

Documentary and Standby Letters of Credit
Letter of credit law and practice, until quite recently, has evolved with the use of letters of credit in commercial sale of goods transactions. Stated simplistically, letters of credit have enabled sellers, unwilling to rely simply upon the promise of the buyers to pay for goods once the goods are loaded on board a vessel destined to the buyer’s country, to be assured that they can obtain payment once those goods are so loaded. A seller may present the agreed shipping documents to, and thereby obtain payment from, a bank whose undertaking to make such payment would be primary and independent of the contract between the seller and his buyer.

The letter of credit (or credit) is part of a three-party relationship in a commercial transaction: (1) the contract between the parties (applicant and beneficiary) pursuant to which one party (the applicant) is obligated to obtain the credit for the benefit of the other (the beneficiary), (2) the contract between the applicant and the person whom the applicant asks to issue the credit (the issuer), usually a bank or other financial institution, and (3) the undertaking by the issuer in favor of the beneficiary, to honor a presentation by payment or delivery of an item of value. The undertaking of the issuer in the letter of credit, however, is primary and must be honored without any claim, counter claim, setoff or defense that the issuer or the applicant may have against the beneficiary. This ‘independence’ of the letter of credit from the transaction between the applicant and the beneficiary is its special feature.

A letter of credit will be either a documentary or standby credit. Common to all credits is that the issuer undertakes to pay or give an item of value against a specific document or documents which accompany the request for payment. Such payment can be at the time of presentation, known as at sight, or at a later time, known as deferred payment. The issuer can give an item of value, such as a bill of exchange drawn on the bank, also payable at sight or at a later time. The documentary credit specifies the documents that must accompany the presentation, such as an invoice, bill of lading and insurance certificate. With a standby credit the presentation required by the undertaking may be the request for payment itself, with or without other documents. Frequently, a standby credit is given to support an obligation of the applicant: the beneficiary can obtain payment under the standby credit by presenting a simple demand, as specified in the credit, to the issuer. Standby credits are also used to support an obligation by the applicant to make an advance payment; they are used as bid bonds to support the bidder’s duty to execute a contract; they are used a credit support in loan transactions to ensure repayment by the borrower; and they may be used as a method of obtaining direct payment under a contract. Standby credits, as in the preceding examples, are performance, financial or direct pay undertakings.

As both documentary and standby credits are undertakings to pay against the presentation of one or more documents, the distinction between them is nowhere precisely stated and probably unnecessary to state. The UCP states that it applies to both types of credit without defining them (the definition was unnecessary). Similarly, the UCC, which applies to both, has no need to distinguish the two. ISP 98 states that it applies to standby letters of credit without defining them. In practice, the parties will determine whether a credit is a standby by choosing to incorporate ISP 98 or not. If they do, it will be subject to the special rules in ISP 98 applicable to standby credits; if not, they will presumably choose the UCP and the credit will be subject to that regime, which was developed principally for documentary credits.