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. Two types of letters of credit are frequently used in commercial transactions: documentary letters of credit and standby letters of credit.
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Parties select either the Uniform Commercial Code of the relevant jurisdiction, or "UCC," or the Uniform Customs and Practice for Documentary Credits, or "UCP," issued by the International Chamber of Commerce to govern their letter of credit. Usually, the letter of credit is accompanied by a promissory note from the applicant to the beneficiary and the applicant's agreement to reimburse the issuer upon its payment to the beneficiary. Three main parties are involved in a letter of credit transaction, namely, the issuer (bank), the customer of the issuer (applicant) and the beneficiary (obligee).
It authorizes a party to draw up to a certain amount of money under terms outlined by the instrument. Letters of CreditĪ letter of credit is a written instrument that is traditionally issued by a bank. The key distinctions between letters of credit and surety bonds arise from the business concepts and legal principles underpinning these forms of security.
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. 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. Parties to commercial transactions have for years argued over the forms of security providing credit support to their deals.
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There are key differences between the two instruments.Ī letter of credit is a promise by a bank to advance up to a certain amount of money to one deal party if the other party defaults.Ī surety bond is a guarantee in which a third party - often an insurance company - agrees to assume a defaulting party's financial obligations.Īlthough letters of credit and surety bonds are similar in function, there are legal differences that could affect a beneficiary's ability to obtain full and prompt payment on its claim. Parties to project finance transactions are sometimes asked to accept surety bonds as security in place of letters of credit.
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