1. The Standby Credit v. the Commercial Credit
    Most of the time, commercial parties (sellers and buyers) use the documentary credit to support the international sale of goods and serve as the payment vehicle under that credit. Such credits are referred to as “commercial letters of credit” or “export letters of credit”. Sometimes commercial parties use standby credits, which are credits that they do not expect the beneficiary to draw on. Normally, draws on a commercial credit indicate that the transaction is proceeding normally. Sometimes, though not always, draws on a standby indicate that something has gone wrong in the underlying transaction.
    The typical standby serves to guarantee payment or performance. The following discussion uses three transactions to illustrate standby use in international trade:
    1. the invoice standby transaction;
    2. the standby securing a construction company’s performance guarantee; and
    3. the standby securing return of progress payments.


  1. The Invoice Standby Transaction
    In Illustration 18-1, the commercial parties, the seller and the buyer, have used a standby credit to support the periodic sale of goods or commodities. Under the arrangement, the buyer issues purchase orders from time to time, and the seller ships on open account, invoicing the buyer with normal credit terms. The shipments may be for significant amounts, and the parties seek to avoid bank charges for each shipment. Instead of using a commercial letter of credit every time the buyer issues a purchase order, the buyer causes its bank to issue one standby, which is payable against the seller’s invoice and a certificate stating that invoices are overdue. The standby usually has a one year expiry. If the buyer makes timely payments, the seller will not draw, and the standby will expire without any payment or may be renewed to cover another year’s shipments. If the buyer defaults on a payment obligation, the seller will draw, and the letter of credit issuer will pay the amount demanded by the seller as past due. The buyer will pay bank charges for only one credit per year, for the maximum amount it will owe the seller at any point in time, rather than the several charges that the buyer would pay if it needed a commercial credit for each shipment.


  1. Standby Securing Seller Performance
    In an international construction contract, the seller’s bank sometimes secures a performance guarantee issued in favour of the buyer by a bank in the buyer’s country. It is not uncommon in large value construction contracts for buyers, frequently government agencies in the buyer’s country, to insist that the seller/construction company’s performance be secured by a bank guarantee, usually a guarantee payable on first demand, issued by a local bank, subject to local guarantee laws. Issuer 1 in the illustration will not issue the guarantee, however, unless it is secure. The seller arranges that security by causing its own bank to issue the standby in the illustration. That standby is payable against a certificate from Issuer 1 that it has paid the buyer under the guarantee. Note that this is an example of a letter of credit in favour of the buyer rather than the seller.

  1. Standby Securing Return of Progress Payments
    It is unusual for a buyer of construction goods and services to pay in full the seller’s periodic applications for payment. Rather, the buyer usually holds back part of each payment in order to guard against future contract breaches that may exceed the amount of remaining payments. A standby can permit the seller of construction goods and services to receive progress payments without any holdback.
    Normally, buyers of construction goods and services hold back, say, 10% of all progress payments to the construction company providing the goods and services (i.e. the seller) to guard against future defaults. Those holdbacks impact the construction company’s ability to pay construction costs. In international trade, it is not uncommon for the parties to agree that the buyer will pay the construction company 100% of its applications for payment on the condition that the construction company/seller will cause its bank to issue a standby to secure the return of all or part of the payments in the event of the seller’s breach. Usually, the standby is payable against the buyer’s naked assertion that the seller has breached the contract. The standby issuer will pay the buyer even if the construction company disputes the assertion that it is in breach. The buyer then holds the funds pending resolution of the contract dispute.
    The standby in this transaction permits the buyer to pay without any holdback but restores the amount owed in the event of a breach.


  1. Summary
    These illustrations are, of course, not exhaustive. Parties engaging in large-value international sales of services use the standby in numerous ways, many of them complex. The standby facility supports imaginative and path-breaking transactions in international trade.