A typical standby letter of credit includes a guarantee from a bank to pay a stipulated sum of money to a beneficiary and a description of the requirements for payment, reports Justin Pritchard for About.com. Standby letters of credit are safety nets that beneficiaries utilize when they do not receive payments or services that businesses agree to provide. Some landlords also accept them from tenants in lieu of cash for security deposits on commercial property, states Nolo.Continue Reading
Businesses often use standby letters of credit when conducting domestic and international trade transactions, explains Pritchard. If a business does not pay on time due to a cash flow problem, frozen assets, dissatisfaction with the goods or dishonesty, the beneficiary can collect the funds the business owes from the bank that issues the letter of credit. Sometimes banks issue confirmed standby letters of credit, which means another bank the beneficiary trusts guarantees payment. Most standby letters of credit are irrevocable after banks issue them and cannot be changed unless all parties agree.
Contractors also use standby letters of credit to guarantee the completion of projects within deadlines, according to Pritchard. If something prevents a contractor from performing a service on time, the letter of credit enables the beneficiary to collect the payment as a penalty or hire another contractor. Having standby letters of credit as security deposits on rental property allows tenants to use available cash to grow their businesses instead of the cash being tied up with the landlord, says Nolo.Learn more about Credit & Lending