Letter of Credit Forum

Standby letters of Credit, bank guarantees and commercial letters of credit have one feature in common: a beneficiary can ask for payment from a bank. The request of the beneficiary and the obligation of the bank to pay are independent of the relation between the beneficiary to a client/customer.

Owing to the necessity of presenting a document in order to avail
oneself of a standby , a standby is classified as a “documentary promise to pay.” This classification distinguishes the standby from an international guarantee, which is usually payable on first demand, and only in exceptional circumstances, when required by the guarantee itself, is it payable against documents. In order to demand payment under a standby, the beneficiary must present a document, even if the standby itself does not mention this requirement.

If a standby does not specify any required document, it will be deemed to require a documentary demand for payment.
The reasons for formalizing the demand for payment under a standby can be found in American banking legislation. The American banking system is characterized by the strict separation of investment and commercial banking, which was implemented by the Glass-Steagall Act of 1933. Hence, the majority of banks are not permitted to issue
bank guarantees or suretyships. Reputable authors have long disputed
the validity of this prohibition. In 1996 the Office of the Comptroller of the Currency (OCC) liberated American banks from this prohibition:
On February 5, 1996, the OCC issued its final revised Interpretive Ruling Section 7.7016 (61 Fed. Reg. 4865)(Feb. 9, 1996), which authorizes national banks to issue and commit to issue letters of credit and “other independent undertakings” to pay against documents—such as bank guarantees—that are within the scope of applicable law or legally recognized rules of practice. The OCC has described the purpose of the change: “to reflect modern market standards and industry usage
and replace the term ‘letters of credit’ with ‘independent undertakings’.”

Even with this change of legislation, the practice for standbys has not shifted. A standby has basically the character of a bank guarantee; however, much like a letter of credit, its demand depends on the presentation of a document however described.

A standby letter of credit may be processed according to the rules for commercial letters of credit. Commonly in international finance the rules used are the UCP 600 (Uniform Customs and Practices, publication No. 600 as issued by the International Chamber of Commerce in Paris).

Also, a standby may be issued according to the ISP 98, rules issued by the Institute of International Banking Law and Practice, another private organization with no legislative authority.

Finally, states and countries may enact their own rules for guarantees.

The conflict between these three set of rules is discussed here.