360 DAYS OR 720 DAYS? THE ZIGZAG BETWEEN A WARRANTY GUARANTEE AND AN LC

INTRO

Here is an interesting question about a USD 9 million machinery import, involving a deferred payment LC and a Warranty Guarantee.

At first glance, everything seems straightforward: USD 5.7 million is payable against shipping documents, while the remaining USD 300,000 is payable against a Warranty Guarantee and an Acceptance Certificate.

But there is an interesting “zigzag” here:

The Warranty Guarantee is valid for 360 days, while the LC has a deferred payment period of 720 days.

So, what happens if a demand is made under the Warranty Guarantee during those 360 days? And does that have any effect on the 720-day payment obligation under the LC?

Let’s take a closer look.

QUESTION

Dear Mr. Old Man,

We would like to seek your advice regarding the following case:

We are planning to issue a Letter of Credit (LC) for the importation of a machinery line under a contract valued at USD 9 million. The payment structure is as follows:

• USD 3 million has already been paid in advance by the customer.
• USD 6 million will be settled under a deferred payment LC over a two-year period, as follows:
  • USD 5.7 million payable against presentation of the shipping documents (Invoice, Bill of Lading, Packing List, etc.).
  • USD 0.3 million payable against presentation of the Warranty Guarantee and the Acceptance Certificate.

The Warranty Guarantee will be valid for one year (360 days).

We would appreciate your guidance on the following points:

1. How should the payment timing for these two installments be stipulated in the LC?
2. How should the requirements for the Warranty Guarantee be specified? In particular, is it necessary for the guarantee to be issued via SWIFT and notified through the LC-issuing bank?
3. What documents should be required to claim the USD 0.3 million, and what would be the applicable timeframes, particularly given that the Warranty Guarantee is valid for only 360 days while the LC has a deferred payment period of 720 days?

Thank you very much for your advice.

Best regards,

LT

______

ANSWER

Dear L.T,

Thank you for your inquiry.

Your bank may issue the LC available with the issuing bank by deferred payment at 720 days after sight.

The payment may be structured in two installments as follows:

1. First payment — USD 5,700,000

Against presentation of:

• Commercial Invoice
• Bill of Lading
• Packing List
• …

2. Second payment — USD 300,000

Against presentation of:

• Warranty Guarantee for USD 300,000 (*)
• Acceptance Certificate signed by both the Beneficiary and the Applicant.

Note:

(*) Since the LC is available by deferred payment at 720 days after sight, the second installment should also be stipulated on the same deferred-payment basis, unless the underlying contract provides otherwise.

As for the Warranty Guarantee, it may be issued by the Beneficiary’s bank either in paper form or through SWIFT MT 760.

If the guarantee is issued through SWIFT MT 760, the LC may require presentation of a copy of the guarantee together with confirmation from the issuing bank that the original guarantee has been issued to the Beneficiary and transmitted through the LC-issuing bank.

The Warranty Guarantee itself should clearly specify its validity period and when and how the Beneficiary may make a demand for payment.

For example, if the Warranty Guarantee is valid for 360 days and is payable at sight upon first demand, the Beneficiary may make a demand under the guarantee during its validity period, and the guarantor bank will make payment in accordance with the terms and conditions of the guarantee.

The important point here is that the Warranty Guarantee and the LC are two independent undertakings.

For example, the Warranty Guarantee may be valid for only 360 days, while the LC provides that the USD 300,000 will be payable 720 days after the presentation of the Warranty Guarantee and Acceptance Certificate.

Therefore, if the Beneficiary makes a demand under the Warranty Guarantee within its 360-day validity period, payment under the guarantee may be made at that time. This does not change the maturity of the USD 300,000 payment obligation under the LC.

Conversely, if no demand is made under the Warranty Guarantee during its validity period, the USD 300,000 may still become payable under the LC upon presentation of the Warranty Guarantee and Acceptance Certificate in compliance with the LC terms, with payment being made at the LC maturity, i.e. 720 days as stipulated in the LC.

This is the somewhat “zigzag” point that should be made very clear in the LC:

The validity period and payment mechanism of the Warranty Guarantee should not be confused with the deferred-payment period of the LC.

In other words, the LC should clearly specify the documents required to establish the issuing bank’s payment obligation for the USD 300,000 and the maturity of that payment.

The making and payment of a demand under the Warranty Guarantee, however, should be governed by the terms and conditions of the Warranty Guarantee itself.

(**) I have encountered a deferred payment LC with a deferral period of up to five years, under which the issuing bank undertook to make payments in installments according to a quarterly repayment schedule.

Best regards,

Mr. Old Man