STANDBY LCs and BACK TO BACK LCs

QUERY

Dear Mr. Huu Duc,

Occasionally, I have read your comments in some forums in international banking, especially LC. I also visited your blog and collect something about this matter. I am concerning about Standby LC and Back to back LC which I never practice with the real case. I wonder if you are available to help me to have the examples of these kinds of LC.

I am looking forward to your reply.

Thanks and Best Regards,
Tran Thi Thu Cam

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COMMENT

Dear Thu Cam,

Below is my quick answer to your question:

Standby LC

As in my comment on www.letterofcreditforum.com , standby LCs are used mainly in the US. Under the law of most of US states banks are prohibited from issuing guarantees, therefore, standby LCs are issued instead. The use of this type of LC is also increasing in EU.

The types of payment and performance that can be guaranteed by standby LCs consist of the following:

1/ payment of time bill of exchange (b/e guarantee)
2/ repayment of bank advance (# advance payment guarantee)
3/ payment of goods delivered (# shipping guarantee)
4/ delivery of goods in accordance with contract (# performance bond)
5/ execution of supply-and-install contracts (# tender guarantee, performance bond, warranty guarantee)
etc.

A Vietnamese buyer who wishes to his US partner to provide a bank guarantee, e.g., an advance payment guarantee, will receive a standby LC instead. As said US banks are not allowed to issued guarantees. On the contrary, an American seller who wishes to receive a standby LC from a Vietnamese partner will receive a bank guarantee instead as Vietnam banks mainly issue guarantees.

One thing I would like to note you is that a standby LC is normally subject to UCP or ISP 98, whereas a guarantee is normally issued subject to the local law. Of course, you may encounter guarantees subject to URDG.

Back to back LC

A trader (middle businessman) may wish to pay a supplier by transferring a sum owed to him under an LC even though the LC is not transferable. This can be done under a special arrangement called back-to-back LC.

The trader’s bank issues a second LC in favour of the supplier based on the security of the previous LC issued in favour of the trader. The bank is prepared to do so if the additional risks can be covered. Therefore, it insists on being nominated as paying bank for the second credit.

The bank also needs to be sure that there will be a smooth exchange of invoice because the original LC in favour of the the trader can not be settled on the strength of the supplier’s invoice from the second LC.
Please note UCP has no articles dealing with this special arrangement.

To illustrate the process, you are invited to observe the following example:

A Vietnamese importer requests his bank in Vietnam, e.g., Vietcombank Danang to issue an LC in favour of a trader in Hong Kong to import the goods produced in China.

As the Hong Kong trader is just a middle man, he must import the goods from a Chinese supplier to re-sell to the Vietnamese importer. But the Hong Kong trader does not have enough funds to pay the Chinese supplier. Therefore, he uses the LC issued by Vietcombank Danang in favour of himself as a security for his bank in Hong Kong, e.g., Cathay Bank Ltd Hong Kong, to issue an LC in favour of the Chinese supplier. This new LC is called a back-to-back LC.

Upon receipt of this LC, the Chinese supplier effects the shipment and presents the documents to his bank in China for negotiation. After negotiating (purchasing) the documents, the Chinese bank will forward the documents to Cathay Bank Ltd Hong Kong for reimbursement.

Upon receipt of the documents, the import division of Cathay Bank Ltd Hong Kong will examine the documents and send the documents together with the advice of the draft value to be paid by the Hong Kong trader to the export division of Cathay Bank Ltd Hong Kong. The Hong Kong trader is requested to present his draft and invoice to Cathay bank Ltd. Hong Kong. If the documents examined are complying with the terms of the export LC issued by Vietcombank Danang, Cathay Bank Ltd Hong Kong uses this proceeds to pay to the import division of this bank for the amount equivalent to the total amount paid to the beneficiary in China under the back-to-back LC. Then Cathay Bank Ltd Hong Kong will credit the Hong Kong Trader’s account for the difference (profit earned from the transaction).

Eventually, the documents are to be forwarded to Vietcombank Danang for payment/reimbursement. When the documents are taken up by the Vietnamese importer, the transaction are regarded as completed.

The trader is often facing dificulty in handling documents, especially the bill of lading. B/Ls prepared by a third party normally contain discrepancies such as:

* not complying with LC terms
* wrong endorsement
* not fully presented
* C/P presented

To avoid said discrepancies, the trader must be sure that the terms and conditions of the back-to-back LC must be based on relevant terms and conditions of the LC issued the final importer’s bank.

In practice, a middle trader prefers transferable LCs to back-to-back LCs. He just applies for a back-to-back LC when the LC issued by the importer’s bank is not transferable.

Hoping it is clear enough.

Best regards,
Nguyen Huu Duc …