PRACTICAL UCC – UNDERSTANDING AND DRAFTING LETTERS OF CREDIT IN

BUSINESS TRANSACTIONS

First Run Broadcast: November 30, 2012

1:00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes)

Letters of credit are extensively used to secure payment and ensure performance in commercial,

business and real estate transactions. They are often essential to the completion of a deal and

involve a complicated mix of parties –applicants, issuers, beneficiaries and sometimes assignees.

The challenge in using these instruments is ensuring their compliance with UCC Article 5, the

shortest and most obscure portion of the code. Imperfectly drafted letters can easily lead to a

failed transaction. This program will provide you with a real-world to guide to how letters of

credit are used in transactions, drafting the most essential components of a letter, understanding

the roles and rights of each of the parties to a letter, and common traps in complying with UCC

Article 5.

Practical uses of letters of credit in transactional deals

Understanding and drafting essential components of a letter of credit

Roles and rights of applicants, issuers, beneficiaries, and assignees

Common traps in letters of credit practice

How letters of credit differ from other credit enhancements or guarantees of performance

Role attorneys advising a clients on letters of credit

Speakers:

Carter H. Klein is a partner in Chicago office of Jenner & Block, where he has an extensive

commercial law practice, including secured and unsecured lending, credit enhancement issues

and credit workouts. He formerly chaired the ABA’s Letter of Credit Subcommittee and

formerly served as chair of the Commercial and Financial Transactions Committee of the

Chicago Bar Association. Mr. Klein is co-editor of “Uniform Laws Annotated -- Uniform

Commercial Code Forms and Materials,” published by Thomson-West. He is a member of the

American College of Commercial Finance Lawyers and formerly served as an Adjunct Professor

at Northwestern University’s Kellogg School of Business. Mr. Klein received his B.A. from the

University of Illinois at Urbana-Champaign and his J.D. from the University of Illinois College

of Law.

John Murdock is a partner in the Nashville office of Bradley Arant Boult Cummings, LLP,

where his practice includes business acquisitions and dispositions, commercial lending, and

commercial law generally. He is a member of the Commercial Financial Services Committee of

the ABA Business Law Section and formerly served as chair of its Lender Liability

Subcommittee. He is also a Fellow of the American College of Commercial Finance Lawyers.

Mr. Murdock received his B.S., magna cum laude, from Vanderbilt University and his J.D. from

Vanderbilt University Law School.

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Practical UCC – Understanding & Drafting Letters of Credit in Business Transactions

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PROFESSIONAL EDUCATION BROADCAST NETWORK

Speaker Contact Information

Practical UCC – Understanding and Drafting Letters of Credit in BusinessTransactions

Carter H. KleinJenner & Block – Chicago(o) (312) 923-2950cklein@jenner.com

John MurdockBradley Arant Boult Cummings, LLP - Nashville(o) (615) 252-2359JMurdock@babc.com

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Letters of Credit:in Business and Commercial Transactions

Prepared for

Professional Education Broadcast NetworkLive Teleseminar

Carter H. KleinJenner & Block LLPcklein@jenner.com

I. Introduction

Letter of credit bankers at large money center banks and their in-house counselhave a distinct advantage when it comes to knowing the rules, customs and practices thatgovern or define letter of credit transactions. Letter of credit activity in this country isconcentrated in a handful of large banks, allowing them to capitalize on their expertise.1

Those banks issue, advise, confirm, negotiate and examine documents presented onhundreds of letters of credit every day. They have well-trained employees, some with 20years or more of experience in letter of credit banking. Letter of credit bankers regularlyattend internal staff meetings to discuss letter of credit developments and occurrences,control risk and refine practices. Their attorneys are well-versed in letter of credit rulesand law, have carefully prepared and reviewed the bank’s letter of credit forms,agreements and procedures and are available to advise their bank clients on letter ofcredit problems and issues as they arise. Letter of credit bankers attend and participate inletter of credit conferences presented by experts and specialists from other major banks,the IIBLP,2 the IFSA,3 the ICC,4 the USCIB5 and private trade specialists. They take

1 Although there are over 7,000 banks in the United States, 10 banks account for well over half the dollar amount of alloutstanding letters of credit issued by U.S. banks. JPMorgan Chase Bank alone accounts for almost $100 billionface amount of standbys issued and outstanding as of the end of 2011. See Doc. Credit World (July-Aug. 2012).

2 Institute for International Banking Law and Practice. The IIBLP was instrumental in the drafting of the InternationalStandby Practices or ISP, publishes salient works on letters of credit, and holds major seminars on letter of creditpractice and law throughout the world. Their website is www.iiblp.org.

3 International Financial Services Association. IFSA is now merged with and known as BAFT–IFSA, BAFT standingfor Bankers’ Association for Finance and Trade. BAFT-IFSA membership is composed primarily of banks,including the largest U.S. banks and most of the major banks of the world with branches or banking subsidiaries inthe United States. BAFT-IFSA members handle over 98% of the letters of credit issued in the United States andover 98% of the U.S. funds transfer volume. The BAFT-IFSA represents the international operations of financialservices providers and trade finance personnel with particular emphasis on trade payments involving documentarycredits, funds transfer, treasury operations, compliance and regulatory reporting. BAFT-IFSA regularly sponsorsand conducts educational programs and conferences on payments, collections and letters of credit at the regional andnational levels.

4 International Chamber of Commerce. The ICC, through its Committee on Banking Technique, has promulgated theUniform Customs and Practice for Documentary Credits (the “UCP”) which gets revised about every ten years. Thelatest version of the UCP is the UCP 600. The ICC publishes commentary and supplement guides for the UCP.Their website is www.iccwbo.org.

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letter of credit training courses, tutorials and exams to become certified documentarycredit specialists (“CDCS”).6 They subscribe to and review letter of credit publicationssuch as the IIBLP’s Documentary Credit World or the ICC’s DC Insight. Finally,standard letter of credit practices used to supplement applicable letter of credit regimesare based on what letter of credit banks themselves do on a regular basis. 7

The purpose of this presentation is to provide attorneys that do not practicefrequently with letters of credit with practical legal advice on how to use letters of credit.This presentation explores rules, practices or practice pointers dealing primarily withstandby letters of credit as opposed to commercial letters of credit. Most lawyers thatonly occasionally have contact with letters of credit in their practice, have situations thatinvolve standby letters of credit. Standby letters of credit frequently involve negotiated,agreements and larger dollar amounts where lawyers tend to be more involved. Exceptperhaps to enjoin a fraudulent draw, most attorneys do not normally have much contactwith commercial letters of credit used to pay for goods shipped in international trade.Unless there is a dispute over a commercial letter of credit leading to litigation, applicantsand beneficiaries usually seek assistance, not from lawyers, but from experienced letter ofcredit bankers, international factors, freight forwarders, document preparation services,trained export-import staff, or other trade specialists.

II. What is a letter of credit and how is it used

A. Types. There are two major types of letters of credit: standby letters ofcredit used to secure payment or performance of an obligation, andcommercial letters of credit used to pay for goods in international trade.Commercial letters of credit were frequently used in the late 1800s andtheir use became widespread after World War I with the growth ofinternational trade. Standby letters of credit acquired use in the 1960s forcertain types of financings, such as real estate developments, shipbuildingand Middle East infrastructure projects and gained widespread use andrecognition in the 1970s. See Paul R. Verkuil, Bank Solvency andGuaranty Letters of Credit, 25 Stan. L.Rev. 716 (May 1973); John R.Dolan, The Law of Letters of Credit: Commercial and Standby Credits(A.S. Pratt 2002) ¶¶ 3.05 & 3.06.

5 The United States Council for International Business. The Banking Committee of the USCIB educates its membersand promotes their interests on international trade finance issues, including the UCP 600, documentary collections,and dispute resolution.

6 Becoming a CDCS requires some 4-6 months of independent study and passing a 3 hour examination consisting of120 multiple choice questions as well as 3 “in basket” exercises with questions which demonstrate skill in real-worldapplications of the UCP. The IFSA has a training course and exam for letter of credit personnel to become aCertified Documentary Credit Specialist. The ICC sponsors an on-line training program and discussion groups calledDC Pro. Private trade firms such as Mantissa and Sitpro also offer letter of credit training.

7 UCC §5-108(e) provides that an issuer shall observe standard practices of financial institutions that regularly issueletters of credit. The ISP rules are to be interpreted as mercantile usage with regard for practice and terminology ofbanks and businesses in day-to-day transactions and consistency within the worldwide system of banking operationsand commerce. ISP Rule 1.03(b) & (c). Compliance of documents presented with the credit terms are determinedby international standard banking practices as reflected in the UCP. UCP 500, Art. 13(a). A complyingpresentation under UCP 600 is one that is in accordance with the terms and conditions of the credit, the applicableUCP articles and international standard banking practice. UCP 600, Art. 2.

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1. Commercial Letters of Credit. Commercial letters of credit arealways drawn upon to effect payment against live documents suchas bills of lading, insurance certificates, invoices, inspectioncertificates and customs invoices. Upon presentation ofconforming documents, the seller receives through the network ofletter of credit banks involved, payment and the buyer receivescontrol of the goods ordered. The issuing or negotiating bankreceives a security interest or title to the goods until it isreimbursed, unless it chooses to release those documents to theapplicant or issuer before it is reimbursed.

a. Almost all commercial letters of credit are governed by theUniform Customs and Practice for Documentary Credits orUCP promulgated by the International Chamber ofCommerce (the “ICC”). The current version is UCP 600named after the ICC publication number in which the UCPis found. The UCP 600 was adopted in October of 2006 bythe ICC Banking Commission and became effective on July1, 2007. Although the UCP 600 still has someshortcomings, most bankers, applicants and beneficiariesfind it more user-friendly than the UCP 500 and haveaccepted its use in commercial letters of credit.

b. Commercial letters of credit are usually of short duration –ninety days or less. Their duration is only long enough forthe seller to procure or manufacture and ship goodsordered. If the goods are not shipped within a time certain,as shown by the documents called for by the letter of creditsuch as a bill of lading, then the letter of credit cannot bedrawn upon.8 If the beneficiary wants to avoid thispreclusion, he should either state in the letter of credit“Stale Documents Permitted” or provide for a longer timeto present them than the 21 day default rule of the UCP.

c. Commercial letters of credit are characterized by highdiscrepancy rates due to a combination of (i) the complexnature and variety of the documentation involved in cross-border shipping, (ii) the lower level personnel involved inpreparing them (frequently with language and translationissues), (iii) the technical nature and detail of the rulesunder the UCP for determining the compliance of thedocuments with the documents described or specified in the

8 The default rule under the UCP is that the shipping documents show that the seller has delivered the described goodsto a carrier at a designated shipping point for its intended destination within 21 days from the date of issuance of theletter of credit. UCP 500, Art. 43; UCP 600, Art. 14(c). If the seller does not want this rule to apply, it shouldnegotiate for a longer period or request that the letter of credit permit presentation of stale documents.

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letter of credit, and (iv) the strictness with which the UCP’srules for determining compliance of the documents with thecredit are applied (the “strict compliance standard”).9

d. Most attorneys would be well-advised to work with a letterof credit specialist in reviewing commercial letters of creditbecause commercial letter of credit practice and rules arecomplex, subject to interpretation, and discrepancies likely.Rules and interpretation of rules governing UCPcommercial letters of credit are embodied in the 39 articlesof UCP 600, in the 185 sections interpreting the UCP 600contained in the ICC’s International Standard BankingPractices publication or the ISBP, and by dozens ofinterpretations and DocDex decisions rendered by the ICCBanking Commission. In addition, commercial letters ofcredit used in international trade are usually issued bySWIFT message, which has its own set of codes and fieldswhich must be understood.

2. Standby Letters of Credit. Standby letters of credit are usedprimarily to assure payment of financial obligations. Thirty of thevarious types of obligations which standbys are used to secure arelisted below in Section II.C. Standby letters of credit are usuallybut need not be longer term than commercial letters of credit. Theamounts involved can be quite large. Standbys are divided intotwo major subtypes: true, traditional or default standbys and directpay standby letters of credit.

a. A true, default or traditional standby letter of credit isworded to call for a default certificate or statementcertifying or stating that a default has occurred in thepayment or performance of the underlying obligation thatthe standby letter of credit is issued to secure.

b. A direct pay letter of credit is priced and risk-assessed likea standby, but is meant to be drawn upon to satisfy theobligation which it secures. Direct pay letters of credit areused instead of a traditional standby to provide thebeneficiary with better protection against preferences underSection 547 of the Bankruptcy Code. (See below.) If thebeneficiary receives payment from the issuing bank, thepayment is not normally subject to avoidance as apreference even if the applicant files for bankruptcy within

9 Many letter of credit cases and the UCC provide that documents presented under letters of credit must strictlycomply with the term and conditions of the letter of credit which call for them. See UCC §5-108(a). Some foreignbanks are known for being sticklers for documentary compliance to drive up discrepancy fees.

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90 days after the payment is made through the letter ofcredit.10 That is because the courts have determined thatthe beneficiary receives funds of the issuer and not thebankrupt applicant so that there is no “transfer” of propertyof the debtor when the letter of credit is drawn upon withinthe meaning of Section 547 of the Bankruptcy Code.Direct pay letters of credit are frequently used to securemunicipal bond issues and commercial paper issuances.

c. Once drawn upon, some direct pay standby letters of creditprovide that they automatically reload by the amount drawnunless the issuer gives written notice within a designatedtime after the draw to the beneficiary that it will not reloadthe letter of credit. These types of standbys are used tosecure rated or structured debt issues so that again, thebeneficiary will not be subject to preferences.

B. Definition. A letter of credit is an independent undertaking by an issuer,issued at the request of or for the account of an applicant to honor, usuallyby payment, a beneficiary’s timely presentation of documents whichconform to the terms of the credit. UCC 5-102(a)(10).

1. Two-party letters of credit. A financial institution can issue atwo-party letter of credit, i.e., one for its own account such as abank acting both as trustee for industrial revenue bondholders andas an issuer of a letter of credit securing the industrial revenuedevelopment bonds issued. Id.

2. Issuers are usually banks. Although not required by Article 5 ofthe Uniform Commercial Code, an issuer is usually a financialinstitution, usually a bank, as opposed to a corporation or business.Individuals are not permitted to issue letters of credit for personal,family or household purposes. UCC 5-102(a)(9).

a. Sometimes major merchants such as Target or Wal-Martwill issue their own two-party letters of credit to suppliers,especially Chinese Suppliers or their middlemen. Thesedocuments look like letters of credit, and are frequently

10 A famous case illustrating this point is In re Powerine Oil Co., 59 F.3d 969 (9th Cir. 1995). Justice Kozinski in hisopening remarks in the case stated: “Can an unsecured creditor be better off when the debtor defaults rather thanpaying off the debt? Yes, truth can be stranger than fiction in the Preference Zone.” The case involved a traditionalletter of credit posted to secure oil shipment payments. When payment was late, instead of drawing on the letter ofcredit, the seller accepted late payment during the preference period. Those payments were attacked and partially setaside as preferential. The creditor would have been better off drawing on the letter of credit to effect payment,avoiding a preference. Better yet, the use of a direct pay letter of credit would have avoided the preference issuealtogether since even payments made on time would be paid through draws on the letter of credit and there would beno need to prove that the payment was made in the ordinary course of business (an exception or defense against apreference challenge) as opposed to having been made under circumstances involving financial distress of the debtor.

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advised through legitimate major banks. The suppliersusually accept these “letters of credit” by manufacturingand shipping the goods. However, they frequently containconditions controlled by the applicant-issuer such as acertificate of approval from the applicant that the goodsconform to the order. This means the applicant has thefinal right of approval of whether a drawing will be allowedunder its “letter of credit.” Merchant letters of credit alsoinclude a lot of additional fees and charges.

b. A major retailer bankruptcy or major litigation challengingthese “letters of credit” could undermine their use.However, they seem to be working for the large retailchains because of their command of the marketplace.

3. Formalities. Letters of credit, their amendment, advice andconfirmation must be in writing or evidenced by a record andauthenticated by a signature or by an authentication methodauthorized by the parties or standard letter of credit practice. UCC5-104.

a. As noted above, letters of credit issued internationally arefrequently issued and authenticated through SWIFT basedon codes, conventions and data filled in designated fieldsby the issuing bank. The advising bank then will producefrom this coded message, a document that will look like astandard letter of credit.

b. In 2002, the International Chamber of Commercepromulgated an addendum to the Uniform Customs andPractice for Documentary Credits called the eUCP. Thisaddendum contemplates electronic presentation (not justfax presentation) of documents to effect a draw. It is notused much in practice, as the international trade industry,including shipping lines, insurers, bankers, and majorindustries, struggle with how to electronify bills of ladingin a safe and internationally acceptable manner. Theproblem is that almost 200 nations of the world have theirown laws, many of them paper based, and in almost allcases, they have no laws at all governing electronicdocuments. The eUCP has not been used much in practice.It is one of the few areas where the ICC tried to make rulesfor a system before it was actually in use.

C. Uses -- Commercial letters of credit are used to pay for goods sold anddelivered in international trade. Standby letters of credit can be used tosupport or pay almost any type of underlying obligation. Standby letters

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of credit have been used to secure obligations in connection with thefollowing types of transactions:

1. Workmen’s compensation insurance fronting arrangements2. Surety bonds3. Commercial paper4. Municipal or industrial revenue bonds5. Power plant construction6. Other construction contracts7. Open account indebtedness8. Government permits9. Government contracts10. Cable installation obligations11. Purchase price holdbacks12. Advance payment guarantees13. Bank guarantees14. Environmental clean-up15. Executive compensation16. Reinsurance obligations of nonadmitted reinsurers17. Financial contracts such as SWAPs18. Forward Contracts (e.g., power purchase agreements)19. Clearing obligations (e.g. Chicago Mercantile Exchange)20. Road and subdivision improvements21. Obligations to consumers or the public22. Supersedeas in lieu of appeal bond23. Pre-judgment attachment security24. Injunction security25. Preliminary arbitration awards26. Office lease security27. Equipment lease security28. Securitizations29. Oil for food and medicine (Iraq)30. Exchange of prisoners (Cuba)

D. Largest Dollar Amount Use -- Although there are dozens of differentuses for letters of credit, the greatest use by dollar volume for standbyletters of credit are standby’s posted as security for the following types ofobligations:

1. Municipal bond issues;2. Obligations of foreign reinsurers to U.S. insurance companies and

sureties;3. Indemnities by private business to insurance companies fronting

for workmens compensation and other types of state mandatedinsurance.

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E. Standby Letter of Credit Volume -- According to the FDIC, U.S. banksand thrifts and U.S. branches of foreign banks had issued and outstandingover $614,000,000,000 in standby letters of credit at the end of 2011.11

F. Commercial Letter of Credit Volume -- Over $1,000,000,000,000 ofgoods sold and shipped in international trade is paid for each year by useof letters of credit.12

G. Largest Letters of Credit Issued -- The largest letters of credit issuedinclude the severally issued letter of credit posted by AT&T to act assupersedeas for the $1.9 billion judgment obtained against it by MCI in ananti-trust case filed and tried in the Northern District of Illinois, and aletter of credit in excess of $5 billion posted by Exxon to secure paymentof the judgment against it arising out of the Exxon -Valdez oil spill case.Each of these letters of credit were severally issued by a consortium ofbanks.

III. What Distinguishes Letters of Credit from Other Types of CreditEnhancements

A. Primary Alternatives to Letters of Credit:

1. Surety or performance bond -- Bonds are issued by insurancecompanies. Most do not have expiration dates, although theircoverage period for claims can be specified in the bond. Theirpayment of a claim goes through a claims review process, andunlike letters of credit, the surety can raise the defenses of theprimary obligor against payment on the bond and in some cases itsown suretyship defenses. This can lead to litigation which must becompleted or settled before payment is effected. The pricing of abond is usually lower than that for a letter of credit, but frequentlythe bonding company will require that a letter of credit be issued toit by a major rated bank that can easily be drawn on and will beextended indefinitely until the insurer chooses to draw on it orrelease it. Thus the primary obligor ends up paying two fees – apremium for the issuance of the bond, and the annual and otherfees for issuance of the letter of credit and is also stuck withkeeping in place a letter of credit issued to the bonding company

11 $434,364,255,000 standby letters of credit were issued by U.S. banks and outstanding as at the end of the fourth quarter 2011;$177,339,779,000 in outstanding standby letters of credit were issued by U.S. branches of foreign banks at the end of the fourthquarter 2011; and $3,065,017,000 of standbys issued by thrifts were outstanding at the end of the fourth quarter 2011. SeeStatistics Section of DCW Issues July/Aug 2012, Sept. 2012, and Oct. 2012.

12 This figure is an extrapolation of the estimated amount of annual world trade ($12,000,000,000,000) times the amount of worldtrade paid through commercial letters of credit (11%). The amount of commercial letters of credit issued and outstanding in theUnited States at any one time is only about one-tenth of the amount of standbys issued and outstanding. The figure for the totalamount of commercial letters of credit issued in a year is larger than the standby figure because (i) commercial LC’s have arelatively short duration (90 days or less), so that annually many more are issued (and expire) during a year than are outstanding atany given time, and (ii) the figures for commercial LC’s include those issued by banks all over the world and not just from the U.S.

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until the bonding company decides all conceivable issues, claimsand statutes of limitations have run their course.

2. Financial guaranty insurance. Financial guarantee insurance isissued by a handful of what are known as monoline insurancecompanies that until recently had AAA ratings.13 The cost offinancial guaranty insurance was generally very low, but thesemonoline insurers usually would only insure obligations of state orlocal governmental bodies that had taxing power to repay theinsured debt, or they insured debt of companies that already had acredit rating of A or would have such a rating if rated. The purposeof the use of this type of insurance is to move the rating of theinsured debt from say “A” to “AAA” to enable it, with the higherrating, to command a lower interest rate in the financialmarketplace for rated bonded debt. This mean that only very largedebt issues are insured, because the debt has to be rated,underwriting analysis performed, and then the say 50 basis pintssavings involved has to justify the cost of the insurance, obtainingand maintaining a debt rating and other costs of the underwriting.Monoline insurers would thus insure specific debt issues only ofstate or municipal governmental bodies, large corporations withgood credit ratings or with debt that could structured with the useof a special purpose vehicle as having a separate good rating.Until 2007, no monocline had ever defaulted on making a paymentof insured debt and in fact none were ever even downgraded.Monolines captured almost 50% of the municipal debt market bythat time.

Monolines got into trouble when they insured credit default swapsand debt securities of subprime mortgage pools which wereunderwritten with assumptions that did not contemplate the defaultrates, foreclosures and decline in real estate values of the subprimemortgage crisis. The result of their insuring mortgage backedsecurities is that five of the seven major monocline insurerssuffered a decline in their AAA ratings. Some were evendowngraded below investment grade because they had to pay outhuge losses in derivatives market transactions that they insured.Unless they possessed sufficient capital to shore up these losses,their ratings suffered and they became unable to compete in themarkets from which they generate the bulk of their business –raising a rating of a debt issue from A to AAA. One result of thedecline of the ratings of the monolines has been a reported uptick

13 The large monoline insurers included American Bond Assurance Corporation (Ambac), Municipal Bond InsuranceAssociation (MBIA), ACA Financial Guarantee Group, Assured Guaranty Corporation, Financial GuarantyInsurance Company (FGIC), Financial Security Assurance (FSA), and XL Capital Assurance.

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in letter of credit backed industrial revenue and governmentalagency bonds that previously were insured by the monolines.

3. Export insurance. Export insurance is a strong competitor withcommercial letters of credit for international trade paymentassurance. The three major export insurers are Euler, CoFace, andAtradius. Export insurance, with a number of exceptions, insuresloss from a credit default by the buyer in an international sale ofgoods or services. To qualify for the insurance, both the exporterand the foreign buyer must be on approved lists of the exportinsurers, the trade credit extended must be within aggregate limits,within limits specified by the insurer for the particular buyer, andthe terms of the sale otherwise must conform to the terms of exportinsurance policy. The export insurer insures against nonpaymentdue to insolvency and political or country risks, but does not insureor pay if nonpayment is due to disputes over the quality of thegoods shipped, their conformity to contract terms, or the timelinessof their delivery. Export insurance is usually less expensive thanthe cost of letters of credit, but obtaining export insurance involvespre-approval and documentation processes that are burdensome.Unlike letters of credit, export insurance does not tie up lines ofcredit of the buyer or require collateral. State and federalgovernment export insurance programs are also available toencourage U.S. exporters to sell on credit into specifiedinternational markets subject to the conditions and criteriaspecified in the respective government export insurance program.14

4. Documentary Collections. Documentary collections are simplythe payment for goods shipped in international trade againstspecified shipping documents, again through the banking system.If the buyer does not pay, the bill of lading and control of thegoods remains with the seller and the seller’s bank. While cheaperthan letters of credit, documentary collection does not assure theseller that it will receive payment when it ships the goods. Nobank stands behind the obligation of the buyer to pay for the goodsshipped. The seller therefore may be stuck with unsold goodsoverseas in a declining market or without ready means to disposeof the goods without incurring substantial losses, in either case, ifthe buyer chooses not to or is unable to pay for them.

5. Private guaranty. A corporate or other guaranty can providecomfort to a party entitled to payment or performance from acompany which is an affiliate of the guarantor. Problems withguaranties include the availability and willingness of a guarantor to

14 The U.S. government’s program is through the Export-Import Bank or Ex-Im Bank. See their website for moredetails of their export insurance program at http://www.exim.gov/products/insurance/index.cfm.

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furnish a guaranty and the creditworthiness of the guarantor.Guaranties do not provide either instant liquidity or avoid the needto prove in a lawsuit or otherwise, that the beneficiary of theguaranty fully performed and the primary obligor breached theunderlying obligation guaranteed. Unless waived in the guaranty,the beneficiary is subject to a variety of suretyship defenses thatthe guarantor can raise.15

6. Independent bank guarantee. Bank guarantees are sometimescalled demand guarantees, independent bank guarantees,unconditional guarantees, simple demand guarantees or firstdemand guarantees. A bank guarantee is in some respects theEuropean equivalent of a standby letter of credit. Although theUNCITRAL Convention on Independent Guarantees and Stand-ByLetters of Credit has not been ratified by any major country, it setsforth a number of principles applicable to bank guarantees parallelto those applicable to letters of credit. Like letters of credit, thepayment undertaking under a bank guarantee is regarded asindependent of determination of performance of the underlyingobligation the guarantee supports. The guarantee is usually issuedby a bank and payment is made after the beneficiary makesdemand on the guarantee. True bank guarantees are consideredindependent obligations of the issuer and thus are not normallysubject to injunction in the absence of a showing of fraud.

Bank guarantees and the law governing them are not as clear asU.S. law and the ISP governing standby letters of credit. However,the ICC in 1992 promulgated a regime to govern bank guaranteescalled the Uniform Rules for Demand Guarantees, ICC PublicationNo. 458 (the “URDG”). The ICC has now updated URDG with anewer version, ICC Publication No. 758, which became operativeon July 1, 2009. Bank guarantees differ from standby letters ofcredit in that bank guarantees may not have an expiration date,may be subject to termination upon the occurrence of an event, andpayment is normally triggered by a simple demand. The wordingof demand guarantees can vary and in some cases the issuer of ademand guarantee may not regard it as totally independent of theunderlying obligation that it supports. Like a bond, to induce aforeign bank to issue a bank guarantee in favor of a foreignbeneficiary to secure performance of a contract or shipment ofgoods, the foreign bank guarantor will usually require the U.S.applicant to obtain and furnish a standby letter of credit to securethe issuer of the bank guarantee in case it is called upon.Significant problems and difficulties can be encountered to obtain

15 See e.g., UCC 3-605.which covers discharge of endorsers and accommodation parties on a note.

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release of that letter of credit when the U.S. seller or contractorbelieves it has performed and the foreign buyer argues otherwise,asking instead for a payment or discount on the price.16

7. Cash or other collateral. Documenting a security interest incollateral is one way of assuring payment or performance of anobligation. Sometimes, however, the cash or other collateral is notavailable. If the collateral is not cash, than the secured party isfaced with the problem of converting it to cash by a foreclosureprocess that can be uncertain, technical, contested and interruptedby a bankruptcy or counterclaim.

8. Escrow. Escrows can be established to hold funds or documents tosecure or await performance of an obligation. If the escrow is ajoint order escrow, the escrow agent will not act unless both partiesagree to direct it to act, or a court of competent jurisdiction ordersit to act. Sometimes an escrow agent will agree to act at theunilateral direction of a secured party. Not all escrow agents willagree to do so. Escrow agreements require careful drafting and canentail substantial expense if the escrow agent is a major institutionand/or the amount held in escrow amount is large. Sometimesescrows will be the subject of litigation, in which event the escrowagent will usually not release funds or other escrowed propertyuntil the litigation is resolved. Finally, escrow agents will notusually exercise independent judgment to determine whether torelease property held in escrow.

9. Netting. Netting is the offset of obligations either on a bilateral ormultilateral basis based on multiple financial transactions, toreduce the net amount owed on those transactions occurring overthe same period of time. It is commonly used in SWAPagreements of various types between the same parties or corporategroups. In the Enron bankruptcy, there were dozens of caseswhere corporate groups asserted netting and the bankruptcy estateresisted on the grounds that the debts were not mutual. While theBankruptcy Act and the FDIC regulations have been amended tomore liberally allow netting, it still cannot be used to reduceexposure for single transaction obligations. Nor does it in and ofitself provide security for the net amount owed. The CollateralAnnex to the standard ISDA SWAP Agreement provides a form ofletter of credit to be posted under certain circumstances to securethe net amount owed from time to time.

B. Advantages of Letters of Credit:

16 See Carter H. Klein, “Standby Letter of Credit Rules and Practices Misunderstood or Little Understood byApplicants and Beneficiaries,” 40 U.C.C.L.J. 2 (Fall 2007).

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1. Instant liquidity -- The terms of a letter of credit can specify thatfax presentments are allowed and that the draw must be honored(or notice of dishonor given) within a few days or less. In somecases for special large customers, such as trustees for bondholders,to secure commercial paper or to secure clearing obligations owedto commodities or security exchanges, the letter of credit will bepayable on the same day as presentation is made. The payment isby cash usually via wire transfer by the issuer to the beneficiary’saccount.

2. Solvency of issuer – By use of a letter of credit, the beneficiary isassured that the payment obligation is backed by credit of a bankwhich is substituted for or added to credit of a corporate orindividual applicant. The creditworthiness of the bank can bedetermined or specified in the selection process and/or set forth inthe letter of credit or the underlying agreement that provides foruse of a letter of credit. If the credit of the issuing bankdeteriorates below identified credit categories or designated ratingslevels, the beneficiary of the letter of credit should be able to drawon the letter of credit if the applicant does not replace the letter ofcredit with one issued by a bank with an acceptable credit ratingwithin a time certain – say 30 days after the downgrade of theissuing bank.17

3. Independence of issuer – Except for material fraud, the issuer’sobligation to honor is independent of the obligations of the parties(applicant and beneficiary) to and their disputes over theunderlying contract which the letter of credit supports. The issueronly looks to see if the documents presented are timely andconform to the documentary conditions specified in the letter ofcredit. The issuer looks to standard banking practice for thatdetermination, as supplemented by the UCP and ISBP if the UCP isapplicable to the credit, or the ISP, if the ISP is applicable. SeeUCC 5-108(a), (e); UCP 500, Art. 13(a); UCP 600, Art. 2(definition of “Complying Presentation”); ISP Rules 1.03(b) and4.01(b). The issuer does not and should not involve itself inwhether the undying contract has been properly performed.

17 Typical formulations of issuing bank qualifications include banks that are over a certain asset size,maintain a minimum capital level, that are “well capitalized” within the regulatory guidelines, or its depositsor holding company debt ratings are rated by a major ratings company above certain levels. During thefinancial crisis, other measures were used or considered including the loss of deposits from period to periodover certain amounts or percentages, or its credit default spread exceeded a certain threshold (not generallyknown except by other banks). To be well-capitalized under federal bank regulatory agency definitions, abank or bank holding company must have a Tier 1 capital ratio of at least 6%, a combined Tier 1 and Tier 2capital ratio of at least 10%, and a leverage ratio of at least 5%, and not be subject to a directive, order, orwritten agreement to meet and maintain specific capital levels. These capital ratios are reported quarterly onthe bank’s call report. See 12 CFR 325.103.

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4. Bankruptcy avoidance

a. Automatic stay -- Unlike attempting to realize oncollateral, because a draw on a letter of credit is treated as adraw on the funds of the issuing bank and not the funds ofthe bankrupt debtor, courts should not enjoin otherwiseproper draws or treat the automatic bankruptcy stay underSec. 365 of the Bankruptcy Code as applicable.

b. Ipso facto clause -- Sec. 365(e)(1) of the Bankruptcy Codeprevents a counterparty from declaring a default andterminating a contract with a debtor simply because thedebtor is insolvent or bankrupt. However, that provisiondoes not stop a beneficiary from drawing on a letter ofcredit to repay itself for indebtedness owed to it secured bythe letter of credit, if the conditions of the letter of credit toeffect a draw are met. See In re Prime Motor Inns, 130B.R. 610 (S.D. Fla. 1991). Some caution should beexercised here.

c. Preferences – As noted above, a draw on a letter of creditto pay for an obligation of a bankrupt applicant is notnormally regarded as transfer of the bankrupt’s estate;rather the money transferred are regarded as funds of theissuing bank. Id. As a result, courts will not normally setaside as preferential a paydown of a debt effected by a drawon a letter of credit. The exception is if the letter of creditwas posted to secure the debt within 90 days of theapplicants bankruptcy, the debt was antecedent, and theletter of credit reimbursement obligation was secured. SeeIn re Compton, 831 F.2d 586 (5th Cir. 1987); In re AirConditioning, 845 F.2d 293 (11th Cr. 1988).

5. Pay now, litigate later -- Courts have taken the view that if thereis a problem with the underlying contract or its performance whilea draw is being made or about to be made on a letter of credit, thebeneficiary should be entitled to draw and hold or use the proceedsuntil the dispute or litigation is resolved. In the absence ofegregious fraud, courts will treat the rights of a beneficiary under aletter of credit, similar to those of a party already holding the cash,usually without restriction. Courts have used the phrase -- paynow, litigate later to describe the beneficiary’s rights against theobligation of the issuer and applicant to allow the beneficiary todraw on the letter of credit. See Eakin v. Continental Illinois Nat.

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Bank & Trust Co., 875 F.2d 114 (7th Cir. 1989); In re Sabratek,Corp., 257 B.R. 732 (Bankr. Del. 2000).

6. Difficult to enjoin draws -- The standard to enjoin a draw on aletter of credit is material fraud. UCC 5-109. Official Comment 1to that section states that “material fraud by the beneficiary occursonly when the beneficiary has no colorable right to expect honorand where there is no basis in fact to support such a right to honor.The comment goes on to endorse cases such as Intraworld Indus. v.Girard Trust Bank, 336 A.2d 316 (Pa. 1975) and Ground AirTransfer, Inc. v. Westates Airlines, Inc., 899 F. 2d 1269 (1st Cir.1990) where the standard for injunction is very high -- the fraudmust be “so serious as to make it obviously pointless and unjust topermit the beneficiary to obtain the money.” In addition, UCC 5-109 puts the burden on the applicant to show all the otherrequirements for equitable relief have been met, includingirreparable harm, no adequate remedy at law, the public interestand posting a bond.

7. Adaptability. As is shown from the variety of uses for letters ofcredit enumerated above, a letter of credit can be tailored to securealmost any type of obligation. The draw conditions can requireelaborate or simple certifications identifying the obligation securedand the events justifying the draw.

8. Expiration date can be extended. Although issuing banks insertan expiration date on a letter of credit, which is usually one year orless from the date of issue, through the use of an automaticextension clause, the letter of credit can be extended over a multi-year period or even indefinitely. These clauses work automatically,so that unless the issuer sends out notice in advance of expirationalerting the beneficiary that it will not extend the letter of credit,the letter of credit will be extended. If the notice is sent and theletter of credit and/or underlying agreement is properly worded, thebeneficiary can then draw on the letter of credit to hold the cashproceeds as cash collateral unless the applicant procures a suitablereplacement letter of credit two weeks or more before the currentletter of credit expires.

9. Documentary safeguards. An applicant that is concerned aboutuncontrolled draws by a beneficiary can draft documentaryconditions to guard or protect against untoward or unjustifieddraws. These safeguards could include such documents as thirdparty inspection certificates, copies of judgments or arbitrationawards, copies or originals of bills of lading and other shippingdocuments, or even opinions of counsel as well as detailed

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statements, which if false, could give rise to a cause of actionagainst the beneficiary after the draw is effected or if fraudulent, toenjoin the draw.

10. Payment against right to receive goods. Documentary creditsused in international trade provide that the beneficiary mustpresent to the issuer shipping documents, including bills of lading,to receive payment. These documents are passed along to theapplicant to enable it to receive the goods shipped which are beingpaid from a draw on the letter of credit.

11. Cost is relatively modest. The cost of a letter of credit can varywith the creditworthiness of the applicant or if cash or liquidcollateral is posted to secure it. One rule of thumb that largerbanks sometimes use is to charge for letters of credit based on thespread between the prime rate and the borrowing on the loanfacility offered to the applicant. This pricing in theory reflectsextra cost for extra risk. If the borrowing rate is prime + 1.5%, aletter of credit fee will be 150 basis points. That method does notwork for borrowers that borrow at prime, so there is a minimumpercentage charge that bank issuers will impose to reflect their costof capital, expenses, and profit. On letters of credit issued by abank secured by a brokerage account of an affiliate containingliquid securities, the fee could be as low as 80 basis points. So thenormal range for the annual fee, usually paid quarterly, is between75 and 150 basis points. There are other fees as well, such asissuance and payment fees, amendment fees, document preparationfees, fees for advising or confirming a credit, and others. Whilebond premiums are usually less than letter of credit fees, as notedabove, a letter of credit usually has to be posted to the bondingcompany to induce it to issue the bond – resulting in two feesbeing paid.

IV. Sources of Letter of Credit Law -- Statutes and Conventions

A. UCC Revised Article 5

1. Revised Article 5 of the UCC is effective in all states and theDistrict of Columbia.

2. It has been uniformly adopted with the following exceptions:

a. A few states have deleted or varied provisions on themandatory award of attorneys fees (UCC § 5-111(e)),

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b. A few states allow a jury rather than the court to determinestandard banking practice where that is an issue in the case(UCC § 5-108(e)), and

c. One state has altered the Article 5 definition of good faithto include the observance of reasonable commercialstandards of fair dealing. (UCC § 5-102(a)(7))

3. Revised Article 5 clarifies fraud standard by adopting the materialfraud test and requiring other requirements for injunctive relief tobe met. (UCC § 5-109).

4. Article 5 clarifies warranties of presenter (UCC § 5-110). Now abeneficiary presenting documents warrants to the issuer, anyconfirmer and the applicant that there is no fraud in the transactionand that the presentation of documents to effect a draw does notviolate the terms of any underlying agreement the obligations ofwhich the letter of credit supports. If you represent the applicant,try to draft the requirements of the draw certificate so that it runs tothe applicant as well as the issuer to better support your case ofmisrepresentation or breach.

5. Article 5 provides for subrogation rights to the applicant and issuerbut only after a draw is honored. This provision of revised Article5 resolves a split in the pre-revised Article 5 caselaw. (UCC § 5-117).

6. Endorses and largely defers to regimes such as the UCP and ISP(UCC § 5-116(c)). The ISP has gap filler terms that arereasonable, transparent and user friendly. Use of ISP isrecommended for standbys.

7. Revised Article 5 allows the parties to choose the law and forumgoverning the letter of credit. In the absence of a choice to thecontrary in the letter of credit, the law of the issuer’s locationgoverns the letter of credit. (UCC § 5-116). An issuer generallydoes not submit to the jurisdiction of the applicant simply byissuing a letter of credit to an applicant located in a foreign or outof state jurisdiction.

8. Article 5 adopts standard banking practice as the properinterpretative rule for determining compliance of documents withthe terms of the letter of credit. (UCC § 5-108(e))

9. Except in a few states, attorneys fees are now to be awarded to theprevailing party in letter of credit litigation (UCC § 5-111(e)).

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10. UCC Article 5 revisions are summarized in the ABA’s August 1995Business Lawyer and ABA’s 1998 “The ABC’s of the UCCArticle 5.”

B. UCC Article 9 Revisions Affecting Letters of Credit

1. Letter of credit drawing rights are governed by UCC Article 5, notArticle 9.

2. A transfer of drawing rights is a novation producing a new orparallel letter of credit; it is not a creation of a security interest.

3. Assignments of letter of credit proceeds are governed by both UCCArticle 5 (see § 5-114) and UCC Article 9. See §§ 9-107, 9-203(f),9-308(d); 9-312(b)(2); 9-314(a); 9-329.

4. The right to letter of credit proceeds (called "letter of credit right"in UCC Rev. Revised Article 9) is assignable before drawing. UCC§ 5-114.

5. A perfected security interest in the beneficiary’s underlying rightsecured or to be paid by an letter of credit, such as an account,automatically perfects security interest in beneficiary’s right toletter of credit proceeds under Rev. 9 as a supporting obligationUCC § 9-308(d).

6. A bank’s consent to assignment of letter of credit proceeds(“control”) is required under UCC Articles 5 and 9 to perfect bothan outright assignment of proceeds and a security interest inproceeds. § 5-114; § 9-107.

7. Assignments of letter of credit rights as additional security seldomused in practice by secured lenders.

8. Issuer’s discourage blanket assignments of letter of credit proceedsunless the issuer is also the secured lender.

C. Uniform Customs and Practices for Commercial Credits (UCP 600)

1. The UCP is almost universally used for commercial letters ofcredit and for a large number of standby letters of credit (perhaps20-40%).

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2. The UCP governs standby letters of credit to the extent its articlesare applicable.18 The UCP does not explain when and how itsarticles should be applied to standby letters of credit. Mostlawyers and their clients do not have a working knowledge of thearticles of the UCP or the written19 and unwritten standard customsand practice of banks that regularly issue, confirm or advise lettersof credit and examine and negotiate or accept documents presentedunder letters of credit. Even preparing a draft to be presentedunder a standby letter of credit can present challenges for thosethat do not have a working knowledge of how banks expect draftsto be worded and presented. Yet every regime that governs lettersof credit provides that standard banking practices or internationalstandard banking practices are to be used to determine whetherdocumentary presentations and other aspects of letter of credittransactions are proper and compliant.20

3. The UCP contains a number of provisions inappropriate forstandbys. These include those dealing with inconsistencies, forcemajeure, installment drawings, stale documents and limits ontransfer. See discussion below on ISP.

4. ICC Publication 600 can be purchased from the ICC aticcbooksusa.com.

5. The eUCP (effective April 2002) is a supplement coveringelectronic presentations, which as noted above, is not used much inpractice.

6. The International Standard Banking Practice (ICC Publication 645)- provides 200 interpretations and “mini-rules” for UCP. It wasrecently revised to accommodate the UCP 600.

D. International Standby Practices (ISP 98)

1. The ISP was drafted and sponsored by the Institute forInternational Banking Law & Practice (IIBLP) and adopted by theICC as ICC Pub. 590, which is available at iccpub@interport.netand www.iiblp.org). It has been in effect for about ten years now

18 UCP 500, Art. 1; UCP 600, Art. 1.19 The UCP is supplemented by the International Standard Banking Practices (“ISBP”) approved by the ICC Banking

Commission in October 2002. The ISBP is a distillation into 185 sections of interpretations of the UCP, written by aspecially-appointed committee of the ICC Banking Commission after receiving and reviewing national committeecomments and dozens of ICC interpretative letters on the UCP. The ISBP has been revised for the UCP 600.Although the ISBP has a statement of general principles, most of its sections deal with specific commercial letter ofcredit practice and documents.

20 Under the UCP, the ISP and Article 5 of the Uniform Commercial Code, the conformance of documents to theterms of the credit are determined under standard banking practice. UCP 500, Art. 13(a); UCP 600, Art. 2 (definitionof “Complying Presentation”); ISP, Rules 1.03(b) and 4.01(b); UCC §5-108(a), (e).

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and has received widespread usage and acceptance for standbys byU.S. banks and their customers. Major banks report that the ISP isused in about 70-80% of their standbys. It is easy to read,understand, and apply and is drafted expressly for standbys. TheISP, like the UCC and the UCP, adopts international bankingstandards for interpretation and application of its rules

2. Much of the lack of familiarity with or transparency of standbyletter of credit practices has been overcome by the InternationalStandby Practices or ISP. The ISP’s rules specifically addressstandby letter of credit practice separate and apart fromcommercial letter of credit practice. The ISP’s rules are wellwritten and for the most part are clear, even-handed and straight-forward. They avoid significant pitfalls of using the UCP instandby letters of credit, such as presentation of stale documents,21

installment drawings,22 force majeure23 and the requirement thatdocuments and data in documents be consistent.24 Unfortunately,the UCP is still used many standby letters of credit issued in thiscountry, and probably in most standbys issued by foreign banks inother countries. Additionally, even the ISP’s rules are not all-encompassing. Resort to standard banking practices outside theISP, caselaw and the UCC is necessary to fill in the gaps. Finally,there are several rules or provisions of the ISP, the UCP or theUCC that govern standby letters of credit that lawyers and theirletter of credit applicant or beneficiary clients may not be familiarwith, overlook, or miscomprehend their import. Many letter ofcredit customs, practices and rules are counterintuitive and cannotbe predicted by resort to simple contract law principles or evenother articles of the UCC.25

3. The ISP provides for many situations in which the UCP and theUCC are silent, such as conditions on transfer and assignment, lostoriginals, when consent of the applicant is not necessary for wavierof certain conditions, and what constitutes acceptablenondocumentary conditions.

21 UCP 500, Art. 43; UCP 600, Art. 14(c).22 UCP 500, Art. 41; UCP 600, Art. 32.23 UCP 500, Art. 17; UCP 600, Art. 36.24 UCP 500, Art. 13(a); UCP 600, Art. 14(d).25 For example, Article 5 of the UCC is the only article of the UCC that defines good faith as “honesty in fact in the

conduct or transaction in question” without reference to the observance of reasonable commercial standards of fairdealing. See UCC §5-102(a)(7). Assignments of proceeds of letters of credit can be used to perfect a securityinterest in letter of credit rights, but a transfer of drawing rights to the secured party is outside the scope of Article 9of the UCC. See UCC §5-114(e) & (f) and Official Comment 4 to UCC §9-107. A failure to identify a discrepancyon dozens of prior drawings of the same or similar letters of credit does not preclude the issuer from raising thatdiscrepancy, without prior notice, on any subsequent drawing on that or another letter of credit issued to the samebeneficiary. See Official Comment 7 to UCC §5-108. Many other examples could be cited.

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4. Secondary sources on the ISP include Official Commentary on ISPand The ISP98 and UCP500 Compared, both published byProfessor James Byrne and the IIBLP.

E. OCC Interpretative Guidelines on Letters of Credit (12 CFR §7.1016)

F. UNCITRAL Convention on Independent Bank Guarantees andStandby Letters of Credit

1. Most countries do not have laws governing letters of credit2. This convention could fill this void if adopted3. It is not widely adopted; only 7 countries4. U.S. has not yet ratified it.5. Progress is being made in Canada to do so which may spur the

U.S. adoption of it.

G. SWIFT

1. Most commercial LC’s are issued via S.W.I.F.T. interbankmessage.

2. S.W.I.F.T. message types influence LC texts and systems

H. Secondary Resources

1. IIBLP Annual Survey of Letter of Credit Law2. IIBLP, LC Rules & Laws – Critical Texts for Independent

Undertakings (5th ed. 2012)3. John Dolan, The Law of Letters of Credit (A.S. Pratt)4. ABA Business Lawyer Annual Survey of Letter of Credit Law

(August)5. James Barnes, ABC’s of the UCC -- Article 5 (ABA)6. IIBLP Documentary Credit World7. ICC Documentary Insight.

V. Letter of Credit Terms

A. Participants

1. Issuer – need not be a bank2. Applicant – party for whose account L/C is issued3. Beneficiary – party to whom letter of credit is issued and who has

drawing rights4. Nominated bank – a bank authorized by the issuer in the credit to

honor or negotiate a drawing under the letter of credit5. Advising bank – a bank that authenticates the letter of credit but is

not liable on it6. Transferee beneficiary of letter of credit – a party to whom the

right has been transferred to make drawings under the letter ofcredit, consent to amendments and cancel the letter of credit.

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Transfers have to be authorized by the letter of credit or all partiesto it.

7. Assignee of proceeds of letter of credit – a party to whom thebeneficiary has assigned and the issuer has recognized the right toreceive the proceeds of draw otherwise payable to the beneficiary.Assignees of proceeds do not have drawing, amendment orcancellation rights.

8. Negotiating bank – a bank nominated in the letter of credit toaccept and pay or commit to pay the draft and documentspresented under a letter of credit and receive payment from theissuer in place of the beneficiary.

9. Confirmer – a party nominated or authorized by the letter of credit,that commits to honor a conforming draw on the letter of credit andis entitled to reimbursement from the issuer as if it were thebeneficiary when it forwards the documents it received andhonored.

B. Other Terms

1. Expiration date or expiry2. Draft or demand for payment3. Documents4. Nondocumentary conditions5. Negotiation6. Place of presentation7. Advice8. Confirmation9. Presentation10. Honor11. Notice of dishonor12. Strict compliance13. Originals14. Expiration drawing15. Automatic extensions or evergreen clauses16. Clean or suicide letters of credit17. Negotiable letters of credit18. Straight letters of credit19. Presentation credits

VI. Drawing on a Letter of Credit – Pointers and Problems

A. Structure of a Letter of Credit (see attachment)

1. L/C No.2. Amount3. Date4. Place of presentment5. Identification of beneficiary

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6. Expiration date7. Issuer (name and address)8. Identification of applicant9. Commitment to honor10. Draw triggers or documentary conditions for drawing11. Governing regime12. Choice of law13. Other terms

B. Common Problems

1. Impossibility2. Ambiguity3. Mistake4. Confusing a surety applicant with the counterparty on the

underlying contract5. Nondocumentary conditions6. Inconsistency7. Use of UCP in standby credits8. Right to draw for failure to extend9. Presentation credits – lost originals10. Specification of applicant signed draw documents11. Failure to deal with letter of credit issues in underlying agreement12. Not using an experienced reputable issuing letter of credit bank13. Not using a letter of credit banker or experienced freight forwarder

for advice on documentary letters of credit

C. Special Drafting Issues

1. Automatic extension provisions2. Choice of law and forum3. Payment to a designated account4. Transferability5. Fax presentations6. Omission of draft requirement7. Foreign issuers8. Confirmations9. Time to honor

D. Common Draw Problems and Tips

1. Waiting too long to effect a draw; not allowing enough time to cure2. Not strictly complying with the draw conditions; substantial

compliance is not enough3. Where draw conditions are ambiguous, consider submitting

alternative draw documents4. Expecting the issuer to honor when beneficiary walks the

documents into the bank

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5. Not realizing that the issuer has a reasonable time up to five toseven business days to honor or give notice of dishonor

6. Not having the necessary third party documents available7. Not having the proper signers of the documents available8. Losing the original of a presentation letter of credit and expecting

the issuer to waive the requirement or issue another

E. Ethical Issues for Lawyers in Counseling Letter of Credit Participants

1. Drawing when no colorable basis exists for a draw2. Drawing for excess amounts3. Counseling the issuer on its independence

VII. Common Types of Letter of Credit Disputes

A. Wrongful Dishonor

B. Wrongful Honor

C. Fraud/Forgery Defenses and Enjoining Honor of a Letter of Credit

1. §5-109 requirements2. Probable success - showing egregious or material fraud3. No adequate remedy at law4. Public interest5. Bond6. Close cases:

a. Fraud not serious enoughb. No forged or fraudulent documentsc. Draw documents literally trued. Lack of scientere. Lack of materiality

7. Attorneys fees under §5-111(e)

D. Sovereign Compulsion/Illegality as a Defense

E. Letters of Credit in Bankruptcy

1. Indirect preferences (In re Air Conditioning, 845 F.2d 293 (11th Cir.1988); In re Compton, 831 F.2d 586 (5th Cir. 1987))

2. Powerine preference trap (In re Powerine Oil Co., 59 F.3d 969 (9th

Cir. 1995))3. Draw conditions which require violation of automatic stay4. Bankruptcy caps on certain claims (landlords, executives,

securities options). See §502(b)(6) of the Bankruptcy Code.

*******

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CARTER H. KLEIN is a partner at Jenner & Block LLP where he has practiced for over 38 years in theareas of financial services, Uniform Commercial Code, credit enhancements, and complex settlements andtrade finance. He is co-author of West’s Uniform Laws Annotated – Uniform Commercial Code Forms andMaterials; West’s Illinois Practice – Uniform Commercial Code Forms Annotated; and West/ThompsonIllinois Code Comments. He was 2004-2007 Chair of the ABA’s Business Law Section Letter of CreditSubcommittee of the Uniform Commercial Code Committee; was 2003-2004 Co-Chair of the Chicago BarAssociation’s Commercial and Financial Transactions Committee; is an editorial advisor for DocumentaryCredit World; is a member of the American College of Commercial Finance Lawyers; is the liaison for theBusiness Law Section of the American Bar Association to the Permanent Editorial Board of the UniformCommercial Code; and is a member of the Banking Committee for the U.S. Council on InternationalBusiness. He participated in the drafting of the International Standby Practices (1998) and Revised Article5 of the Uniform Commercial Code and has authored numerous articles and lectured frequently on UniformCommercial Code topics. He can be reached at 312-923-2950 or cklein@jenner.com.

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ATTACHMENT A

ISP98 Form 126

Model Standby Incorporating AnnexedForm of Payment Demand with Statement*

[name and address of beneficiary] [date of issuance]

Issuance. At the request and for the account of [name and address of applicant](“Applicant”),i we [name and address of issuer at place of issuance] (“Issuer”) issue ii

this irrevocableiii standby letter of credit number [reference number] (“Standby”)iv infavour of [name and address of beneficiary] (“Beneficiary”)v in the maximumaggregate amountvi of [currency/amount].

Undertaking. Issuer undertakes to Beneficiaryvii to payviii Beneficiary’s demandfor payment in the currency and for an amount available under this Standbyix and in theform of the Annexed Payment Demand completed as indicatedx and presentedxi to Issuerat the following place for presentation: [address of place for presentation],xii on orbefore the expiration date.xiii

Expiration. The expiration date of this Standby is [date].xiv

[Payment. Payment against a complying presentation shall be made within 3business daysxv after presentation at the place for presentation or by wire transfer to aduly requested account of Beneficiary. An advice of such payment shall be sent toBeneficiary’s above-stated address.]xvi

[Drawing. Partial and multiple drawings are permitted.]xvii

[Reduction. Any payment made under this Standby shall reduce the amountavailable under it.]xviii

ISP98. This Standby is issued subject to the International Standby Practices 1998(ISP98) (International Chamber of Commerce Publication No. 590).xix

[Communications. Communications other than demands may be made to Issuerby telephone, telefax, or SWIFT message, to the following: [numbers/addresses].Beneficiary requests for amendment of this Standby, including amendment to reflect achange in Beneficiary’s address, should be made to Applicant, who may then requestIssuer to issue the desired amendment.]xx

26 Note: ISP Forms are the copyright of the International Institute of Banking Law & Practice, Inc. (IIBLP).These forms are found at and downloadable from the IIBLP’s website – www.iiblp.org. The IIBLP grantspermission to copy and use ISP98 model forms, including endnotes, for all purposes except publication for a chargeto a purchaser or subscriber. These forms are published for educational purposes and not as legal or professionaladvice. Potential users should consult with their own advisers in the drafting or use of a standby letter of credit.The speaker was granted permission by the IIBLP to make this form and endnotes available for this program.

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[Issuer’s name]

__[signature]__________________Authorized Signature

Annexed Payment Demand

[INSERT DATE]xxi

[name and address of Issuer or other addressee at place of presentation as stated instandby]xxii

Re: Standby Letter of Credit No. [reference number], dated [date], issued by [Issuer’sname] (“Standby”)xxiii

The undersigned Beneficiary demands payment of [INSERT CURRENCY/AMOUNT] underthe Standby.xxiv

Beneficiary statesxxv that Applicantxxvi is obligatedxxvii to pay to Beneficiary the amountdemanded[, which amount is due and unpaidxxviii] under[ or in connection with] theagreementxxix between Beneficiary and Applicantxxx titled [agreement title] and dated[date].

[Beneficiary further states that the proceedsxxxi from this demand will be used tosatisfyxxxii the above-identified obligations and that Beneficiary will account toApplicantxxxiii for any proceeds that are not so used.]

Beneficiary requests that payment be made by wire transfer to an account of Beneficiaryas follows: [INSERT NAME, ADDRESS, AND ROUTING NUMBER OF BENEFICIARY’S BANK, AND

NAME AND NUMBER OF BENEFICIARY’S ACCOUNT].xxxiv

[Beneficiary’s name andaddress]xxxv

By its authorized officer:

[INSERT ORIGINAL SIGNATURE]xxxvi

[INSERT TYPED/PRINTED

NAME AND TITLE]

[Before the standby is issued, all text in [bold] should be completed, and optional text in[italics] should be included or deleted (or redrafted). Text in the annexed demand formpreceded by “INSERT” (or other ALL CAPITALS guidance) and in [ALL CAPITALS

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UNDERLINED] is to be completed as indicated when the beneficiary prepares and presentsa demand.]

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* Copyright © 2012 by the Institute of International Banking Law & Practice, Inc.,www.iiblp.org (“IIBLP”). Unlimited permission is hereby granted to copy and use thisISP98 form, including endnotes, for all purposes except publication for a charge to apurchaser or subscriber.

This ISP98 Form 1 model standby includes terms that ISP98 indicates should be includedin a standby. It includes terms that restate other ISP98 rules for the avoidance of doubt,e.g., that the standby is irrevocable and permits partial demands. It uses words, phrases,and spellings that are used in ISP98. It also includes optional terms that are specificabout when and how payment will be made.

This ISP98 Form 1 incorporates an annexed model form of payment demand thatincludes terms that ISP98 indicates should be included when making a presentation. Thisdemand form also includes beneficiary statements of a type the applicant or beneficiarymay desire in order to identify the underlying obligation(s) to be supported by thestandby (and to be satisfied upon honour of the standby).

The annexed demand form may also be used as a precedent by a beneficiary preparing ademand to be presented under an ISP98 standby that does not specify the entire form ofdemand to be presented. See ISP98 Form 5 (Simplified Demand Only Standby).

This ISP98 Form 1 is intended to be self-contained and, absent special circumstances,useable without extended reference to the text of ISP98.

The endnotes to this form include alternative and other optional terms, as well asreferences to relevant ISP98 rules. Other ISP98 model standby forms vary this form,e.g., by adding text and annexes (with relevant endnotes) that focus on expiration,reduction, transfer, confirmation, and counter standby support.

This form is published for educational purposes and not as legal or professional advice.Potential users should consult with their own advisers in the drafting or use of a standbyletter of credit. ISP98 and letter of credit educational and training materials, includingThe Official Commentary on the International Standby Practices containing officialinterpretations of ISP98, are available from IIBLP at www.iiblp.org.

iApplicant. As noted in ISP98 Rule 1.09(a) (Definitions), the “applicant” is the person who

applies for issuance or for whose account the standby is issued. Typically, the applicant stated inthe standby is the person whose underlying obligation is supported by the standby. Thestandby’s terms should be appropriate to support those underlying obligations, and theunderlying documentation should appropriately provide for the standby and for the use of fundspaid under the standby.

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Where a standby is issued on the application of a correspondent bank from whom the issuerexpects reimbursement, consideration should be given to an alternative clause: “At the requestand for the account of [name of correspondent bank], (“Applicant”) acting at the request and forthe account of its customer, [XYZ]...”. Similarly, where a standby is issued on the application of a

parent company, consideration should be given to an alternative clause: “At the request and forthe account of [Parent] (“Applicant”) acting at the request and for the account of its subsidiary[name]…”.

This standby form adds “(“Applicant”)” after the name of the applicant, and that defined term isused in the annexed model demand form. If this parenthetical definition (or the parentheticaldefinition for the issuer or the beneficiary) is not wanted, appropriate adjustments should be madein the standby, including in any statement required to be included with any beneficiary demand. Ifan adjustment is made because the applicant is not also the underlying obligor (or the beneficiaryis not also the underlying obligee), then the adjustments should be made in the standby and alsoin the documentation underlying the standby. See endnote 30.

Except for endnotes 1 and 30, these endnotes do not address issues that may arise where theapplicant is not the underlying obligor or where there are multiple applicants.

iiIssuance. The name of the issuer and the place(s) of issuance and presentation should be

indicated in the standby. The indicated place of issuance is significant in determining what lawgoverns the issuer’s obligations. Absent an indication of the place of issuance in the standby, itmay prove difficult to determine a single place of issuance, even with full knowledge of theprocess resulting in sending the standby to the beneficiary. This form, including endnotes, doesnot address the possibility, briefly addressed in ISP98 Rule 10 (Syndication/Participation), ofmultiple issuers or of participating interests in a single issuer’s standby facility.

Rule 2.03 (Conditions to Issuance) provides generally that a standby is issued when it leaves theissuer's control, and Rule 3.05 (When Timely Presentation Made) allows presentation any timeafter issuance (and before expiry) It is customary for a standby to recite the issuance date eitherat the top of the undertaking or in the first paragraph of the text (or both).

iiiIrrevocability. It is unnecessary to state that an ISP98 standby is irrevocable. See ISP98 Rule

1.06(a) and (b) (Nature of Standbys). However, because of the contrary rule in UCP82 (1933)until UCP500 (1993), some letter of credit users expect or require inclusion of the word“irrevocable”.

ivName of undertaking. While this form of undertaking is named a “standby letter of credit”, the

name is not determinative of its character as an undertaking within the scope of ISP98 or as anindependent undertaking under applicable law. As provided in ISP98 Rule 1.01(b) (Scope andApplication), it could be called an independent guarantee, bank guarantee, bond, or any othername.

vBeneficiary. The beneficiary named in a standby is the person to whom the issuer’s obligation is

owed. Typically, there is one named beneficiary of the issuer’s undertaking, who is also theobligee of the applicant’s obligation that is supported by the standby. This standby form,including endnotes, does not address issues that may arise where the named beneficiary is notthe underlying obligee or where there are multiple beneficiaries.

viAmount available. A standby should expressly state the amount available under the standby.

Standbys commonly add that the stated amount of a standby is the “maximum” (or “full” or “not toexceed”) “aggregate” amount. These are unnecessary additions because ISP98 Rule 3.08(Partial Drawings & Multiple Presentations; Amount of Drawings) permits presentations for less,but not more, than the amount available under a standby.

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Under ISP98 Rule 3.08(e) (Partial Drawings & Multiple Presentations; Amount of Drawings), adrawing that exceeds the amount available under the standby is discrepant. To override that ruleand require the issuer to pay the full amount available under the standby against a presentationthat would comply but for the “credit overdrawn” discrepancy, the following clause may be added:“If a demand exceeds the amount available, but the presentation otherwise complies, Issuerundertakes to pay the amount available.”

viiUndertaking to the beneficiary only. It is unnecessary to state that an issuer’s payment

obligation is made “to Beneficiary”. Except as otherwise stated in the standby or mandated byapplicable law, a standby that names a beneficiary and does not identify any other person ashaving rights under the standby obligates the issuer solely to the named beneficiary. ISP98 Rule2.04 (Nomination) provides for the possibility that a standby nominates another person to confirmthe issuer’s undertaking or otherwise to give value against the named beneficiary’s complyingdemand. ISP98 Rule 6 (Transfer, Assignment, and Transfer by Operation of Law) provides forthe possibility that an issuer is requested to acknowledge a person claiming to be a transfereebeneficiary or an assignee of standby proceeds or a successor beneficiary. ISP98 Form 4 (ModelStandby Providing for Transfer and Incorporating Annexed Form of Transfer Demand) focuses ontransfer of drawing rights by beneficiary demand and other standby terms affecting a claimedtransferee beneficiary, assignee of standby proceeds, or successor beneficiary.

viiiHonour by payment. An issuer may undertake to honour a letter of credit other than by sight

payment. Under ISP98 Rule 2.01 (Undertaking to Honour by Issuer and Any Confirmer toBeneficiary) an issuer may undertake to honour by non-recourse negotiation (purchase) of thedocuments presented or by acceptance of a time draft or incurrence of a deferred paymentundertaking, followed by payment at maturity. Also, an issuer may undertake to honour by thedelivery of an item of value, such as gold, in which case the issuer must be able to deliver thespecified item. These other forms of honour are not covered in this form because they are muchless common for standbys than honour by sight payment.

ixPresentation of standby. An issuer's obligation is not dependant on the beneficiary's holding or

presenting the standby, unless the standby so provides. See ISP98 Rule 2.03 (Conditions toIssuance). This form, like most standbys, does not require presentation of the standby with apayment demand. Any such requirement exposes the beneficiary to the risk that a demand maybe rightfully refused if the standby is lost or otherwise cannot be timely presented. It alsoexposes the issuer to disputes over the issuer's receipt, handling, or return of the standby. Thereare other ways to avoid payment against a forged demand, e.g., by providing in the standby thatpayment must be made to a specified beneficiary account.

Under ISP98 Rule 3.12 (Original Standby Lost, Stolen, Mutilated, or Destroyed), an issuer isentitled to enforce a requirement that the standby be presented with a demand. However, therule also gives an issuer considerable discretion to excuse or remedy a beneficiary’s failureto present the standby. If greater certainty is desired, then the standby could add the following ora variation: "Issuer undertakes to exercise its discretion under ISP98 Rule 3.12 to waive therequirement to present this Standby (or to replace it) against Beneficiary's representations andindemnities (including third party indemnities deemed appropriate by Issuer) in favor of Issuer andApplicant that are reasonably satisfactory to Issuer." The representations and indemnities shouldrun to the applicant as well as the issuer. Although the issuer would determine what isreasonable at the time of taking any representations or indemnities, the applicant would bear theultimate risk of payment against a forged demand.

The term "this Standby" in this ISP98 Form 1, like the term "original standby" in ISP98 Rule 3.12(and Rule 6.03 (Conditions to Transfer)), refers to the originally signed/authenticated undertakingthat evidences the issuer's obligation. Unless the issuer sends a signed/authenticatedundertaking directly to the beneficiary, it may be desirable to clarify in the standby what must or

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may be presented as, or in lieu of, the issuer's undertaking in the form it left the issuer's control.If the standby was sent by an authenticated SWIFT message from an issuing bank to an advisor,the document to be presented would be the advisor's signed/authenticated message to thebeneficiary annexing, or reproducing the text of, the SWIFT message sent by the issuer. Theremay be no unique undertaking for the beneficiary to present. If, for example, a standby was sentto a beneficiary in an electronic medium, its presentation to the issuer in an electronic medium oras a paper printout would serve merely to identify the standby to be transferred.

The terms "this standby" and "original standby" do not necessarily refer also to amendments.Some standbys state that all amendments must also be presented, and some also require astatement from the beneficiary as to whether it has consented (or not) to each amendment issuedby the issuer. Neither should be necessary. An issuer should be able to determine from its ownrecords whether amendments are binding on the issuer and the beneficiary, but it maynonetheless be desirable to address the status of amendments in any standby term requiringpresentation of the standby.

xForm of payment demand. This ISP98 Form 1 standby incorporates an annexed model form of

payment demand to be completed and presented by the beneficiary. Annexing the desired formof payment demand (with any desired beneficiary statement) to a standby is unnecessary butpromotes the efficient use of standbys. Requiring a "draft" (or bill of exchange) drawn at sight bythe beneficiary on the issuer is neither necessary nor efficient under a standby that undertakes topay at sight.

A standby that specifies wording in an annexed form of demand is subject to ISP98 Rule 4.09(b)(Identical Wording and Quotation Marks). That subsection requires or permits the beneficiary tocomplete blank lines or spaces and to correct apparent typographical errors and the like. It isintended to cover practically all circumstances in which a form of beneficiary demand andstatement is annexed to the standby.

If more flexibility is desired, Rule 4.09(a) should be consulted, but flexibility is better introduced byadding alternative wording to the annexed form of demand or otherwise indicating in the annexedform of demand how blank spaces may be completed. If no flexibility whatsoever is desired (e.g.,because the demand or statement must be delivered to a third person in a precisely specifiedform), then Rule 4.09(c) should be consulted, with the understanding that it should be invokedrarely, that it requires use of the word "exact" or "identical" in the standby, and that its use maylead to unintended consequences for the issuer, applicant, or beneficiary.

The phrase “completed as indicated” assumes that the annexed form of demand adequatelyindicates how it is to be completed (e.g., by the inclusion of instructions and blank lines) and thatit is to be dated and signed by the beneficiary. It does not add that the demand be “apparently”signed by the beneficiary or the beneficiary’s “purported” representative, because such additionsare more likely to confuse than clarify the allocation of risks under ISP98 and applicable law ofpayment or non-payment of a forged demand.

ISP98 Rule 4.08 (Demand Document Implied) requires presentation of a documentary demandfor payment. ISP98 itself does not require the named beneficiary to present any beneficiarystatement.

Some standbys state that they are available by “one or more demands” or by “demand(s)”, ratherthan by “demand” in the singular. This is unnecessary for the reasons indicated in endnote 17.

xiManner of presentation. This standby form is based on the usual practice of sending original

documents, sometimes including the original standby, in a package by courier to the issuer’sindicated place of presentation. Presentations by telefax and the like are prohibited unlessexpressly permitted in the standby or unless the beneficiary is a SWIFT participant or bank

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sending a demand using SWIFT or other similar authenticated means. See ISP98 Rule 3.06(Complying Medium of Presentation). ISP98 Rule 1.09(c) (Electronic Presentations) includesdefined terms that may be used in a standby that permits electronic presentation.

xiiPlace of Presentation. ISP98 Rule 3.01 (Complying Presentation under a Standby) provides

that a standby should indicate the place, the location within that place, and the person to whompresentation should be made. ISP98 Rule 3.04 (Where and to Whom Complying PresentationMade) provides default rules. The indicated place of presentation is significant in determiningwhether a complying demand is timely presented.

Standbys frequently include a requirement that the presentation be addressed to the attention ofthe Standby Letter of Credit Department or the like, which may prove critical on a last minutepresentation. Some standbys also include in the address for presentation a specific floor oroffice, which, if it is not accessible to the beneficiary, may prove contentious in the case of a lastminute presentation. Beneficiaries and issuers both should avoid testing the limits of suchrequirements.

A standby may require presentation to the issuer to be made at a place that is not the place ofissuance, e.g., to and at the address of a processing agent for the issuer (which could be anaffiliate or another bank). A standby may also nominate another branch or bank to receive apresentation and act on that nomination. This standby form does not include any nomination oraddress issues which arise from a nomination. See ISP98 Rule 2.04 (Nomination).

xiiiTime of presentation. ISP98 Rule 3.05 (When Timely Presentation Made) provides that

presentation must be made before expiry on the expiration date and that a presentation afterbusiness hours is treated as made the next business day. Rule 9.04 (Time of Day of Expiration)provides that expiry occurs at the close of business at the place of presentation.

xivExpiration. Standbys must contain an expiration date under ISP98 Rule 9.01 (Duration of

Standby) and likely also under applicable commercial law and banking regulations. This standbyform is based on the common practice of stating a specific calendar date. The stated date shouldbe set sufficiently after the underlying obligation becomes due to allow for drawing after refusal ofan initial drawing. If payment of the underlying obligation may be made outside of the standby,the stated date should be set to allow also for drawing after any possible rescission of an outsidepayment made by an insolvent payor.

Many issuers are subject to laws, regulations, or internal policies that limit their incurrence ofobligations that are indefinite or long term. A common response is to set a one year expirationdate and allow for automatic annual extensions unless the issuer sends or the beneficiaryreceives advance notice of non-extension. ISP98 Rule 2.06(a) (When an Amendment isAuthorized and Binding) makes “automatic amendments”, including extensions of the expirationdate, effective without further notification or consent, if the automatic amendment is expresslystated in a standby. ISP98 Form 2 (Model Standby Providing for Extension) focuses on annualautomatic extension and other alternatives to a single fixed expiration date.

The expiration date stated in a standby is not necessarily the last day on which a complyingpresentation may be made under the standby. ISP98 Rules 3.13 (Expiration Date on a Non-Business Day) and 3.14 (Closure on a Business Day and Authorization of Another ReasonablePlace for Presentation) extend the expiration date where it falls on a non-business day or on aday the bank is closed for any other reason.

xvThree days to examine and pay a presentation. ISP98 Rules 2.01(c) (Undertaking to Honour

by Issuer and Any Confirmer to Beneficiary) and 5.01 (Timely Notice of Dishonour) provide for thetime an issuer has to honour or dishonour and include a safe-harbor of three business days afterpresentation. The three day period begins on the business day following the business day of

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presentation. This optional standby text converts that 3-day safe harbor period in ISP98 into atiming requirement for payment of a complying presentation.

Many so-called financial standbys state a shorter period within which a complying presentationmust be paid, and some also state that the shortened period also applies to the time allowed forthe issuer to avoid preclusion by giving a notice of dishonour. For example, a standby payableagainst a simple demand to be presented by a bank beneficiary might state: “Payment of acomplying presentation shall be made[, or in the case of a non-complying presentation a notice ofdishonour shall be given,] on the first banking day following the banking day on which Issuerreceives a presentation from Beneficiary[, if received before noon,][by SWIFT/telefax message atIssuer’s following SWIFT address/telefax number]…”

Some standbys permit a longer period for payment, e.g., 30 days after presentation or 10 daysafter a presentation is determined to comply. Lengthening the time for honour would not, withoutmore, lengthen the timing requirements of ISP98 Rule 5.01 (Timely Notice of Dishonour) forgiving a notice of dishonour or for precluding defenses under ISP98 Rule 5.03 (Failure to GiveTimely Notice of Dishonour).

xviPlace and method of payment. If a standby, including an annexed form of demand, does not

state the method of payment, then an issuer may voluntarily follow the presenter’s request.ISP98 Rule 5.08 (Cover Instructions/Transmittal Letter) permits an issuer to deal with thepresenter and to follow instructions accompanying a presentation. Similarly, ISP98 Rule 6.10(Reimbursement for Payment Based on an Assignment) protects an issuer’s reimbursementrights in cases of payment to an acknowledged assignee of standby proceeds. ISP98 Rule2.01(e) (Undertaking to Honour by Issuer and Any Confirmer to Beneficiary) provides that honourby payment is to be made in immediately available funds. This optional standby text facilitatespayment by wire transfer in response to a request duly made by the beneficiary.

Unless the standby otherwise states, an issuer is not required to pay anyone other than abeneficiary, a nominated person, or an acknowledged assignee of standby proceeds and is notrequired to pay anywhere other than at the place of presentation. See ISP98 Rule 6 (Transfer,Assignment, and Transfer by Operation of Law). Payment may be made at the place ofpresentation by sending a bank check to the order of the beneficiary or by initiating a wiretransfer.

If payment by check is the sole desired method of honour, the following may be substituted:“Payment shall be made by Issuer’s check payable to Beneficiary sent to Beneficiary’s above-stated address by registered mail or [inter]nationally recognized courier or other means ofreceipted delivery to Beneficiary.”

If payment by wire transfer is the sole desired method of honour, the following standby text maybe substituted: “Payment shall be made by wire transfer to an account of Beneficiary as follows:[name, address, and routing number of Beneficiary’s bank, and name and number ofBeneficiary’s account] or to such other bank account of Beneficiary as Beneficiary may duly

request of Issuer”. An issuer’s response to a beneficiary request may be affected by regulatoryrequirements limiting payment to a permissible account at a permissible financial institutionlocated in a permissible country. The annexed form of demand and statement incorporated intothis ISP98 Form 1 standby contains model wording for a beneficiary’s request for payment bywire transfer. Including a detailed method of payment in a standby may deter forged beneficiarydemands, as well as avoid delays resulting from the issuer’s receipt of an inadequate request asto the method of payment.

No matter what a standby, demand form, or separate request for routing payment may state,applicable law, e.g., a court or government agency order, may block payment. Applicable lawmay also allocate the risks of loss in case of payment to the wrong person.

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xviiMore than one drawing. It is unnecessary to state that a beneficiary may make multiple

drawings or drawings for less than the full amount available. A standby that undertakes to honour“a demand” (in the singular) does not affect the beneficiary’s right to present more than onedemand under standard practice applicable to standby (and commercial) letters of credit. ISP98Rule 3.08 (Partial Drawings & Multiple Presentations; Amount of Drawings) permits both partialand multiple drawings unless prohibited in the standby. If a standby is to be honoured once only,then the standby should state that affirmatively or, as indicated in ISP98 Rule 3.08(d), state“multiple drawings prohibited”.

xviiiReduction by honour. It is unnecessary to state that the amount available under a standby is

reduced by the amount of any drawing that is honoured. This is because honour discharges(rather than amends or cancels) the issuer’s obligations and because ISP98 Rule 1.10(c)(ii)(Redundant or Otherwise Undesirable Terms) presumes that reinstatement is not intended.ISP98 Form 3 (Model Standby Providing for Reduction and Incorporating Annexed Form ofReduction Demand) focuses on reduction, including reduction to zero, by beneficiary demand andby other optional terms permitting or requiring reductions in the amount available under astandby.

xixIncorporation of ISP98; law, court, arbitration, and sanctions. Incorporation of ISP98 into an

undertaking that is payable against the presentation of documents should qualify the undertakingas independent under applicable law. ISP98 invokes letter of credit law by emphasizing the letterof credit aspects of a standby and its independence in ISP98 Rules 1.06(c) (Nature ofStandbys) and 1.07 (Independence of the Issuer-Beneficiary Relationship). See Team TelecomInt’l v. Hutchison 3G UK Ltd, 2003 EWHC 762 (Q.B. Div’l Ct.) [England], abstracted at 2004Annual Survey of Letter of Credit Law & Practice 335 (bond subject to ISP98 is an independentundertaking).

It is unnecessary for a standby to recite that it is independent or that it is enforceable withoutregard to the validity of any claim of performance or non-performance in the underlyingtransaction. It is unnecessary for a standby to add a recital (including an "integration" or “merger”clause) that would deny or limit the effect of any document or other matter mentioned in thestandby or of any negotiations leading up to or following standby issuance. Such clauses andrecitals risk limiting the various ISP98 rules that provide for the standby’s independence.

Where a choice-of-law clause is included in a standby, most courts will give effect to it.Otherwise, a court will likely apply its own conflict-of-laws’ rules. Conflict-of-laws’ rules affect thelegal standards for compliance of any presentation, for the scope of any fraud/abuse exception,for the availability of any excuse based on government sanctions, etc. Under many legalsystems, the conflict-of-laws’ rules provide that the law at the place of issuance of the standby (orconfirmation) should govern the issuer’s (or confirmer’s) obligations. See, e.g., the UNConvention on Independent Guarantees and Standby Letters of Credit, Articles 21 (Choice ofapplicable law) and 22 (Determination of applicable law). However, courts may hear a wrongfuldishonour claim filed other than where the issuer (or confirmer) is located, may apply differentconflict-of-laws’ rules, and may determine, e.g., that the law of the place where the beneficiary islocated should govern.

As indicated, most courts will respect a choice-of-law clause and a choice-of-exclusive-forumclause in a standby (or confirmation of a standby). Including a choice of law clause or anexclusive forum clause or both fosters certainty. E.g.: “Issuer’s obligations under this Standby aregoverned by the laws of [State]. The courts located in [State] shall have exclusive jurisdiction

over any action to enforce Issuer’s obligations under this Standby.”

The Preface to ISP98 includes a suggested arbitration clause: “This Standby [undertaking] isissued subject to ISP98, and all disputes arising out of it or related to it are subject to arbitration

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under ICLOCA Rules (1996).” (The ICLOCA Rules, which are based on the UNCITRAL Rules ofArbitration, are available at www.icloca.org. The International Center for Letter of CreditArbitration is located in metropolitan Washington, D.C., at 20405 Ryecroft Court, MontgomeryVillage, MD 20886 USA.)

Particularly if the standby does not choose applicable law, the issuer may wish to considerincluding a “sanctions” clause covering sovereign compulsion excusing the issuer, e.g.: “Issuerdisclaims liability for delay, non-return of documents, non-payment, or other action or inactioncompelled by a judicial order or government regulation applicable to Issuer.”

A standby consists of obligations of the issuer limited by its terms and conditions. Accordingly, achoice of law or forum or both in a standby applies to those issuer obligations and not to theobligations of any confirmer or other person. There is no problem under a straight standby thatstates that “this standby is governed” by the chosen law or that any litigation under it is limited tothe chosen court, but this same wording might prove confusing when included in a standby thatnominates another person to advise, confirm, or otherwise act on the standby.

xxCommunications. This optional clause or a variation of it is particularly apt for a standby that is

long term or that provides for communications from or to the beneficiary (apart from paymentdemands). If a beneficiary requires greater certainty that its request to amend its address will begiven effect, then the standby should expressly provide for automatic amendment againstpresentation of a complying beneficiary demand for an address change. Standby language witha demand form for this purpose may be adapted from ISP98 Forms 3 and 4 providing forreduction and transfer on demand by the beneficiary.

xxiDemand Date. ISP98 Rule 4.16(b)(ii) (Demand for Payment) provides that a demand must

contain an issuance date, and ISP98 Rule 4.06 (Date of Documents) provides that its issuancedate may not be later than the date of its presentation. To override that rule, e.g., to permit post-dated documents, the following clause may be added to the Standby text: “The issuance date orany other date on any document, including the required demand, may be a date on, before, orafter the date the document is presented under this Standby.”

xxiiAddressee. The information in the text of the standby indicating where, how, and to whom a

presentation is to be made under the standby should be repeated in the demand form. SeeISP98 Rules 3.01 (Complying Presentation under a Standby), 3.04 (Where and to WhomComplying Presentation Made), and 3.06 (Complying Medium of Presentation). Particularattention should be given to the possibility that a standby may require presentation at an addressthat differs from the issuer’s letterhead address.

xxiiiStandby identification. A demand form should identify the standby by including the information

in the standby text that identifies it, particularly the issuer’s reference number. See ISP98 Rules3.01 (Complying Presentation under a Standby) and 3.03 (Identification of Standby).

xxivDemand. This model form of annexed demand should satisfy the requirements of ISP98

Rules 4.16 (Demand for Payment) and 4.17 (Statement of Default or other Drawing Event), sothat, when the beneficiary completes it as indicated, it will include a demand for payment of astated amount, be dated and signed, and contain any required beneficiary statements.

xxvBeneficiary statements. Standbys commonly require presentation of beneficiary statements

and commonly combine them with the required form of demand for payment. Words other than“states”, such as “certifies”, “represents”, “warrants”, “promises”, or a combination of those words,are also used and may be preferable in the context of the underlying transaction. Any such wordof assurance, when required to be included in a document presented under a standby, may giverise to a claim against the beneficiary who obtains payment under the standby. The nature andsufficiency of such claim may depend on the precise wording included in the demand, the identity

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of the claimant, and the status of any related claims based on the obligations intended to besupported by the standby.

The applicant or issuer or both may prefer a combination of specific representations andundertakings from the beneficiary. The beneficiary may prefer no such wording or onlyconclusory wording qualified by the beneficiary’s reference to “good faith” belief or the like. Theapplicant or issuer or both may prefer that the beneficiary make its statements expressly to theapplicant or issuer or both.

ISP98 Rule 4.12 (Formality of Statements in Documents) provides guidance on standbyrequirements for statements that are to be “sworn to”, “witnessed”, “legalized”, or the like.

It should be unnecessary to include in a demand form that the amount demanded is availableunder the standby, because that amount should be determinable without dependence on anysuch statement.

xxvi“Applicant” as underlying obligor. This demand form uses “Applicant”, which is a defined term

in the text of the standby, and assumes that the applicant and beneficiary are parties to anunderlying agreement that establishes the obligations to be supported by the standby. Seeendnotes 1 and 30.

xxviiObligated/in default. This statement indicates that the applicant is “obligated to pay” the

amount demanded, not that there is a “default”. A default statement is inapt where the amountdemanded is payable on the date demanded without regard to the occurrence or continuance of adefault or where “default” is not adequately defined in the documentation for the underlyingobligations or where “default” may require that an action be taken that may be prohibited underlaws triggered by the insolvency of the applicant or other party.

xxviiiUnpaid. The term “unpaid” in the optional “due and unpaid” recital may raise a question

where the applicant has made a direct payment to the beneficiary but the funds paid are subjectto recapture by an insolvency representative of the applicant. It should be possible for abeneficiary in that context to state, without running afoul of a fraud or abuse exception underapplicable letter of credit law, that the underlying obligation remains unpaid where a directpayment has been received subject to a credible claim that the direct payment is voidable andmust be returned.

xxixUnderlying obligation. Although some standbys are payable on simple demand, the applicant,

beneficiary, or issuer may insist that a demand under a standby identify the underlying obligation,obligor, and obligee, particularly where there may be no single underlying agreement between theapplicant and beneficiary that establishes the underlying obligations and provides that thoseobligations be supported by a standby.

xxxApplicant-beneficiary relationship. This model form of annexed demand assumes that the

standby supports one or more obligations of the applicant to the beneficiary. Under commercialand regulatory laws, the issuer, any nominated bank, the applicant and beneficiary, and, wheredifferent, the underlying obligor and obligee may need to identify the underlying obligationsintended to be supported by the standby and to be satisfied or secured by the proceeds of adrawing under the standby. Accordingly, this form of demand should be redrafted if, e.g., theapplicant is a surety for the underlying obligor or the beneficiary is a creditor of the underlyingobligee. Additionally, the underlying documentation should be drafted to provide for the pre- andpost-honour obligations of the applicant and beneficiary (and, where different, of the underlyingobligor and obligee) to each other, particularly if the named applicant has or intends to claim therights of an ordinary guarantor or surety. In this regard, it may be desirable for the beneficiary’sstatement to refer expressly to the underlying obligations, as they may be amended by the obligorand obligee, without (or with) the further consent of the applicant.

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xxxiUse of proceeds. This optional beneficiary statement is unnecessary if the underlying

agreement adequately provides for the use of all proceeds from a drawing under the standby andif the applicant reimburses the issuer. Otherwise, some mention in the form of demand of therelationship of any standby proceeds to the underlying obligation is helpful in answering post-honour questions about the disposition of any excess standby proceeds. Absent such aprovision, the “independence” of the standby obligation may hinder appropriate post-honouraccounting for the use of funds received under a standby.

xxxiiProceeds as cash collateral. Where the proceeds cannot or might not be used to “satisfy” the

applicant’s obligations, the demand form should indicate that the proceeds will be used to“secure” them. This consideration is important under standbys that are intended to be used, atleast in some circumstances, to fund the applicant’s underlying obligation to provide cashcollateral. The most common circumstance involves standbys that may expire before theunderlying obligations become fully due and payable.

xxxiiiAccounting to issuer for unused proceeds. The issuer may want to take a security interest in

the applicant’s rights to unused proceeds and/or require the beneficiary to state, e.g.,: “…and thatBeneficiary will account to Issuer or Applicant, as their interests may appear, for any proceedsthat are not so used.”

xxxivRequest for wire transfer to beneficiary’s account. This term in the demand form is

unnecessary if the text of the standby includes satisfactory wire transfer information for paymentto the beneficiary. See endnote 16.

Issuers are not required to pay wherever, however, or whomever the beneficiary requests, unlessthe standby so states. Under ISP98 Rule 5.08 (Cover Instructions/Transmittal Letter), issuers arepermitted to follow a request to pay by wire transfer to the beneficiary’s account, subject to timelyreceipt of customary account information and deduction of customary wire transfer charges anddue consideration of any regulations or bank policies affecting wire transfer of funds to therequested country, bank, and account.

A request to pay to another’s account is a request for acknowledgement of an assignment ofproceeds, which is subject to the special rules in ISP98 Rules 6.06-6.10 (Acknowledgement ofAssignment of Proceeds), as well as laws protecting issuers and applicants and other lawsregulating money laundering, etc.

To deter forged demands, and to address anti-money-laundering concerns, this model form ofrequest for payment by wire transfer states that payment is to be made to the named beneficiaryat a specified beneficiary account at a specified bank location.

xxxvSigner authentication. This demand form requires the signer to indicate in the signature line

that the demand and statement are made by the named beneficiary located at the address statedin the standby. Accordingly, the beneficiary's name and address should be stated in this demandform when the standby incorporating it is issued.

xxxviOriginal signature. What is an original signature depends on the mode of communication.

See ISP98 Rules 1.09(a) (Defined Terms) (“Signature”) and 3.06(d) (Complying Medium ofPresentation).

[IIBLP as of 10 May 2012]

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APPENDIX B

ISP98 Form 2Model Standby Providing for Extension and IncorporatingAnnexed Form of Payment Demand with Alternative Non-

Extension Statement

[name and address of beneficiary] [date of issuance]

Issuance. At the request and for the account of [name and address of applicant](“Applicant”), we [name and address of issuer at place of issuance] (“Issuer”) issuethis irrevocable standby letter of credit number [reference number] (“Standby”) infavour of [name and address of beneficiary] (“Beneficiary”) in the maximum aggregateamount of [currency/amount].

Undertaking. Issuer undertakes to Beneficiary to pay Beneficiary’s demand forpayment in the currency and for an amount available under this Standby and in the formof the Annexed Payment Demand completed as indicated and presented to Issuer at thefollowing place for presentation: [address of place for presentation], on or before theexpiration date.

Expiration. The expiration date of this Standby is [date].xxxvi

Extension. The expiration date of this Standby shall be automaticallyxxxvi

extendedxxxvi for successive one year periods, unless Issuer notifies Beneficiary byregistered mail or other receipted means of delivery sentxxxvi to Beneficiary’s above-stated address [30]xxxvi or more days before the then current expiration date that Issuerelects not to extend the expiration date.xxxvi The expiration date is not subject toautomatic extension beyond [date], and any pending automatic one-year extension shallbe ineffective beyond that date.xxxvi [The expiration date may also be extended inaccordance with the terms of an amendment issued by Issuer to which Beneficiaryconsents and in accordance with ISP98 rules on closure of the place for presentation onthe expiration date.]xxxvi

[Payment. Payment against a complying presentation shall be made within 3business days after presentation at the place for presentation or by wire transfer to a dulyrequested account of Beneficiary. An advice of such payment shall be sent toBeneficiary’s above-stated address.]

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[Drawing. Partial and multiple drawings are permitted.]

[Reduction. Any payment made under this Standby shall reduce the amountavailable under it.]

ISP98. This Standby is issued subject to the International Standby Practices 1998(ISP98) (International Chamber of Commerce Publication No. 590).

[Communications. Communications other than demands may be made to Issuerby telephone, telefax, or SWIFT message, to the following: [numbers/addresses].Beneficiary requests for amendment of this Standby, including amendment to reflect achange in Beneficiary’s address, should be made to Applicant, who may then requestIssuer to issue the desired amendment.]xxxvi

[Issuer’s name]

__[signature]__________________Authorized Signature

Annexed Payment Demand

[INSERT DATE]

[name and address of Issuer or other addressee at place of presentation as stated instandby]

Re: Standby Letter of Credit No. [reference number], dated [date], issued by [Issuer’sname] (“Standby”)

The undersigned Beneficiary demands payment of [INSERT CURRENCY/AMOUNT] underthe Standby.

Beneficiary states that

[INSERT ONE OF THE FOLLOWING ALTERNATIVE STATEMENTSxxxvi:

Applicant is obligated to pay to Beneficiary the amount demanded[, which amount is dueand unpaid] under[ or in connection with] the agreement between Beneficiary andApplicant titled [agreement title] and dated [date].xxxvi [Beneficiary further states thatthe proceeds from this demand will be used to satisfy the above-identified obligations andthat Beneficiary will account to Applicant for any proceeds that are not so used.]

orxxxvi

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the Standby is set to expire fewer than [30] days from the date hereof, because Issuer hasgiven a notice of non-extension of the Standby,xxxvi andxxxvi the amount demanded isrequired as cash collateral to secure the unmatured or contingent obligations of Applicantunder[ or in connection with] the agreement between Beneficiary and Applicant titled[agreement title] and dated [date]. Beneficiary further states that the proceeds from thisdemand will be used to securexxxvi the above-identified obligations and then to satisfythem as they become absolute and due and that Beneficiary will account to Applicantxxxvi

for any proceeds that are not so used.]

Beneficiary requests that payment be made by wire transfer to an account of Beneficiaryas follows: [INSERT NAME, ADDRESS, AND ROUTING NUMBER OF BENEFICIARY’S BANK, AND

NAME AND NUMBER OF BENEFICIARY’S ACCOUNT].

[Beneficiary’s name and address]

By its authorized officer:

[INSERT ORIGINAL SIGNATURE][INSERT TYPED/PRINTED NAME AND

TITLE]

[Before the standby is issued, all text in [bold] should be completed, and optional text in[italics] should be included or deleted (or redrafted). Text in the annexed demand formpreceded by “INSERT” (or other ALL CAPITALS guidance) and in [ALL CAPITALS

UNDERLINED] is to be completed as indicated when the beneficiary prepares and presentsa demand.]

****************************

* Copyright © 2012 by the Institute of International Banking Law & Practice, Inc.,www.iiblp.org (“IIBLP”). Unlimited permission is hereby granted to copy and use thisISP98 form, including endnotes, for all purposes except publication for a charge to apurchaser or subscriber.

This ISP98 Form 2 model standby repeats the text of ISP98 Form 1. It adds a provisionfor automatic extension and incorporates a model form of payment demand that adds analternative beneficiary statement demanding payment because of the issuer’s actionresulting in non-extension of the expiration date of the standby. Like ISP98 Form 1, thisForm 2 is intended to be self-contained and, absent special circumstances, useablewithout extended reference to the text of ISP98.

The endnotes to this standby include alternative and other optional terms of particularrelevance to standbys providing for automatic amendment of an expiration date, as wellas references to relevant ISP98 rules. See the ISP98 Form 1 endnotes for explanation of

41

wording that is common to ISP98 Forms 1 and 2 and for alternative and optional wordingfor general terms common to both forms. (There are more than 30 endnotes to Form 1that are not repeated in this Form 2.)

xxxviExpiration. ISP98 Rule 9.01 (Duration of Standby) provides that “A standbys must: (a)

contain an expiration date or (b) permit the issuer to terminate the standby upon reasonable priornotice or payment”. Commercial law and banking regulations are likely to impose similarrequirements. As reflected in ISP98 Form 1, a standby may set an expiration date and leave thepossibility of shortening or extending that date to future amendment(s) issued by the issuer towhich the beneficiary consents, as provided in ISP98 Rule 2.06(b)-(d) (When an Amendment isAuthorised and Binding). Also, a beneficiary may seek the issuer’s consent to an amendment ofthe expiration date by requesting the amendment or by making an extend or pay demand.

xxxviAutomatic amendment. Many issuers are subject to laws, regulations, or internal policies that

limit their incurrence of obligations that are indefinite or long term. A common response to anapplicant’s request for a medium or long term standby is to set a one year expiration date andthen state in the standby that it automatically extends for successive one-year periods unless theissuer sends, or the beneficiary receives, advance notice of non-extension, as provided in ISP98Rule 2.06(a) (When an Amendment is Authorised and Binding). This ISP98 Form 2 reflects thatcommon response.

Alternative responses include the following model clause for automatic early termination of thestandby based on the issuer’s giving advance notice to the beneficiary, e.g.: “The expiration dateof this Standby is [date]. The expiration date shall be automatically amended to an earlier date if

Issuer notifies Beneficiary of the proposed earlier expiration date by registered mail or otherreceipted means of delivery sent to Beneficiary's above-stated address [30] or more days before

the proposed earlier expiration date stated in the notice."

Another alternative is based on early payment, e.g., “The expiration date of this Standby is [date].

The expiration date shall be automatically amended to an earlier date if Issuer notifies Beneficiaryby registered mail or other receipted means of delivery sent to Beneficiary's above-statedaddress that Issuer elects to terminate this Standby with Issuer’s payment to Beneficiary of thefull amount available under this Standby and payment is made to Beneficiary, whereupon thisStandby shall expire.” See ISP98 Rule 9.01(b) (Duration of Standby).

ISP98 Rule 2.06(a) (When an Amendment is Authorized and Binding) makes “automaticamendments” effective without further notification or consent if the automatic amendment isexpressly stated in a standby. Accordingly, it is desirable to include the word “automatic” in anystandby clause intended to make an amendment effective based on the terms of the standby andnot by obtaining the beneficiary’s consent. It is unnecessary to recite that an automatic extensionis “without amendment” or that an automatic extension clause is a “condition”.

xxxviAutomatic extension. The words “extend” and “non-extension” are used, rather than “renew”

and “non-renewal”, to avoid any doubt that the intent is to amend, rather than replace, thestandby.

It is not desirable to include the word “evergreen” in an automatic extension clause. The word“evergreen” is popularly used to refer to automatic extension clauses, such as the one included inthis ISP98 Form 2. However, this word cannot substitute for, or usefully supplement, anautomatic extension clause. See ISP98 Rule 1.10(c)(ii) (Redundant or Otherwise UndesirableTerms).

42

xxxviSend/receive. Automatic extension clauses vary in the extent to which they spell out where

and how a notice of non-extension must or may be sent to, or be received by, the beneficiary inorder to establish an expiration date that is not subject to further automatic extension. Foralternative wording, consider: “…is sent to Beneficiary’s above-stated address by registered mailor by [inter]nationally recognized courier or is received by Beneficiary at Beneficiary’s above-stated or current address….” Under ISP98 Rule 4.11(c)(ii) (Non-Documentary Terms orConditions), standby requirements based on when, where, and how issuer notices are sent orreceived by the issuer or beneficiary are effective. However, there may be practical difficulties inproving when an issuer’s non-extension notice was sent to or received by the beneficiary. Strictcompliance concepts applicable to beneficiary presentations under a standby are sometimesapplied to issuer notices to a beneficiary. Some standbys address these concerns by providingalternative beneficiary addresses or by providing that timely actual receipt of notice by thebeneficiary is sufficient.

If notice by e-mail, telefax, or the like is also to be permitted, then the automatic extension clauseshould state the alternative, e.g. “Such notice may also be given by [e-mail] [telefax][authenticated SWIFT message] sent to the following Beneficiary [address][number].…”

xxxvi30 days/one year. A 30-day period for giving or receiving a notice of non-extension is

common, but shorter (e.g., 15 days) and longer (e.g., 60 days) periods are also common.Although unnecessary, "calendar day" may be substituted for "day" to emphasize the distinctionbetween "business day" and "banking day" which are defined in ISP98 Rule 1.09(a) (Definitions)and “day” which is not defined. The length of the period is affected by the length of time expectedfor (i) the issuer to re-approve the applicant’s credit, (ii) the beneficiary to draw as permitted bythe standby and the underlying transaction, and (iii) the applicant to replace the standby.

A one-year period for setting the initial expiration date and for the duration of automatic extensionperiods is very common. It is based on the common practice of bank issuers that annually re-evaluate applicant credit-worthiness.

xxxviRetraction of non-extension notice. Standby operations personnel may not receive credit

approval for extension before the date required to initiate sending a timely non-extension noticeand, as a result, may issue a notice of non-extension and later receive credit approval forextension. The following optional model clause would permit a full right of retraction: “At any timebefore the next expiration date Issuer may retract its notice of non-extension and therebyautomatically extend the expiration date as if its notice of non-extension had not been sent orreceived and may treat any pending (unhonoured) demand for payment based on non-extensionas automatically retracted by Beneficiary.”

xxxviFinal expiration date. An end date for automatic extensions, even if it is set many years out,

is desirable for record keeping purposes, particularly to avoid having to retain indefinitely proofthat a standby was terminated by expiration following an effective notification of non-extension (orwas honoured or otherwise reduced to zero).

xxxviExtension under ISP98 Rules 3.13 (Expiration Date on a Non-Business Day) and 3.14

(Closure on Expiry Date). The initial or automatically extended expiration date stated in astandby may not be the last day on which a presentation may be made. ISP98 provides forextensions for a presentation that is received during a weekend or holiday or that is attemptedduring a business day at a place of presentation that is closed for any reason. Separately, ISP98Rule 9.03(b) (Calculation of Time) provides that an extension period starts on the calendar dayfollowing a stated expiration date that falls on a day when the issuer is closed. (This rule isintended to keep the same calendar date as the expiration date under an annually extendedstandby.)

43

xxxviCommunications. See ISP98 Form 1 endnote 20. This optional clause is particularly apt for

a standby that is long term or otherwise more complex than most standbys, such thatcommunication from or to the beneficiary (apart from payment demands) may be expected. Anissuer may wish to expand this clause or the clause on giving notice of non-extension to thebeneficiary, to assure that effect will be given to a notice duly sent but not (provably) received bythe beneficiary, “A notice shown to have been delivered to the Beneficiary’s above address bymail or courier certificate, invoice, or the like shall be deemed received by Beneficiary andeffective not later than 5 Business Days after the date of delivery shown thereon.”

xxxviAlternative Statements. Depending on the terms of the underlying obligation, an issuer’s non-

extension notice may entitle the beneficiary to a payment either that satisfies the underlyingobligation or serves as cash collateral for an underlying obligation or that is not yet due. ISP98Form 2 contemplates that the beneficiary will present separate demands and statements if thebeneficiary is entitled to make partial demands of both types.

xxxviFirst alternative statement (drawing to satisfy underlying obligation). The first alternative

beneficiary statement is substantially the same as the beneficiary statement in ISP98 Form 1.This first alternative statement might be apt for a drawing made after sending/receipt of a non-extension notice, particularly if the underlying agreement entitled the beneficiary to accelerate anunderlying debt obligation upon the imminent expiration of standby support. Any such underlyingagreement could limit the beneficiary’s right to accelerate to situations in which there was noretraction of the non-extension notice sent/received and no substitute standby was issued.

xxxviSecond alternative statement (drawing to cash collateralize underlying obligation). The

second alternative statement would be apt for a drawing made after sending/receipt of a non-extension notice, particularly if the first alternative statement requires a statement that the amountdemanded is due and if the underlying agreement does not treat imminent expiration of thestandby as accelerating the underlying payment obligations.

xxxviExtend or pay demands. ISP98 Rule 3.09 (Extend or Pay) provides that an “extend or pay”

demand must be examined for compliance with the standby’s terms and conditions for honouringpayment demands. Imminent expiration would not excuse compliance with a requirement that apayment demand state that the underlying obligation is in default or the like. It would not excusecompliance with a requirement that a payment demand state that the issuer has sent a notice ofnon-extension. Accordingly, if the standby is to facilitate extend or pay demands, the standby textand the required form of payment demand in this model ISP98 Form 2 should be re-worded.

xxxviNo retraction or standby substitution. The required beneficiary statement might here add a

statement that no retraction of the non-extension notice has been timely sent/received and thatno permitted substitute standby (or other equivalent security) has been timely sent/received. Insuch case, the 30 day period stated in the automatic extension clause in this ISP98 Form 2should be reduced, e.g., to 15 days, to allow time for retraction or permitted standby substitution.It is possible to include all of the features of a permitted standby substitution (or for the tender ofpermitted equivalent security), but ordinarily what is permissible should be spelled out in theunderlying agreement and cross referenced in the beneficiary’s statement.

xxxviProceeds as cash collateral. Where the proceeds cannot or might not be used to “satisfy” the

Applicant’s obligations, it may be appropriate to state that the proceeds are being used to“secure” them. The terms permitting a drawing and then holding of cash collateral should bestated in an underlying agreement between the applicant and beneficiary, particularly if the cashcollateral is to be held in an interest bearing or other special account. Such terms may be statedalso in the required form of beneficiary statement regarding the basis for the drawing andsubsequent use of standby proceeds as security.

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xxxviAccounting for proceeds. As noted in ISP98 Form 1, the issuer may wish that the demand

form state that the beneficiary must account to the issuer for any unused proceeds resulting froma drawing based on the issuer’s advance notice of non-extension and to take further steps toprotect its interest in such unused proceeds.

[IIBLP as of 27 June 2012]