how a standby letter of credit works
a sloc is most often sought by a business to help it obtain a contract the contract is a standby agreement because the bank will have to pay only in a worst case scenario although an sblc guarantees payment to a seller the agreement must be followed exactly for example a delay in shipping or misspelling a company s name can lead to the bank refusing to make the payment there are two main types of standby letters of credit the recipient of a standby letter of credit is assured that it is doing business with an individual or company that is capable of paying the bill or finishing the project the procedure for obtaining a sloc is similar to an application for a loan the bank issues it only after appraising the creditworthiness of the applicant in the worst case scenario if a company goes into bankruptcy or ceases operations the bank issuing the sloc will fulfill its client s obligations the client pays a fee for each year that the letter is valid typically the fee is 1 to 10 of the total obligation per year 1advantages of a stand by letter of creditthe sloc is often seen in contracts involving international trade which tend to involve a large commitment of money and have added risks for the business that is presented with a sloc the greatest advantage is the potential ease of getting out of that worst case scenario if an agreement calls for payment within 30 days of delivery and the payment is not made the seller can present the sloc to the buyer s bank for payment thus the seller is guaranteed to be paid another advantage for the seller is that the sblc reduces the risk of the production order being changed or canceled by the buyer an sblc helps ensure that the buyer will receive the goods or service that s outlined in the document for example if a contract calls for the construction of a building and the builder fails to deliver the client presents the sloc to the bank to be made whole another advantage when involved in global trade a buyer has an increased certainty that the goods will be delivered from the seller also small businesses can have difficulty competing against bigger and better known rivals an sblc can add credibility to its bid for a project and can often times help avoid an upfront payment to the seller 