Guarantees and stand-by letters of credit for trade

Your needs

In your ideal scenario for doing business abroad, you want to access untapped markets and establish solid, trusting relationships with new trading partners. However, you also want to avoid any unpleasant surprises before, during or after a trade transaction.

As a seller-exporter, you need to be sure that the buyer-importer will fulfil their contractual payment obligations. As a buyer-importer, you want the reassurance of knowing that you will be compensated if the seller-exporter fails to meet their contractual obligations, for example by not delivering the goods or delivering them late.

A demand guarantee and a standby letter of credit can help in these situations.

Characteristics of a demand guarantee and standby letter of credit

A demand guarantee is issued by the seller-exporter's bank at their request. The bank issues it in favour of the buyer-importer for an agreed amount. You can call on it if the seller does not deliver the goods or services as agreed in the contract.

Conversely, the buyer-importer may ask their bank to issue a demand guarantee in favour of the seller-exporter. The seller can then invoke this guarantee if the buyer does not pay for the goods or services in line with the contract.

A beneficiary of a demand guarantee can request payment from the issuing bank without providing any additional proof. They do not have to prove that the counterparty has failed to fulfil their contractual obligations. They must only formally confirm to the issuing bank that the counterparty is in default. The issuing bank must then pay irrevocably, in the same way as with a documentary credit.

However, it is common practice for the guarantee to list certain documents that must accompany the request. Without these documents, the issuing bank will not pay the beneficiary.
For clarity, the issuing bank’s commitment is limited to paying a specified amount. It will never assume the contractual obligations of the seller-exporter or buyer-importer.
Finally, unlike a documentary credit, the intention behind a demand guarantee is that it will not be used.

A standby letter of credit (SBLC) is a demand guarantee presented in the format of a documentary credit. The choice between the two sometimes depends on the country you are dealing with. For example, SBLCs are common in the United States, but less so in other countries. We can guide you through this process.
An SBLC is particularly useful if you regularly trade with the same counterparty. In such cases, you will already know each other well and have a positive track record. You can use the SBLC for multiple successive transactions.

A demand guarantee, on the other hand, applies to one specific transaction only. If you regularly trade with the same partner, a new demand guarantee would need to be issued each time. This is why an SBLC is effectively a standby documentary credit within a broader bank guarantee international trade solution.
Whatever your scenario, there is always an appropriate solution to meet your needs in international trade.

Examples

• A payment guarantee ensures that the seller-exporter is paid if the buyer-importer fails to pay.
• A performance guarantee ensures that the buyer-importer receives compensation if the seller-exporter fails to fulfil their contractual delivery obligations. These include standard performance guarantees, advance repayment guarantees, tender guarantees, retention guarantees, and maintenance guarantees.
• There are also guarantees in favour of customs and excise authorities.

Risks of a demand guarantee and standby letter of credit

The main risk with these instruments arises from the combination of their irrevocable nature and the fact that the beneficiary does not need to provide proof of the counterparty's non-performance. This may lead to so-called 'abusive drawing', whereby the beneficiary makes a potentially fraudulent claim under a demand guarantee or SBLC.

Advantages and disadvantages

Clear advantages include:

• The entire process follows international rules. All parties must comply with these rules, which are overseen by the banks.
• These solutions do not affect your company’s working capital. You do not need to release funds. The issuing bank provides the guarantee on your behalf under a bank guarantee international trade structure.

Important considerations:

• Before the issuing bank can provide a demand guarantee or an SBLC on your behalf, you must have the necessary credit line.
• There is also a risk of fraudulent claims.

You can rely on BNP Paribas Fortis

At BNP Paribas Fortis, we understand that entrepreneurs have many questions when considering foreign trade and the right bank guarantee international trade solution. Are you planning to import or export, looking to expand your existing international activities, or searching for new opportunities abroad? If so, contact your relationship manager. They will be happy to put you in touch with a specialist.