Letters of Credit Supporting Debt for Borrowed Money: The Standby as Backup

There are several ways in which debt for borrowed money benefits from being supported by a bank letter of credit. In a situation where the debt issuer does not have sufficient creditworthiness to have its debt purchased, a bank letter of credit that supports the debt would permit the debt to be judged to a large extent on the creditworthiness of the bank. Purchasers of debt would also be more likely to accept a significantly lower interest rate if a bank issued a letter of credit supporting the debt. The structure of a bank letter-of-credit transaction has a customer of the bank who owes an underlying obligation to a third party with that obligation being supported by the letter of credit. The customer agrees to repay the bank for any payments the bank has to make. This credit reimbursement agreement is a ''loan agreement,'' but the bank only lends credit rather than cash. A bank's authority to issue a standby letter of credit in a particular situation is determined by the law governing a bank's activities. A reading of the pertinent sections of the Uniform Commercial Code and the Uniform Customs and Practice for Documentary Credits will reveal the scope of permissible letters. Generally, these letters are easily understood, and if drafted and administered well, they will present few problems.