Letters of credit are a common form of collateral commonly used to secure surety transactions.
A letter of credit is a guarantee issued by a bank for a certain sum to be paid. Surety letters of credit are unconditional and generally referred to as irrevocable letters of credit. They contain a clause that requires an automatic renewal, which is commonly referred to as an evergreen clause. The irrevocable letter of credit issued to collateralize a surety bond is generally in the amount of the bond or, in some cases, may have a little additional buffer. A letter of credit, since it’s a guarantee that a bank will pay and not conditioned on the bond principal defaulting, makes the obligation to pay that of a bank. With that said, the bank needs to be acceptable to the surety. The surety wants to see that it’s above a certain size and has an acceptable credit rating to make sure that they are protected from the possible chance of a bank defaulting. There is no specific formula. Each bank is reviewed independently, and there is no list of approved banks. Banks that are major household names are normally almost always approved. It is best to have my office approve each individual bank to avoid any issues. We always provide prompt responses.
A common question asked is whether or not a foreign bank can issue a letter of credit. In most instances, the foreign bank cannot issue a letter of credit unless they have what’s called a confirming bank, which would be a US bank that they work with to confirm the letter of credit.
In certain cases, certain foreign banks are acceptable on a case-by-case basis. There are some forward-thinking surety markets that will review certain letters of credit issued by foreign banks. Some of the requirements are that the bank can issue a letter of credit payable at a U.S. counter, which means that the letter of credit would have to have the condition that it is payable in U.S. dollars and at a location in the U.S. There are certain surety markets that would accept the letter of credit payable at a foreign counter, meaning this could be payable at a foreign bank. So, let’s say you have a bank based in England that does not have any U.S. operations or a U.S. address. There is the possibility of special exceptions, although it’s not common, and it does not happen often, that a foreign bank, in this example, based in England, could pay the letter of credit at their normal branch or headquarters in another country, provided it is in U.S. dollars. When dealing with foreign letters of credit, it generally takes more time to obtain them from the bank and more time for surety approvals.
So, adding additional time to have the bond approved under those terms will allow my office to obtain confirmation that the surety can accept the letter of credit from a foreign bank. Not all foreign banks are accepted. It’s a very strict process, and very few are, but it is a possibility, and I do want to put this on my client’s radar if it is of use to them. If you’re dealing with a foreign client who wants to use a letter of credit from a foreign bank, give my office a call, and we will go over the process and see whether or not this will be accepted.
Neil Pedersen
PEDERSEN & SONS SURETY BOND AGENCY, INC.
15 Maiden Lane, Suite #800
New York, NY, 10038
212-227-7277
neil@courtbondnow.com
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