Letters of Credit and Applicant Bankruptcy

October 1, 2019

By: Michael Evan Avidon, Mark N. Parry, and Kirk Haynes

Business Law Today, American Bar Association

This article explores certain potential effects on a letter of credit transaction of the applicant for the credit becoming the subject of a bankruptcy proceeding under the United States Bankruptcy Code (Title 11 of the United States Code).

What Is a Letter of Credit?

A letter of credit (LC) is an undertaking by an issuer, typically a bank (Issuer), at the request or for the account of its customer (Applicant) or, in rare cases, for itself, to a beneficiary (Beneficiary), to pay or otherwise honor a documentary presentation made by the Beneficiary (Uniform Commercial Code (UCC) § 5-102(a)(10)). A classic use of an LC is for a buyer of goods to pay the purchase price for the goods by arranging for its bank to issue an LC to the seller, payable against the seller’s presentation to the bank of a copy of the seller’s invoice for the goods and an original or copy of the transport document covering the shipment of the goods to the buyer. In this example, the buyer would be the Applicant, the bank would be the Issuer, and the seller would be the Beneficiary. Another common use of an LC is as a standby in case of a default in payment or performance of an obligation, such as an LC payable against the Beneficiary’s statement that the Applicant has defaulted in performing a specified obligation to the Beneficiary.

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