A travelers’ letter of credit is issued to facilitate travel. This letter of credit is addressed by the bank to its correspondents authorizing the correspondents to honor drafts drawn by the person named in the letter of credit in accordance with specified terms. These letters are generally sold for cash.
A standby letter of credit is a letter of credit or similar arrangement that:
(1) represents an obligation on the part of the issuing bank to a designated third party (the beneficiary) contingent upon the failure of the issuing bank’s customer (the account party) to perform under the terms of the underlying contract with the beneficiary, or
(2) obligates the bank to guarantee or stand as surety for the benefit of a third party to the extent permitted by law or regulation.
The underlying contract may entail either financial or nonfinancial undertakings of the account party with the beneficiary. The underlying contract may involve such things as the customer’s payment of commercial paper, delivery of merchandise, completion of a construction contract, release of maritime liens, or repayment of the account party’s obligations to the beneficiary. Under the terms of a standby letter, as a general rule, drafts will be drawn only when the underlying event fails to occur as intended.