Structuring LCs to Protect Your Company

"The letter of credit (LC) is an obligation that banks have to your company if
certain conditions set forth in the LC are met," said Robert Mercer, Esq. of law
firm Powell Goldstein, LLP. "This is an attempt to isolate your company from the
customer."

Mercer, a partner at Powell Goldstein’s Atlanta office who practices in its
Bankruptcy & Financial Restructuring Group, discussed LCs and the best ways
to structure them at a recent NACM teleconference entitled "Structuring Letters
of Credit That Won’t Leave You Stranded in a Customer Bankruptcy." Over the
course of his presentation, Mercer outlined common stipulations that creditors
should include as well as some that they should avoid when drafting their
LCs.

Most importantly, Mercer noted, a vendor using an LC should be sure to
include a Bankruptcy trigger in the LC, rather than just in the supply contract.
Since the revisions made to the bankruptcy Code in the 1970s, provisions in
contracts that attempt to construe a customer bankruptcy as a form of default
have been unenforceable, meaning that when a customer files, the vendor is left
open to preferences and placed in the running with the rest of the customer’s
unsecured creditors. Still, these provisions are used very frequently. "You see
them in many commercial documents," said Mercer. "Put in the LC that, if the
customer files bankruptcy, it’s a basis under which your company can draw on the
LC." In this way, when a customer files bankruptcy, under the terms of the LC,
the bank is still obligated to pay your company.

"This is a really simple fix," he added. "That’s a provision you want in the
LC."

Mercer also discussed the importance of removing as many conditions as
possible from the LC, including provisions that require a vendor to give a bank
or the customer a few days notice before drawing on the LC or provisions that
require the vendor to seek consent before drawing.

For more information on NACM’s teleconferences, or to register, click here.

Jacob Barron, NACM staff writer

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