Standby letter of credit, Wire transfer, Guarantee of payment, Confirmation
The Fear of not Getting Paid
The athletic director of a Colorado university called with a dilemma. Along with the rival team of a neighboring state, Colorado football players were scheduled to play an exhibition game in Australia.
Both schools and the promoter of the event in Australia agreed in advance to share the game’s receipts, which amounted to a considerable sum of money. Colorado’s share of the money would cover expenses such as travel and lodging.
Since the promoter promised to initiate a wire transfer within a week after the game, it occurred to the athletic director that the school would face an undesirable deficit if they never received the wire transfer. “How can I have assurance of payment?” he asked.
A Standby Letter of Credit as a Solution
I suggested a standby letter of credit as a solution. The athletic director certainly could outsmart me in the offensive and defensive strategies in the game of football, but he did not understand the concept of a standby letter of credit.
I explained how the promoter in Australia could request a bank in Australia to issue a standby letter of credit (effectively, a bank’s guarantee of payment). His school could demand payment from the bank in the event they did not receive the wire transfer as agreed. As he began to understand the scenario, the athletic director asked an insightful question: “Why would the promoter in Australia agree to issue a standby letter of credit to us? What if we collect the money without even making the trip?”
A Standby Letter of Credit can Protect Both Parties
His question looked at the issue from the other side and it lead to a discussion of how the letter of credit could also protect the promoter in Australia. We decided the promoter would be protected if the letter of credit to the Colorado university required the presentation of two documents: (a) a statement that the school did not receive the wire transfer, and (b) an article from an Australian newspaper covering the game. This would prove that the schools actually played the game.
Both parties agreed to the solution and a bank in Australia issued the standby letter of credit accordingly.
Later, the athletic director had another intuitive thought. “I don’t know anything about banks in Australia. How do I know they can stand behind their commitment?”
I assured him, “My bank knows the Australian bank well, and if it would help you sleep better at night, we will confirm the letter of credit.” Since a confirmation would act as a guarantee, he wouldn’t need to worry about the Australian bank and he liked this solution.
Getting Paid with a Letter of Credit
A week after the team returned from the game in Australia, I received a call from the director. He asked to make an appointment so he could collect payment from the standby letter of credit.
Surprised, I asked, “Did they default on their payment?”
“No,” he answered, “they decided to simply permit us to use the standby letter of credit as the payment.”
When he arrived in my office, I asked, “Did you bring a newspaper clipping with you?” He opened his brief case and produced five complete newspapers, each from a different publisher in Australia. Since we only needed one article as proof, we sent him back to the university with the other four, happily carrying a cashier’s check for his school’s share of the game’s receipts.
Because of the flexibility of standby letters of credit, they can provide security in a variety of scenarios. This lesson illustrates how they can provide security for a financial obligation.