Standby Letters of Credit (LOC) have long been a tool used in commercial aircraft leasing; affording a lessee the ability or option to provide a lessor an LOC in lieu of paying a cash security deposit or periodic cash maintenance reserves. For the lessee (the applicant), the LOC frees up its cash for other purposes and can alleviate the impact of having to pay periodic maintenance reserves; provided bank fees and the administrative burden associated with the maintenance of the LOC do not outweigh the lessee’s need for cash at hand.
Many lessors end up agreeing to such LOC provisions in commercial aircraft leases, often echoing the lessee’s encouraging words “but it’s the same as cash” and believing it true. A lessor (the beneficiary) must be aware that an LOC is not “the same as cash” and there are very real risks associated with LOC use which could prevent a lessor from a successful drawdown of an LOC to cash. Consider the following the next time a LOC comes across your desk.
Evergreen provisions (more than just a tree). Require an “evergreen” LOC which provides for automatic one-year extensions to the term of the LOC unless the issuing bank gives written notice to the lessor that the LOC will not be renewed or provides an expiration date. The lease itself should give lessor the right to draw upon the LOC in the event a replacement LOC is not provided prior to the expiration of an existing LOC or upon the occurrence of a lease event of default (which should include any failure of the lessee to provide the lessor with an LOC). If an LOC is in danger of expiring, the lessor must have the ability to drawdown on such LOC prior to such expiration and failure to renew. In the event an LOC does have an expiration date, it is good practice for a lessor to actively monitor the LOC to ensure no expiration occurs. Additionally, if there is a defined expiration date, ensure it is 120+ days beyond the scheduled termination date of the lease.
Ensure partial drawings are permitted. An LOC should expressly permit partial drawings up to the stated amount. Also consider in the lease an obligation on the lessee to top-up any LOC which has been drawn upon, which may even contemplate the issuance of a new LOC.
Keep presentment documents simple. Here is where “keep it simple stupid” (KISS) really benefits a lessor. An LOC is payable only when the documents expressly set forth in the LOC required for any such draw down have been presented to the issuing bank, and many banks will look for any opportunity to deny a draw. In an aircraft lease scenario, this would typically involve a demand for payment (sight draft) signed by the lessor (as beneficiary) referencing the LOC and demanding the payment of a specified sum and in some cases certifying that money is owed or that an event of default under the lease has occurred. This demand for payment should be a form/exhibit contained in the LOC and permit only the filling in of certain blanks of needed information from the lessor (i.e., sum demanded and lessor account information). Avoid any provisions which require numerous documentary conditions for a presentment to be honored. Ensure any presentment does not require any signature of the lessee or any third party and does not require any notice to the lessee or any action by the lessee. It should really be as simple as filling out a few blanks in the form demand for payment (sight draft) and presenting it to the issuing bank.
Avoid needing originals. Avoid a provision which requires presentment of the original LOC as a prerequisite for draw down. A copy should suffice and you would be surprised how often these originals seem to get misplaced over the term of a lease. In the event an original is required, include a provision obligating the issuing bank to provide a replacement original if the original is lost or destroyed.
Allow presentment by SWIFT or fax. Instead of hopping on the next flight to Switzerland or leaving the job in the hands of a courier, consider allowing for presentation of authenticated SWIFT message through the beneficiaries bank or by fax. Provided no originals are needed, this method of presentation is simple and efficient. In the alternative, negotiate for the ability to draw at a convenient local bank office.
Understand bankruptcy traps. It is well settled in most jurisdictions that LOC and the proceeds thereof are not property of a debtor’s bankruptcy estate (and therefore the automatic stay would not apply to a beneficiary attempting to draw upon an LOC relating thereto), but some care should be given to avoid a few pitfalls which could land a beneficiary waist deep in the muck of the automatic stay and running afoul of the preference period. Be careful not to allow the terms of presentment to require that the beneficiary certify that the beneficiary made a demand on the lessee/debtor for payment as this could prohibit the beneficiary from drawing on the LOC. Additionally, to the extent able, ensure the LOC is issued at least 90 days prior to the lessee/debtor filing for bankruptcy to avoid preference claims.
Must be freely transferable. In today’s age where aircraft and leases are being traded as frequently as Pokémon cards on a school playground, it is vitally important for an LOC to be freely transferable and this should be expressly set forth in the LOC itself. The terms should include that the LOC is transferable in its entirety (and more than once) by delivery to the issuing bank of a transfer certificate, form of which should be agreed in the LOC. Again, keep it simple.
Understand there are differences in governing law. Getting a bit into the weeds on this one, but a lessor should be aware that governing law of an LOC could make a difference. The laws generally governing letters of credit are Article 5 of the UCC, the International Standby Practices (ISP98), or the Uniform Customs and Practice for Documentary Credits (UCP 600). The ISP98 governs the practice, custom, and usage of standby letters of credit, while the UCP 600 applies to letters of credit more generally including commercial letters of credit. Though beyond the scope of this brief article, there are differences in each which can impact a beneficiary’s ability to drawdown on an LOC. By way of example, under ISP98 (without express language in the LOC to the contrary), an LOC may be transferred in its entirety more than once but may not be partially transferred. While under UCP 600 (without express language in the LOC to the contrary), an LOC may be partially transferred but may not be transferred in its entirety more than once. Knowing the intricacies of the differences between these governing laws is where the advice of a professional may come in handy.
Done right, a lessor can mitigate some of the risks that an issuing bank may dishonor a drawdown. Keep these tips in mind for next time a draft LOC comes across your desk or a lessee promises you “but it’s the same as cash”.
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