Faegre Baker Daniels partner Brian Clifford authored the following article for the Control System Integrators Association in February 2014.
Participants in the control systems industry are increasingly crossing borders — both national and international — to do work for customers in need of their unique expertise. I am often asked what steps can be taken to ensure payment by a customer that has not yet established a credit history with an integration firm, especially when the potential new customer is a startup company or is headquartered far from the integrator’s offices. While there are many techniques that can be used, I often ask if a letter of credit can be posted at the start of a new relationship. Letters of credit are widely available from banking institutions worldwide, have relatively low maintenance costs to the customer, and can provide payment security to the integrator as the parties work together to establish other long-term credit arrangements. Here are a few key terms you should look for in any letter of credit:
Irrevocable: As the name implies, an irrevocable letter of credit (or “ILOC”) cannot be cancelled or revised without the consent of the beneficiary (i.e., the company extending credit to the customer that is providing the letter of credit from its bank). Such a term gives comfort to the beneficiary that payments will be made even if the customer experiences financial difficulty and has other banking products (such as a commercial line of credit) restricted or terminated.
Term: Even though the letter of credit is irrevocable, it generally will still have a defined expiration date. A beneficiary should check to be sure that all payment obligations are satisfied by the customer before the end of such term — or that the ILOC is renewed or replaced prior to expiration date if there is still work to be performed, items to be delivered or payments to be made.
“At Sight Instrument:” This is a term of art used with letters of credit. Essentially, it means that the beneficiary is entitled to payment from the bank that issued the letter of credit by merely presenting a written demand for payment (or other similar documentation stated in the ILOC). The issuing bank generally is not permitted to dispute whether or not its customer actually owes the sought-after payment to the beneficiary. For example, the bank generally cannot refuse payment by alleging that the work was incorrectly performed or that the goods that were delivered had defects.
Amount: All letters of credit have a maximum payment limit. A beneficiary should ensure that the amount of the letter of credit is sufficient to cover the expected aggregate amount of all payments that may be outstanding with its customer at any given time. If “net 30” payment terms are used with the customer, this may be the value of two to three months of average invoices (assuming the beneficiary suspends performance and deliveries if the outstanding balance grows too large or too delinquent).
With the added security of a letter of credit, you may be able to safely expand your customer base into new markets. Good luck!