The bank appraises the applicant’s creditworthiness and approves the credit facility. The process of a direct payment LC starts with the applicant approaching a bank.
READ: Intercreditor Agreement: Definition and Key Challenges A direct payment LC eliminates the condition of performance and clears the payment upon demand draft presentation by the beneficiary. The buyer provides a standby LC to mitigate the risk of non-payment, which helps both parties to boost the trust. How Does Direct Pay Letter of Credit Work?Ī standby letter of credit is used to protect the buyer from the non-performance of the seller. Although it does not happen often, the sellers can claim the payment without proceeding with the shipment of goods to the buyer. It offers a higher degree of risk as compared to a normal standby, such that it does not come with a covenant for the undertaking of a certain event happening. On the other hand, it also possesses similar risks to the applicant and the issuing bank. Hence, it offers discrete financial security to both parties in the trade agreement. The direct pay LC works independently from the trade agreement. Unlike a standby, the beneficiary does not need to present the documents on default of the buyer only. The issuing bank clears the payment upon payment draft presentation by the beneficiary.
In a direct pay letter of credit or simply direct pay LC, the advisory bank makes a direct payment to the beneficiary. In both forms, the issuing bank bears the responsibility of non-payment by the applicant. Whereas, a standby LC is used to make payments in case of default of the buyer. Like a standby, it can provide financial security to the seller by the presentation of the payment draft.Ī direct pay letter of credit differs from standby in the sense that it acts as a primary source of payment to the seller. It does not include any clause of performance or non-performance from the seller. With a direct payment letter of credit, the issuing bank directly pays to the beneficiary. A direct pay letter of credit is a special form of standby letter of credit.
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