Here is a great question that came up during one of our training sessions in the office:
What’s the difference between an Irrevocable Letter of Credit, a Line of Credit and a Set-aside Letter?
Letter of Credit
This document is also referred to as an “ILOC,” a Letter of Credit or a Standby Letter of Credit. They are a commercial bank customers undistributed loan payable to a designated 3rd party. Wow, THAT explains it!
Here is an example: Elon is entering into a contract that must be secured. It could be a construction contract that requires either a Performance Bond or an ILOC. The instrument is needed by Elon and he is the applicant and paying for it, but the beneficiary is the other party in the contract, LaFawnduh.
The instrument says that if a default occurs the beneficiary can seek recovery via that instrument. LaFawnduh, can send a demand letter to the bank which will be obligated to send funds. It will be recorded as a loan to Elon.
Line of Credit
This is simply a credit facility, such a a home equity loan or Working Capital Loan for a business. The applicant / borrower can draw out funds when needed. A loan document governs the transactions.
Set-Aside Letter
This is an agreement executed by a bank regarding a customer they share with a bonding company. The bank is loaning money to the client to fund a project guaranteed / covered by a surety bond. This could be on a subdivision, where the borrower must self-fund the cost of construction.
In the event of the demise of the borrower, the set-aside letter promises to keep the loan in play so the surety has a source of funds to finish the work.
Now, was that so bad? All three concern the handling of money, but for different purposes.
Want to solve more bonding stuff? Call us with your next Contract Surety, Site or Subdivision Bond. We’re problem solvers!
FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417
Providing A rated, T-listed bonds in all states!
