Essentials for a Letter of Credit for a Construction Contract

by Carl Carabelli; Updated September 26, 2017
Explaining

A letter of credit for a construction contract is a guarantee the work will be completed on time and to specifications. Issued by a financial institution on behalf of the contractor for the benefit of the municipality, the letter must contain specific information. It must include the borrower information, the beneficiary information, the conditions to draw and the expiration and renewal options.

Principals

Every letter of credit needs to identify three main parties -- the issuer, the borrower and the beneficiary. For a construction contract, the issuer typically is a bank. The bank is responsible for providing the funds if the letter is drawn upon. The borrower is the individual or company performing the construction the bank is guaranteeing. The beneficiary is the recipient of the work, typically a municipality or utilities authority. This usually is the agency responsible for ensuring the project is in accordance with regulations.

Details

The letter of credit must detail several specific items -- the amount the issuer is guaranteeing, the specifics of the project, an identifying number and the dates of issuance and expiration. The amount varies based on the needs of the project. The project specifics include a description of the site and any specific improvements needed. The identifying number is the tracking number utilized by the bank and beneficiary. The dates of issuance and expiration are self-explanatory. The typical term is one year.

Conditions to Draw

The purpose of the letter of credit is to ensure funds are available for the completion of the project. The bank guarantees this by issuing the letter. If the required site work is not completed, the beneficiary has the right to draw upon the letter of credit to fund its completion. The conditions for the beneficiary should be specifically outlined in the body of the letter. Typically the beneficiary must provide proof of default on the part of the construction company, in addition to a “punch list” of items to be completed. If the original letter of credit must accompany the draw request, that will be detailed within.

Renewal Terms

A letter of credit for a construction project must provide the terms for renewal. In the case of construction, the letter automatically is reviewed on an annual basis. To cancel the letter, the bank must provide advance notice. The requisite amount of time is detailed in the letter. The most common time frame for the issuer to provide notification to cancel the letter is 60 days prior to the current maturity date. The notice of cancellation must be received by the beneficiary prior to this date by courier or registered mail.

About the Author

Carl Carabelli has been writing in various capacities for more than 15 years. He has utilized his creative writing skills to enhance his other ventures such as financial analysis, copywriting and contributing various articles and opinion pieces. Carabelli earned a bachelor's degree in communications from Seton Hall and has worked in banking, notably commercial lending, since 2001.

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