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Monitor Your Company’s Letters of Credit

Letters of Credit frequently are reviewed and filed away. It is time to open the file drawer, dust off those Letters of Credit, and review them again. Failure to do so could lead to some unpleasant, but avoidable, results.

It was recently reported that one in four Wisconsin banks was unprofitable in 2009. The FDIC has also recently reported that the “problem list” of banks has grown from 252 at the end of 2008 to 702 at the end of 2009. Given this continued uncertainty in the financial industry and the likelihood of more bank failures throughout 2010 and beyond, beneficiaries under existing and new letters of credit, including real estate companies, should carefully monitor their rights under these instruments.

Letters of Credit are used in a number of different ways in commercial real estate transactions: (i) as security deposits under office, retail and industrial leases in lieu of cash; (ii) to secure substantial construction, maintenance and repair obligations; and (iii) as earnest money deposits under purchase and sale agreements in lieu of cash.

Beneficiaries will want to ensure that when the time comes to draw upon their letters of credit they will be able to do so. Beneficiaries should carefully review existing Letters of Credit and confirm that the issuing banks are still in good financial condition and will be able to fulfill their obligations under the letters of credit. If not, the beneficiaries will need to review the underlying documentation creating the Letter of Credit obligations to determine what remedies they may have.

For newly issued letters of credit, the beneficiary should carefully review and specify which banks will be acceptable as the issuing bank. In addition, the Letter of Credit agreement will ideally provide that the applicant (the party providing the Letter of Credit) must provide a replacement Letter of Credit from an issuer acceptable to beneficiary in the event that (i) the issuer’s credit rating drops below a specified level, or (ii) the issuer is added to any applicable “problem list” of banks. Alternatively, the Letter of Credit itself can provide that the beneficiary shall be immediately entitled to draw on the Letter of Credit for the full amount in the event either of these two events occur.

For more information regarding Letter of Credit matters, contact Matt Impola at 414.225.1412 or or your Davis & Kuelthau, s.c. attorney.