Pros and Cons of Using a Letter of Credit to Stay Enforcement of a Judgment

While supersedeas bonds are by far the most common form of security used by appellants to stay enforcement of a judgment, there are a limited number of jurisdictions that allow letters of credit from banks as an alternative form of security. If you happen to have a client with a judgment in one of those jurisdictions that allow for a letter of credit, it’s important to understand the pros and the cons of that form of security to make an informed decision with how to best proceed with staying enforcement of the judgment.

What is a letter of credit?

It’s worth taking a moment to clarify what a letter of credit is. Letters of credit are issued by banks, and they state that the bank will make funds available up to a certain amount to be drawn upon at any time by the beneficiary. The bank does not actually disperse funds until a demand is made, but they underwrite it just like any other loan, and they charge a fee instead of actual interest. Interest is charged once the letter of credit is drawn upon and funds are disbursed.

Pros when Using a Letter of Credit as Security

Letters of credit generally make the most sense for larger, well capitalized companies with strong existing banking relationships where the client has a lot of unused borrowing capacity, and the bank will approve them for the letter of credit on an unsecured basis. Unsecured means the client does not have to set aside cash or other assets to collateralize the letter of credit.

If in a hypothetical situation a client is able to get an unsecured letter of credit, but a surety company would require collateral, the client obviously benefits by not tying up other assets and going the letter of credit route. However, banks have similar underwriting standards for letters of credit that surety companies do when underwriting supersedeas bonds. Thus, if a bank is willing to issue an unsecured letter of credit to a client, there is a good chance, a surety company may be willing to write the bond an unsecured basis without collateral as well.

Another instance where it can be advantageous to use a letter of credit is when a client has a large real estate portfolio and a strong relationship with their bank. There are certainly surety companies that can use real estate as collateral to issue a supersedeas bond, but because of the bank’s relationship with the client and their familiarity with their real estate assets, the bank may be able to offer a letter of credit with better terms than a surety could provide a bond.

Cons to Using Letters of Credit as Security

Clients generally don’t have unlimited borrowing capacity. When they use a letter of credit, the
client is using some of that available capacity. On the other hand, supersedeas bonds that are issued on an unsecured basis do not impact or reduce the client’s borrowing capacity. In addition to not impacting the client’s borrowing capacity, the cost for supersedeas bonds is often the same or less than what banks charge for letters of credit.

Sometimes banks require cash to secure the letter of credit. In that situation, there is really no advantage to the client, because the client could simply wire transfer the cash to the surety to use as collateral to provide the bond. Surety companies pay interest, so the client would earn interest on the cash deposit.

Beyond the borrowing capacity and cost issues just discussed, there are substantive procedural considerations. Surety companies have standard supersedeas bond forms that are widely accepted by the opposing parties and the court. While banks also have standard letters of credit, they are typically just drawn on demand. This means the beneficiary, or the judgment creditor in this case, would be able to draw on the letter of credit at any time even before the appeal has been decided. Thus, standard letters of credit have to be modified for the specific purpose of providing it to the court as security to include a triggering event that indicates when the judgment creditor can draw upon it, which has to be agreed to by the parties and the bank. This can involve significant back-and-forth negotiation between the parties, and the client may need to get additional attorneys involved that are versed in letters of credit. All of this adds legal expenses for the client above and beyond the letter of credit fee.

The time to put letters of credit in place directly with the court can also be a concern. Since banks don’t deal with letters of credit often for the purpose of staying enforcement of a civil judgment, it can cause questions and confusion that adds delay. When that is added to the negotiation between the parties on the letter of credit format, it can end up being a much longer process than obtaining a superseded bond.

There are times after an appeal has been decided when there is a dispute between the parties as to whether the amount is due to the judgment creditor or the exact amount that is due to the judgment creditor. Surety companies are uniquely positioned to handle these situations, because they have claims departments with attorneys versed in handling such matters. Banks, on the other hand, aren’t accustomed to managing these disputes, because their typical letter of credit just pays on demand and doesn’t contemplate triggering events. Furthermore, since banks don’t issue letters of credit often for this purpose, they have very little experience to rely on.

Conclusion

Like many things in life, there is more than meets the eye when it comes to using a letter of credit as security to stay enforcement of a judgment. Attorneys can aid their clients by being well versed in the nuances outlined in this article and educating them on the factors they should consider when deciding between a supersedeas bond and letter of credit.

Dan Huckabay​

President

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