Letter of Credit

A letter of credit, in Canadian federal contracting, is an arrangement under which a financial institution agrees, at a customer's request, to pay the Crown when it receives a compliant written demand. In federal policy this is generally an irrevocable standby letter of credit. It gives the government a source of funds if a supplier does not do what it promised.

Contracting authorities may accept a letter of credit as an alternative to other forms of bid or contract security. It is used to encourage a supplier to enter into or perform a contract, and to provide funds to mitigate damages if the supplier fails to do so. The Treasury Board policy material sets out how the instrument works.

Bid-support and contract-support letters of credit

Federal policy describes two types, and each covers a different failure. A bid-support letter of credit covers a proposed contractor that fails to enter into the written contract or fails to provide required contract security. The Crown may demand payment in those cases.

A contract-support letter of credit covers a contractor that does not perform the contract according to its terms. The Crown may demand payment if that happens. Both types are described in the Treasury Board policy on letters of credit.

A separate instrument from the contract

A letter of credit is a financial-security instrument that stands apart from the underlying procurement contract. Federal policy states that the issuing financial institution is not concerned with, or bound by, that contract, even when the letter refers to it. The bank pays on a compliant demand. It does not decide whether the supplier was in default.

For that reason the wording of the letter matters. The amount, expiry date, beneficiary and demand provisions must match what the solicitation or contract specifies.

Issuer requirements and expiry dates

Federal policy requires the letter of credit to be issued by a financial institution that is a member of the Canadian Payments Association. A letter from any other source does not meet the requirement.

CanadaBuys lists irrevocable standby letters of credit among the acceptable forms of financial security. Its financial security guidance says the expiry date should extend beyond the relevant risk period. For offer security, that means beyond the expected award date. For contract security, it means beyond expected completion.

Use in ITB contracts and other federal programs

Innovation, Science and Economic Development Canada allows Canada to require a letter of credit in Industrial and Technological Benefits contracts when the contractor has not completed its ITB obligations before the final milestone payment. Under the ITB model terms and conditions, the letter must meet these conditions:

• It is issued by a financial institution that is a member of the Canadian Payments Association.
• It is satisfactory to the ITB Authority.
• It is unconditional and irrevocable.
• It is provided at the contractor's cost.
• It is subject to the Uniform Customs and Practice for Documentary Credits (UCP 600, ICC Publication No. 600, 2007).

Letters of credit also appear outside procurement. Fisheries and Oceans Canada materials describe them as securing a proponent's obligation to complete authorization conditions. If the proponent defaults, the department may use the funds to ensure the conditions are met.

What it means for a supplier

When a solicitation or contract requires a letter of credit, you must obtain the specified form from an eligible financial institution. Check that its amount, expiry date, beneficiary and demand provisions match the document exactly, and submit it by the stated deadline. Under the ITB model terms, the supplier bears the cost.

Keep the letter valid for the whole risk period. Arrange it early, because the issuing institution needs time to prepare wording that meets the Crown's requirements.