Letter of Credit

A letter of credit is a bank’s promise to pay the landlord up to a stated amount if the tenant defaults. Commercial tenants often provide one as security instead of a cash deposit, keeping their own cash free while giving the landlord a guaranteed source of payment.

How it works

The tenant’s bank issues an irrevocable standby letter of credit naming the landlord as beneficiary. If the tenant defaults, the landlord presents a demand to the bank, usually a simple written statement, and the bank pays without needing the tenant’s agreement. The bank then looks to the tenant for repayment.

Terms to abstract

• Amount, and any scheduled reductions (“burn-downs”) over the term
• Issuing bank, and any rating requirement the lease sets for it
• Expiration date, and whether it renews automatically (“evergreen”)
• Draw conditions, ideally a simple demand without proof of default
• Transferability, so a buyer of the building can take it over
• Replenishment, requiring the tenant to restore the amount after a draw

The critical dates

Letters of credit expire. Most leases require the tenant to renew or replace the letter a set period before expiration, often 30 to 60 days, and allow the landlord to draw the full amount if it does not. Missing that window can leave the landlord unsecured. Burn-down dates, when the required amount steps down, are also worth tracking. Each belongs on the critical date list.

On a sale

A letter of credit is issued to a named beneficiary. On a sale of the building, it must be transferred to the buyer or replaced, which takes time and bank fees. Buyers will check it against the estoppel certificate and rent roll.

The commercial lease administration guide covers tracking security alongside other lease obligations.