28.204-3 Irrevocable letter of credit
Source: FAR 28.204-3 on acquisition.gov
FAR 28.204-3 allows contractors to use irrevocable letters of credit as bond security, but imposes strict requirements on the ILC's terms, issuing institutions, and ongoing compliance to protect government interests.
Overview
FAR 28.204-3 outlines the requirements and procedures for using an irrevocable letter of credit (ILC) as an alternative to traditional surety bonds in government contracting. Contractors may choose to provide an ILC in the penal sum required for each bond, subject to strict conditions regarding the issuing financial institution, expiration, and draw procedures. The regulation details the necessary characteristics of the ILC, the process for drawing on it, expiration and renewal requirements, and the standards for acceptable financial institutions. It also mandates specific actions if the ILC is set to expire or if the issuing institution's credit rating falls below investment grade. The section references the Uniform Customs and Practice for Documentary Credits (UCP 600) as the governing standard for ILCs.
Key Rules
- Option to Use ILC
- Contractors required to furnish a bond may opt to provide an ILC in the required amount, with a separate ILC for each bond.
- ILC Requirements
- The ILC must be irrevocable, require minimal documentation for draw, and be issued/confirmed by a federally insured, investment-grade financial institution.
- Draw Procedures
- Contracting officers use a specific sight draft and must act if the ILC is not replaced before expiration or if claims remain unresolved after contract performance.
- Expiration and Renewal
- ILCs must meet minimum expiration periods and include automatic renewal provisions unless proper notice is given.
- Financial Institution Standards
- Only federally insured, investment-grade institutions may issue/confirm ILCs, with additional requirements for large ILCs.
Responsibilities
- Contracting Officers: Verify ILC compliance, monitor expiration, draw on ILC when required, and ensure financial institution ratings remain investment grade.
- Contractors: Provide compliant ILCs, ensure timely renewal or replacement, and submit required credit ratings.
- Agencies: Oversee adherence to financial security requirements and maintain documentation.
Practical Implications
- This section provides a flexible alternative to surety bonds, but imposes strict compliance and monitoring requirements. Contractors must carefully select financial institutions and manage ILC renewals to avoid contract disruptions. Failure to comply can result in immediate draws on the ILC, impacting project cash flow and performance.
(a) Any person required to furnish a bond has the option to furnish a bond secured by an irrevocable letter of credit (ILC) in an amount equal to the penal sum required to be secured (see 28.204). A separate ILC is required for each bond.
(b) The ILC shall be irrevocable, require presentation of no document other than a written demand and the ILC (and letter of confirmation, if any), expire only as provided in paragraph (f) of this subsection, and be issued/confirmed by an acceptable federally insured financial institution as provided in paragraph (g) of this subsection.
(c) To draw on the ILC, the contracting officer shall use the sight draft set forth in the clause at 52.228-14, and present it with the ILC (including letter of confirmation, if any) to the issuing financial institution or the confirming financial institution (if any).
(d) If the contractor does not furnish an acceptable replacement ILC, or other acceptable substitute, at least 30 days before an ILC’s scheduled expiration, the contracting officer shall immediately draw on the ILC.
(e) If, after the period of performance of a contract where ILCs are used to support payment bonds, there are outstanding claims against the payment bond, the contracting officer shall draw on the ILC prior to the expiration date of the ILC to cover these claims.
(f) The period for which financial security is required shall be as follows:
(1) If used as a bid guarantee, the ILC should expire no earlier than 60 days after the close of the bid acceptance period.
(2) If used as an alternative to corporate or individual sureties as security for a performance or payment bond, the offeror/contractor may submit an ILC with an initial expiration date estimated to cover the entire period for which financial security is required or an ILC with an initial expiration date that is a minimum period of oneyear from the date of issuance. The ILC shall provide that, unless the issuer provides the beneficiary written notice of non-renewal at least 60 days in advance of the current expiration date, the ILC is automatically extended without amendment for oneyear from the expiration date, or any future expiration date, until the period of required coverage is completed and the contracting officer provides the financial institution with a written statement waiving the right to payment. The period of required coverage shall be:
(i) For contracts subject to the Bonds statute, the later of-
(A) Oneyear following the expected date of final payment;
(B) For performance bonds only, until completion of any warranty period; or
(C) For payment bonds only, until resolution of all claims filed against the payment bond during the one-year period following final payment.
(ii) For contracts not subject to the Bonds statute, the later of-
(A) 90 days following final payment; or
(B) For performance bonds only, until completion of any warranty period.
(g) Only federally insured financial institutions rated investment grade shall issue or confirm the ILC. Unless the financial institution issuing the ILC had letter of credit business of at least $25 million in the past year, ILCs over $5 million must be confirmed by another acceptable financial institution that had letter of credit business of at least $25 million in the past year.
(1) The offeror/contractor is required by paragraph (d) of the clause at 52.228-14. Irrevocable Letter of Credit, to provide the contracting officer a credit rating from a recognized commercial rating service that indicates the financial institution has the required rating(s) as of the date of issuance of the ILC.
(2) To support the credit rating of the financial institution(s) issuing or confirming the ILC, the contracting officer shall verify the following information:
(i) Federal insurance: Each financial institution is federally insured. Verification of federal insurance is available through the Federal Deposit Insurance Corporation (FDIC) institution directory at the website http://www2.fdic.gov/idasp/index.asp" target="_blank">http://www2.fdic.gov/idasp/index.asp.
(ii) Current credit rating. The current credit rating for each financial institution is investment grade and that the credit rating is from a Nationally Recognized Statistical Rating Organization (NRSRO). NRSROs can be located at the website http://www.sec.gov/answers/nrsro.htm" target="_blank">http://www.sec.gov/answers/nrsro.htm maintained by the SEC.
(3) The rating services listed in the website http://www.sec.gov/answers/nrsro.htm" target="_blank">http://www.sec.gov/answers/nrsro.htm use different rating scales (e.g., AAA, AA, A, BBB, BB, B, CCC, CC, C, and D; or Aaa, Aa, A, Baa, Ba, B, Caa, Ca, and C) to provide evaluations of institutional credit risk; however, all such systems specify the range of investment grade ratings (e.g., BBB-AAA or Baa-Aaa in the examples in this section) and permit evaluation of the relative risk associated with a specific institution. If the contracting officer learns that a financial institution's rating has dropped below investment grade level, the contracting officer shall give the contractor 30 days to substitute an acceptable ILC or shall draw on the ILC using the sight draft in paragraph (g) of the clause at 52.228-14.
(h) A copy of the Uniform Customs and Practice (UCP) for Documentary Credits, 2007 Edition, International Chamber of Commerce Publication No. 600, is available from:
ICC Books USA, 1212 Avenue of the Americas, 21 st Floor, New York, NY 10036;
Phone: 212-703-5078; Fax: 212-391-6568; E-mail: iccbooks@uscib.org; Via the Internet at:http://www.uscib.org/ucp-600-ud-4465/" target="_blank">http://www.uscib.org/ucp-600-ud-4465/.