Irrevocable letter of credit
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.