Standby Letters of Credit in Texas and Missouri: Rules and Drafting Points

Introduction

This short article is an introduction to standby letters of credit. As a real estate development attorney, you will eventually negotiate for a letter of credit from an issuer. Many times your clients will need this as a credit enhancement. Sometimes your client’s completion guaranty is going to be called and your client will never want to give up its cash (or, if they are like most developers, they do not have the liquid cash) so they will typically desire a standby letter of credit.

You need to understand the basic mechanics and governing law. This article is a primer for Texas and Missouri.

The Statutory Framework

Texas codifies the law of letters of credit at Tex. Bus. & Com. Code §§ 5.101 through 5.118. Missouri codifies it at Mo. Rev. Stat. §§ 400.5-101 through 400.5-118. Both enactments are substantively identical to the 1995 Official Text of revised UCC Article 5. Authority from other Article 5 jurisdictions — including the leading treatises by White & Summers, Dolan, and Anderson — is persuasive in both states.

Article 5 governs both commercial and standby letters of credit, but the balance of this article addresses the standby in particular. Standbys are the dominant U.S. practice for non-trade applications and, by industry convention, are typically made expressly subject to the International Standby Practices (ISP98, ICC Publication No. 590). Where the standby incorporates ISP98 — as it should — those rules govern over Article 5 in case of conflict, except as to a short list of nonvariable Article 5 provisions. Tex. Bus. & Com. Code § 5.116(c); Mo. Rev. Stat. § 400.5-1116(c); Tex. Bus. & Com. Code § 5.103(c); Mo. Rev. Stat. § 400.5-1103(c).

The Independence Principle

The single most important concept in standby law is the independence principle. The issuer’s payment obligation to the beneficiary is independent of the underlying contract between the applicant and the beneficiary. Tex. Bus. & Com. Code § 5.103(d); Mo. Rev. Stat. § 400.5-1103(d). If the beneficiary presents documents that strictly comply with the standby, the issuer must pay — even if the applicant and beneficiary are locked in a dispute over the underlying transaction.

This principle is nonvariable: parties cannot contract around it. It is what makes the standby commercially valuable. A landlord holding a standby as lease security knows the bank will pay on a complying presentation, regardless of whether the tenant disputes the default.

One nuance worth flagging. The independence principle protects the distribution of the proceeds. It does not immunize the beneficiary from later claims by the applicant — for unjust enrichment, unreasonable liquidated damages, or overdrawing — under the underlying agreement. Beneficiaries who draw aggressively should understand that the money may have to be paid back through a separate lawsuit on the underlying contract.

Strict Compliance and the Examination Window

An issuer is required to honor a presentation that, judged against the standard practice of financial institutions that regularly issue standbys, strictly complies on its face with the terms of the credit. Tex. Bus. & Com. Code § 5.108(a); Mo. Rev. Stat. § 400.5-1108(a). Compliance is judged by the documents alone, not by reference to the underlying transaction.

Both states give the issuer seven business days as the hard outside deadline to honor, accept, or give written notice of each discrepancy. Tex. Bus. & Com. Code § 5.108(b); Mo. Rev. Stat. § 400.5-1108(b). Any discrepancy not stated in a timely notice is waived. For standbys incorporating ISP98, Rule 5.01(a)(iii) tightens the operating safe harbor to three business days, with the seven-day statutory cap as the outer backstop.

A critical drafting point: under both states’ § 5.108(g), if a purported standby contains nondocumentary conditions — for example, “payment will be made only if the borrower is in default” — the issuer must disregard those conditions as if they were never written. Every condition in the standby must be tied to a document the beneficiary will present, not to a fact the issuer would have to independently verify.

Duration, Irrevocability, and Auto-Renewal

Standbys are irrevocable by default in both states. A credit is revocable only if it says so on its face. Tex. Bus. & Com. Code § 5.106(a); Mo. Rev. Stat. § 400.5-1106(a).

Two default rules govern duration:

• If the standby has no stated expiration date, it expires one year after issuance.
• If the standby purports to be “perpetual,” it expires five years after issuance — and this five-year cap is nonvariable. Tex. Bus. & Com. Code § 5.106(c)–(d); Mo. Rev. Stat. § 400.5-1106(c)–(d).

The five-year cap creates a trap for the unwary on long-term deals (for example, tax-exempt bonds with thirty-year amortizations). The standard fix is an evergreen (auto-renewal) provision — expressly recognized under Article 5 and consistent with ISP98 Rule 2.06. Three elements make evergreen clauses work: a fixed initial expiration date, a defined non-renewal notice period, and a stated final outside expiration date that avoids the five-year cap.

Draw Mechanics: Demands, Not Drafts

This is one of the most consequential drafting points in standby practice, and it is the point most often gotten wrong by attorneys whose primary background is in commercial-credit or general transactional work. A standby should require a signed demand for payment — preferably in a form annexed as an exhibit — that specifies the date, the amount drawn, the standby reference number, the reason for the draw, and the wire instructions. A standby should not require a “draft” as the draw instrument.

Drafts make sense in negotiable commercial credits, where a nominated bank purchases the draft and presents it for payment. Standbys are almost always straight credits payable only to the named beneficiary, and a draft serves no negotiation function. The principal downside of using a draft is that drafts must comply with technical Article 3 (negotiable instruments) requirements; a draft that is technically defective can give the issuer a basis for dishonor that has nothing to do with whether the beneficiary’s claim on the underlying transaction is valid. The Enron/BNL litigation is the cautionary tale: a $39 million claim turned in part on a dispute over whether the draft was negotiable.

The Narrow Fraud Exception and the Imposter Risk

Article 5 carves out a narrow fraud exception to the independence principle. If a required document is forged or materially fraudulent, or if honor would facilitate a material fraud by the beneficiary, the issuer may (but need not) dishonor. Tex. Bus. & Com. Code § 5.109(a)(2); Mo. Rev. Stat. § 400.5-1109(a)(2).

Applicants seeking an injunction against a draw face a high bar. The court must find the applicant more likely than not to succeed on the fraud claim, that the presenter is not a protected purchaser (nominated person, confirmer, holder in due course, or qualifying assignee), and that any adversely affected party is adequately protected. In practice, fraud injunctions against complying presentations are rare.

A related rule deserves more attention than it usually gets. Tex. Bus. & Com. Code § 5.108(i)(5) and Mo. Rev. Stat. § 400.5-1108(i)(5) provide that the issuer is discharged to the extent of its performance under the standby unless the issuer honored a presentation in which a required signature of the beneficiary was forged. If a stranger forges the beneficiary’s signature on the draw documents and the issuer honors, the issuer is not discharged as against the true beneficiary; the issuer’s remedy is reimbursement from the applicant. The Official Comment makes clear that the provision protects the true beneficiary against impostor scenarios.

The practical antifraud measure follows from the rule: every standby should specify on its face a designated payee wire account, and any change should require a written amendment. This neutralizes the imposter risk and is the single most effective antifraud measure available in standby drafting.

Remedies and a Short Limitations Period

Wrongful dishonor exposes the issuer to the face amount of the standby plus incidental damages, prejudgment interest, and reasonable attorneys’ fees — but not consequential or punitive damages. The attorneys’ fee provision is reciprocal and applies to wrongful-honor claims as well. Tex. Bus. & Com. Code § 5.111; Mo. Rev. Stat. § 400.5-1111.

The statute of limitations for any Article 5 claim is one year from the later of the standby’s expiration date or the date the cause of action accrued. Tex. Bus. & Com. Code § 5.115; Mo. Rev. Stat. § 400.5-1115. This is dramatically shorter than the general contract limitations period in either state, and it runs regardless of the plaintiff’s knowledge of the breach. Calendar it carefully.

Transferability and Assignment of Proceeds

Two distinct concepts. The standby itself is not transferable unless it expressly says so. Tex. Bus. & Com. Code § 5.112(a); Mo. Rev. Stat. § 400.5-1112(a). Even an expressly transferable standby can be transferred only on the issuer’s standard transfer terms.

Assignment of proceeds is different. The beneficiary may assign its right to all or part of the proceeds at any time, even before presentation. Tex. Bus. & Com. Code § 5.114; Mo. Rev. Stat. § 400.5-1114. The issuer need not recognize a proceeds assignment until it consents, but consent cannot be unreasonably withheld where the assignee possesses and exhibits the original standby and presentation of the credit is a condition to honor.

Article 9 supplies an important override that catches many drafters by surprise. A term in a standby that prohibits or restricts assignment of LC proceeds is ineffective to the extent it would prevent the creation, attachment, or perfection of a security interest in the proceeds in favor of a secured creditor of the beneficiary. Tex. Bus. & Com. Code § 9-409; Mo. Rev. Stat. § 400.9-409. The override is for security-interest purposes only; whether the issuer must pay the secured party rather than the beneficiary still turns on consent under § 5.114(c)–(d).

Where Texas and Missouri Practice Diverge

Most of the divergence between the two states is at the level of statutory citation, not substance. Two practical differences are worth noting.

First, case law. Texas case law on revised Article 5 is modest. The leading Texas authorities — Westwind Exploration, Inc. v. Homestate Savings Ass’n, 696 S.W.2d 378 (Tex. 1985), and Westech Engineering, Inc. v. Clearwater Constructors, Inc., 835 S.W.2d 190 (Tex. App.—Austin 1992, no writ) — are largely pre-1999 vintage. Missouri’s record is similarly thin; Mercantile Bank of Kansas City v. United States, 856 F. Supp. 1355 (W.D. Mo. 1994), is the leading reference, and Missouri courts look to Eighth Circuit authority for further guidance. In both jurisdictions, counsel should monitor decisions from other Article 5 states and the ABA Business Lawyer annual surveys for emerging developments.

Second, the Article 9 override on assignment of LC proceeds is codified at Tex. Bus. & Com. Code § 9-409 in Texas and at Mo. Rev. Stat. § 400.9-409 in Missouri. Substance is identical.

When the Issuer Is a National Bank, Federal Law Overlays State Law

When the issuer is a national banking association chartered by the Office of the Comptroller of the Currency, federal banking law applies in addition to — and overlaying — state Article 5. The substantive Article 5 framework is unchanged, but several federal points matter:

• OCC authorization. 12 C.F.R. § 7.1016 expressly authorizes national banks to issue standbys under Article 5, UCP 600, ISP98, the eUCP supplements, and the UN Independent Guarantees and Standby Letters of Credit Convention.
• Federal lending limits. Standbys (and commitments to issue them) are generally treated as extensions of credit under 12 C.F.R. Part 32 and count toward the bank’s 15%-of-capital-and-surplus single-borrower limit. For evergreen standbys, each automatic renewal reaffirms the credit decision and must remain within the lending limit at the time of renewal.
• OCC visitorial powers. Under 12 U.S.C. § 484 and 12 C.F.R. § 7.4000, the OCC has exclusive supervisory and examination authority over a national bank’s standby business.
• Federal preemption. A national bank may invoke preemption under Barnett Bank of Marion County, N.A. v. Nelson, 517 U.S. 25 (1996), as codified at 12 U.S.C. § 25b, against state laws that significantly interfere with its national-bank powers. Article 5 itself is rarely preempted — the OCC has expressly embraced it — but state consumer protection, licensing, or non-UCC requirements may be.
• FDIC receivership risk. If the issuer is placed in receivership, the FDIC takes the position that, as receiver, it may repudiate undrawn standbys as burdensome contracts where no default has occurred at receivership. This is principally a credit-risk consideration for beneficiaries; sophisticated counterparties negotiate downgrade or substitution covenants in the underlying agreement.

Drafting Checklist for Standbys

The same checklist applies in both Texas and Missouri:

1. State governing law and forum expressly. Both states permit unrestricted choice of law and choice of forum under § 5.116.
2. Incorporate ISP98 (ICC Publication No. 590). It is the rule set written specifically for standby practice.
3. Condition payment on documents only. Strip nondocumentary conditions; they will be disregarded by operation of statute.
4. State a fixed expiration date. Pair any evergreen provision with a final outside expiration to avoid the five-year cap on “perpetual” credits.
5. Require a signed demand for payment, not a draft. Annex the form of demand as an exhibit; specify the date, amount, credit reference, reason for the draw, and wire instructions.
6. Lock in the payee wire account on the face of the standby. Any change should require a written amendment. This is the single most effective antifraud measure available.
7. Calendar the one-year limitations period from expiration or accrual, whichever is later.

Closing

For practitioners working across the Texas–Missouri footprint, the encouraging news is that the substantive Article 5 framework is the same on both sides of the line. The traps are the universal ones — nondocumentary conditions, the five-year cap on “perpetual” credits, the seven-day examination window, the one-year limitations period, draft-versus-demand draw mechanics, and the impostor-forgery risk — not jurisdiction-specific surprises. Get the drafting right, and the standby delivers the certainty it was designed to provide. Get it wrong, and the beneficiary, the applicant, or the issuer pays the price.

If you are negotiating a standby letter of credit and want a second set of eyes on either the document or the underlying agreement it secures, KraftNeeld LLC handles letter-of-credit work in Texas and Missouri.

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Citations

Texas Statutes

• Tex. Bus. & Com. Code §§ 5.101 through 5.118 (UCC Article 5, Letters of Credit)
• Tex. Bus. & Com. Code § 9-409 (Restrictions on Assignment of LC Rights Ineffective)
• Act of May 30, 1999, 76th Leg., R.S., ch. 962, 1999 Tex. Gen. Laws 3670 (enacting revised Article 5)

Missouri Statutes

• Mo. Rev. Stat. §§ 400.5-101 through 400.5-118 (UCC Article 5, Letters of Credit)
• Mo. Rev. Stat. § 400.9-409 (Restrictions on Assignment of LC Rights Ineffective)
• H.B. 374, 89th Gen. Assemb., 1st Reg. Sess. (Mo. 1997) (enacting revised Article 5)

Federal Statutes and Regulations

• 12 U.S.C. § 25b; 12 U.S.C. § 484; 28 U.S.C. § 1348
• 12 C.F.R. § 7.1016; 12 C.F.R. Part 7, Subpart D; 12 C.F.R. § 7.4000
• 12 C.F.R. Part 32 (lending limits); 12 C.F.R. Part 22 (flood); 12 C.F.R. Part 215 (Regulation O)

Texas Case Law

• Westwind Exploration, Inc. v. Homestate Savings Ass’n, 696 S.W.2d 378 (Tex. 1985)
• Westech Engineering, Inc. v. Clearwater Constructors, Inc., 835 S.W.2d 190 (Tex. App.—Austin 1992, no writ)

Missouri Case Law

• Mercantile Bank of Kansas City v. United States, 856 F. Supp. 1355 (W.D. Mo. 1994)
• Eakin v. Continental Illinois Nat’l Bank & Trust Co., 875 F.2d 114 (7th Cir. 1989) (persuasive authority)

Federal Case Law

• Barnett Bank of Marion County, N.A. v. Nelson, 517 U.S. 25 (1996)
• Wachovia Bank, N.A. v. Schmidt, 546 U.S. 303 (2006)

International Rules of Practice

• ISP98, ICC Pub. No. 590 (1999)
• UCP 600, ICC Pub. No. 600 (2007)
• eUCP v.2.0 (2019)
• ISBP 821, ICC Pub. No. 821 (2023)
• United Nations Convention on Independent Guarantees and Stand-by Letters of Credit (1995)

Secondary Authorities

• Carter H. Klein, Standby Letter of Credit Rules and Practices Misunderstood, 40 UCC L.J. No. 2 (2008)
• Carter H. Klein, Letters of Credit, 79 Bus. Law. 1245 (Fall 2024) (Annual Survey)
• Michael Evan Avidon, Letter of Credit Basics, Bus. Law Today (Am. Bar Ass’n, Sept. 15, 2025)
• James J. White & Robert S. Summers, Uniform Commercial Code (Practitioner Treatise Series, 4th ed. 1995)
• John F. Dolan, The Law of Letters of Credit (1996)
• Office of the Comptroller of the Currency, Comptroller’s Handbook: Trade Finance and Services (current edition)