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Can Insurance Giant Back Up Letters of Credit
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Can Insurance Giant Back up Letters of Credit

One of the big contributors to the hysteria that led to the financial crisis globally in the fall of 2008 was the concern that an insurance giant, AIG, could not pay all of its potential insurance claims. AIG sold credit default swaps to banks which obligated them to pay those banks if certain loan defaults occurred. As so many defaults were triggered at the same time, the capacity of AIG to meet all of its obligations at that time was undermined.

Now an Australian insurance giant, QBE, faces similar challenges. After losing $6 billion in market value, their annual report lists two large “guaranteed and contingent liabilities” totaling over $3.3 billion dollars in the form of letters of credit.  Letters of credit, a crucial instrument for the conduct of business internationally, provide guarantees that a bank will cover the debt of one of its customers in the event the customer fails to make payment on a purchase it makes. The bank substitutes its credit for the credit of the seller, its customer. The reduced creditworthiness of QBE raises questions as to whether it has sufficient reserve assets to undergird these letters of credit. Now that QBE has been put on a “negative credit watch”, a credit downgrade, the holders of these letters of credit may require the insurance conglomerate to provide more security than these mere letters offer.

Usually the negotiation between entities seeking a letter of credit before selling certain goods or services entails the bank’s vouching for a purchaser’s creditworthiness before agreeing to specific triggering terms. The situation with QBD resembles the predicament that faced AIG: the insurance company’s own reliability is in question.

The attorneys at Glass & Goldberg in California provide high quality, cost-effective legal services and advice for clients in all aspects of commercial compliance, business litigation and transactional law, including the negotiation and drafting of letters of credit.  Call us at (818) 888-2220, send an email inquiry to info@glassgoldberg.com or visit us online at www.glassgoldberg.com to learn more about the firm and to sign up for future newsletters.

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