FAR 28.204-3—Irrevocable letter of credit.
Plain-English Summary
FAR 28.204-3 explains how an irrevocable letter of credit (ILC) can be used as financial security in place of a traditional surety bond, and it lays out the rules for when and how that option works. It covers the contractor’s option to use an ILC for bid, performance, or payment bond purposes; the requirement that each bond be backed by a separate ILC; the mandatory terms of the ILC itself; how the contracting officer draws on the ILC; when the government must draw if the contractor fails to replace or renew it; and when the government must draw to cover outstanding payment-bond claims after contract performance ends. The section also specifies the required coverage periods for bid guarantees and for ILCs used instead of corporate or individual sureties, including different rules for contracts subject to the Miller Act/Bonds statute and those that are not. In addition, it sets financial institution eligibility standards, including federal insurance, investment-grade credit ratings, and confirmation requirements for larger ILCs, and it requires the contracting officer to verify those ratings and insurance status. Finally, it references the sight draft in FAR 52.228-14 and the Uniform Customs and Practice for Documentary Credits (UCP 600), which matter because they govern the mechanics and interpretation of the credit instrument in practice.
Key Rules
ILC is an allowed bond security
A person required to furnish a bond may choose to secure that bond with an irrevocable letter of credit in an amount equal to the required penal sum. A separate ILC is required for each bond, so one ILC cannot generally be used to cover multiple bond obligations.
ILC must be truly irrevocable
The ILC must be irrevocable, require no document other than a written demand and the ILC itself (and any confirmation letter), and expire only under the rules in paragraph (f). It must also be issued or confirmed by an acceptable federally insured financial institution.
Government draws using prescribed sight draft
If the contracting officer needs to draw on the ILC, the officer must use the sight draft in FAR 52.228-14 and present it with the ILC and any confirmation letter to the issuing or confirming institution. This standardizes the draw process and reduces disputes over form.
Replacement or renewal is mandatory before expiration
If the contractor does not provide an acceptable replacement ILC or other acceptable substitute at least 30 days before expiration, the contracting officer must immediately draw on the ILC. This prevents a lapse in financial protection.
Outstanding payment-bond claims must be covered
If there are unresolved claims against a payment bond after the contract period of performance ends, the contracting officer must draw on the ILC before it expires to cover those claims. The government cannot allow the security to disappear while valid claims remain unpaid.
Coverage period depends on bond type and contract type
For bid guarantees, the ILC should expire no earlier than 60 days after bid acceptance closes. For performance or payment bond security, the ILC must cover the full required period, which differs for contracts subject to the Bonds statute and those not subject to it, including final payment, warranty periods, and claim-resolution periods.
Automatic one-year extensions are required
For performance or payment bond security, the ILC may be issued for the full expected period or for at least one year initially, but it must automatically extend for one-year periods unless the issuer gives 60 days’ written notice of non-renewal. Coverage continues until the required period ends and the contracting officer waives the right to payment in writing.
Financial institutions must meet strict standards
Only federally insured financial institutions with investment-grade ratings may issue or confirm the ILC. If the issuer’s annual letter-of-credit business was under $25 million, ILCs over $5 million must also be confirmed by another acceptable institution that meets the same business-volume standard.
Contractor must provide rating evidence
The offeror or contractor must provide the contracting officer a credit rating from a recognized commercial rating service showing that the issuing institution meets the required rating as of the ILC issuance date. This supports the government’s eligibility review.
Contracting officer must verify eligibility
The contracting officer must verify that each institution is federally insured and that its current credit rating is investment grade from a Nationally Recognized Statistical Rating Organization (NRSRO). If the rating falls below investment grade, the contractor gets 30 days to substitute an acceptable ILC or the contracting officer must draw on the ILC.
UCP 600 informs interpretation
The section points to UCP 600, which is the standard international ruleset for documentary credits. While not a substitute for FAR requirements, it helps govern how the letter of credit is understood and administered.
Responsibilities
Contractor / Offeror
May elect to use an ILC instead of a traditional bond surety, but must ensure the ILC amount equals the required penal sum and that a separate ILC is provided for each bond. The contractor must provide the required credit rating information, maintain or replace the ILC before expiration, and substitute an acceptable ILC if the issuer’s rating drops below investment grade.
Contracting Officer
Must accept only ILCs that meet FAR requirements, verify federal insurance and investment-grade status of the issuing and confirming institutions, and monitor expiration dates and credit ratings. The contracting officer must draw on the ILC when replacement is not provided in time, when payment-bond claims remain outstanding after performance, or when the institution’s rating falls below investment grade and no acceptable substitute is furnished within 30 days.
Issuing Financial Institution
Must issue an irrevocable ILC that complies with the FAR terms, including the required form of demand, expiration rules, and eligibility standards. If applicable, it must provide notice of non-renewal at least 60 days before expiration to prevent automatic extension.
Confirming Financial Institution
If confirmation is required, the confirming institution must also be federally insured and investment grade, and it must support the ILC in the same manner as required by the FAR. It becomes part of the draw process if the government presents the sight draft to the confirming institution.
Agency / Government
Must use the prescribed sight draft and follow the regulatory draw procedures. The agency must also ensure that the ILC remains effective for the full required coverage period and that claims are protected before expiration.
Practical Implications
Contractors using ILCs need a calendar system that tracks both the ILC expiration date and the 30-day replacement deadline; missing either can trigger an immediate draw by the government.
A low-rated or downgraded bank can create an urgent compliance problem even if the contractor is otherwise performing well, so contractors should monitor the issuer’s rating throughout the life of the bond.
For larger ILCs, the confirmation requirement can add cost and complexity, especially when the issuer’s annual letter-of-credit business is below the threshold.
Contracting officers should verify eligibility early, not just at award, because credit ratings and financial condition can change during performance.
Payment-bond ILCs can remain exposed after final performance because unresolved claims may still require a draw, so “contract complete” does not always mean “security can be released.”
Official Regulatory Text
(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 . (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 maintained by the SEC. (3) The rating services listed in the website 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/ .