FAR 32.406—Letters of credit.
Plain-English Summary
FAR 32.406 explains how advance payments are to be financed through letters of credit and related Treasury cash-management methods. It covers Treasury’s governing role, when agencies must use a letter of credit versus a direct Treasury check, how to handle contractors that are eligible for more than one letter of credit, and how drawdowns should be timed to minimize the contractor’s use of Government cash before it is actually needed. The section also addresses Treasury-approved techniques such as delay of drawdown and checks paid methods, which are intended to reduce idle Federal funds and improve cash control. Finally, it describes what happens when a contractor cannot or will not minimize the time between receipt and disbursement of advance funds, including termination of the advance-financing arrangement or use of a working capital method. In practice, this section is about protecting Government cash, standardizing advance-payment administration, and ensuring agencies use the Treasury’s required financing mechanisms unless a waiver applies.
Key Rules
Treasury Controls Letter of Credit Use
Treasury, not the contracting agency alone, prescribes the rules and instructions for using letters of credit for advance payments. Agencies must follow Treasury Circular 1075, 31 CFR part 205, and the Treasury Financial Manual implementing guidance.
Use Letter of Credit When Threshold Met
If an agency expects a continuing relationship of at least one year and annual advances of at least $120,000, it must use a letter of credit for advance payments unless Treasury has granted a waiver. This is the default method for qualifying advance-payment relationships.
Use Direct Treasury Check Otherwise
If the relationship or advance amount does not meet the letter-of-credit threshold, the agency must use a direct Treasury check unless a Treasury waiver changes the requirement. This creates a fallback method for smaller or shorter-term advance arrangements.
Consolidate Multiple Credit Arrangements
When a contractor has multiple contracts or a mix of contracts and assistance agreements that make it eligible for more than one letter of credit, the agency must follow Treasury procedures to consolidate funding under one letter of credit or replace multiple letters with a single one.
Draw Only What Is Needed
A letter of credit is intended to let the contractor withdraw only the funds needed to cover its own cash disbursements for performance. Whenever feasible, agencies should use Treasury-approved methods that delay drawdown until checks are forwarded to payees or presented to the bank.
Minimize Time Between Advance and Disbursement
Treasury regulations require termination of the advance-financing arrangement if the contractor is unwilling or unable to reduce the elapsed time between receiving advances and actually disbursing the funds. If normal payment methods cannot be restored, Treasury allows a working capital method that limits advances to estimated initial-period disbursements and then to actual cash disbursements.
Responsibilities
Department of the Treasury
Issue the governing regulations, instructions, and procedures for letters of credit and advance-payment cash management; approve or direct use of Treasury methods such as delay of drawdown or checks paid; and administer waivers and consolidation procedures under Treasury rules.
Contracting Agency
Use the required advance-payment financing method, determine whether the letter-of-credit threshold is met, obtain Treasury waivers when needed, coordinate consolidation of multiple credit arrangements, and ensure the contractor’s drawdowns are controlled and minimized in accordance with Treasury procedures.
Contracting Officer
Apply the correct advance-payment method in the contract administration context, coordinate with financial management or Treasury guidance, ensure the contract uses the proper letter-of-credit or Treasury check approach, and monitor compliance with drawdown and cash-disbursement requirements.
Contractor
Use advance funds only as needed for contract performance, minimize the time between receipt of advances and disbursement, comply with the drawdown method required by the agency and Treasury, and accept consolidation or replacement of multiple letters of credit when directed under Treasury procedures.
Financial Management/Financial Advice Offices
Provide agencies with Treasury guidance and implementation support, including access to the Treasury Financial Manual and practical advice on the proper use of letters of credit and related advance-payment methods.
Practical Implications
This section is mainly about cash control, not just payment mechanics. Agencies and contractors should expect close scrutiny of how quickly advance funds are drawn and spent, because Treasury wants to avoid idle Federal cash sitting with the contractor.
The $120,000 annual advance and one-year relationship threshold is a key planning point. If a program is likely to cross that line, the agency should plan for a letter of credit early rather than treating advance payments as an ad hoc payment method.
Multiple awards to the same contractor can create unnecessary administrative complexity if each award has its own credit arrangement. Agencies should look for opportunities to consolidate funding under one letter of credit to reduce duplication and improve oversight.
Contractors that hold advances too long or cannot manage cash disbursements efficiently may lose the advance-financing arrangement. In that case, the agency may need to shift to normal payment methods or a working capital method, which can materially affect contractor cash flow.
A common pitfall is assuming the contracting office can choose any advance-payment method it wants. Treasury rules control the method, and agencies need Treasury waivers or approvals when the standard requirements do not fit the situation.
Official Regulatory Text
(a) The Department of the Treasury (Treasury) prescribes regulations and instructions covering the use of letters of credit for advance payments under contracts. See Treasury Department Circular1075 ( 31 CFR Part 205 ), and the implementing instructions in the Treasury Financial Manual, available in offices providing financial advice and assistance. (b) If agencies provide advance payments to contractors, use of the following methods is required unless the agency has obtained a waiver from the Treasury Department: (1) By letter of credit if the contracting agency expects to have a continuing relationship with the contractor for a year or more, with advances totaling at least $120,000 a year. (2) By direct Treasury check if the circumstances do not meet the criteria in paragraph (b)(1) of this section. (c) If the agency has entered into multiple contracts (or a combination of contract(s) and assistance agreement(s)) involving eligibility of a contractor for more than one letter of credit, the agency shall follow arrangements made under Treasury procedures for- (1) Consolidating funding to the same contractor under one letter of credit or (2) Replacing multiple letters of credit with a single letter of credit. (d) The letter of credit enables the contractor to withdraw Government funds in amounts needed to cover its own disbursements of cash for contract performance. Whenever feasible, the agency shall, under the direction and approval of the Department of the Treasury, use a letter of credit method that requires the contractor not to withdraw the Government funds until the contractor’s checks have been- (1) Forwarded to the payees (delay of drawdown technique), or (2) Presented to the contractor’s bank for payment (checks paid technique) (see 31 CFR205.3 and 205.4(d)). (e) The Treasury regulations provide for terminating the advance financing arrangement if the contractor is unwilling or unable to minimize the elapsed time between receipt of the advance and disbursement of the funds. In such cases, if reversion to normal payment methods is not feasible, the Treasury regulation provides for use of a working capital method of advance; i.e., for limiting advances to- (1) Only the estimated disbursements for a given initial period; and (2) Subsequently, for only actual cash disbursements (31 CFR205.3(k) and 205.7).