What is a Backup Line of Credit?

A backup line gives protection to the investors of a company if the company defaults on the commercial paper it offers. Commercial paper is an unsecured short-term debt security that a company offers to its investors rather than issuing them bonds or stocks. Commercial papers have a maturity period of less than a year, their redemption value is often their face value amount. Usually, a company with a high credit rating engages in this type of arrangement. In a case where the company defaults on its commercial paper, a backup line can offer protection to the investors.

How Does a Backup Line of Credit Work?

A backup line is a Line of Credit (LOC) in which a company that offers commercial papers to its investors is required to pay a fee to a bank. The fee paid to a bank is an exchange for a backup line that protects its investors in case of default by the company. The bank uses the backup line to settle the company's commercial papers. A company that pays a fee in exchange for a backup line can either cover all of its commercial paper by the backup line or a part of it. Companies with high credit ratings use backup lines as an effective plan to pay off commercial paper in a case of default.

How a Backup Line Works

A company can decide to use a backup line for a number of reasons. A company with high credit ratings can use this plan, companies that want to undergo significant expansion in their business line can also opt for a backup line. For example, a fabric company that wants to purchase a heavy equipment for manufacturing fabrics can issue commercial paper worth $2 million to its investors instead of bonds or stocks. Due to the tendency of the company defaulting on the commercial paper, the company goes to a bank and require for a backup line equivalent to the commercial paper issued. The backup line would be used to pay off its commercial paper if it defaults. Banks offer backup lines to companies in exchange for a fee.

Related Topics

• Commercial Paper (Intro)
• What is Commercial Paper?
• Negotiable Instrument
• What are the common types of commercial paper?
• Promissory Note
• Cashier's Check
• Convenience Check
• Certified Check
• Substitute Check
• Bill of Exchange
• Bank Draft Definition
• Sight Draft Definition
• Bankers Acceptance 
• Who is a Holder of a negotiable instrument?
• Commercial Paper Funding Program
• What is Negotiability and why is it important?
• What is required for commercial paper to be negotiable?
• Sum Certain (Contracts)
• Inflation Adjustment Clause
• When does commercial paper contain an Unconditional promise to pay?
• Backup Line of Credit
• What is Payable on Demand or Payable on Time?
• What is Order Paper and Bearer Paper?
• Bearer Form
• How is a payee identified on the negotiable instrument?
• What rules does the court apply in determining negotiability?
• How is commercial paper negotiated to a holder?
• What is Transfer of a negotiable instrument?
• What is Indorsement of a negotiable instrument?
• What are the various types of indorsement?
• Bank Endorsement
• Blank Endorsement
• Accommodation Endorsement
• How does a holder receive payment on a negotiable instrument?
• Who is potentially liable on (or obligated to pay) a negotiable instrument?
• When is an individual liable for a representative signing a negotiable instrument?
• What rules apply if a holder loses a negotiable instrument?
• When is payment of a negotiable instrument overdue?
• What effect does a negotiable instrument have on the underlying obligation?
• What is a holder in due course?
• What are the requirements for a holder to become a holder in due course?
• Receive an instrument for value?
• Receive an instrument in good faith?
• Receive an instrument without notice of a valid defense?
• How does discharge of the Underlying Obligation affect a holder in due course?
• What is the Shelter Rule?
• Can you limit a transferee from becoming a holder in due course?
• Personal Defenses?
• Real Defenses?
• What is a Claim in Recoupment?
• What are the rights of a holder in due course if the instrument involves a consumer transaction?
• What happens if a negotiable instrument is Forged?
• What happens if a negotiable instrument is Stolen?
• Guaranty or Guarantee
• Letter of Guarantee
• Personal Guarantee
• What is the role of a Guarantor or Surety of a negotiable instrument?
  
• Surety 
  
• Cosign
• Accommodation Paper Definition
• Secondary Liability
• Avalize Definition
• What is an Accord & Satisfaction?
• What is primary and secondary liability on an instrument?
• What is Drawer or Maker Liability for a negotiable instrument?
• What is Transferor Warranty of a negotiable instrument?
• What is Indorser Warranty of a negotiable instrument?
• What is Presentment Warranty of a negotiable instrument?
• What is a warrantors liability for a dishonored note or draft?
• What is the time limitation for warranty of a negotiable instrument?
• When are the warranties of a negotiable instrument discharged?