Understanding FFDLCs

Documentary Letters of Credits (DLC) are mostly used in international business transactions, where the buyer or exporter and seller or importer have yet to build a close business relationship and or are in different countries.

When closing a business deal with a buyer or importer in a foreign country, the seller or exporter is exposed to certain risks including international legal systems and a lack of trust with the buyer or importer. Dues to this, a seller or exporter can be hesitant to do such a deal without a Documentary Letter of Credit (DLC) from a trusted credit-worthy bank or financial institution as financial security.

A seller may have certain requirements for the financial institutions from which it will accept letters of credit. A letter of credit serves as a binding and legal document that the seller can accept and legally contest if payment is not made according to the detailed terms. A fully funded documentary letter of credit is a letter of credit in which the funds necessary are held in a separate account which serves as a type of escrow account. Buyers using an FFDLC may deposit some of their own funds and require funding from a financial institution for the remainder of the funds. Typically, in an FFDLC, the buyer will need to begin paying interest on the borrowed funds as soon as they are placed in a separate account.

Buyers and sellers will usually work with third parties to fully complete transactions involving all types of letters of credit and specifically FFDLC. The seller may hold documentary letters of credit with their own bank who then acts as their agent. The seller’s agent bank can manage the documentary collection process when appropriate and can help the seller to receive payment more easily into its account. Other operational procedures may also be included in the documentary collection. Some documentary letters of credit may include an at-sight provision, which requires that the buyer initiate the transaction as soon as they receive the specified goods and accompanying paperwork.

Revocable Letters of Credit, which can be changed or canceled by the issuing bank without prior notice to the recipient of funds. Revoking of letter of credit does not create any obligation of the issuing bank to the payee. The nominated bank is obligated to make a payment or other operations on a revocable letter of credit if at the time of their commission they have not received notice of the change of conditions or canceling credit. A letter of credit is revocable if its text does not explicitly state otherwise.

Irrevocable letter of credit is a firm obligation of the issuing bank to pay money in order and the terms defined by the conditions of the letter of credit, if the documents provided for by it, submitted to the bank specified in the credit. Irrevocable letter of credit guarantees that the exporter will make payment to the performance of its obligations, even if an importer wants to abandon the deal. Therefore, the exporter, performing a special order, for which will not be another buyer, chooses exactly this kind of letter of credit.

Irrevocable unconfirmed letter of credit. When making an unconfirmed letter of the credit-issuing bank, providing a letter of credit, is the only party that is responsible for the disbursement to the seller. The nominated bank must pay only after receiving the money from the issuing bank. A nominated bank simply acts on behalf of the bank providing credit, so it does not take any risk.

Irrevocable confirmed letter of credit – the obligation of the issuing bank is confirmed by another bank. Confirmation is an additional guarantee of payment from another bank (Bank of the exporter or prime bank). Bank, confirming letter of credit is committed to paying for documents according to the conditions of the letter of credit if the issuing bank fails to make the payment.

Back-to-back letters of credit consist of two letters of credit (LoCs) used together to finance a transaction. A back-to-back letter of credit is usually used in a transaction involving an intermediary between the buyer and seller, such as a broker, or when a seller must purchase the goods, it will sell from a supplier as part of the sale to his buyer.

Currently, LC issuance is governed by the latest version of UCP 600.