Payment Terms

Payments in Foreign trade

The rapid growth and expansion in global trade cannot be sustained without efficient and timely payment arrangements. Nonpayment or delays in payment for imports could tie up limited credit facilities and create liquidity problems for many exporting companies. Advance payments by overseas customers would similarly tie up a buyers’ limited resources and do not necessarily guarantee delivery of agreed merchandise. The ideal payment method is one that protects the contending interests of both sellers and buyers.

Exporters often seek to develop foreign markets by using payment arrangements that are less costly to the buyer, such as consignment sales, open accounts, and documentary drafts, whereby the seller is paid by the foreign wholesaler or retailer, only after the goods have been received or sold. It is estimated that about 35 to 50 percent of exports from the United States and the United Kingdom are sold on open account and/or consignment. This means that the risk of delay in payment or nonpayment could have a crucial effect on cash flow and profits.

Export companies need access to credit reports on a global basis. There is a need to increase the existing database on companies in different parts of the world to ensure that formal reviews on credit decisions are based on current and reliable information. It is also important to consider credit insurance and other safeguards.

 

Revision of UCP 500 (UCP 600)

In May 2003, the International Chamber of Commerce authorized the ICC Commission on Banking Technique and Practice (Banking Commission) to begin a revision of the Uniform Customs and Practice for Documentary Credits, ICC Publication 500.

As with other revisions, the general objective was to address developments in the banking, transport and insurance industries. Additionally, there was a need to look at the language and style used in the UCP to remove wording that could lead to inconsistent application and interpretation.

When work on the revision started, a number of global surveys indicated that, because of discrepancies, approximately 70% of documents presented under letters of credit were being rejected on first presentation. This obviously had, and continues to have, a negative effect on the letter of credit being seen as a means of payment and, if unchecked, could have serious implications for maintaining or increasing its market share as a recognized means of settlement in international trade. The introduction by banks of a discrepancy fee has highlighted the importance of this issue, especially when the underlying discrepancies have been found to be dubious or unsound. Whilst the number of cases involving litigation has not grown during the lifetime of UCP
500, the introduction of the ICC’s Documentary Credit Dispute Resolution Expertise Rules (DOCDEX) in October 1997 (subsequently revised in March 2002) has resulted in more than 60 cases being decided.

To address these and other concerns, the Banking Commission established a Drafting Group to revise UCP 500. It was also decided to create a second group, known as the Consulting Group, to review and advise on early drafts submitted by the Drafting Group. The Consulting Group, made up of over 40 individuals from 26 countries, consisted of banking and transport industry experts.
The Drafting Group began the review process by analyzing the content of the official Opinions issued by the Banking Commission under UCP 500. Some 500 Opinions were reviewed to assess whether the issues involved warranted a change in, an addition to or a deletion of any UCP article.

Methods of payment in International Trade

CONSIGNMENT SALES

    This is a method in which the exporter sends the product to an importer on a deferred payment basis; that is, the importer does not pay for the merchandise until it is sold to a third party. Title to the merchandise passes to the importer only when payment is made to the exporter. Consignment is rarely used between unrelated parties, for example, independent exporters and importers. It is best used in cases involving an increasing demand for a product for which a proportioned stock is required to meet such need. It is also used when a seller wants to test-market new products or tests the market in a new country. There is a potential risk of non-payment or delays in payment.

 

OPEN ACCOUNT

An open account is a contractual relationship between an exporter and importer in which a trade credit is extended by the former to the latter whereby payment is to be made to the exporter within an agreed period. The seller ships the merchandise to the buyer and separately mails the relevant shipping documents. Terms of payment range from 30 days to 120 days after date of shipping invoice or receipt of merchandise, depending on the country. There is a potential risk of non-payment or delays in payment.

 

DOCUMENTARY COLLECTION (DOCUMENTARY DRAFT)

The documentary collection or documentary draft is one of the most customary methods of making payments in international trade. To facilitate the transaction, two banks are usually involved, one in the exporter’s country and one in the buyer’s country. The banks may be independent banks or branches of the same bank.

A draft can be drawn (documents payable) in the currency of the country of payment or in a foreign currency. This method of payment falls between the open account, which favors the buyer, and letter of credit, which protects the exporter. Bank fees are less expensive, usually a specific sum for each service, as opposed to a percentage of the transaction amount, which is used for letters of credit.

A typical documentary collection procedure includes the following steps:

  • After the exporter (drawer) and overseas customer (drawee) agree on the terms of sale, the exporter arranges for shipment and prepares the necessary documents such as invoice, bill of lading, certificate of origin, and draft.
  • The exporter forwards the documents to its bank (remitting bank) with instructions.
  • The remitting bank then forwards the documents to its overseas correspondent bank   (collecting bank) in the importer’s country, with the exporter’s instruction letter that authorizes release of documents against payment (D/P) or acceptance (D/A) or other terms.
  • The collecting bank contacts the importer to effect or accept payment. If the instruction is documents against payment (D/P), the importer pays the collecting bank in exchange for the documents. The collecting bank will then send proceeds to the remitting bank for payment to the seller. If the instructions are documents against acceptance (D/A), the collecting bank will release documents to the overseas customer only upon formal acceptance of the draft. Once accepted, the collecting bank will release the documents to the buyer. On or before maturity, the collecting bank will present the accepted draft for payment. When the buyer pays, the collecting bank will remit the funds in accordance with instructions.

 

DOCUMENTARY LETTER OF CREDIT

A letter of credit (L/C) is a document in which a bank or other financial institution assumes liability for payment of the purchase price to the seller on behalf of the buyer. The bank could deal directly or through the intervention of a bank in the seller’s country. In all types of letters of credit, the buyer arranges with a bank to provide finance for the exporter in exchange for certain documents. The bank makes its credit available to its client, the buyer in consideration of a security that often includes a pledge of the documents of title to the goods, or placement of funds in advance, or of a pledge to reimburse with a commission. The essential feature of this method, and its value to an exporter of goods, is that it superimposes upon the credit of the buyer the credit of a bank, often one carrying on business in the seller’s country. The letter of credit is a legally enforceable commitment by a bank to pay money upon the performance of certain conditions, stipulated therein, to the seller (exporter or beneficiary) for the account of the buyer (importer or applicant).

Payment risk to exporter: Ranking in terms of risk

 

 

Cash in advance

Least risk to exporter (high cost to buyer)

Confirmed irrevocable letter of credit (LC)

 

Irrevocable letter of credit

 

Bank collection sight draft

 

Bank collection time draft

 

Consignment sales, open account

High risk to exporter (low cost to buyer)

 

Common Features of Documentary Fraud

           

Fraud by Seller

 

  • Fraudulent seller ships worthless goods or goods of lower quality: Seller ships worthless goods or goods of lower quality, pay for freight costs and obtains a genuine bill of lading which would enable him/her to receive payment from the advising or issuing bank for the shipment.
  • Fraudulent seller does not ship any merchandise: Seller will forge an entire set of documents required under the letter of credit and presents to the bank for payment. Such sellers even furnish the buyer with a performance bond (for 10% of the value of the cargo) and obtain full value of the purchase price without sending any merchandise to buyer.

Fraud by Buyer

  • Fraudulent buyer forges original documents for payment: Seller sends cargo (under documents against payment arrangement) to buyer and submits the original documents to the collecting bank in the buyer’s country for presentation against payment. Meanwhile, a copy of the original documents is sent directly to the buyer. The buyer will forge the original documents and present them to the carrier to clear the cargo. The authentic documents are still with the collecting bank.
  • Fraudulent buyer receives merchandise from carrier on the strength of letter of indemnity: Indemnities are issued to enable the discharge of cargo (or induce the carrier to discharge at a different destination if sold to another party while on transit) without presentation of the bill of lading. The letter of indemnity substitutes for the bill of lading thus allowing the buyer to receive the goods. This occurs when the cargo arrives before the bill of lading. The buyer obtains delivery of the goods and sells the bill of lading to an innocent buyer.

Fraud by buyer, seller and other parties

  • Buyer and seller conspire to defraud paying bank: Seller and buyer conspire to defraud paying bank by using forged documentary credits. Seller may also induce buyer into sending goods on a fraudulent letter of credit.
  • Seller and carrier falsify the actual order and condition of the goods: Seller and carrier falsify to the buyer the order and condition of the goods by issuing a clean bill of lading. A letter of indemnity taken out by the seller covers the carrier against any liability in connection with the release of the goods. It is fraud on the buyer who receives a clean bill of lading and assumes the cargo to be in good condition.

Protective Measures Against Documentary Fraud

 

Proactive measures by sellers

  • Verify the background and credibility of your partner through your government agency, bank, or professional associations
  • Stipulate the required documents and other pertinent conditions in the sales contract
  • Check the validity of the letter of credit as well as the credibility of the issuing bank. It is also important to verify that the terms in the letter of credit comply with the sales contract

Proactive measures by buyers

 

  • Verify the background and credibility of your partner through your government agency, bank, or professional associations
  • Choose FOB trade term rather the CIF in a sales contract so that you have more control over the shipment. It is also important to verify the availability of the ship, its capacity to carry the agreed merchandise and its physical location
  • Use independent inspectors to verify the quality and quantity of goods and whether they have been loaded on the vessel
  • Choose time drafts (instead of sight drafts) to allow you make payment some days after acceptance of the draft. This allows the buyer discover fraud after the goods arrive but before the date of payment. It is also possible to condition the passage of title upon buyer’s inspection and approval of the goods.
  • Verify the authenticity of the documents especially, the bill of lading before they are presented to the bank for payment. To reduce possible forgery, the buyer can require that original bills of lading be sent directly to banks and not to the seller (shipper) in CIF contracts.
  • Sellers can provide performance guarantee to buyer to carry out its obligations. In the event of fraud by seller, issuing bank will be obligated to compensate buyer, solely upon demand by buyer. Buyers can also take export credit insurance.

 

Proactive measures by banks

  • Paying bank should offer an additional service for a fee: Banks can undertake an investigation into the validity, genuineness or accuracy of the documents before payment. The Bank of China, for example, provides a commercial credibility investigation service for its customers. The service includes a report on the foreign partner’s background, credit status, solvency, name of loading ship, port, and condition of the goods as well as information of the carrier.
  • Make further investigations in cases where fraud is suspected to avoid future occurrences.