Methods of Payment

Areej Aftab Siddiqui

Importance of Terms of Payment

The terms of payment often decide obtaining of the order

Determination of Terms of Payment

Export Control Regulations Trade Practices Buyers Credibility
Exporters knowledge of the Buyer Degree of security of payment

Speed of Remittance

Country Stability
Bargaining Strength

Cost of remittance

Competition faced by the exporter

Key Players in International Trade

Exporters Bank Importers Bank

Exporter

Importer

International Carrier

BORDER Export Clearance

BORDER
Import Clearance

Link when in an International Sales Contract

Exporters Bank Importers Bank

Exporter

SALES CONTRACT

Importer

International Carrier

BORDER Export Clearance

How to secure the payment after shipment

BORDER
Import Clearance
How to secure the delivery after payment

Methods of Payment

Consignment Open account

Payment will be made after goods being sold in import country

Delivery first before payment

Collection Letter of Credit

Delivery first before payment (through bank)

A guarantee for payment by Bank

Advance payment
Pay first before delivery

Exporters Risk

Consignment
Demand for payment is usually made by means of a clean draft( no documents attached). Payment typically occurs after the products have been resold by the buyer.

Application/Use
The consignee is reliable The consignee has a good credit history The consignees country has economic and political stability The consignee is the branch office of the main company

Open Account
A term of payment in which no banks are involved, only an agreement between seller and buyer that payment will be made within an agreed period of time. The buyer opens an account in the name of the seller in the buyers book and show values of the goods as an amount owing to the seller Banks become involved through wire transfers, but no negotiations. Normally one should use this method only when he/ she has confidence in the creditworthiness of the buyer. The seller sends the goods to the buyer BEFORE the payment

Contractual Relationship

8. Payment
Bank or FI

Exporter

7. Shipping Documents 1. Sale Contract 5. Bill of Lading

Importer

2. Contract of carriage

Transportation

4. Shipment

6. Insurance Certificate 3. Insurance contract Insurance

Application/Use
There is long-term relationship and confidence between the buyer and the seller The seller is under pressure to sell his goods The buyer has a very good reputation and is wellknown in the market The buyer is solvent

Cash in Advance (Advance Payment)

Buyer pays BEFORE shipment Used in new relationship Transactions are small and buyer has no choice Maximum security to sellers No guarantee that goods are shipped

Contractual Relationship
4. Advance payment

Bank or FI

Exporter

8. Shipping Documents 1. Sale Contract 6. Bill of Lading

Importer

2. Contract of carriage

Transportation

5. Shipment

7. Insurance Certificate 3. Insurance contract Insurance

Application/Use
The buyer lacks creditworthiness The buyer is not able to offer sufficient security for payment The buyer is located in a region of politic and/or economic instability The product is so specialized that it is specifically made for the customer and cannot be easily sold to another customer

Advance PaymentBuyer at Risk

High Risk Approaches

Open AccountSeller at Risk

Documentary Collections
A collection, which is accompanied by commercial documents. Means that the bank handles documents according to the instructions received. This payment method is most often used in international trade in the exchange of merchandise for money. With this method, the goods are shipped to the foreign country, but the documents are sent to the buyers bank. Bank has the only duty to collect the payment from the buyer in exchange for delivery of the shipping & financial documents Bank assumes no risk & responsibility associated with default payment AS LONG AS it follows the sellers instruction

Three types of collection

Clean collection The seller has already sent the goods and shipping documents directly to the buyer The seller subsequently sends the financial document through the bank Similar to open account mechanism Document against payment - D/P The bank gives the shipping & financial document in exchange for payment (simultaneously action) Document against acceptance - D/A The bank gives the shipping & financial document to the buyer and obtain the buyers acceptance agreed to pay at a future date

Drafts
An unconditional order in writing prepared by one (drawer) and addressed to another (drawee) The draft is drawn by the beneficiary under the term of authorization in the letter of credit and in straight conformance with the conditions stated. The draft has to include the name of the issuing bank. Draft (in some countries) is said to be drawn to the account of the bank or buyer.

Types of Draft
Clean or Documentary
Accompanied by the relevant document needed to complete the export transaction. Clean draft is one no document attached and is usually handed to a bank for collection in a foreign country. Open account, the sale of stoke and bonds payment for services.

Sight or Usance

Drawn to be payable either at sight or at some specified future time. Name implies, sight draft supposed to paid first seen by the drawee. Some countries is customary drawee to delay payment of sight draft until the merchandise.

With or Without Recourse

With recourse means purchase by a banker or other financial institution of draft. Without recourse means exact opposite. Consignee fails for any original drawer of the draft.

Contractual Relationship (Clean Collection)

9. Payment Bank or FI 8 . Financial Documents

7. Shipping Documents Exporter 1. Sale Contract 5. Bill of Lading 2. Contract of carriage Transportation 4. Shipment Importer

6. Insurance Certificate 3. Insurance contract Insurance

Contractual Relationship (D/P)

9. Payment (simultaneously)
Bank or FI 8 . Financial & Shipping Documents

Exporter
1. Sale Contract 5. Bill of Lading 2. Contract of carriage

Importer

Transportation

4. Shipment

6. Insurance Certificate 3. Insurance contract

Insurance

Contractual relationship (D/A)

9. Payment (at the future date) Bank or FI 8 . Financial & Shipping Documents

Exporter 1. Sale Contract 5. Bill of Lading 2. Contract of carriage Transportation

Importer

4. Shipment

6. Insurance Certificate 3. Insurance contract Insurance

Risk associated with Collection

Clean collection

Risk is almost the same as open account

D/P D/A

The seller remains at risk since the goods are dispatched to the buyer BUT still have room to retrieve the goods back

The risk to the seller is total. The buyer can make a default payment after taking the delivery

What is a Letter of Credit?

Document and undertaking issued by a bank At the request of the applicant (buyer, importer) In favor of a beneficiary (seller, exporter) Substitutes the banks name and credit risk for that of the applicant (buyer, importer) Guarantees payment of a customers draft up to a stated amount for a specified period if certain conditions are met

Summary of a contract between seller and buyer with the bank(s) as referee

Governed by UCP 600

Why Have A Letter Of Credit?

IF I SHIP GOODS, WILL YOU PAY?

IF I PAY, WILL YOU SHIP THE GOODS?

Solves Issues Of Mutual Mistrust By Using Banks As Arbiters

NEGOTIATE L/C TERMS BEFORE ENTERING A CONTRACT

Trade Finance Letter Of Credit Documents

Banks do not deal in the merchandise which the letter of credit covers

Banks deal only in

DOCUMENTS
SWIFT : Society for Worldwide Interbank Financial Telecommunication

Parties to the Documentary Credit

Exporter ( Beneficiary) 4. Advice of L/C

1. Sale Contract

Importer (Applicant) 2. Credit Application

Advising Bank

3. Documentary Credit

Issuing Bank (Guarantor)

Case
Mang Juan shows his beautiful candle holder at the Manila International Gift Show. Mr. Smith from the UK falls in love with the product Mang Juan is selling it at the price of $1.00 Mr. Smith wants to buy 100,000 pieces! Mang Juan is thrilled to death, but $100,000 is a very big order! Almost 5 million pesos! How will he be sure Mr. Smith will be able to pay him? What if Mr. Smith changes his mind and cancels the order?

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Methods of Payment which can be adopted

1. Can Mang Juan ask Mr. Smith to pay 50% in advance? Would Mr. Smith feel this is right? Remember, they have met for the first time. What if Mang Juan takes the money but does not ship the goods! How can Mang Juan and possibly those who will finance his production be reassured he will be paid? How about Mr. Smith? What assurance does he have that Mang Juan will deliver the 100,000 pieces on the agreed date and the same quality as he showed? Would it be fair to Mang Juan if Mr. Smith pays him only after the goods have been shipped to him and inspected by Mr. Smith? That would be ideal for Mr. Smith.

2. 3.

4.

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How do we solve this problem of trust? Through A bank instrument called the Letter of Credit
1. 2. It is a bank, and not Mr. Smith, who guarantees Mang Juan that he will be paid Mr. Smith, the importer-buyer, applies to his bank for a letter of credit which if he is a good client of the bank, will be approved with a marginal deposit from Mr. Smith. With the Letter of Credit, it is the Issuing Bank and not Mr. Smith, who assures the exporter-seller, Mang Juan, that he will be paid, provided he complies with the terms of the Letter of Credit. Mr. Smith can stipulate in the Letter of Credit however the latest shipping date of the order, if partial shipments will be allowed, and that an inspection certificate approving the goods for shipment by a trusted firm specified by the buyer is required.
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3.

4.

THE BANKS COMMITMENT IN THE LETTER OF CREDIT

THE L/C SAYS WHAT IT MEANS & MEANS WHAT IT SAYS

KEY ELEMENTS
AMOUNT EXPIRY LATEST SHIPMENT DATE DOCUMENTS REQUIRED

PAYMENT WILL BE MADE ONLY WHEN ALL TERMS AND CONDITIONS ARE MET
RESOLVE UNCLEAR ITEMS PRIOR TO SHIPMENT

Letter of Credit Process

1. L/C Application
Exporters Bank Importers Bank

Exporter

3. Bill of Lading

Importer

International Carrier

BORDER

2. Shipment
Letter of Credit

BORDER

Need Guarantee for payment before delivery

- Guarantee for payment by bank under terms & conditions - Assure appropriate documents (B/L) are presented

Need Bill of Lading to demand for the goods at the destination

Documentary Credit Procedure

Buyer (Importer) (1) Contract of Sale (5) Delivery of Goods Seller (Exporter)

(2) Request to Provide Credit

(8) Documents & Claim for Payment (7) Documents Presented to issuing Bank

(6) Documents Presented

(4) Letter of Credit Delivered

Importers Bank (Issuing Bank)

(9) Payment (3) Credit Sent to Correspondent

Correspondent Bank

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Terms and Conditions in an L/C

Draft Letters of Credit usually necessitate that the Beneficiary draw a draft on the Issuing Bank. The period of time from the date on which either the complying documents are presented or the draft is drawn, to the date on which payment is payable is the tenor of the draft. If the draft is payable upon presentation, the draft will be drawn payable at sight. If the draft is payable, for example, 30 days after presentation of complying documents (30 days sight) or 30 days after the date the draft is drawn (30 days date), the draft is a time draft.

Expiration Date
A Letter of Credit should contain a stated expiry date. The Beneficiary is required to present the draft(s) and documents to the Issuing Bank or a Nominated Bank on or before that date. Under the Uniform Customs and Practice for Documentary Credits Act (UCP), published by the International Chamber of Commerce (and incorporated by reference in most commercial letters of credit), if the expiration date falls on a day when banks at the place of presentation are closed, the expiration date is extended to the next business day. Letters of Credit expire at the times and locations specified in the Letter of Credit.

Latest Shipping Date

Most Commercial Letters of Credit contain a latest shipping date. The documents confirming shipment must not be dated after that date. When on board transportation documents are required, the date indicated in the on board notation on the transport documents is considered to be the date of shipment.

Latest Date for Presentation

Unless the credit stipulates otherwise, the UCP requires that documents be presented within 21 days of the date of shipment or at another such period stated in the Letter of Credit.

Strict Compl iance

Auton omy

Doctrines

Doctrine of Strict Compliance

Payment is made if and only if the details matches that of other documents In the absence of conformity with the L/C, the Seller cannot force payment and the bank pays at its own risk. Sellers should be careful and remember that the bank may insist upon strict compliance with all documentary requirements in the LC. If the documents do not conform, the bank should give the seller prompt, detailed notice, specifying all discrepancies and shortfalls.

Doctrine of Autonomy
Letters of credit deal in documents, not goods. L/Cs are purely documentary transactions, separate and independent from the underlying contract between the Buyer and the Seller. The bank honoring the L/C is concerned only to see that the documents conform with the requirements in the L/C. If the documents conform, the bank will pay, and obtain reimbursement from the Buyer/Applicant. The bank need not look past the documents to examine the underlying sale of merchandise or the product itself. The letter of credit is independent from the underlying transaction and, except in rare cases of fraud or forgery, the issuing bank must honor conforming documents. Thus, sellers are given protections that the issuing bank must honor its demand for payment regardless of whether the goods conform with the underlying sale contract.

Types of Letters of Credit

1. Revocablechanged or cancelled at any time without notice to the beneficiary 2.Irrevocablecannot be unilaterally cancelled or amended by the importer

3.Transferrabl eTransfer of all or part of the letter credit. 4.Nontransfera ble- may not be transferred by the beneficiary.

5. Deferred Exporter will be paid at specified dates after shipment. Single shipment will be paid by number of payments. Pay at maturity and not before.

6. Revolving Are regular and continuous. Three types: Noncumulative revolving credit, cumulative, credit unused shipment.

7. Confirmed It is an L/C in which the advising bank is further protected of any kind of risk that may arise especially if it is doubtful about the credibility of the Issuing Bank

Types of Letters of Credit

8. Red Clause Exporter requests the importer to pay an advance in order to finance the production or purchase of the goods to be delivered .this clause in the L/C is written in red

9. Green Clause- Almost similar to Red Clause L/C. The finance obtained in advance is also used for warehousing purposes.

10. Back to Back- it consists of two separate and different types of LC. One for the exporter and based on this L/C one for the supplier to the exporter. It is used in intermediary trade.

11. Stand By It is an obligation of the issuing bank to: (i)Repay money borrowed by or advanced to the account party (ii) Make payment on the account of any evidence of indebtedness undertaken by the account party. (iii) Make payment on account of any default by the account party in the performance of a contractual obligation.

Confirmed L/C
Buyer (Importer) (1) Contract of Sale (5) Delivery of Goods Seller (Exporter)

(2) Request to Provide Credit

(8) Documents & Claim for Payment (7) Documents Presented to issuing Bank

(6) Documents Presented

(4) Confirmed Letter of Credit Delivered

Importers Bank (Issuing Bank)

(9) Payment (3) L/C Sent to Correspondent

Exporters Bank (Advising Bank)

3a. Confirmed L/C

Confirming Bank

3a. L/C 55

The Documents Required By The Letter Of Credit

All Documents Must Conform To The Letter Of Credit And Be Consistent With Each Other Three Forms Of Documents:

Financial Documents Transport Documents Commercial Documents

FINANCIAL DOCUMENTS: Bill of Exchange Promissory Note Trust Receipt Delivery Order

TRANSPORT DOCUMENTS:
Bill of Lading Airway Bill

Air Consignment Note

Postal Parcel Receipt Truck Receipt Railway Receipt

COMMERCIAL DOCUMENTS
Commercial Invoice Packing List Insurance Certificate Certificate Of Origin Inspection Certificate Weight Note Certificate Of Analysis Black List Certificate etc.

DOCUMENTARY REQUIREMENTS

Drafts should
Be drawn by the Beneficiary on behalf of the parties specificied in the Letter of Credit Not exceed the Letter of Credit amount or its remaining balance Not be payable or endorsed to parties other than the Beneficiary or the issuing or the nominated bank Be in negotiable form, endorsed by the Beneficiary as necessary Refer to the Letter of Credit

Invoices should
Be issued by the Beneficiary named in the letter of credit Be issued to the Applicant Describe the goods and show the prices and terms as detailed in the Letter of Credit Not exceed the Letter of Credit amount or its remaining balance, except in UCP 600

Insurance documents should

Cover the risks stated in the Letter of Credit Cover, at minimum, 110% of the cost, insurance and freight (CIF), or carriage and insurance paid (CIP) value of the shipment Be countersigned and if the assured is other than the Confirming, Issuing bank or buyer, be appropriately endorsed, or endorsed in blank Be presented in full set(s) (all relevant documents) Be in force as of a date not later than the date appearing on the transport document or on board notation

Common Defects in Documentation

About half of all drawings contain discrepancies, like: The L/C expires prior to presentation of documents B/L evidences delivery prior to or after the date range stated in L/C Changes included in invoice not authorized in L/C Inconsistent description of goods Insurance document errors. A document required may be missing Invoice amount not equal to draft amount Name of documents not exact as described in the credit. Beneficiary information not exact Invoice/statement not signed as stipulated in L/C

Importance of L/C for Exporter

Dependence on Credit worthiness of a bank instead of importer

If the credit is confirmed by a bank in the exporters country, the exporter is neither subject to commercial not to country risk
If the credit is irrevocable, it cant be cancelled without the exporters consent and notice of revocation can be rejected by the exporter if received after shipment The documents and therefore the goods will not be released until payment or commitment to payment is made (In terms of L/C) Where credit has been allowed the accepted bill of exchange can be used to obtain the finances

Importance of L/C for Importer

The importer can negotiate better terms as the exporter is assured of payment Importer is assured that no funds will be released unless title documents and received correct and in order Protection is provided documentary Credit under UCP for

Risk Situations in a L/C Transaction

General- If goods being offered for sale at a price that is too good to be true, then it is a risky situation Fraud- Payment may be obtained for non-existent or worthless goods against presentation of by the beneficiary of forged or falsified documents or credit itself may be forged Risks to applicant non delivery of goods, short shipment, inferior quality, early/late shipment, damages in transit, Failure of bank viz. issuing bank/collecting bank Risks to beneficiary- failure to comply with credit conditions, failure of, or delays in payment from the issuing bank contd

Risk Situations in a L/C Transaction (contd)

Sovereign & Regulatory Risks- possibility that L/C may be prevented by the government action out side the control of parties Risks to issuing bank- Insolvency of the applicant, fraud risk, sovereign, regulatory & legal risks Risks to advising bank- if it is a paying bank failure to check apparent authenticity of L/C and advising it to beneficiary Risks to confirming bank- Once having paid the beneficiary, it may not be able to obtain reimbursement from the issuing bank because of insolvency of issuing bank

COMPARISON OF VARIOUS METHODS

Guarantees
A Guarantee is issued by a bank on behalf of its customer, the Exporter, as financial assurance to the Importer to be collected in the event that the Exporter defaults on certain specified contractual obligations. The bank that issues a Guarantee will pay the named beneficiary the amount specified on presentation of a written demand as outlined in the Guarantee. While there are standard Guarantee formats, Guarantees can be tailored to meet your specific contractual needs.

Types of Guarantees
An Importer will often ask foreign contract bidders to post a Bid Guarantee as evidence of serious intent to supply the goods or services if selected. In the event that the selected supplier is unwilling or unable to carry out the contract, the Importer can collect the amount An Advance Payment Guarantee covers the amount of the downpayment the Exporter requests from the Importer and provides the Importer with some security if the Exporter does not deliver under the terms of the contract, the amount of the down-payment would be retrievable permits the Importer to draw on the Guarantee if the Exporter fails to perform according to the terms of the contract in the event that the Exporter is unable to complete the contract as agreed halfway through a project, the Importer is compensated with the amount

Advance Payment

Performance

Bid

Class Discussion Activity

The importer applied for a credit for the full CFR value of the goods. This credit contained as term of payment: 40% of the value payable at sight against presentation of compliant documents 60% to be settled by draft at 90 days sight on credit applicant without responsibility or engagement on our part ( meaning the issuing bank) Compliant documents were prepared by the exporter and presented to the bank and the 40% payment was effected. The 90 days sight draft for the remaining 60% was duly accepted by the credit applicant. At maturity, it remained unpaid and the issuing bank took refuge in the wording. without responsibility or engagement on our part. The beneficiary is in the opinion that a bank issuing a credit for the full value of the goods should accept responsibility for the beneficiary also to be paid in full.

Questions
What do you think about this kind of credit? What is wrong with the terms of payment in the credit? Do you think the beneficiary has made his objection on time?