Maryland Journal of International Law

Volume 6 | Issue 2 Article 6

Countertrade and Barter: Alternative TradeFinancing by Third World NationsThomas B. McVey

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Recommended CitationThomas B. McVey, Countertrade and Barter: Alternative Trade Financing by Third World Nations, 6 Md. J. Int'l L. 197 (1981).Available at: http://digitalcommons.law.umaryland.edu/mjil/vol6/iss2/6

COUNTERTRADE AND BARTER: ALTERNATIVE TRADEFINANCING BY THIRD WORLD NATIONS*

THOMAS B. MCVEY**

I. Introduction

A significant development in recent trade transactions involving ThirdWorld Nations is the increase in the use of barter and countertrade.' Barter,the simplest form of trade transaction, is the two-way exchange of goodseffectuated without the use of currency. Countertrade, in comparison, is anagreement between an importing nation and a foreign seller requiring that,as a condition for the completion of the import transaction, the sellerseparately purchase certain goods from the importing nation Both aremethods of effectuating the transfer of goods, services and technologies tonations experiencing hard currency shortages or low currency values. Inresponse to new economic demands created by constantly changing interna-tional conditions, Third World Nations are turning with greater frequency tothese and similar innovative methods of structuring their trade transactionsin an effort to deal with the ever worsening problem of financing neededimports. This article is designed as an introduction to the concepts of barterand countertrade and as a preliminary guide to the use of these techniques intrading activities with Third World Nations.

Conditions Underlying the Recent Rise in Barter and Countertrade

At the root of the recent surge in barter and countertrade activities arethe shifts in international economic conditions which have been responsiblefor the inability of many nations to adequately finance their importactivities. The rapid increase in the cost of key imports has left importingnations with significantly diminished supplies of hard currency with which to

* Portions of this article have been adipted from a lecture presented by Mr. McVey at an American Management Association seminar on the topic of countertrade andbarter.

** B. A. Columbia University, J.D. Georgetown University Law Center, currentlypracticing international trade and energy law with the law firm of Bracewell & Patter-son, Washington, D.C.

1. The term "offset trade" is used by some businessmen in place of the term"countertrade," although "offset trade" is more frequently used to refer to a specifictype of countertrade known as "compensation trade." See § II infra.

2. For more detailed definitions of barter and countertrade transactions as wellas a discussion of the various types of countertrade, See § I infra.

(197)

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meet their ever expanding industrial and social needs. This currencydepletion is especially severe in non-OPEC Third World Nations which relyupon foreign energy sources for their sputtering national economies.' Theseproblems have been exacerbated by protectionist "import relief" measurestaken by Western nations in the effort to bolster key domestic industries andprotect segments of their respective labor forces from the lower priced ThirdWorld imports.4 Such import relief measures have further reduced thecurrency generating capabilities of the Third World Nations, thus furtherimpairing their hard currency positions.' With their borrowing capabilitiesstrained to the breaking point, Third World Nations have been forced todevise new methods of dealing with their currency shortages and meetingimport finance obligations.

Barter and countertrade have increasingly been employed as means forovercoming or significantly reducing the above stated economic pressures.Their application is exemplified by the following hypothetical: Brazil, whennegotiating the purchase of a product from a U.S. manufacturer, will seek toimpose a barter or countertrade requirement as a condition to completing theunderlying transaction. Under a barter requirement, the manufacturer mustagree to accept a product or commodity (often a surplus product withexhausted sales capabilities or of inferior quality) instead of currency aspayment for the purchase of the manufactured goods. Thus, Brazil will be ina position to purchase the product without the need of currency by conveyinga product which it might otherwise be unable to sell in the internationalmarket-place. The U.S. manufacturer would prefer to be paid in currency, butwill consent to the barter requirement if the failure to do so would jeopardizethe completion of the transaction. In the countertrade transaction, Brazil willrequire that in order to complete the sale, the seller must agree to purchase acertain quantity of raw materials or component parts (typically of a lessdesirable quality or in lower demand) from Brazilian sources. In essence,Brazil pays in currency for the manufactured product, but shortly thereafteris repaid the currency through the seller's "counterpurchase" of the agreedupon Brazilian products, thus insuring a stable currency position without the

3. See generally Organization For Economic Co-Operation and Development,Workshop on Energy Data of Developing Countries (Colloque Sur Les Donnees Energeti-ques Dans Les Pays En Development), Volume II, Basic Energy Statistics and EnergyBalances of Developing Countries, Paris, 1979; International Energy Agency, Orga-nization for Economic Co-Operation & Development, Crude Oil Import Prices, 1973-1978, Paris, 1979.

4. See, e.g., U.S. countervailing and antidumping duties provisions set forth at 19U.S.C. § 1671 et seq. (1978).

5. See Pompiliu Verzariu, Jr., "Countertrade, A Summary for Executives," LESNouvelles, Licensing Executives, December 1980.

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forfeiture of the imported goods or technology. Once again, the U.S.manufacturer would most likely prefer a conventional form of dealing, butwill consent to a countertrade requirement if necessary to complete thetransaction. Clearly, the imposition of either the barter or the countertraderequirement assists in expanding Brazil's export activities by placing theburden of selling its product on the U.S. company and drawing upon thecompany's marketing resources in broadening the exposure of the Brazilianproducts in the international market place.

Examples of recent barter transactions with Third World Nationsinclude: the sale of a U.S. manufactured atomic research reactor to Ghana inexchange for quantities of Ghanaian lumber,6 the sale of U.S. manufacturedtractors to the government of the Sudan in exchange for Sudanese cotton,7

and the sale by a U.S. company of phosphate rock to Poland in exchange forPolish molten sulfur.' Examples of countertrade transactions include the saleof U.S. produced passenger jet aircraft to Yugoslavia in exchange for thesubsequent repurchase of certain finished goods including, inter alia, cannedhams and tools,9 and the development of a phosphate mine in Morocco inexchange for the repurchase of phosphate rock produced from the developedmine.1°

Although relatively new in Third World trading transactions, counter-trade requirements have been common in transactions between privatecorporations and the Soviet Union, East European nations and, morerecently, the People's Republic of China." It is to these earlier transactionsthat businessmen and their attorneys can look to gain an understanding ofthe processes of barter and countertrade for use in dealing with othernations.'2 It must be kept in mind, however, that the nature of these

6. See Eldwood E. Parrish, "Offset/Barter Trading, A New Approach To Interna-tional Business," Economy, March 1979, p. 8.

7. Id.8. See Leo Welt, "Countertrade Gains Popularity As International Trade Tool,"

Business America, July 14, 1980, p. 13.9. Id., p 14.

10. See Weigland, "Countertrade In Chemicals," Chemical and Engineering News,August 14, 1978, at 32.

11. For a detailed list of approximately 280 countertrade transactions involvingthe Soviet Union, East Europe and the People's Republic of China, see, Pompiliu Ver-zariu, Countertrade Practices in East Europe, the Soviet Union and China: An Introduc-tory Guide to Business, United States Department of Commerce, April 1980, pp. 78-102.

12. Id.

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transactions is constantly evolving, and the businessman and his attorneymust be ever vigilant for new and unexpected developments in this area.

Response by the Business Community

Obviously, barter or countertrade requirements often serve to alienateotherwise compatible trading partners and stand as a barrier to an untoldnumber of transactions. Companies which are aggressive competitors in theinternational market place, however, are begrudgingly attempting to devisemethods of meeting the increasing countertrade demands of the Third Worldin order to assure their continued presence in the international trademarkets." Most companies attempt to resist the countertrade obligation, orwhen pressed, look to enter a "best efforts" arrangement before assuming theobligation of a full countertrade commitment. However, when put to the test,many companies would prefer to undertake a realistic barter or countertradeobligation if necessary in order to establish or continue sales relationships inthe often lucrative Third World markets.

Companies submitting to barter and countertrade requirements aredealing with them in a number of ways. Companies will typically attempt tolimit the products which they agree to purchase to those which they can useinternally. The company will look to purchase products which it can use in itsmanufacturing process, such as raw materials or component parts, oroccasionally, office equipment or goods suitable for distribution to itsemployees. As a generally less desirable alternative, the company will look totake back goods in anticipation of resale on the international market. Thisresale is generally accomplished through either the utilization of an in-housetrading arm or the transfer of the countertrade obligation to an outsidetrading house. As a result of the increased frequency of the imposition ofcounterpurchase requirements and the use of in-house trading subsidiaries,the in-house trading company is becoming an increasingly significantcomponent in the overall corporate structure.

II. DEFINITIONS

Barter

As introduced above, the barter transaction consists of a simple exchangeof goods. Under the basic barter transactional format, both parties present

13. United States companies active in barter and countertrade activities include,inter alia, Lockheed Corp., Rockwell International Corp., General Motors Corp., RCACorp., Occidental Petroleum Corp., McDonnell Douglas Corp., International HarvesterCo. and Levi Strauss and Co.

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goods of equal value and undertake a simultaneous two-way trade. Typically,

hard currency is not exchanged and one contract is utilized to formalize the

agreement between the parties. In more complicated barter transactions,

there can be three or more parties, the exchange can take place over a longer

period of time and currency can be utilized to offset variations in the values

of the bartered goods. Barter transactions can be between private parties,between a private party and a sovereign nation,' or between sovereign

nations."

Countertrade

The countertrade transaction consists of a parallel set of obligationswherein the parties each undertake to sell goods or technology to the other inseparate but related transactions. Countertrade can best be understood as atwo step process. First, the "seller," typically a private corporation [the "firstparty"] agrees to present its goods to the "buyer," typically a governmentalpurchasing agency in a Communist or Third World country [the "secondparty"] for an agreed upon purchase price in hard currency. Second, the firstparty then agrees, as a condition of the completion of this first transaction, topurchase goods supplied by the second party, again in exchange for hardcurrency. In essence, the second party agrees to purchase goods from the firstparty upon the condition that the first party agrees to purchase goods fromthe second party. The two obligations are "linked" or "cross-referenced" toeach other by either a provision in one of the two agreements or in a separatedocument (typically referred to as a "protocol"). While the two obligations areoften negotiated at the same time and part of the same overall commercialsetting, the two should be viewed as distinct transactions with separatecontracts and separate currency payments. The significance of the structur-ing of the transaction in this manner, as well as the use of the protocol, isexplained below.

Types of Countertrade

There are a number of distinct types of countertrade transactions and anadditional number of more complex countertrade "variations."'6

14. See examples cited in text supra, at 199.15. Examples of barter transactions between sovereign nations include: the ex-

change of wheat and frozen veal from Argentina for iron pellets from Peru; the ex-change of a $585 million steel making complex from Germany for crude oil from In-donesia.

16. For excellent discussions of the various types of countertrade transactions andvariations thereof, see Welt, supra note 8; and Verzariu, Countertrade Practices in East

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1. Counterpurchase. In a counterpurchase transaction, the first partyagrees to sell goods to the second party and under a separate but relatedagreement undertakes to purchase other, unrelated products from the secondparty."7 Typically, the first party agrees to provide a specified product undercertain conditions of quality, quantity, and time and place of delivery. Inturn, the first party is required to purchase a certain "dollar value" worth ofdesignated goods (usually designated in terms of a percentage of the contractprice under the first obligation) and is permitted a certain time period inwhich to fulfill its purchase obligation."8 In addition, the first party is oftenpermitted to select the items it will purchase from a list of goods agreed uponat the time the parties enter into the counterpurchase transaction.

2. Compensation (Cooperation or Buy back). In a compensation transac-tion, the first party agrees to sell machinery, equipment, technology, or aturnkey plant ("equipment/technology") to the second party, and the firstparty separately agrees to purchase from the second party a predeterminedamount of the product manufactured from the equipment/technology.'Generally, the second party pays for the equipment/technology in currencyand receives payments in currency for its sale of the product to the firstparty. (An alternative form of this type of transaction is for the second partyto "pay for" the equipment/technology by shipping the product to the firstparty in lieu of a cash payment, i.e., as a royalty. This variation, however,constitutes a cooperative barter transaction which is somewhat more difficultto structure and finance than a straight "cash" compensation transaction). Inaddition to serving as a mechanism for increasing exports of the secondparty, the compensation transaction provides an alternative means offinancing the establishment of new industrial activity as well as stimulatingthe development and transfer of technology.

Countertrade Variations

1. Reverse Countertrade. Reverse countertrade is an arrangementwhereby a nation with supplies of a scarce commodity (typically a Third

Europe, the Soviet Union and China: An Introductory Guide to Business, supra note II;see also forthcoming publication by Leo Welt entitled Barter and Countertrade, WeltPublishing Co., Washington, D.C., expected release: mid-1981.

17. See note 16 supra. An example of this type of transaction, as set forth on p. 5supra., is the sale by a U.S. company of jet aircraft to Yugoslavia in exchange for thesubsequent repurchase by the U.S. company of Yugoslavia canned hams, tools andother finished goods.

18. One to three years is common.19. See note 16 supra. An example of a compensation transaction, as set forth on p.

199 supra, is the development of a phosphate mine in Morocco in exchange for the rightto repurchase phosphate rock produced from the mine.

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World OPEC Nation with abundant supplies of crude oil) imposes arequirement that in order for a foreign party (i.e., a private multinational oilcompany) to purchase the commodity, the foreign party must agree to sell tothe nation another scarce commodity otherwise unavailable to the sellingnation, or to undertake a financial investment in the nation. A recentexample of such a transaction is the arrangement wherein several major U.S.oil companies invested in refining and related petrochemical plants in SaudiArabia in exchange for the right to receive additional quantities of crude oilon a long term contract basis. 0

2. Swap. A "swap" transaction is a "short-cut" method employed by fourparties to reduce transportation charges.2' An example of this type oftransaction is where a U.S. company has contracted to sell a certain ore to aSouth Korean steel company, while a Mexican company has agreed topurchase the same type of ore from Australia. Under the terms of the swap,the U.S. company delivers its ore to Mexico, while the South Koreans andAustralians undertake the same exchange. The result is that each purchaserobtains the designated commodity with a substantial savings in transporta-tion costs.

3. Commodity Exchange Agreements. Often nations will enter intobilateral agreements wherein they agree in principle to purchase certainquantities of the other party's goods within a specified period of time. Theseagreements are referred to as commodity exchange agreements and consti-tute, in essence, countertrade agreements between sovereign states.2 Com-modity exchange agreements often set the framework for specific individualsubordinate trade contracts between the states themselves, their subordinateeconomic units (purchasing agencies, etc.) or private enter prises within theirterritorial jurisdiction.

4. Switch. A "switch" transaction is a three-way transaction whereinthe first and second parties are nations which have entered into a bilateralcommodity exchange agreement, but the second party later finds that it lacksthe hard currency to fulfill its obligation under the agreement.2 3 The second

20. One major U.S. company invested $300 million in an export refinery and anadditional $300 million in a petrochemical complex in Saudi Arabia in exchange forthe right to be able to purchase an additional 1.4 billion barrels of Saudi crude over a15 year period. See Robert C. Goodwin, Jr., "Scheduled End of U.S. Controls MuddiesOil Picture," The Legal Times of Washington, January 19, 1981.

21. See note 16 supra.22. Id.23. Id.

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party then sells its product (which presumably the first party is notinterested in purchasing) to a third party, and the third party eitherundertakes a currency payment to the first party or delivers goods acceptableto the first party in order to satisfy the prior bilateral obligation of the secondparty.

As will be discussed at greater length below, the three major types ofbarter/countertrade transactions are: (1) pure barter, (2) counterpurchase,and, (3) compensation. This article focuses primarily on the counterpurchasetransaction, since the elements of this form of trade best typify the basicelements of the countertrade transaction and can be easily modified for usewith the other types of transactions set forth above. In addition, both barterand compensation will be discussed briefly to point out a number ofcharacteristics unique to each.

11. THE COUNTERPURCHASE TRANSACTION

Mechanics of the Counterpurchase Transaction

1. Generally. In essence, the counterpurchase transaction consists oftwo separate purchase agreements "linked" under a single heading orprotocol. The agreements are separated to allow for separate financingarrangements and risk guarantees, as well as to insulate the obligations ofthe two transactions from each other. The linkage of the two agreements,however, performs the critical function of establishing the incentive for thefirst party to deal with the second party in the second transaction. Undermost circumstances, the first party is not interested in purchasing the goodsof the second party, but does so only as a condition of completing theunderlying sale.

Typically, the two sales agreements are negotiated and executedsimultaneously. As stated above, the first agreement generally consists of astandard contract for the transnational sale of goods where the first partyagrees to provide a specified product under certain conditions of quality,quantity, time and place of delivery. A price is set and payment is generallycalled for in hard currency upon delivery. The second agreement, wherein thefirst party agrees to purchase goods from the second party, is often broader inscope and more loosely structured. Occasionally, the first party agrees topurchase a set quantity of specified goods at a firm price at the time of thecompletion of the first transaction. It is more common, however, for thesecond agreement to require the first party to select the goods it intends topurchase from a wider selection of goods available for export from the secondparty and to allow the first party to fulfill its purchase obligation within a

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time period of up to three years after the execution of the agreements."4 Thegoods purchased by the first party are usually not related to the products soldby the first party to the second party.

The quantity of goods to be purchased by the first party is generallydesignated in currency terms as a percentage of the contract price of the firstobligation, and the "price" of the goods is often designated in the form of apricing formula such as "the recognized international price for the commodityat the time of purchase." The dollar amount of goods purchased by the firstparty can be lower, equal to, or greater than the total price involved in thefirst obligation.

The goods to be counterpurchased are often of an inferior quality or notin great demand on the international markets. Consequently, a penaltyclause is generally included in the second agreement which provides that ifthe first party fails to purchase the agreed-upon quantity of specified goodswithin the agreed-upon time period, it will be required to pay a percentage ofthe countertrade value or its unfilled portion.25 The financing of each of thetwo agreements in the counterpurchase transaction is quite similar to that ofthe standard transnational trade transaction since the -products in eachinstance will be exchanged for currency.

2. The Importance of Separate Transactions. The key to understandingthe counterpurchase transaction is to understand the importance of the two"linked but separate" commercial undertakings. As stated above, the twoagreements must be linked in order to provide the incentive for the firstparty to agree to counterpurchase the less desirable goods of the secondparty. (The second party will look to "lock" the first party into the otherwiseundesirable position of agreeing to buy less desirable goods subject to aguaranteed penalty clause through the incentive of consummating the firstportion of the transaction). Care must be taken, however, not to allow the twoagreements to become so closely entwined that they "merge" into oneobligation. This is undesirable for a number of reasons. To begin with, a bankwhich would normally be interested in financing the conventional portion ofthe transaction (the first agreement) will most likely opt not to do so if thesecond agreement is legally connected to the first. The bank will generally

24. As an example, the first party will agree to sell to the second party specifiedmining equipment for the price of $1 million, and will agree to purchase from thesecond party $1 million worth of either electrical components, hand tools or finishedelectrical products within three years from the purchase date of the mining equipment.The first party will have the option of selecting which of the three types of goods (orcombination thereof) it will purchase in order to fulfill its obligation.

25. A penalty of ten to twenty percent of the second obligation is not uncommon.

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insist that the first agreement be completely free of any conditions orrequirements related to counterpurchase and look at the borrower (thesecond party) based upon its independent ability to repay the borrowed funds.Banks are often not willing to take the risk of extending credit to a purchaserwhose ability to repay the loan is dependent upon a variable such as the

expected income from a counterpurchase transaction.

Similarly, export risk guarantees from such institutions as the UnitedStates Export-Import Bank ("Eximbank") are much simpler to obtain if thetransaction is free from such variables. Counterpurchase obligations areoften viewed as awkward and risky complications upon which a guarantor is

not willing to depend.A third reason for the separation of the contracts is that the first

agreement will be allowed to mature independently of the second. The firstsale can be undertaken and paid for with all parties satisfied, and if problemsarise with the second sale, the first transaction would not be encumbered.

Counterpurchase Contracts

The "contract" in a counterpurchase transaction generally consists ofthree separate components: two purchase agreements and a protocol. Each ofthese three components has a separate legal significance independent of theother two, but when joined together, form one integrated legal instrumentembodying all of the interlocking components of the counterpurchase

transaction. Generally, the components are negotiated and executed simul-taneously or in the order set forth below.

The following is a list of suggested provisions to be included in acounterpurchase contract, setting forth the three major components of thecontract as well as the various subordinate provisions under each of the threemain headings. It should be recognized that this list is not intended to serveas a rigid model for contract drafting but rather as a flexible starting pointfrom which the businessman and his attorney can begin their work innegotiating and consummating a satisfactory counterpurchase transaction."Due to space limitations, only those contract clauses which have uniquesignificance in the counterpurchase transaction will be discussed in detail.

26. In addition, since the parties to the contract will most likely be from differentcountries, it is advisable that "local" counsel familiar with the laws of the non-U.S.party be consulted in order to determine the legality and effectiveness of the contractunder the laws of the country of the other party.

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Counterpurchase Contract

1. Protocol2. Primary Sales Agreement

partiesrecitals

acknowledgement of obligation to purchase goods

description of goods, specificationsquantityprice, terms of paymentmethod of payment, guarantee thereof

time, terms and other details regarding deliverypackingshippinginsurance

documents, documentary transfer

guarantee of quality, quality controlright to inspectright to neutral surveyor

determination and settlement of claims

penalties, remedies (or other agreed upon arrangements)in the event of:

- late delivery- delivery of non-conforming goods

- failure to deliver

force majeurearbitrationchoice of law

3. Secondary Sales Agreement

partiesrecitalsacknowledgment of obligation to counterpurchase goods

list of available goodsspecifications, description, quality

quantity of counterpurchaseprice, terms of payment, guarantee thereoftime period in which to fulfill obligation

terms and other details regarding deliverylinkagemarketing restrictionspackingshipping

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insurance

documents, documentary transfer

guarantee of quality, quality controlright to inspectright to neutral surveyordetermination and settlement of claimsfirst party penalties, remedies

second party penalties, remediescancellation of first sales agreementtransferability of counterpurchase agreementforce majeurearbitration

choice of law

1. Protocol. As discussed above, the "link" between the two subordinatesales agreements is generally created through the use of a protocol or

preliminary statement that the parties agree to enter into both subordinate

agreements simultaneously. The protocol should be looked upon as a contract

in itself, separate from the two underlying purchase agreements, which is

fulfilled upon the parties' execution of both underlying sales agreements.

2. Primary Sales Agreement. The agreement for the primary sale of

goods from the first party to the second party is generally a standard contract

for the sale of goods used in a conventional international trade transaction.

One point of particular importance, however, should be recognized. It is

critical that no reference should be made in the primary contract to the

obligation of the first party to purchase goods from the second party under

the second contract. References should especially be avoided which acknowl-

edge that the obligation under the second contract is part of the consideration

paid by the first party in connection with the first obligation, or which in any

other way describes the second obligation as part of the "bargain" involved in

the first agreement. To do so would cause the two agreements to "merge" into

one obligation, thus initiating all of the problems involving financing,

guarantees and execution discussed supra.

3. Secondary Sales Agreement. The second agreement, where the first

party agrees to purchase the goods of the second party, should include the

following provisions:

a.) Recitals. The parties may wish to use the recital portion of the

second agreement as an opportunity to tie the second agreement

into the first agreement in lieu of a protocol. As stated above,

however, care must be used to prevent the merger of the two

separate agreements into one integrated obligation.

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b.) Acknowledgment of Purchase Obligation. The first party acknowl-edges its obligation to purchase certain products from the secondparty in consideration for the purchase price to be specified eitherin the agreement or at a later date.

c.) Time Period. The parties designate a period of time in which thefirst party is allowed to fulfill its counterpurchase obligation. Atime period of one to three years is common. Obviously, the greaterthe time period which is available, the greater the advantage to thefirst party.

d.) List of Available Goods. As is the case with the time period, the

greater the flexibility afforded in the selection of goods to bepurchased, the greater the benefits available to the first party inconnection with the subsequent resale of the purchased goods. Thespecific parameters within which the first party can operate inselecting its counterpurchase goods depend upon the sophisticationof its position in the international markets, either via its own salesnetwork or through its contacts with outside trading companies. Inmost cases, the most undesirable counterpurchase goods arefinished products, while the most desirable goods include raw orsemiprocessed materials, ores, chemicals and other easily tradedgoods.

e.) Quality of Counterpurchase Goods. Due to the nature of manycounterpurchase goods, i.e., being of inferior quality or in lowdemand, it is essential that quality control provisions be estab-lished which set forth detailed specifications for acceptable goodsand which either (a) state that goods will not be accepted unlessmeeting the agreed upon specifications, or (b) set forth contingentarrangements or options for the first party in the event that thegoods fail to conform to the agreed upon specifications (e.g.,reduction in price, alteration of purchase requirement, etc.)

f.) Quantity of Purchase. The quantity of goods to be counterpurchasedshould be designated. This can be accomplished either through thedesignation of an exact quantity of specified items or in a dollaramount as a percentage of the first sales agreement.

g.) Price. If the quantity and description of the goods and exact date ofsale have been definitively set in the second agreement, aprearranged selling price will most likely be established andincluded in the contract. In the event that the goods to be purchasedwill be selected by the first party at a future date, a "pricingformula" will most likely be included in the agreement in lieu of afirm price. For example, price provisions such as "the acceptableinternational price at time of purchase" or "five percent below the

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fair market value of the goods in the first party's home country" arecommon. In the event that a pricing formula is to be utilized for thefuture selection of prices, it is most likely in the interest of bothparties that the formula be carefully structured, extremely specificand accurately articulated. (Occasionally it is determined by aparty that due to market volatility or other external conditions, itmay be in its best interest to enter into an agreement withambiguous pricing provisions.)

h.) Right to Inspect, Right to Neutral Surveyor. It is clearly in theinterest of the first party to obtain the right to inspect thecounterpurchase goods. It is preferable for the first party to havethe right to reject the goods in the event that it determines that thegoods do not conform to the contract specifications. An alternativearrangement is to provide for the selection of a neutral surveyor,selected by both parties, to render a binding decision concerning thequality of the goods in question.

i.) First Party Penalties. The second party will most likely insist that a

penalty provision be included which provides that in the event thefirst party fails to fulfill its counterpurchase obligations in full, apenalty be paid by the first party. A penalty of from ten to twentypercent of the value of the countertrade goods or the unfulfilledportion of the second agreement is common. It should be specified,however, that payment of a penalty by the first party does not affectthe obligations of the parties under the first agreement. Additional-

ly, the first party should be assured that once the penalty is paid,all of its obligations under the second agreement shall terminate. Itshould be recognized that this provision may be used by the firstparty as an "escape clause" in the event that it is no longer willingor able to fulfill its obligation under the second agreement andshould be negotiated in anticipation of the possibility of such anoccurrence. While the first party would prefer not to be required toobtain a bank guarantee for the penalty clause, such a request bythe second party is common and frequently agreed to by the firstparty.

j.) Second Party Penalties. A penalty provision should also be includedfor the benefit of the first party in the event that the second partyfails to perform as agreed. The second party would fail to performthrough its failure to provide the contract goods, its tendering ofinferior goods, or through the late delivery of the otherwiseconforming goods. One option would be to impose a financialpenalty upon the second party in proportion to the degree ofseverity of its failure to perform, e.g., a minor variation in quality

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would result in a slight reduction in contract price, while asignificant variation would result in a substantial price reduction.Another option would be for the obligation of the first party underthe second agreement to be void or voidable, i.e., its obligation topurchase goods from the second party is eliminated or it obtains theoption of withdrawing from the second agreement. Once again, itshould be specified that the imposition of any penalties would notaffect the rights of either of the parties under the first agreement.

k.) Cancellation of First Agreement. It should be agreed between theparties that in the event that the first agreement is cancelled, thesecond agreement is void or voidable at the option of the first party.

1.) Linkage. In the event that the second party is a communist countryor other country with a variety of governmental offices responsiblefor the sale and control of different commodities, the first party maywish to be guaranteed the opportunity to purchase certain commod-ities from branches of the government other than the one withwhich it is entering the agreement. This concept is known as"linkage." Obviously, this is beneficial to the first party, since itbroadens its options in connection with the goods available forcounterpurchase.

m.) Transferability of Second Agreement. It is greatly to the advantageof the first party to have the option to transfer its rights andobligations under the second agreement to a trading house orexport trading company which may be better equipped to marketthe counterpurchase goods. A clause should be included whichwould specifically provide the first party the right to transfer itsinterest under the second agreement to another party. In the eventthat the second party requires that this be allowed only with itspermission, it should be agreed that this permission will not beunreasonably withheld.

n.) Marketing Restrictions. The first party should obtain the consent ofthe second party to market the counterpurchase goods free of anyinterference or other restrictions from the second party. This wouldinclude restrictions on geographic areas of marketing and onpotential purchasers.

o.) Dispute Settlement. It is essential to specify in the agreement themechanism which is to be utilized in the event a dispute arises inthe course of performance under the agreement. Due to thetransnational nature of the transaction, conventional litigation isoften an awkward, expensive and unreliable means of disputesettlement. A viable alternative is for the parties to consentmutually to binding arbitration. A common arrangement is to agree

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that arbitration will be conducted in the home country of the party

complained against, utilizing three arbitrators: one selected by eachof the two parties and the third selected by the first two arbitrators.A second option is to designate a prearranged arbitrating body suchas the International Chamber of Commerce or the Stockholm

Chamber of Commerce, a prearranged third country of arbitration,and a set of arbitration rules such as the United Nations

Commission on International Trade Law (UNCITRAL) ArbitrationRules. Western firms often prefer "neutral" nations such asSwitzerland, Sweden, or Austria as a forum country. If a choice oflaw is to be agreed upon, a codified legal system is generallypreferred over a case law system such as that utilized in the UnitedStates.

p.) Force Majeure. A clause should be included which provides that theseller shall not be held responsible for the delay or non-delivery ofthe goods due to force majeure.It is advisable to specify the eventswhich would constitute force majeure (communist governments willmost likely reject the term "acts of God" since God is not recognized,

although "acts of nature" can be substituted therefor).

IV. THE BARTER TRANSACTIONS

Mechanics of the Barter Transaction

On its face, the barter transaction appears to be relatively uncompli-cated; however, a closer look reveals a number of potentially difficult areaswhich must be taken into consideration in order to be assured of a safe andorderly transaction.

Under a conventional trade transaction (utilizing the customarydocumentary transfer and letter of credit), the letter of credit provides the

source of security to both parties: first, to the seller in the form of aguarantee of payment, and second, to the purchaser in the form of aguarantee that funds will not be released until the goods are found to besatisfactory to the issuing bank. Once the "currency" portion of thetransaction is eliminated as a result of a barter requirement, the securityprovided by the letter of credit is no longer present.

A way to avoid this pitfall is to undertake the normal transfer ofdocuments (bills of lading, etc.) for each of the sets of goods being bartered inconjunction with a set of non-currency or "standby" bank guarantees. Under

such an arrangement, the first party requests that the second party's bankissue a standby letter of credit, providing, in essence, that in the event the

second party fails to meet its obligation under the barter contract (i.e., fails to

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ship the designated goods to the first party), the first party would be entitledto draw payment in hard currency for the goods under the standby letter ofcredit. Upon issuance of the letter of credit by the second party bank, the firstparty would have the letter of credit confirmed by its own bank in its homecountry." Of course, the second party would seek the same form of guaranteefrom its own bank for its own benefit. Another arrangement is to establish anevidence account at a neutral bank where equal credits are made to eachparty upon delivery. If the transaction proceeds as expected, the crediting ofeach party's account will occur simultaneously and cancel each other out. Theparties will be left with their respective delivered products, having providedguarantees of security in case of default.

The Barter Contract

The barter transaction requires the use of one contract as compared tothe use of multiple contracts in the countertrade transaction. As one mayexpect, a barter contract includes most of the standard provisions containedin a conventional transnational trade contract, with the addition of a numberof special provisions to effectuate the barter arrangement. The conventionalcontract is adapted through the elimination of the normal provisionsconcerning price and currency payments and by the substitution of provisionsregarding description and delivery of the second product to be bartered. Inaddition, the contract should clearly and accurately set forth provisionsconcerning penalties, "escape clauses" and other "contingency clauses" andthe accompanying bank guarantees, as the situation may dictate.28

1. Special Attention to Contingencies. When all of the details arestripped away, the ordinary contract for the cash sale of goods contains twobasic elements - provisions regarding the goods to be provided and thepurchase price to be paid. Of these two, the first generally provides thegreatest degree of difficulty for the parties due to the innumerable variables

27. In the event that the first party would find it difficult to have the second partyletter of credit confirmed, such as is the case in transactions with the People's Republicof China, an alternative form of guarantee is. also available. Here, the first party wouldrequest that the second party's bank issue a performance bond, similar in substance tothe standby letter of credit discussed above, which would subsequently be guaranteedby the first party's bank. In the case of a U.S. first party with a U.S. bank, since U.S.banks are not permitted by law to issue "guarantees," a foreign (e. g., Hong Kong)branch of the U.S. bank would issue the guarantee required to secure the performancebond of the second party. Once again, the same form of protection could be establishedin favor of the second party by simply reversing the above process in favor of the secondparty.

28. See Barter Contract Checklist, infra at 215-16.

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associated with the production, packaging, shipping, and delivery of thecommodity in the quantity and time frame designated. In the conventionaltransaction, the experienced businessman anticipates these difficulties andprovides for a broad variety of specific contingent arrangements in thecontract (arbitration, force majeure, penalties, etc.) in order to avoid thesubsequent breakdown of the transaction. It must be emphasized that in abarter transaction, the chances of full or partial default occurring, are almosttwice as great as in a conventional transaction, due to the presence of twosets of goods and two sets of the above-stated variables. Consequently, thedraftsman of the barter contract should be especially attentive to anticipat-ing the problems connected with the quality and delivery of both sets of goodsand insist upon the inclusion of a full range of quality control andcontingency clauses in the barter contract. This would include, inter alia,provisions covering the following:

detailed specifications and description of goodsguarantee of quality and quality controlright of inspectionright to neutral surveyordetermination and settlement of claims penalties:

- late delivery- delivery of non-conforming goods- failure to deliver

force majeurearbitrationchoice of lawbank guarantees

2. Escape Clause. A contingency clause worthy of special considerationin the context of the barter transaction is an "escape clause" to be exercisedin the event that one of the parties fails to perform satisfactorily under theagreement. In essence, the escape clause provides that in the event one partyis determined (through arbitration or other means as provided in thecontract) to have substantially breached its portion of the obligation, thenon-breaching party has the option to be paid immediately a pre-agreed pricein currency in lieu of being forced to wait for delivery of the barteredproduct.' In addition, the clause should provide that if the breaching party islater in a position to perform, i.e., to deliver the conformed product, thenon-breaching party would be under no obligation to purchase the delivered

items.

29. This clause can be drafted in conjunction with the bank guarantee clause dis-cussed supra at pp. 212-13.

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The following is a list of suggested provisions to be included in a baiter

contract, setting forth the major provisions to be utilized in formalizing the

barter transaction, including the contingency and guarantee clauses discus-

sed above. Once again, it should be noted that since no two transactions are

indentical (especially in the barter context), this list is not intended to serve

as a rigid model but rather as a flexible framework and starting point for the

preparation of the contract document.

Barter Contract Checklist

partiesrecitals

acknowledgement of obligation of first party to provide and accept goods

acknowledgement of obligation of second party to provide and accept

goodsfirst party goods

- description of goods, specifications- quantity- time, terms and other details regarding delivery

- packing- shipping- insurance

- documents, documentary transfersecond party goods

- description of goods, specifications- quantity- time, terms and other details regarding delivery

- packing- shipping- insurance

- documents, documentary transfer

bank guarantees providing for full payment in the event of the

non-performance of one party

guarantee of quality, quality controlright to inspect

right to neutral surveyordetermination and settlement of claims

penalties (or other agreed upon arrangements) in the event of:- late delivery- delivery of non-conforming goods- failure to deliver

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force majeurearbitrationchoice of law

V. COMPENSATION TRANSACTION

Mechanics of the Compensation Transaction

As discussed above, the compensation transaction consists of a pair ofagreements wherein the first party undertakes to sell equipment, machinery,technology and/or an entire turnkey manufacturing facility ("equipment/technology") to the second party and agrees to purchase a certain predeter-mined quantity of the goods produced by the equipment/technology from thesecond party. Generally, compensation transactions are considerably morecomplex than the straightforward counterpurchase transaction due to thegreater number of variables involved in the establishment of a full-scaleoverseas manufacturing facility. Not surprisingly, there are often muchgreater amounts of money involved and the period of repurchase is frequentlymuch longer than under the counterpurchase agreement (generally five toten years) as a result of, inter alia, the start-up time involved in theplanning, construction and training activities related to the project.

As with the counterpurchase transaction, the compensation form ofcountertrade involves two separate agreements linked by a protocol. Thereasons for the structuring of the transaction in this way are the same as inthe counterpurchase transaction. However, this form of structuring isespecially necessary in compensation transactions, due to the desire to keeplarge front-end payment obligations for the equipment/technology separatefrom the innumerable variables involved in the establishment and com-mencement of the manufacturing activity. In addition, the first party willmost likely wish to keep the contracts "linked" to insure that the goods it willbe purchasing will be produced from its own equipment/technology instead offrom a less desirable foreign substitute.

Compensation Contracts

The compensation contract is very similar in format to the counterpur-chase contract, including the use of the three major components: the twopurchase agreements and the protocol. Attention should be drawn, however,to the first agreement, i.e., the one dealing with the sale of the equipmenttechnology. Unlike the conventional international trade agreement asutilized in the counterpurchase transaction, the contract for the transfer ofequipment and technology is anything but "standard", and a large -number ofopportunities exist for difficulties to arise. The first party is advised to payspecial attention to the terms of the agreement in conveying its equipment/

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technology in order to protect its technologically competitive position in the

international market place and to avoid future disputes throughout thecourse of the cooperative effort with the second party.

The following is a list of the major provisions contained in a compensa-

tion contract, once again provided as a flexible framework and starting pointrather than as a rigid drafting model.

Compensation Contract

1. Protocol2. Primary Sales Agreement

partiesrecitals

acknowledgment of obligation to purchase equipment/technologydescription of equipment/technology, specificationsprice, terms of paymentmethod of payment, guarantee thereoftime, terms and other details regarding deliveryadditional provisions related to specific aspects of agreement such

as performance of equipment/technology, use, im-provements upon and transfer of technology, rolesplayed by employees, consultants and technical advi-

sors, and overall operation of equipment/technologypackingshippinginsurance

documents, documentary transfer

guarantee of quality, quality controlright to inspectright to neutral surveyor

determination and settlement of claims

penalties (or other agreed upon arrangements) in the event of:- late delivery- delivery of non-conforming goods- failure to deliver

force majeurearbitrationchoice of law

3. Secondary Sales Agreementpartiesrecitalsacknowledgment of obligation to counterpurchase goods

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list of available goodsspecifications, description, qualityquantity of counterpurchaseprice, terms of payment, guarantee thereoftime period in which to fulfill obligationterms and other details regarding deliverylinkagemarketing restrictionspackingshippinginsurancedocuments, documentary transferguarantee of quality, quality controlright to inspectright to neutral surveyordetermination and settlement of claimsfirst party penalties, remediessecond party penalties, remediescancellation of first sales agreementtransferability of counterpurchase agreementforce majeurearbitrationchoice of law

1. Protocol. As with the counterpurchase transaction, the two under-lying agreements should be linked as a result of the two parties agreeing toenter into both of the subordinate contracts simultaneously. Once again, thisis accomplished through the use of a protocol.

2. Primary Sales Agreement. Emphasis should be placed upon athorough anticipation of all the aspects of the sale of the equipment/technology and upon clear and precise definition of all the rights andobligations of the parties connected thereto, including the rights andobligations involved in the delivery and performance of equipment andmachinery, the use and transfer of technology and the roles played by anyemployees, consultants and technical advisors provided by the first party.3 0

Special attention should be devoted to specifying and limiting the extent of

30. For an excellent discussion of compensation contracts, see James W. Schroeder,"Some Legal Considerations in Joint Venture and Countertrade Arrangements in U.S.-China Trade," presented before the American Management Association, June 20, 1980.See also "Selling Technology to China," National Council for U.S. - China Trade,1979.

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the first party's rights and obligations related to manpower assistance,

performance guarantees, and the secrecy of improvements upon, and

transfers of technology and know-how.Payment should be called for in hard currency at the time of the transfer

of the technology or in time increments as the manufacturing facility is

transported and constructed in the host country. Once again, if goods

produced from the factory are designated to be used as payment for the

purchase of equipment and technology, the result will be a "merged"

barter-type transaction, and the parties may experience difficulty in obtain-

ing adequate financing and risk guarantees.

3. Secondary (Compensation) Sales Agreement. The second sales agree-ment in the compensation transaction is generally a counterpurchaseagreement similar to that utilized in the second agreement in the counter-

purchase transaction discussed in Part III above. The major differences one

may encounter between the second compensation agreement and the secondcounterpurchase agreement is that in the compensation transaction the goods

to be purchased by the first party will most likely be specified (i.e., thoseproduced from the plant in question) and the length of the counterpurchaseperiod will be considerably greater. Special attention should be paid to the

following clauses because of the broad degree of variables inherent in thecompensation transaction:

a) specifications regarding acceptable goods, quality control (it is

common for local skilled-labor problems to result in poor workman-

ship and low quality goods);b) price, terms of payment;c) marketing restrictions; andd) dispute settlement, arbitration and choice of law.

VI. CONCLUSION

Although not a predominant form of transnational commercial dealing,

barter and countertrade are coming into greater prominence in Third Worldtrade transactions in response to ever-changing conditions in the internation-al economic and political environment. Hard currency shortages, dramatic

changes in the world energy situation and ever present pressures to reducetrade deficits have created a need for the innovative structuring and

financing of international trade transactions. Unlike the case with many ofthe more conventional forms of international trade, however, barter and

countertrade are characterized by uncertainty and risk due to theirheretofore limited use, and businessmen confronted with the opportunity ofengaging in the same, face the task of exploring new ground in the intricateworld of transnational business dealings. The result of these developments is

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that international businessmen and their attorneys have the freedom to bemore creative and responsive in their business activities, but are forced to bemore thorough and alert in structuring and memorializing their new form oftrade undertaking.