Methods of Payment

Areej Aftab Siddiqui

Importance of Terms of Payment

Determination of Terms of Payment

Key Players in International Trade

Exporter Importer

International Carrier

Exporter’s Bank

BORDER

Importer’s Bank

Export Clearance Import Clearance

BORDER

SALES CONTRACT

Link when in an International Sales Contract

Exporter Importer

International Carrier

Exporter’s Bank

BORDER BORDER

Importer’s Bank

Export Clearance Import Clearance

How to secure the payment after shipment

How to secure the delivery after payment

Methods of Payment

ConsignmeConsignmentnt

Open accountOpen account

CollectionCollection

Letter of CreditLetter of Credit

Advance paymentAdvance payment

Payment will be made after goods being sold in import country

Delivery first before payment

Delivery first before payment (through bank)

A guarantee for payment by Bank

Pay first before delivery

Exporter’s 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 consignee’s 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 t he buyer’s book and show values of the goods as an amo unt 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

Exporter Importer

Transportation

Bank or FI

Insurance

1. Sale Contract

2. Contract of carriage

3. Insurance contract

8. Payment

4 . Shipment

5 . Bill of Lading

6 . Insurance Certificate

7. Shipping Documents

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

well-known 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

Exporter Importer

Transportation

Bank or FI

Insurance

1. Sale Contract

2. Contract of carriage

3. Insurance contract

4. Advance payment

5. Shipment

6. Bill of Lading

7 . Insurance Certificate

8. Shipping Documents

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

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 buyer’s bank.

• Bank has the only duty to collect the payment fro m the buyer in exchange for delivery of the shippi ng & financial documents

• Bank assumes no risk & responsibility associated with default payment AS LONG AS it follows the s

eller’s instruction

Three types of collection

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

•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)

Exporter Importer

Transportation

Bank or FI

Insurance

1. Sale Contract

2. Contract of carriage

3. Insurance contract

9 . Payment

4. Shipment

5 . Bill of Lading

6 . Insurance Certificate

8 . Financial Documents

7. Shipping Documents

Contractual Relationship (D/P)

Exporter Importer

Transportation

Bank or FI

Insurance

1. Sale Contract

2. Contract of carriage

3. Insurance contract

9. P ayment(simultaneously)

4. Shipment

5 . Bill of Lading

6 . Insurance Certificate

8 . Financial & Shipping Documents

Contractual relationship (D/A)

Exporter Importer

Transportation

Bank or FI

Insurance

1. Sale Contract

2. Contract of carriage

3. Insurance contract

9. P ayment (at the future date)

4. Shipment

5 . Bill of Lading

6 . Insurance Certificate

8 . Financial & Shipping Documents

Risk associated with Collection

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 bank’s name and credit risk for

that of the applicant (buyer, importer)• Guarantees payment of a customer’s draft up

to a stated amount for a specified period if certain conditions are met

Letter of CreditLetter of Credit

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 UsingBanks As Arbiters

NEGOTIATE L/C TERMS BEFOREENTERING 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)

Importer (Applicant)

Issuing Bank (Guarantor)

Advising Bank

1. Sale Contract

2. Credit Application

3. Documentary Credit

4. Advice of L/C

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!

2. How can Mang Juan and possibly those who will finance his production be reassured he will be paid?

3. 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?

4. 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.

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How do we solve this problem of trust?

Through A bank instrument called the Letter of Credit

1. It is a bank, and not Mr. Smith, who guarantees Mang Juan that he will be paid

2. 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.

3. 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.

4. 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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THE BANK’S COMMITMENT IN THE LETTER OF CREDIT

• AMOUNT• EXPIRY• LATEST SHIPMENT DATE• DOCUMENTS REQUIRED

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

PAYMENT WILL BE MADE ONLY WHEN ALL TERMS AND CONDITIONS ARE MET

KEY ELEMENTS

RESOLVE UNCLEAR ITEMS PRIOR TO SHIPMENT

Letter of Credit Process

Exporter Importer

International Carrier

Exporter’s Bank

BORDER BORDER

Importer’s Bank

Need Guarantee for payment before delivery

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

1. L/C Application

2. Shipment

3. Bill of Lading

Letter of Credit- Guarantee for payment by

bank under terms & conditions

- Assure appropriate documents(B/L) are presented

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Documentary Credit Procedure

Buyer(Importer)

Seller(Exporter)

Importer’s Bank(Issuing Bank)

CorrespondentBank

(1) Contract of Sale

(5) Delivery of Goods

(7) Documents Presented toissuing Bank

(3) Credit Sent to Correspondent

(6) Documents

Presented

(4) Letter of CreditDelivered

(8) Documents& Claim forPayment

(2) Request

to ProvideCredit

(9) Payment

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.

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

Types of Letters of Credit

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Confirmed L/C

Buyer(Importer)

Seller(Exporter)

Importer’s Bank(Issuing Bank)

Exporter’s Bank(Advising Bank)

(1) Contract of Sale

(5) Delivery of Goods

(7) Documents Presented toissuing Bank

(3) L/C Sent to Correspondent

(6) Documents

Presented

(4) Confirmed Letter of CreditDelivered

(8) Documents& Claim forPayment

(2) Request

to ProvideCredit

(9) Payment

Confirming Bank 3a. L/C3a. Confirmed L/C

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 ExchangePromissory NoteTrust ReceiptDelivery Order

TRANSPORT DOCUMENTS:

Bill of Lading

Airway Bill

Air Consignment Note

Postal Parcel Receipt

Truck Receipt

Railway Receipt

COMMERCIAL DOCUMENTS

Commercial Invoice Packing ListInsurance CertificateCertificate Of OriginInspection CertificateWeight NoteCertificate Of AnalysisBlack 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 DocumentationAbout 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 exporter’s country, the exporter is neither subject to commercial not to country risk

• If the credit is irrevocable, it can’t be cancelled without the exporter’s 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 under UCP for documentary Credit

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

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 day’s 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?