Ingles
Legal
International
Trade:
US INTERNATIONAL PAYMENT METHODS
USED BY IMPORTERS AND EXPORTERS :
Cash in advance, confirmed letter of credit, advised letter of credit,
documents against payment, documents against acceptance, and open account.
MOST SECURE TO LEAST SECURE PAYMENT METHOD: EXPORTER'S
PERSPECTIVE
Cash in advance, confirmed letter of credit, advised letter of credit,
documents against payment, documents against acceptance, and open account.
MOST SECURE TO LEAST SECURE PAYMENT METHOD: IMPORTER'S
PERSPECTIVE
Open account, documents against acceptance, documents against payment
advised letter of credit, confirmed letter of credit, and cash in advance
FACTOR TO CONSIDER TO DETERMINE PAYMENT METHOD
Credit standing of the buyer, political and economic conditions in the
buyer's country, exchange controls in the buyer's country, the value of
the export, customary payment practices in the exporter's industry and
payment methods offered by the exporter's competitors.
I. CASH IN ADVANCE TRANSACTION
The importer\ buyer pays the exporter\ seller by check, draft or wire
transfer before the exporter\ seller ships the product to the importer\
buyer. An exporter\ seller who receives payment by check or draft should
not consider such payment as "cash in advance" until the check
or draft has cleared and good funds have been deposited in the exporter's\
seller's bank account.
II. CONFIRMED LETTER OF CREDIT
A confirmed letter of credit is a formal written undertaking issued by
a bank in the buyer's country (issuing bank) and guaranteed or confirmed
by a bank in the seller's country (confirming bank) in accord with which
both banks agree to pay a seller (the letter of credit beneficiary) a
specified amount on behalf of a buyer (the letter of credit applicant
\ account party), if the seller complies with the terms and conditions
that are specified within the letter of credit.
A confirmed letter of credit is a desirable (albeit expensive) payment
method for a company that is buying a product internationally and a desirable
(albeit expensive) payment method for a company that is selling product
internationally. The buyer who uses this payment method can feel comfortable
that two banks are assessing the seller's performance under the letter
of credit which has been issued on behalf of the buyer. Likewise, the
buyer can feel comfortable that the seller will not be paid if the seller
does not perform exactly as the confirmed letter of credit requires. The
seller, on the other hand, should also feel comfortable with a confirmed
letter of credit transaction in that the seller knows that it will be
paid in the U.S. by a U.S. bank if it performs in accordance with the
terms and conditions that are specified by the letter of credit.
BANKING PROCEDURE
The bank that issues a confirmed letter of credit (the issuing bank) assumes
the role of the foreign buyer, whereas the bank that confirms the letter
of credit (confirming bank) assumes the role of the foreign issuing bank.
By functioning in this manner, the issuing bank effectively eliminates
payment risk associated with the foreign buyer whereas the confirming
bank effectively eliminates payment risk associated with the issuing bank.
ADVISED OR UNCONFIRMED LETTER OF CREDIT
An advised (or unconfirmed) letter of credit is a formal written undertaking
issued by a bank in the buyer's country (issuing bank) and conveyed to
the seller / exporter (letter of credit beneficiary) by a bank in the
seller's country (advising bank) in accord with the issuing bank agrees
to pay the seller a specified amount on behalf of a buyer (the letter
of credit applicant \ account party), if the seller complies with the
terms and conditions that are specified within the letter of credit.
An advised letter of credit is a desirable (albeit expensive)
payment method for a company that is buying a product internationally
and a desirable (albeit expensive) payment method for a company that is
selling product internationally. The buyer who uses this payment method
can feel comfortable that the issuing bank will assess the seller's performance
under the letter of credit which has been issued on behalf of the buyer
before the issuing bank pays the seller under the letter of credit. Consequently,
the buyer can feel comfortable that the seller will not be paid under
the letter of credit if the seller does not perform exactly as the letter
of credit requires. The seller, on the other hand, should also feel comfortable
with an advised letter of credit transaction in that the seller knows
that it will be paid under the letter of credit if it performs in accordance
with the terms and conditions that are specified by the letter of credit.
BANKING PROCEDURE
The bank that issues an advised letter of credit (the issuing bank) assumes
the role of the foreign buyer, whereas the bank that conveys the letter
of credit to the seller (advising bank) assumes no role other than conveying
the letter of credit to the beneficiary. By functioning in this manner,
the issuing bank effectively eliminates the payment risk associated with
the foreign buyer. Since the advising bank assumes no role other than
conveying the letter of credit terms to the beneficiary, however, the
payment risk associated with the issuing bank remains the payment risk
with which the seller \ exporter must contend.
CONFIRMED AN ADVISED LETTER OF CREDIT: DIFFERENCES
The principal difference between an advised letter of credit and a confirmed
letter of credit is the absence of a U.S. confirming (guaranteeing) bank
in an advised letter of credit. The risk for payment under an unconfirmed
letter of credit, therefore, is the foreign issuing bank, not a U.S. confirming
Bank. The involvement of a U.S. bank in an unconfirmed letter of credit
will be limited to "advising" the unconfirmed letter of credit's
details to the seller and possibly to paying the seller under the unconfirmed
letter of credit with recourse, i.e. with the ability to retrieve from
the seller any funds paid to the seller, in the event that the U.S. bank
does not receive reimbursement from the foreign issuing bank.
DOCUMENTARY LETTER OF CREDIT
A documentary letter of credit (also known as a commercial letter of credit
or a merchandise letter of credit) is a letter of credit that is issued
for the purpose of making payment to a specified beneficiary if the beneficiary
performs as required. Documentary letters of credit are called documentary
letters of credit because the banks involved in the letter of credit transaction
deal in documents as opposed to goods. The terms and conditions specified
in a documentary letter of credit generally involve the presentation of
specific documents within a stated period of time.
STANDBY LETTER OF CREDIT
A standby letter of credit is a letter of credit that is issued in favor
of the standby letter of credit beneficiary for the purpose of "backing-up"
certain specified obligations of the standby letter of credit applicant.
A standby letter of credit requires the beneficiary's presentation of
documents which indicate that the letter of credit applicant has not met
the obligations which the standby letter of credit backs-up. A standby
letter of credit, therefore, is not intended to be drawn upon by the standby
letter of credit beneficiary unless the standby letter of credit applicant
does not meet its obligations as specified by the standby letter of credit.
DOCUMENTARY AND STANDBY LETTER OF CREDIT: DIFFERENCES
The principal difference between a documentary letter of credit and a
standby letter of credit is the fact that a documentary is an active payment
instrument under which payment is intended if the terms and conditions
prescribed by the letter of credit are met, whereas a standby letter of
credit is a passive payment instrument under which payment is not intended
and will occur only if the standby letter of credit applicant fails to
meet its obligations as specified by the standby letter of credit.
BANKS INVOLVED IN A LETTER OF CREDIT TRANSACTION:
ENCRYPTED LETTER OF CREDIT
At least two separate banks are involved in a letter of credit transaction,
i.e. the issuing bank in the applicant's country and the advising \ confirming
bank in the beneficiary's country. Bank involvement in a letter of credit
transaction is critical in that the issuing bank takes instructions from
the applicant and passes these instructions in the form of an "encrypted"
letter of credit to the advising or confirming bank which "decrypts"
the letter of credit and conveys the letter of credit to the letter of
credit beneficiary, provided that the advising \ confirming bank is convinced
of the validity of the letter of credit.
The encryption \ decryption functions of the issuing and advising or
confirming bank are key aspects of a letter of credit in that they insure
the beneficiary of the letter of credit's validity. As a consequence,
a letter of credit beneficiary should never act on any letter of credit
received directly from a purported letter of credit applicant, unless
the letter of credit also passes through banking channels.
ASSIGNMENT OF PROCEEDS UNDER A LETTER OF CREDIT
An assignment of proceeds under a letter of credit is the allocation of
a portion of the payment available under a letter of credit to a party
other than the letter of credit beneficiary. The assignment is typically
arranged by the letter of credit beneficiary through the advising \ confirming
bank, as appropriate. The party to which the assignment is made (assignee)
is assured of payment under the letter of credit if and when the letter
of credit is successfully negotiated. The assignee does not, however,
receive any rights or protection under the letter of credit.
TRANSFERABLE LETTER OF CREDIT
A transferable letter of credit is a letter of credit which specifically
permits a letter of credit beneficiary (transferor) to transfer all or
some of the rights and protection afforded the transferor under the letter
of credit to a third party (transferee) who then becomes a second beneficiary
on the letter of credit. Transferable letters of credit are typically
used in transactions where the first letter of credit beneficiary is a
middleman and the second letter of credit beneficiary is the middleman's
supplier.
BACK-TO-BACK LETTER OF CREDIT: A SECOND LETTER
OF CREDIT
A back-to-back letter of credit is a letter of credit (second letter of
credit) which is issued on the basis of an already existing letter of
credit (first letter of credit). Generally, the beneficiary on the first
letter of credit is the applicant for the second letter of credit. The
purpose of structuring the credits in this manner is to secure the payment
which is to be made under the second letter of credit with the payment
that is made under the first letter of credit, thereby securing payment
of the second letter of credit with the payment of the first letter of
credit. But this structure has not always worked as intended and as a
result, banks have experienced many problems with back-to-back letters
of credit. Today, back-to-back letters of credit are not offered by many
banks and consequently are only very rarely used. When available through
banks, however, back-to-back letters of credit are used in transactions
where the beneficiary on the first letter of credit is a middleman and
the beneficiary on the second letter of credit is the middleman's supplier.
SIGHT LETTER OF CREDIT
A sight letter of credit is a letter of credit that is payable to the
beneficiary upon the beneficiary's presentation of documents which conform
to the letter of credit's terms and conditions.
USANCE LETTER OF CREDIT
A usance letter of credit (also known as an acceptance credit) is a letter
of credit that requires a beneficiary to present as a required document
under the letter of credit a time draft which is payable to the beneficiary
at a determinable future date after the beneficiary's presentation of
documents which conform to the letter of credit's terms and conditions.
DEFERRED PAYMENT LETTER OF CREDIT
A deferred payment letter of credit is a letter of credit, which requires
that a letter of credit beneficiary present documents for payment but
which delays payment for a stated number of days after shipment or for
a stated number of days after presentation of documents. Time drafts are
not required documents under a deferred payment letter of credit.
IRREVOCABLE LETTER OF CREDIT
An irrevocable letter of credit is a letter of credit that cannot be modified
or altered after it is issued, unless the consent of the letter of credit
beneficiary is first obtained.
REVOCABLE LETTER OF CREDIT
A revocable letter of credit is a letter of credit that can be modified
or altered after it is issued without the consent of the letter of credit
beneficiary.
LETTER OF CREDIT DISCREPANCY
A letter of credit discrepancy is a deviation from the terms specified
by a letter of credit. Beneficiaries generally have an opportunity to
correct discrepancies but if a discrepancy cannot be corrected, letter
of credit protection will be forfeited unless the discrepancy is waived
by the letter of credit applicant.
UCP 500
UCP 500 is an abbreviated reference to the Uniform Customs and Practices
for the handling of letters of credit by banks involved in processing
letters of credit. Developed by the International Chamber of Commerce
(ICC) the UCP 500 are not laws.
DOCUMENTARY COLLECTION
A method of effecting payment for goods whereby the seller/exporter ships
goods to the buyer, but instructs his bank to collect from the buyer /importer
payment of a certain sum or the promise to pay a certain sum in exchange
for transferring to the buyer/importer title, shipping and other documentation
that enable the buyer/importer to take possession of the goods.
The two types of documentary collection are documents
against payment and documents against
acceptance.
III. DOCUMENTS AGAINST PAYMENT COLLECTION:
Cash against documents
This is a collection under which payment is made to the seller after the
product is shipped to the buyer, but ideally before the buyer is able
to take delivery of the product that has been shipped. In a documents
against payment collection transaction, a seller ships product to a buyer
and routes through a collecting bank the title documents for the product,
along with a draft that is payable by the buyer upon first presentation
to the buyer (sight draft).
The collecting bank can be either the seller's bank (standard collection)
or a correspondent of the seller's bank in the buyer's country (direct
collection).
Exporters that want to speed up the flow of their documents against payment
collection transactions generally use direct collections in lieu of standard
collections, as the use of a standard collection almost certainly guarantees
a delay in collection processing time in that the seller's bank must forward
the documents it receives to its correspondent in the buyer's country
for presentation to the buyer.
THE COLLECTING BANK
When the collecting bank in the buyer's country receives the collection
documents, it contacts the buyer and advises the buyer that: (a) it has
received the title documents for a particular transaction; and (b) these
documents will be released to the buyer only when the buyer pays the sight
draft that accompanies the collection documents by authorizing a transfer
of funds to the seller's bank.
The documents against payment collection transaction is a somewhat desirable
payment method for a company that is selling product internationally in
that it enables the seller to retain control over product that has been
shipped to a buyer until the buyer pays for the product by honoring the
sight draft that accompanies the title documents. The seller who uses
this payment method should be comfortable not only with the buyer's credit
worthiness, but also with the credit reliability of the country in which
the buyer is located. The seller should also be confident that the buyer
does in fact desire to obtain the product shipped by the seller, as there
is virtually nothing that a U.S. seller can do in a documents against
payment collection transaction to force the buyer to pay on time or to
force the buyer to pay at all, absent a strong desire by the buyer to
take possession of the product shipped.
PARTIES INVOLVED
A documents against payment collection transaction involves one or more
third parties in the payment process (the collecting bank in the seller's
and the collecting or presenting bank in the buyer's country). The banks'
involvement in a documents against payment collection transaction is limited
to presenting the seller's draft to the buyer, to withholding the title
documents for the goods shipped to the buyer until the buyer has paid
the seller's draft and to transferring the buyer's payment to the seller.
The banks do not in any way guarantee the performance of the buyer unless
separate arrangements have been made in this regard.
CONTROL OVER THE PRODUCT
To retain control over product shipped to a buyer, a seller should avoid
using a straight ocean bill of lading consigned to the buyer or an air
waybill consigned to the buyer, as both of these documents give the buyer
direct and immediate access to the product that the U.S. seller has shipped.
The control available to a seller in a documents against payment collection
transaction can also be undone by the seller's consent to the issuance
of a steamship guarantee or airway release as both of these documents
also give a foreign buyer direct and immediate access to product that
a U.S. seller has shipped.
BUYER DOES NOT RESPECT A SIGHT DRAFT UNDER DOCUMENTS
AGAINST PAYMENT COLLECTION
The seller is in fact left with three recourses available in the event
that a buyer does not honor a sight draft presented under a documents
against payment collection. First, the seller can attempt to find another
buyer for the product that has been shipped to the defaulting buyer. Second,
the seller can repatriate or return to the home country the product that
has been shipped to the defaulting buyer. Lastly, the seller can opt to
dispose of the product that has been shipped to the defaulting buyer.
The only other recourse available to a U.S. seller in a documents against
payment collection where a foreign buyer fails to pay a draft presented
by collecting bank is a protest action undertaken on behalf of a seller
by the collecting bank.
PROTEST ACTION
In undertaking a protest action on behalf of a seller, a collecting bank
will take note of the buyer's default at draft presentation and allow
the lapse of whatever grace period is applicable in the buyer's country.
Thereafter, the collecting bank will legally document the fact that a
draft, which the bank presented to the buyer on the draft's payment due
date, was refused by the buyer.
The collecting bank's documentation of the buyer's default on a draft
will be formally recorded by a notary. The purpose of a protest is to
formally establish the buyer's dishonor and to give legal notice of buyer's
dishonor to all interested parties.
The form, meaning and results of a protest vary country by country. The
results of a protest may be insignificant or very severe depending on
the laws of the buyer's country and may range from an unfavorable credit
reference for the buyer to immediate cancellation of all credit to the
buyer.
In some countries, a protest action may even enhance the seller's position
as protested drafts typically take precedence over unprotested drafts
in a bankruptcy situation and as protest actions can sometimes give the
seller a right of executive action against the defaulting buyer's assets.
PROTEST ACTION MADE BY A COLLECTING'S BANK
A collecting bank will undertake a protest action on behalf of a seller
if it has been so instructed by the seller prior to the buyer's default.
In instructing a collecting bank to undertake a protest action on its
behalf, a seller must realize that a collecting bank will charge a fee
for this service that is separate and distinct from the fee that the collecting
bank charges for acting as collecting bank. Furthermore, a seller inclined
to give protest instructions to a collecting bank must realize that protest
fees vary widely from collecting bank to collecting bank and from country
to country.
IV. DOCUMENTS AGAINST ACCEPTANCE
This is a collection under which payment is made to the seller at some
future date after gaining access to the title documents and the products
that the seller has shipped to the buyer.
DOCUMENTS AGAINST PAYMENT vs DOCUMENTS AGAINST
ACCEPTANCE: DIFFERENCES
The differences between a documents against payment collection and a documents
against acceptance collection are as follows: (a) a documents against
payment collection transaction involves a sight draft (payable upon presentation),
whereas a documents against acceptance collection transaction involves
either a date draft or a time draft; (b) in a documents against payment
collection transaction a buyer has to pay the sight draft to receive the
title documents to a shipment, whereas in a documents against acceptance
collection transaction, a buyer merely has to accept a date draft or a
time draft and promise payment at some future date in order to gain access
to the title documents and the products that the seller has shipped to
the buyer; (c) since the buyer has gained access to the products by accepting
a date draft or a time draft, the seller looses control over the products
and has little protection if the buyer, for whatever reason, is unable
to make payment when the accepted draft matures and becomes payable. The
acceptance of a date draft or time draft by the buyer therefore renders
a documents against acceptance collection transaction equivalent to an
"Open Account" transaction (detailed below), albeit with a written
promise to pay.
PROTEST ACTION IN DOCUMENTS AGAINST ACCEPTANCE
Protest actions are available on documents against acceptance collection
transactions, just as they are on documents against payment collection
transactions. Another possible source of recourse for a seller in a documents
against acceptance collection transaction that is not generally used in
a documents against payment collection transaction is to ask the buyer
to have its bank "avalize" the draft that the buyer has accepted.
This makes the buyer's bank a co-signer on the draft and in so doing acts
to guarantee the buyer's performance.
UNIFORM RULES FOR COLLECTION
These are rules on handling collections that were issued by the International
Chamber of Commerce.
V. OPEN ACCOUNT PAYMENT
An open account payment is a payment that is made by check, draft or wire
transfer to a seller, after the product is shipped to the buyer and generally
after the product is received by the buyer. In an open account
transaction, the seller ships product to a foreign buyer. The buyer may
then take delivery of the goods and inspect the goods. Payment for the
product shipped and received will occur on (but usually after) a date
that has been agreed in advance by the foreign buyer and the U.S. seller,
for example 30 days from invoice date.
Open account is the most desirable payment method for a company that is
buying a product internationally, but it is the least desirable payment
method for a company that is selling product internationally. There is
little that the U.S. seller can do in an open account transaction to compel
a foreign buyer to make a timely payment or to make any payment once the
buyer is in possession of the goods that have been shipped.
CONTROL OVER THE PRODUCT
A seller can retain control over the product that has been shipped to
a foreign buyer by insisting on title documents that forestall the buyer's
access to or possession of the merchandise which has been shipped. Title
documents transfer title or at least possession. In an export transaction
the title documents are comprised of the main carriage transportation
documents or bills of lading, such as ocean bills of lading and air waybills.
Ocean bills of lading can be in either negotiable (order of) form or in
non-negotiable (straight) form, whereas air waybills can only be non-negotiable.
The form of a bill of lading instructs the carrier on how to handle or
disburse the goods that the carrier is transporting when the carrier reaches
its destination. If the bill of lading is in negotiable form, i.e. "order
of the shipper", the carrier will hold the goods until it receives
an original bill of lading that has been endorsed by the shipper (seller).
If the bill of lading is in non-negotiable or straight form and consigned
to the buyer, the carrier will release the goods to the buyer on the buyer's
identification of itself as the buyer. If on the other hand, the bill
of lading is in non-negotiable or straight form and consigned to a third
party, such as the buyer's bank, the carrier will release the goods as
instructed by the third party consignee in a "release" (steamship
guarantee or airway release) issued by the third party consignee to the
carrier.
DRAFT
A draft, also known as a "bill of exchange," is a written demand
for payment issued by the seller or the seller's designate (drawer) against
the buyer or the buyer's designate (drawee).
SIGHT DRAFT
A sight draft is a draft that is payable by the buyer upon presentation
of the draft to the buyer.
DATE DRAFT
A date draft is a draft that specifies a particular date when payment
is due as opposed to a prescribed time period after the draft is accepted,
for example. 30 days bill of lading date vs 30 days from date of acceptance
-- whenever that might be.
TIME DRAFT
A time draft is a draft that links payment to some specified period of
time after the buyer accepts the draft, for example 30 days from date
of acceptance -- whenever that might be -- vs 30 days bill of lading date.
AVAL
An aval is a guarantee that is placed by an avalizor on a draft or promissory
note.
BANKER'S ACCEPTANCE
Banker's Acceptance is a time draft drawn on and accepted by a bank. Once
accepted, the draft becomes a primary obligation of the accepting bank
to pay at maturity. Banker's acceptances may be retained until maturity
for full value, or sold without recourse at a discount rate.
TRADE ACCEPTANCE
Trade Acceptance is a time draft or bill of exchange accepted by the importer.
FORFEITING
The selling, at a discount, of medium to longer term accounts receivable
or promissory notes of a foreign buyer (including those arising out of
a letter of credit transaction) for immediate payment.
FACTORING
The discounting of an account receivable in order to receive immediate
payment. In international trade factoring is the discounting of a foreign
account receivable does not involve a draft. The exporter transfers title
to its foreign accounts receivable to a factoring house for cash at a
discount from the face value. Factoring is often done without recourse
to the exporter.
PAYMENT ORDER
"Payment Order" means instruction of a sender to a receiving
bank, transmitted orally, electronically, or in writing, to pay, or to
cause another bank to pay, a fixed or determinable amount of money to
a beneficiary if:
1. the instruction does
not state a condition to payment to the beneficiary other than
time of payment,
2. the receiving bank is
to be reimbursed by debiting an account of, or otherwise receiving
payment from, the sender, and
3. the instruction is transmitted by the sender directly to
the receiving bank or to an agent,
funds-transfer system, or communication system for transmittal
to the receiving bank.
ELECTRONIC FUNDS TRANSFER (EFT)
"Funds Transfer" means the series of transactions, beginning
with the originator's payment order, made for the purpose of making payment
to the beneficiary of the order. The term includes any payment order issued
by the originator's bank or an intermediary bank intended to carry out
the originator's payment order. A funds transfer is completed by acceptance
by the beneficiary's bank of a payment order for the benefit of the beneficiary
of the originator's payment order.
FEDWIRE
"FedWire" is an acronym for the Federal Reserve Wire Network,
which is owned and operated by the twelve Federal Reserve banks in the
United States. In the early days of the Federal Reserve, financial and
administrative messages were sent between the system's offices by telegraph.
CHIPS
CHIPS is an acronym for the Clearing House Interbank Payment System operated
by the New York Clearing House Association. It is an automated communications
network and settlement clearing facility which processes, for the most
part, international funds transfers among members although it does handle
some domestic transfers as well.
S.W.I.F.T.
SWIFT is an acronym for the Society for Worldwide International Financial
Telecommunication organized under Belgin law as a nonprofit cooperative
company. It is an international communications system for messages among
its member institutions in most of the countries in the Americas, Europe,
Japan, and certain countries in Asia. Its member institutions are banking
organizations engaged in transmitting international financial messages
(and certain non-banking institutions).
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