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Chapter 11 c

Methods of Payment
 Contents
1 • Consignment Sales

2 • Open Account

3 • Documentary Collection (Documentary Draft)

4 • Documentary Letter of Credit

5 • Cash in Advance

6 • Other Letters of Credit

International Method
of Payment
 Consignment sales
Exporter sends the product to an importer on a
deferred payment basis; that is, the importer
does not pay for the merchandise until it is sold
to a third party.
Title to the merchandise passes to the importer
only when payment is made to the exporter
Used in cases involving an increasing demand
for a product or to test market product
 Consignment sales
The problem with this method
includes:
v Delays in payment
v Risk of nonpayment
v Cost of returning
merchandise
v Limited sales effort
by importers
 Consignment sales
The problem with this method
includes:
v Verify credit worthiness of
importers
v Use credit agencies for
information
v U.S. banks, government
agencies also provide
credit info on overseas
customers
v Credit insurance
 Open Account
v Exporter ships merchandise to overseas
customer on credit
v Payment is to be
made within an
agreed time after
receipt of
merchandise
v Risk of delays or
even default in
payment.
 Open Account Diagram
Seller’s bank Buyer’s bank

(3)
Payment within an agreed
period of time

(2)Trade credit

(1) Buyer
Seller Seller ships goods and documents
the risks of the parties involved?
 Documentary Collection
vThis is a documentary draft accompanied
by shipping documents
vInternational rules governing documentary
collections:
- Uniform Rules for
Collections 1995
(International Chamber of
Commerce Publication No.
522)

9
 Documentary Collection Diagram

Seller’s bank Buyer’s bank

or or
Advise of acceptance or
Remitting bank (6) remits payment Collecting bank

Buyer neither
(7)
paid nor
Advise of (3) Remitting bank
received the
acceptance forwards documents to (4)
or remits collection bank set of
(2) Present
payment documents to ? documents
Seller buyer (5)
presents Ask the buyer to sign the
documents Accept or pay on
payment/sign to presentation of
to remitting
bank accept than hand over documents
the documents

(1) Goods
Buyer
 Documentary Draft
vDocuments against payment (D/P): A
sight draft is presented with other documents
specified by the buyer or the buyer’s country
and the collecting bank will provide these
documents to the buyer upon payment.

vDocuments against acceptance

(D/A): The exporter allows the overseas
customer a certain period of time to effect
payment for the shipment.
 Documentary Draft

vDirect collection: Exporters can bypass the

remitting bank and send documents directly to
the foreign collecting bank for payment or
acceptance.

vLiability and responsibility of banks:

Banks act as agents for collection and assume
no responsibility for the consequences arising
out of delay or for loss in transit of any
messages, letters or documents.
 Clean Collections

vThis is a documentary draft presented to

buyer for payment or acceptance without
being accompanied by shipping
documents
 Clean Collections Diagram
Seller’s bank Buyer’s Bank
or or
Remitting bank (6) Advise of acceptance or Collecting bank
remits payment

(7) (3) instructions for collection

+ draft
Advise of (4)
acceptance
(2) offer to accept
or remits
payment
request for
or pay a draft ? (5)
collection Accept or
+ pay on
Draft presentation

Goods
(1)
Documents
Seller Buyer
 Documentary
Letter of Credit (L/C)
v A bank or other financial institution assumes
liability for payment of the purchase price to
exporter on behalf of overseas customer

15
 L/C Diagram
Issuing bank The Advising
(6) Payment
bank

(5) present the docs

(2) Send L/C

(8) Payment

(5) Present the docs

Issue the L/C

(3) advise L/C

(1) Apply for L/C

(6) Payment
(7) Offer to pay

Goods( (4)

Buyer Seller,
Documentary Letter of Credit Diagram
 Parties to the L/C Contract
v S a l es contract: Exporter (beneficiary)
and importer (account party)
v Credit reimbursement contract: Importer and
issuing bank
v L/C contract: Opening
bank and beneficiary
v Confirmation
agreement: Confirming
bank and beneficiary
International Rules on L/C
v The Uniform Customs
Practices for
Documentary Credits
(UCP), 2007 revision,
International Chamber
of Commerce
Publication No. 600
Issuance of a Letter of
Credit

20
UCP 600 : Major Changes
Time to examine
documents

Discrepant documents

Honoring deferred
payments

Strict rules for refusing

payments
 Banker’s (Trade) Acceptance
v If a draft is drawn and accepted by a bank, it is
called banker’s acceptance

v If a draft is
accepted by
nonbank entities,
such as
importers, it is
trade acceptance
 Role of Banks in L/C
v Banks should act equitably and in good
faith: Banks should honor the L/C if the
documents presented comply with the terms of
the credit.
For example, banks cannot dishonor the L/C
based on the knowledge or reasonable belief
that the goods do not conform to the
underlying contract of sale or that it would
not obtain reimbursement from its insolvent
customer.
v Banks can dishonor a L/C in cases of fraud or
forgery.
 Two principles in L/C
v Independent principle: Each of the four
contracts in a letter-of-credit transaction is
entirely independent. It is irrelevant to the bank
whether the seller/buyer has fully carried out its
part of the contract with the buyer/seller. It is
subject to the fraud exception.

v R ule of strict compliance: When conforming

documents are presented, the advising bank
must pay, the issuing bank must reimburse, and
the buyer is obliged to pay the issuing bank.
 Discrepancies
v Accidental discrepancies: These are
discrepancies that can easily be corrected by
the exporter (beneficiary) or the issuing bank.
Such discrepancies include typographical errors,
omission to state the L/C number, errors in
arithmetic, and improper endorsement or
signature on the draft.
 Discrepancies
Minor discrepancies: These are minor errors
in documents that contain the essential
particulars required in the L/C and can be
corrected by obtaining a written waiver from the
buyer. Such errors include failure to legalize
documents, nonpresentation of all documents
required under the L/C, and discrepancy
between the wording on the invoice and the L/C.
 Discrepancies
Major discrepancies: These are discrepancies
that fundamentally affect the essential nature of
the L/C. Certain discrepancies cannot be
corrected under any circumstances:
presentation of documents after the expiry date
of the L/C, shipment of merchandise later than
the specified date under the L/C, or expiration of
the L/C. However, other major discrepancies can
be corrected by an amendment of the L/C.
Amendments require the approval of the issuing
bank, the confirming bank (in the case of a
confirmed L/C), and the exporter.
 Cash in Advance
vA method of payment requiring the
buyer to pay before shipment is effected
 New Payment alternatives
Innovative online payment and financing
platforms are beginning to revolutionize the way
international trade is conducted. Business e-
commerce infrastructures include Tradecard,
Bolero, Tradebeam
They have several
advantages: Reduced
paperwork &
enhanced visibility,
cost savings and
value added services.
 Fraud in documentary credits
Common features
q Fraud by seller:
Fraudulent seller
ships worthless
goods or does not
ship any
merchandise.
q Fraud by buyer: Fraudulent buyer forges
original documents for payment, fraudulent
buyer receives merchandise from carrier on
the strength of letter of indemnity
30
 Fraud in documentary credits
q Fraud by buyer, seller and other parties: Buyer
and seller conspire to defraud paying bank,
Seller and carrier falsify the actual order and
condition of the goods
Proactive Measures
Measures by sellers:
Verify the background
and credibility of your
partner, Stipulate the
required documents,
Check the validity of
the letter of credit as
well as the credibility
of the issuing bank.
 Proactive Measures
Measures by buyers:
Verify the background and credibility of your
partner, Choose FOB trade term rather the CIF in
a sales contract, Use independent inspectors to
verify the quality and quantity of goods, use
time drafts
Verify the authenticity of the
documents, Sellers can
provide performance
guarantee to buyer to carry
out its obligations.
Proactive Measures
Measures by Banks:
Banks can undertake
an investigation into
the validity,
genuineness or
accuracy of the
documents before
payment,
 Other Letters of Credit

v Irrevocable v Green-clause credit

v Revocable v Deferred-Payment credit
v Confirmed v Standby
v Transferable v s t raight
v Back-to-Back v Negotiable
v Red-clause credit
 REVIEW QUESTIONS
1.Discuss the distribution of risk in the following export payment
terms: consignment, time draft.
2.What are the advantages and disadvantages of these payment terms:
documentary collections, open account sales, irrevocable letters of
credit?
3.State the different steps involved in a confirmed documentary letter
of credit, with payment terms of ninety days sight.
4.Compare and contrast documentary collections and documentary
letter of credit.
5.Compare the role and responsibility of banks in documentary
collections and letters of credit.
6. What is the independent principle?
7. Discuss the rule of strict compliance.
8. Provide an example of a major discrepancy in letters of credit.
9.Briefly describe the following: transferable L/C, back-to-back L/C,
deferred L/C, standby L/C.
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Chapter 11