The process of exporting is incomplete without receipt of payment. Export income is considered earned only when payment has been received.
Letter of Credit (L/C)
The most popular and a safer method of payment is by a confirmed irrevocable letter of credit at sight. letter of credit, documentary letter of credit, or commercial letter of credit---is an arrangement whereby the applicant (the importer) requests and instructs the issuing bank (the importer's bank) or the issuing bank acting on its own behalf,
- pays the beneficiary (the exporter) or accepts and pays the draft (bill of exchange) drawn by the beneficiary, or
- authorizes the advising bank or the nominated bank to pay the beneficiary or to accept and pay the draft drawn by the beneficiary, or
- authorizes the advising bank or the nominated bank to negotiate,
against stipulated document(s), provided that the terms and conditions of the documentary credit are fully complied with.
For purpose of maintaining uniformity in the text, the words "letter of credit", "credit" and "L/C" are used on this website to refer to the documentary credit.
A letter of credit (L/C) can be irrevocable or revocable. The L/C usually indicates whether it is an irrevocable or revocable letter of credit. In the absence of such indication, the L/C is deemed to be irrevocable.
Irrevocable Letter of Credit
An irrevocable letter of credit cannot be amended or cancelled without the consent of the issuing bank, the confirming bank, if any, and the beneficiary. The payment is guaranteed by the bank if the credit terms and conditions are fully met by the beneficiary. The words "irrevocable documentary credit" or "irrevocable credit" may be indicated in the L/C.
In some cases, an irrevocable L/C received by the beneficiary may become invalid without the amendment or cancellation of such L/C, for example, when the trade between importing and exporting countries is suspended such as in a trade sanction, or when the issuing bank has ceased operation.
There have been cases of an irrevocable L/C being amended without the consent of the beneficiary in the OEM Arrangements. The beneficiaries affected were export-manufacturers from a developing country. The importers were able to convince and instruct the issuing bank to amend the latest date for shipment in the L/C, changing to a date earlier than the agreed upon date, at which time the beneficiary would not be able to ship the OEM products. The importers used sneaky tactics that aimed to cause the beneficiaries to default in the delivery. The intention of the importers was to cancel the orders from the existing OEM suppliers and buy from other suppliers in another developing country where the prices had become lower.
In the event of an amendment like the above-mentioned case, the beneficiary must give notification of rejection of amendment to the bank that advised the amendment at once.
The irrevocable letter of credit received from an advising bank may be indicated as "irrevocable and without recourse documentary credit". The words "without recourse" mean that the advising bank will not be able to recover the money paid to the beneficiary in case the issuing bank does not pay the advising bank.
Revocable Letter of Credit
A revocable letter of credit can be amended or cancelled by the issuing bank at any time without the consent of the beneficiary, often at the request and on the instructions of the applicant. There is no security of payment in a revocable letter of credit (L/C). The words "this credit is subject to cancellation without notice", "revocable documentary credit" or "revocable credit" usually are indicated in the L/C.
The revocable L/C was not uncommon in the 1970's and earlier when dealing with less developed countries. It is rarely seen these days in international trade.
Confirmed Irrevocable letter of Credit versus Unconfirmed Irrevocable letter of Credit
Confirmed Irrevocable Letter of Credit
An irrevocable letter of credit (L/C) opened by an issuing bank whose authenticity has been confirmed by the advising bank and where the advising bank has added its confirmation to the credit is known as confirmed irrevocable letter of credit. The words "we confirm the credit and hereby undertake ..." or "we add our confirmation to this credit and hereby undertake ..." normally are included in the L/C.
An exporter whose method of payment is a confirmed irrevocable L/C is assured of payment even if the importer or the issuing bank defaults. The confirmed irrevocable L/C is particularly important from buyers in a country which is economically or politically unstable.
In a confirmed letter of credit, the exporter or the importer pays an extra charge called the confirmation fee, which may vary from bank to bank within a country. The fee usually is added to the exporter's account. The exporter may indicate in the sales contract that the confirmation fee and other charges outside the seller's country are on the buyer's account.
Unconfirmed Irrevocable Letter of Credit
An irrevocable letter of credit (L/C) opened by an issuing bank in which the advising bank does not add its confirmation to the credit is known as an unconfirmed irrevocable letter of credit. The promise to pay comes from the issuing bank only, unlike in a confirmed irrevocable L/C where both the issuing bank and the advising bank promise to pay the beneficiary.
Restricted Negotiable Versus Freely Negotiable Letter of Credit
Restricted Negotiable Letter of Credit
In a restricted negotiable letter of credit, the authorization from the issuing bank to pay the beneficiary is restricted to a specific nominated bank. The sample Letter of Credit is a restricted negotiable credit, that is, the authorization from The Sun Bank to pay the UVW Exports is restricted to a specific nominated bank, which is The Moon Bank.
Freely Negotiable Letter of Credit
In a freely negotiable letter of credit, the authorization from the issuing bank to pay the beneficiary is not restricted to a specific bank, any bank can be a nominated bank as long as the bank is willing to pay, to accept draft(s), to incur a deferred payment undertaking, or to negotiate the L/C. The words "this credit is not restricted to any bank for negotiation" or "this credit may be negotiated at any bank", or similar words, may be indicated on the L/C.
Revolving Letter of Credit
When a letter of credit (L/C) is specifically designated "revolving letter of credit", the amount involved when utilized is reinstated, that is, the amount becomes available again without issuing another L/C and usually under the same terms and conditions.
The revolving L/C may be used in shipments of a wide range of goods to a buyer within a period of time (several months to one year usually).
Documentary Collections
Documentary collection is necessary when the draft is drawn on the importer. The exporter must give instructions to the collecting bank on what to do with the draft and shipping documents in documentary collection instructions, also known as a collection letter or letter of instructions. Such letter provides the conditions under which the collecting bank can release documents to the importer and the actions to be undertaken.
The format of the instruction forms and drafts may vary from bank to bank, but they basically have the same information. The forms and drafts are available at banks.
Uniform Rules for Collections
The Uniform Rules for Collections, ICC Publication No. 322, which describes the conditions governing collections (including those for the presentation, payment and acceptance terms), is issued by the International Chamber of Commerce (ICC) in Paris, France. The Uniform Rules for Collections and other ICC publications are available at your local Chambers of Commerce affiliated with the International Chamber of Commerce.
TENOR
The tenor is the credit term of the draft. It can be at sight (in a SIGHT DRAFT) or after sight or after date (in a TERM DRAFT).
CASE OF NEED
The case of need is the party in the importer's country named by the exporter who may assist in obtaining payment or acceptance of draft or who may be empowered by the exporter to act fully on his/her behalf---waiving of protest, allowing a discount, etc.. Whether the case of need is 'for guidance' or 'accept their instructions', put an X in the appropriate box.
DOCUMENTS AGAINST PAYMENTS
In the documents against payment (D/P)---documents on payment (DOP or D/P)---the documents attached to the draft (bill) drawn by the exporter and needed to obtain goods are deliverable to the importer only after he/she has paid the draft. The documents against payment (D/P) applies to a SIGHT DRAFT.
DOCUMENTS AGAINST ACCEPTANCE
In the documents against acceptance (D/A)---documents on acceptance (DOA or D/A)---the documents attached to the draft (bill) drawn by the exporter and needed to obtain goods are deliverable to the importer only after he/she has accepted the draft for payment later. The documents against acceptance (D/A) applies to a TERM DRAFT.
REMIT PROCEEDS
When the payment is received by the collecting bank, it remits the proceeds to the remitting bank. The remitting bank then credit the account of the exporter, less applicable charges.
PROTEST and DO NOT PROTEST
The protest is the legal action to be undertaken by the collecting bank, at the instructions of the exporter, in case the importer does not pay a sight draft, or does not accept a term draft, or does not pay an accepted draft on maturity. In practice, the protest usually is required by the exporter and it is made within three (3) working days after the presentation or maturity date. In certain countries, failure to protest may cause the exporter to lose the legal rights against the importer.
In cases where the instruction is 'do not protest', such instruction may encourage inaction or deferred payment by the importer. In some countries, particularly in the West, protest against the importer may spoil his/her credit standing. Hence, the importer is encouraged to act promptly if 'protest' is instructed by the exporter.
COLLECT INTERESTS
The interest charge, if any, normally is agreed upon between the exporter and importer. It is either built into the export price or collected separately. Under certain pre-arranged credit terms, a discount may be allowed on the early payment of a term draft.
COLLECT ALL YOUR BANK CHARGES
In practice, the collecting bank may not collect some of their charges despite that instructions to collect all their charges is given.
DAYS AFTER OF THIS SOLE OF EXCHANGE (Field in the draft or bill shown below)
The 'SOLE OF EXCHANGE' stands for the sole bill of exchange, popularly called the sola bill, is a draft with only one copy issued.
In a SIGHT DRAFT, enter the word "sight" in the space 'AFTER ___' and leave the '___ DAYS' blank or put dashes (-----) in it, for example,
DAYS AFTER sight
or
----- DAYS AFTER sight
In a TERM DRAFT, enter the number of days in the '___ DAYS' and the word "sight" in the 'AFTER ___' (if draft is after sight), for example,
90 DAYS AFTER sight
Or, enter the word "date" or "B/L date" (bill of lading date) or other wordings in the 'AFTER ___' (if draft is after date), for example,
180 DAYS AFTER date
or
150 DAYS AFTER B/L date
Cheque and Bank Draft
In exporting to the offshore countries, payment by cheque and bank draft occur more often in a small order, ranging from a few hundred to a couple of thousand U.S. dollars. Cheques and bank drafts are often used in open account and consignment trade arrangements.
Both large and small companies may default in their payments, regardless of the amount involved. In times of economic uncertainty, both large and small companies may go out of business. It is important to receive the cheque or bank draft before releasing the shipment. Unless the integrity of the importer is known, it is very important to wait until the cheque or bank draft has cleared before the shipment. International clearing of cheques and bank drafts takes 3 to 4 weeks usually (except in a sight draft with a paying bank in the seller's country).
Not all cheques and bank drafts are genuine, and not all genuine cheques carry a cash value
Trade Arrangements Using the Cheque and Bank Draft
In an open account trade arrangement, the goods are shipped to a buyer without guarantee of payment. Quite often, the buyer does not pay on the agreed time. Unless the buyer's integrity is unquestionable, this trade arrangement is risky to the seller.
Consignment
In a consignment trade arrangement, the seller ships the goods to the buyer when there is no purchase made. The buyer is obliged to pay the seller for the goods when sold. The seller retains title to the goods until the buyer has sold them.
Cash In Advance (CID)
The cash in advance, which is the safest term of payment, most often is effected using the cheque or bank draft. In some cases, the CID term is paid using the telegraphic transfer (T/T).
Telegraphic Transfer (T/T)
The telegraphic transfer---cable transfer or wire transfer---is the equivalent of a cash payment that can be credited directly to the seller's account (the name and address of the seller's bank and the seller's bank account number are required by the buyer's bank). It is fast and safe. Unlike a payment by cheque or bank draft, in which the mailing time alone may take several days to few weeks, plus the clearing time of 3 to 4 weeks for a total of about 4 to 6 weeks before the seller may receive the cash, by means of T/T the seller may receive the cash in a few hours or days.
It is important to wait until the T/T has been received before making the shipment, especially when the integrity of the buyer is unknown.
Combination of Letter of Credit and Telegraphic Transfer
A combination of letter of credit (L/C) and telegraphic transfer (T/T) is a popular means of payment in the undervalue arrangement. The undervalue is an illegal way of reducing or avoiding the import duties and taxes by under declaring the price of imported goods. It is a sneaky way of bringing the landed cost of imported goods to a competitive level. The undervalue is being practiced in certain less developed countries, usually involving items whose import duties are relatively high. There is no need to undervalue the goods if the import duty is 10% or less. Sometimes, an item having a 15% rate of duty may not need to be undervalued too, depending on the method of import duty and sales tax calculations in the importing country.
The undervalue arrangement is highly risky. To avoid trouble the exporter should refrain from using this arrangement. Governments do not encourage exports by undervalue. If an exporter does not violate the foreign exchange control and tax laws of the exporting country and international laws such as copyright and patent, the government of the exporting country usually will not step into the exporter's way in the undervalue arrangement.
The undervalue arrangement uses two sets of documents. For example, an importer contracted 1,000 pieces of product X at FOB US$8 each for a total of US$8,000. The importer may want to declare 25% only (10% to 50% of contract price is declared usually in the undervalue arrangement) or at US$2 each for a total of US$2,000. One set of documents will show 1,000 pieces of product X at US$2 each for a total of US$2,000, while the other set shows the true value.
The importer opens an L/C for US$2,000 and remits the US$6,000 balance by T/T. Following the foreign exchange control procedures on exports, the exporter must surrender a total of US$8,000 inward remittances to the government. While at the destination port, the importer pays the duties and taxes based on US$2,000, plus the ancillary expenses required in the arrangement. If the importer is caught at the port of destination, shipments may be seized by the customs.
The importer has to buy the dollar from the black market and remit it by T/T through a third country. Most often the T/T will not reach the exporter on the agreed time. Quite often, the shipment date arrives before the T/T reaches the exporter.
The undervalue arrangement hinges on mutual trust between exporter and importer. The importer has to be very careful because there is a danger that the exporter may run off after receiving the T/T. In the event of a sour relationship, the importer may run the risk of being blackmailed by the exporter through threat of exposing the private arrangement.
With the growing free trade around the world, the undervalue practice is diminishing.
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