- Which international payment methods are most commonly used by exporters and importers?
Cash in advance, confirmed letter of credit, advised letter of credit, documents against payment, documents against acceptance, and open account.
- From an exporter's perspective how do the most commonly used international payment methods rank in terms of the most secure to the least secure?
Cash in advance, confirmed letter of credit, advised letter of credit, documents against payment, documents against acceptance, and open account.
- From an importer's perspective how do the international payment methods rank in terms of the most secure to the least secure?
Open account, documents against acceptance, documents against payment advised letter of credit, confirmed letter of credit, and cash in advance.
- Which factors should an exporter consider when determining which payment method to use?
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.
- What procedures are involved in a 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 the funds have been deposited in the exporter's/seller's bank account.
- Should a U.S. exporter who is paid on a cash in advance basis attempt to retain control over product that has been exported to a foreign buyer even though the U.S. exporter received payment for the export before the export was made?
No, unless the exporter is motivated to do so for a reason other than securing payment, such as for tax purposes.
- In what types of situations is a cash in advance payment typically used?
A cash in advance payment is typically used by a seller when the seller manufactures goods in accordance with a particular buyer's specifications and cannot sell such "custom-made" goods to another buyer. Cash in advance payment may also be appropriate when: (a) insufficient credit information on a buyer is available; (b) the buyer's credit is so bad that no other payment terms are desirable; (c) the political and/or economic situation in the buyer's country is unstable or problematic; or (d) a seller is enjoying a seller's market for a particular product.
- What is a 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.
- How do the banks involved in a confirmed letter of credit transaction function?
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.
- Should a U.S. exporter, who is the beneficiary of a confirmed letter of credit, attempt to retain control over the exported product until such point that the U.S. exporter receives payment under the confirmed letter of credit?
While not necessarily essential or critical, it may prove to be in the exporter's best interest to do so. This is likely to be the case when a seller is unable to perform exactly as required under a confirmed letter of credit and is also unable to correct its performance deficiency. In such a circumstance the seller will have to ask the buyer to waive or accept the seller's performance deficiency. It is obviously much easier for a seller to obtain a buyer's agreement to waive a discrepancy under a confirmed letter of credit if the buyer does not yet have access to or possession of goods that have been shipped. Sellers must always keep in mind that letter of credit discrepancies they cannot correct, and that the buyer refuses to waive, will cause a seller to fail to meet the performance requirements under the letter of credit. The seller will, therefore, have to forfeit the payment protection that would have been available to the seller under the confirmed letter of credit.
- In what types of situations is a confirmed letter of credit typically used?
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.
- What is an advised (or unconfirmed) letter of credit (L/C)?
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), whereby the issuing bank agrees to pay the seller a specified amount on behalf of a buyer (the letter of credit applicant/account party) provided the seller complies with the terms and conditions that are specified within the letter of credit.
- How do the banks involved in an advised letter of credit transaction function?
The bank that issues an advised letter of credit (the issuing bank) assumes the role of the foreign buyer, whereas the advising bank assumes no role other than conveying the letter of credit to the seller/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.
- Should a U.S. exporter who is the beneficiary of an advised letter of credit attempt to retain control over the exported product until such point that the U.S. exporter receives payment under the advised letter of credit?
While not necessarily essential or critical, it may prove to be in the exporter's best interest to do so. This is likely to be the case when a seller is unable to perform exactly as required under an advised letter of credit and is also unable to correct its performance deficiency. In such a circumstance, the seller will have to ask the buyer to waive or accept the seller's performance deficiency. It is obviously much easier for a seller to obtain a buyer's agreement to waive a discrepancy under an advised letter of credit if the buyer does not yet have access to or possession of goods that have been shipped. Sellers must always keep in mind that letter of credit discrepancies that cannot be corrected by the seller and that the buyer refuses to waive will cause a seller to fail to meet a letter of credit's performance requirements. The seller will, therefore, have to forfeit the payment protection that would have been available to the seller under the confirmed letter of credit.
- In what types of situations is an advised letter of credit typically used?
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.
- How does an advised letter of credit differ from a confirmed letter of credit?
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.
- What is a 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.
- What is a 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.
- How does a documentary letter of credit differ from a standby letter of credit?
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.
- How many banks are typically involved in a letter of credit transaction?
At least two separate banks are involved in a letter of credit transaction - usually the issuing bank in the applicant's country and the advising/confirming bank in the beneficiary's country.
- Why is bank involvement in a letter of credit transaction so important?
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, upon confirming the validity of the letter of credit, conveys the letter of credit to the beneficiary. The encryption/decryption functions of the issuing and advising or confirming bank are key aspects of a letter of credit because 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.
- What is an 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.
- What is a transferable letter of credit?
A transferable letter of credit specifically permits a beneficiary (transferor) to transfer all or some of the rights and protection afforded to it 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.
- What is a back-to-back letter of credit?
A back-to-back letter of credit is a letter of credit (second letter of credit) 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 to be made under the second letter of credit with the payment made under the first letter of credit. However, 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.
- What is a sight letter of credit?
A sight letter of credit is a letter of credit payable to the beneficiary upon the beneficiary's presentation of documents that conform to the letter of credit's terms and conditions.
- What is a 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 conforming to the letter of credit's terms and conditions.
- What is a deferred payment letter of credit?
A deferred payment letter of credit requires that the beneficiary present documents for payment, but delays payment for a stated number of days after shipment or presentation of the documents. Time drafts are not required documents under a deferred payment letter of credit.
- What is an irrevocable letter of credit?
An irrevocable letter of credit cannot be modified or altered after it is issued unless the letter of credit beneficiary consents.
- What is a 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.
- What is a 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.
- What is 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 provisions are not laws.
- What is a 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.
- What are the two types of documentary collections?
The two types of documentary collection are documents against payment (also referred to as cash against documents) and documents against acceptance.
- What is a documents against payment collection?
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.
- What procedures are involved in a documents against payment collection?
In a documents against payment collection transaction, a seller ships goods to a buyer and routes the title documents through a collecting bank 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 generally use direct collections rather than standard collections, because 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. 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.
- How many third parties are involved in a documents against payment collection?
A documents against payment collection transaction involves one or more third parties in the payment process (the collecting bank in the seller's country 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.
- Should an exporter who uses a documents against payment collection as a payment method attempt to retain control over the product that has been exported to a foreign buyer until such point that the U.S. exporter receives payment under the documents against payment collection?
Yes. It is generally not desirable for a seller using a documents against payment collection to forfeit control over product that a seller has shipped to a foreign buyer. This is because product control affords a seller some recourse in the event that a buyer does not pay the collecting bank. In such situation, the collecting bank will refuse to surrender the title documents to the buyer, thereby preventing the buyer from taking possession of the product that has been shipped and insulating the seller from a total loss. 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, because 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.
- What recourse is available to the seller in the event that a buyer does not honor a sight draft presented under a documents against payment collection?
The seller is left with three options in this situation. 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.
- What is the function of a protest action in a documents against payment collection?
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 protest actions can sometimes give the seller a right of executive action against the defaulting buyer's assets.
- When will a collecting bank undertake a protest action on behalf of a seller?
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 separate fee for this service. 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.
- In what types of situations is a documents against payment collection typically used?
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.
- How does documents against acceptance collection differ from a documents against payment collection?
The differences between a documents against acceptance collection and a documents against payment 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 loses 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.
- What recourse is available to a seller if a buyer does not pay a time draft that the buyer has accepted?
Protest actions are available on documents against acceptance collection transactions, just as they are on documents against payment collection transactions. Another possible, although not generally used, recourse for a seller in a documents against acceptance collection 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.
- What are the Uniform Rules for Collections?
These are rules on handling collections that were issued by the International Chamber of Commerce.
- What is an 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 the goods to a foreign buyer who may then take delivery of and inspect the goods. Payment for the product shipped and received will occur on (but usually after) a date agreed to in advance by the foreign buyer and the U.S. seller, for example 30 days from the invoice date.
Open account is the most desirable payment method for a company 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.
- How can an exporter retain control over products exported to a foreign buyer?
A seller can retain control over products exported to a foreign buyer by insisting on title documents that forestall the buyer’s access to or possession of the goods. 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.
- What is a 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).
- What is a sight draft?
A sight draft is a draft that is payable by the buyer upon presentation of the draft to the buyer.
- What is a 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.
- What is a 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.
- What is an aval?
An aval is a guarantee that is placed by an avalizor on a draft or promissory note.
- What is a 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.
- What is a trade acceptance?
Trade Acceptance is a time draft or bill of exchange accepted by the importer.
- What does forfeiting mean?
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.
- What is 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 that 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.
- What is a 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:
(i) the instruction does not state a condition to payment to the beneficiary other than time of payment;
(ii) the receiving bank is to be reimbursed by debiting an account of, or otherwise receiving payment from, the sender; and
(iii) 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.
- What does electronic funds transfer (EFT) mean?
"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.
- What is a 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.
- What is 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 that processes, for the most part, international funds transfers among members although it does handle some domestic transfers as well.
- What is S.W.I.F.T.?
SWIFT is an acronym for the Society for Worldwide International Financial Telecommunication organized under Belgian 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).
