International Trade - Theory Practice WW

International Trade Theory & Practice

© W A WISE – [email protected]

1. INTRODUCTION

Content1.1 Introduction1.2 Why Do Countries Trade

1.1 Introduction

Both large and small businesses, entering the international trade markets for the first time, find the opportunities, challenges and problems very different from those in the home market e.g. distant customers or suppliers, an unfamiliar language and a different time zone. Commercial contracts too, will often be more complex and will differ legally from those drawn up and operating purely in a domestic market.

Domestic trade has the following characteristics which apply to both trading parties: A common language and culture The same laws Absence of customs formalities Simple documentation A single currency Simple formalities to transport goods from buyer to seller

International trade is much more complex in that, it has the opposite characteristics to those listed above.

The big question to ask is why anyone would wish to trade internationally when domestic trade is so much simpler?

The purpose of this manual is to explain the theoretical reasons that support the growth of international trade and then to show how organizations such as banks, the International Chamber of Commerce (ICC), and credit risk insurers can assist in overcoming the additional problems posed by overseas trade.

1.2 Why Do Countries Trade

This question can best be considered by analysing the relationship between consumption and work. Men or women could possibly produce most of what they need by their own labour, but this would not be appealing to many when faced with inefficiency and the choice of a narrow range of goods.

Thus individuals in modern economies do not try to produce exactly what they consume. Instead, individuals work for money, which is then used for consumption purposes.

A person’s work may help to produce only a small range of goods, but the wages paid for that work help that person to obtain access to a much wider range of goods and services. The well-known economic concepts of specialization and division of labour, where people specialize in the production of certain items and then obtain other goods through trade, evolved from the above concepts. Trade is therefore necessary if the full benefits of specialization are to be enjoyed.

Even cities are not normally completely self-sufficient. Those cities that might technically be capable of such self-sufficiency would be worse off without trade because the variety and quality of goods would be reduced if trade did not take place.


Because people gain by trading between each other, trade will take place naturally without the need for any encouragement. Trade also takes place naturally between countries, because it would be illogical to expect gains from trade to stop at national boundaries.

In recent times, the increase in the importance of services, the political impetus from the development of free trade areas such as the North America Free Trade Agreement (NAFFA) and the Single European Market Programme (SMP), and pressure from organizations such as the World Trade Organization - WTO has resulted in an ever-increasing amount of trade in goods and services between different countries.

We shall look at how the WTO and the SMP have begun to overcome the obstacles to trade that exist in practice.

1.2.1 WTO (World Trade Organisation)The WTO came into existence in January 1995. It enjoys equal status with the International Monetary Fund (IMF) and the World Bank (WB). It also has a very wide sphere of activity, which includes responsibility over trade in goods, services and ideas, or in intellectual property.

One of the WTO’s key roles will be to administer the new procedures for settling disputes between its member countries. Strict deadlines are set for each stage of the process; non-confidential evidence is made public for the first time; interested parties like consumer groups can give evidence; and no single member can block the decision of the new Disputes Settlement Board.

At the time of writing, 148 countries are members of the WTO and 32 other countries have observer status but must start accession negotiations within five years of becoming observers, with the exception of the Vatican. 2. WHAT ARE THE RISKS?

Content2.1 Implications, benefits and risks in International Trade

OBJECTIVES

On completion of this chapter the student will be able to:

Explain some of the key issues involved in trading abroad and assist customers to better understand the risks and benefits involved.

2.1 Implications, benefits and risks in International Trade

Companies operating in home markets encounter many common problems when selling their products or services – minimising costs, meeting quality standards, meeting deadlines, collecting payment and financing the whole operation. When exporting, these problems are not too different except that they are peculiar to the task of selling abroad.

The laws, languages and customs of most overseas markets are likely to be unfamiliar, as are particular commercial and specification requirements by overseas buyers. Shipment periods are longer and exporters can lose control over their goods once shipped, yet they need to ensure prompt and secure payment from distant buyers.

© W A WISE – [email protected] 3

Payments in foreign currency coupled with fluctuating exchange rates create uncertainty about the value, which exporters will finally receive. Also, foreign governments may impose exchange control restrictions, which slow down the receipt of proceeds from buyers.

Special documentation may also be required for shipment of goods and these documents vary from country to country. Consequently there are significant differences between selling overseas and selling to home markets.

Exporters could perhaps consider the value of their exports by looking at the problems and requirements under four main headings:

Export Considerations

There are a variety of reasons why companies would find it advantageous to import. Some countries have relatively few indigenous natural resources and may find that the required products and services are simply not available in the domestic market. Even if they are available, it is recognised that certain other countries have well-established reputations for specific products and to compete would be pointless.

Therefore, by being able to tap into the resources of suppliers worldwide for a wider choice of products at a range of price and quality is one benefit of importing. However, dealing with a supplier abroad can be complicated as there could be problems with negotiating a contract under foreign laws, languages and business practices. Transport and customs entry would require special arrangements together with import licensing and documentation.


The market – issues to consider

Local overseas regulations Language Local overseas customs Advertising opportunities Technical specifications Trading standards Customs and excise regulations Local overseas competition Distribution Overseas competition Buyers or sellers market Demand

The buyer – issues to consider

Ability to pay Expertise in the business Reliability After-sales service

Transport – issues to consider

Method of Transport Cost – who pays? Time available, e.g. air or sea Insurance – who pays? Documentation

Payment – issues to consider

Method of settlement Credit terms Credit risk insurance Guarantees Exchange control restrictions

4

3. ROLE OF BANKS

Content3.1 The role of banks in international trade3.2 Principal export services3.3 Principal import services

OBJECTIVES


Explain in general terms what services banks are able to provide in order to assist their customers to trade abroad with confidence.

3.1 The Role of Banks in International Trade

Banks provide a very valuable and necessary and varied service to business clients which help to ease their transition into International Trade. Using experience acquired over a number of years together with a wide network of overseas banking contacts, they are able to provide advice on a wide range of issues; offer a wide range of products and generally work with the client to reduce risk and develop the business.

3.2 Principal export services

1. Status reports on potential buyers and agents abroad via correspondent banks2. Political and economic reports on various overseas countries which give the exporter an option on

economic prospects and country default3. Trade development departments could obtain the names of potential buyers in a particular market4. Information on trade fairs being held overseas at which the exporter can be represented. The bank

may have its own stand at such events and can arrange on the spot introductions to the exporter5. Letters of introduction to overseas banks who can impart detailed knowledge of the market and

arrange introductions to buyers and agents6. Business travel facilities7. Advice on general matters:

Overseas documentary requirements, tariffs, quotas and import requirements Advice on terms of trade and their significance Advice on the advantages and disadvantages of the various methods of settlement Advice on exchange risk protection Introduction to other providers of export services

8. Issue of Contract Guarantees


3.3 Principal import servicesMany countries involved in international trade find that they import more than they export and this situation is particularly prevalent in Kosovo. For importers here, the challenges are many; whether they are looking for raw materials, semi-processed goods or finished products.

How can buyers find the right suppliers, trading partners who are reliable and financially sound? What terms should they agree – including price, methods of payment and periods of credit? How can they protect themselves against someone’s failure to deliver what they need? They may also need to protect themselves against the movement of exchange rates which can eat into profit margins and turn a hard won contract into a loss-maker.

It may all sound very worrying, but with help from the bank, the risks can be minimised and the uncertainties reduced. Banks are able to provide a variety of products and services to the importer and listed below are the key areas in which your bank’s assistance could be invaluable:

Finding overseas sources of supply Obtaining status reports on overseas suppliers Arranging prompt payment to suppliers Advising on exchange risk protection Providing finance for imports Information on trade fairs being held overseas at which the importer can be represented. The bank

may have its own stand at such events and can arrange on the spot introductions to potential business partners

Advice on delivery terms, transport and commercial documents Advice on negotiating the most favourable terms of payment


4. INCOTERMS (International Chamber of Commerce Terms of Trade)

Content4.1 Trade Terms4.2 The purpose of Incoterms4.3 The 13 Incoterms4.4 How Incoterms affect the documents that Exporters must Produce4.5 Why is Insurance for the Goods Necessary?

OBJECTIVES


Explain the purpose of Incoterms Describe the obligations which the various Incoterms impose Explain how Incoterms affect the documents that an exporter must produce Assess the cost implication of Incoterms. Recognize the relationship between the particular Incoterm and the method of transport

4.1 Trade Terms

The price for goods paid by an importer will include the cost of production and an element of profit but it could include other costs as well, such as handling, transport and insurance.

The ‘Contract of Sale’ between the exporter and importer should specify what costs are being included in the price quotation and what costs are subsequently to be borne by the importer. In addition, each party will bear certain responsibilities to ensure that the contract is successfully concluded.

To avoid any possibility of misunderstanding or dispute, these responsibilities should be embodied into a ‘Trade Term’ or ‘Delivery Term’


4.2 The purpose of INCOTERMS

In international trade there are likely to be three separate contracts for transport of the goods:

a) From seller’s premises to a transport operator within the seller’s country.b) From the transport operator’s premises in the seller’s country to a named point in the buyer’s country

(e.g. a port, airport, or container depot).c) From the port, etc. in the buyer’s country to the buyer’s own premises.

It is vital to establish a clearly defined cut-off point to show where the exporter’s responsibility ends and where the importer’s begins. This cut-off point refers, in the main, to payment of freight and to insurance of the goods while in transit. Unless the separation of responsibility is clearly understood, it will be difficult for an exporter to price his goods accurately and for an importer to accurately calculate the full cost of the purchase.

The problem is that different countries have varying interpretations on the same contract wording and his problem can only be solved by creating a set of internationally agreed terms.

The purpose of Incoterms is to provide such a set of standardized terms which mean exactly the same to both parties and which will be interpreted in exactly the same way by courts in every country.

Incoterms were first published in 1936 by the International Chamber of Commerce (ICC) and full details can be found in their latest publication number 560, which is entitled Incoterms 2000. The main reason for this latest revision was the desire to adapt terms to the increasing use of Electronic Data Interchange (EDI).

Incoterms are not incorporated into national or international law, but they can be made binding on both buyer and seller, provided the sales contract specifies that a particular Incoterm will apply


4.3 The Thirteen Incoterms

Each of the thirteen different Incoterms sets out the obligations of the seller/exporter. Generally speaking, if Incoterms set out the obligations of the seller, by a process of elimination, any obligation that does not appear in a particular Incoterm must be the responsibility of the buyer.

The use of an Incoterm or group of Incoterms is determined by the mode of transport used i.e. sea shipments (port to port); combined and/or multimodal transport and the place of final delivery of goods as determined by the commercial contract.

TERMS TRANSPORT SELLER BUYEREXW

(Ex Works)

Any Make goods available at his premises (i.e. works or factory or warehouse)

Take delivery of the goods at the Sellers premises.

Bear all risk of loss or damage to goods from Sellers premises and make all arrangements at his own cost and risk to take goods to their final destination including export and import formalities. (Advisable to insure goods from Sellers premises)

The following tables define each term and highlight the main responsibilities of both the seller and the buyer.

INCOTERMS - MAIN RESPONSIBILITIES


NOTE: This is the MINIMUM obligation on the part of the Seller. However, if Seller arranges export formalities see FCA terms below


TERMS TRANSPORT SELLER BUYERFCA

Free Carrier (.. named point or place)

Any Deliver the goods into the charge of the carrier named by the Buyer.

Provide an export licence and pay any export taxes and duties.

Provide evidence of delivery of the goods to the carrier.

Nominate carrier.

Contract for the carriage of the goods from the named point/place.

Bear risk of loss of damage to the goods from the time delivered to carrier. (Advisable to insure goods from named point/place).

CPT

Carriage Paid To (.. named port of destination)

Any Contract for the carriage and pay the freight costs to the named place of destination.

Deliver the goods into the custody of the Carrier or, if more than one carrier is used to complete the journey, the "first" Carrier.

Obtain export licence, clear goods through customs ready for export, and pay necessary duties and taxes.

Provide the Buyer with the Invoice and the usual transport document depending on the mode of transport.

Receive the goods at the agreed place of destination.

Bear the risk of loss or damage to the goods from the time they have been delivered to the Carrier or "First" Carrier. (Responsible for arranging insurance from this point on).

CIP

Carriage and Insurance paid to(.. named place of destination)


Deliver the goods into the custody of the Carrier, if more than one Carrier is used to complete the journey, the "First" Carrier.

Obtain export licence, clear goods through customs ready for export and pay necessary duties and taxes.

Contract for insurance of the goods during carriage and pay the insurance premium.

Provide the Buyer with the Invoice, the usual transport document depending on the mode of transport and an insurance policy or other evidence of insurance cover.

Receive the goods at the agreed place of destination.

Bear the risk of loss or damage to goods from the time they have been delivered to the Carrier, but cover is provided through the Insurance arranged by the Seller.


TERMS TRANSPORT SELLER BUYER


NOTE: This term is based on the same main principle as FOB except that the Seller fulfils his obligation when he delivers the goods into the custody of the carrier at the named point. This term can be used for ANY mode of transport including multimodal transport such as containers or "Roll-on/Roll-off" traffic by trailers and ferries.

NOTE: Both CPT and CIP are similar to CFR and CIF respectively but cover all modes of transport.

10

FAS

Free Alongside Ship (..named port of shipment)

Sea or Inland Waterway

Deliver the goods alongside the vessel, at the loading berth and port named by the Buyer.

Provide the "customary clean document" as proof of delivery of the goods alongside the ship. This document may be a dock or warehouse receipt or even the transport document itself is "customary" at the port.

Notify buyer of delivery.

Must give the seller the name of the vessel, loading berth and when delivery is required.

Must contract for the carriage and pay the freight. Is also responsible for arranging insurance.

Risk passes to Buyer when goods delivered alongside ship and the Seller has made notice of such delivery.

Obtain export licence and pay export duties and taxes.

FOB Free on Board (.. named port of shipment)


Deliver the goods on board the vessel.

Provide export licence and pay appropriate export taxes and duties.

Provide a clean "on board" receipt.

Pay loading costs according to the custom of the port to the extent that they are not included in the freight

Nominate carrier.

Risk passes to Buyer once goods have passed over ships rail at port of loading.

Must contract for carriage and pay the freight. Is responsible for arranging insurance.

Pay loading costs to the extent that they are included in the freight charge.

Pay unloading costs.

CFR

Cost and Freight(.. named port of destination)


Contract for the carriage and pay the freight costs to the named port of destination.

Deliver goods "on board".

Obtain export licence and carry out necessary customs formalities to clear the goods for export. Pay appropriate duties and taxes.

Provide the Buyer with the Invoice and the usual on board transport document (e.g. Negotiable Bill of Lading).

Pay loading costs.

Pay unloading costs to the extent that they are included in the freight.

Receive the goods at the agreed port of destination.

Bear the risk of loss or damage to the goods once they have passed over the ships rail at port of shipment.

Responsible for arranging insurance for the goods from named point/place.

Pay unloading costs if they are not included in the freight.


NOTE: If Buyer is not able to obtain export licence it would be more appropriate to use FCA or FOB terms.

11


TERMS TRANSPORT SELLER BUYERCIF

Cost Insurance and Freight(.. named port of destination)


Contract for the carriage and pay the freight costs to the named port of destination.

Deliver goods "on board".

Obtain export licence, clear goods for export through customs and pay duties and taxes.

Contract for the insurance of the goods during the carriage and pay the insurance premium.

Provide the Buyer with the Invoice, the usual "on board" transport document (.e.g. Negotiable Bill of Lading) and an Insurance Policy or other evidence of insurance cover.

Pay loading costs.

Pay unloading costs to the extent that they are included in the freight.

Receive the goods at the agreed port of destination.

Bear the risk of loss or damage to the goods once they have passed over the ships rail at port of shipment. (However, cover provided through the insurance arranged by Seller).

Pay unloading costs if they are not included in the freight.

DES

Delivered Ex Ship (..named port of destination)


Deliver the goods on board the ship at the port of destination. Bear the costs and risks involved in bringing the goods to the named port of destination.

Provide documents to enable the Buyer to take delivery from the ship (e.g. Bill or Lading or delivery order).

Take delivery of the goods from the ship at the port of destination. Pay unloading costs.

Obtain import licence and pay necessary import duties and taxes.

DEQ

Delivered Ex Quay (duty paid) (..named port of destination


Deliver the goods on the quay (Wharf) at the named port of destination cleared for import.

Bear all the costs and risks involved until the goods are at the disposal of the Buyer on the quay or wharf.

Provide the usual transport documents (e.g. Bill of Lading) or delivery order to the Buyer.

Pay unloading costs.

Obtain import licence and pay all duties and taxes.

Take delivery of the goods from the quay (wharf) at the named port of destination.

Render every assistance to the Seller in obtaining import licence or other necessary authority.

© W A WISE – [email protected]: This term should not be used if (a) the Seller cannot obtain the import licence or (b) if the mode of transport is anything other than sea or inland waterway. If the Buyer wishes to clear the goods for import and pay the duty, the term "Duty Unpaid" should be used in place of "Duty Paid".

12


TERMS TRANSPORT SELLER BUYERDAF

Delivered at Frontier(.. named place of destination


Deliver the goods cleared for export at the named frontier (or the named place at the frontier).

Provide the buyer at seller’s expense, the usual document or other evidence of delivery at the frontier. At the buyer's expense and request, obtain the "through" document of transport from despatch through to final destination.

Take delivery of the goods at the named frontier (or the named place.)

Bear the risk of loss or damage to the goods from the time they have been delivered to the frontier (or named place).

Pay for on-carriage.

Obtain necessary import licence and pay appropriate duties and taxes.

DDU

Delivered Duty Unpaid (..named place of destination)

Any Deliver the goods at the named place in the country of importation.

Bear all risk of loss or damage in bringing the goods to the named place in the country of importation.

Provide a delivery order or usual transport document (e.g. Bill of Lading) to enable Buyer to obtain the goods).

Take delivery of the goods at the named place.

Obtain import licence and clear goods through customs. Pay all appropriate duties and taxes.

DDP

Delivered Duty Paid (..named place of destination)

Any Deliver the goods at the named place of destination at his risk and expense.

Obtain any import licence any pay appropriate duties and taxes.

Provide the documents (e.g. Bill of Lading) to enable the Buyer to take delivery.

Take delivery of the goods at the named place of destination.

Bear all risks once the goods have been delivered.


NOTE: The Sellers obligations are fulfilled when the goods have arrived at the frontier but before "the customs border" of the adjoining country. The "Frontier" could be the exporters country so it is vital to state which "frontier" is required.This term is primarily for use by road or rail transport but any mode is possible.

NOTE: Whilst the term "Ex Works" signifies the Sellers minimum obligation "DDP" represents the maximum obligation.13

4.4 How Incoterms affect the documents that Exporters must Produce

One function of all documents in overseas trade is to act as proof that an exporter has fulfilled his obligations under a commercial sales contract. Since the Incoterm in the sales contract will determine where the exporter’s obligations end, proof of fulfilment of the commercial obligations of the exporter will depend on whether the documents conform to the relevant Incoterm.

4.5 Why is Insurance for the Goods Necessary?

If goods are damaged in transit, the normal reaction would be to claim from the carrier. However, most transport contracts contain widely drawn clauses which, to a great extent, exclude liability on the part of the carrier unless damage is caused by the carrier’s gross negligence. It is therefore necessary for either the buyer or the seller to take out insurance to cover the relevant parts of the journey.

One special form of insurance which an exporter can take out is transit insurance, or seller’s interest insurance. While the buyer is responsible for arranging insurance for the sea voyage under an FOB or CFR contract, the exporter can, for a much-reduced fee, take out his own seller’s interest cover. This insures the exporter against loss or damage to the goods on the sea voyage when the importer has failed to fulfil his insurance responsibility. Naturally, the existence of such insurance is not disclosed to the buyer.

4.6 Why do bankers need to concern themselves with Incoterms?

Business clients are increasingly relying on their bankers for sound practical advice when in the process of negotiating contracts with their trading partners overseas. Whilst bankers cannot make commercial decisions for their clients, knowledge of this key element in trade negotiations inspires confidence and assists future business development.

Also, staff in trade operations must have a very sound working knowledge of these terms when processing letters of credit and checking documents before providing export/import finance facilities to clients.


5. COMMERCIAL DOCUMENTS

Content5.1 Documents5.2 Commercial Invoice5.3 Customs Invoice5.4 Legalised Invoices5.5 Consular Invoice5.6 Bills of Lading5.7 Air Waybill/Air Consignment Note5.8 Consignment Note/Lorry Waybill (Issued by a Road Haulier)5.9 Parcel Post Receipt5.10 Rail Consignment Note/Rail Waybill 5.11 Insurance 5.12 Movement Certificate – EUR 15.13 Certificate of Origin

Objectives

On completion of this chapter the student will be able to: Describe the important features of invoices Describe the various types of invoice that can be required in international trade Explain the open cover method of insurance of goods and understand the meaning of the

insurance certificate in this respect

Explain the significance of the standard clauses of the Institute of London Underwriters Explain the importance of certificates of origin Explain the role and characteristics of documents used in international trade Describe the important features of the bill of lading and the difference between transport

documents of title and other transport documents

5.1 Documents

The documents required for any international trade transaction will be determined by the individual needs of the contracting companies concerned, export/import requirements and other local problems such as Customs and Exchange Control regulations in the country of import.

These documents generally fall under the heading financial or commercial and can be used separately or together in support of a trade transaction.

Research has shown that the preparation of trade documents is one of the most common problem areas for exporters often resulting in:

Non-delivery of goods Delays in Customs clearance Non-payment for goods by buyers Rejection of documents by banks under Letters of Credit.

Bank staff who are actively involved in international trade operations, have a responsibility to familiarise themselves with the purpose and characteristics of these documents in order to protect the interests of the bank and its customers.

5.1.1 Financial documents are:


Cheques Promissory Notes Bills of Exchange

5.1.2 Commercial documents are:

Invoices Shipping Documents (issued by the carriers of the goods) Insurance Documents Any other documents whatsoever, not being financial documents.

The following pages describe a wide a range of documents which will prove particularly useful to anyone carrying out day-to-day banking operations in International Trade Finance.

WE SHALL DESCRIBE THE CHARACTERISTICS AND USE OF FINANCIAL DOCUMENTS IN THE SECTION TITLED ‘DOCUMENTARY COLLECTIONS’


5.2 Commercial invoiceProduced by the Exporter showing details of the goods, price, terms of shipment, together with details of freight, measurements, etc., as required under the commercial contract.


SELLER (Name & Address)Tian Power Tools40 Fuchengmen Nei DajieBeijingChina

Invoice No. and Date (Tax Point) Seller’s Reference 247 5th Aug 20xx Job No. 5678

Buyers Order & Date Buyer’s Reference

Contract Nr. CH697 18th June 20xx 124/CH697

CONSIGNEE (Name & Address)Wolf Vegla ProfesionaleJosip Rela Street Nr 256PrishtinaKosovo Country of Origin of Goods Country of Destination

China Kosovo

BUYER (if other than consignee)

Terms of Delivery & Payment CIF Thessalonica, Greece

Terms of Delivery & Payment CIF Thessalonica, Greece

Vessel/Flight No. Cardigan Bay

Place of Receipt

Port of Loading

Port of Discharge

Final Destination

Marks and Numbers, Numbers and Kind of Packages, Description of Goods

TPT 5 Wooden Cases124 containingSHANGHAI 400 ELECTRIC1/5 POWER DRILLS

Model LM 425 2 Speed (900RPM/2400RPM) 425 Watt high-torque motor

2 chucks - 12.5mm and 8mm supplied with each drill

Quantity

400

at

Euro20

Amount

Euro 8000

TOTAL Euro 8000

Gross Weight (Kg) Cube (m3) 950 2.376

Freight Euro 140Insurance Euro 18

We declare that this Invoice shows the actual price of the goods described and that all the particulars are true and correct.

17

5.3 Customs InvoiceA special invoice required by customs within various countries for import purposes. The format varies from country to country.

5.4 Legalised InvoicesThe Exporter (e.g. in China) in presents his commercial invoice together with evidence of shipment to the embassy of Saudi Arabia (in Beijing), importing country. The embassy will check, for example, that the goods can be imported and that they represent a fair market price and will stamp the invoices to this effect.

5.5 Consular InvoiceThe same procedure and reason as for the Legalised Invoice except that the invoice will be on a specific format required by the importing country concerned rather than the supplier’s own invoices.

5.6 Bills of Lading (see specimen in two parts)A Bill of Lading is issued when goods are transported by sea. Normally two or three originals are issued and signed on behalf of the Shipping Company or its Agents.

A Bill of Lading is: A receipt for the goods; Evidence of a contract of carriage; A document of title to the goods.

Copy (unsigned) Bills of Lading do not represent title to the goods.

A Bill of Lading can be of two basic types: ‘Received for Shipment’ or ‘Shipped on Board’.

This can normally be seen from the small print at the bottom of the face of the Bill of Lading, although this can vary between shipping companies.

5.6.1 ‘Received for Shipment’ clause (see Point 14 on Specimen Bill of Lading)

RECEIVED the goods in apparent good order and condition, weight, measure, marks, numbers, quality contents and value unknown for carriage to the Port of discharge or so near thereunto as the vessel may get and be always afloat to be delivered in the like order and condition at the aforesaid port (where the carriers liability shall finally cease) unto consignees or the assigns, they paying freight as per note on the margin plus other charges incurred in accordance with the provisions contained in the Bill of Lading.

5.6.2 ‘Shipped On Board’ clause: (see Point 14 on Specimen Bill of Lading)

SHIPPED on board in apparent good order and condition, weight, measure, marks, numbers, quality contents and value unknown for carriage to the port of discharge or so near thereunto as the Vessel may safely get and be always afloat to be delivered in the like good order and condition at the aforesaid Port unto Consignees or their Assigns they pay freight as per note on the margin plus other charges incurred in accordance with the provisions contained in this Bill of Lading.

A ‘Dirty’ Bill of Lading, or ‘Claused’ Bill of Lading is one that has a clause relating to the condition of the goods, e.g. ‘3 cartons – 1 damaged’

5.6.3 Parties to a Bill of Lading


Shipper (see Point 2 on specimen Bill of Lading)The party (i.e. exporter) with whom the contract of carriage has been concluded by the Carrier. It may show the actual Shipper or the Shipper’s Forwarding Agent.

Consignee (see Point 3 on specimen Bill of Lading)Completed either with the name of the Consignee or the words ‘to order’, which means that, the goods are to the order of the Shipper and delivery will be made in accordance with his instructions.

These instructions are given by the Shipper’s endorsement on the Bill of Lading, either: Specific: e.g. ‘Delivery to ABC Ltd’ – the carrier would only release goods to

ABC Ltd against the surrender by them of an original Bill of Lading. Blank: This would make the Bill of Lading a ‘bearer’ document and the carrier would release the goods

to the holder of the Bill of Lading.Notify party (see Point 4 on specimen Bill of Lading)The party to be notified on arrival of the goods.(when Bill of Lading consigned to order).

5.6.4 Standard Bill of Lading (front)

The specimen Bill of Lading shown below is shown in two sections for ease of reading but in reality is one continuous document.

1. The name of the shipping company 2. The name of the shipper (usually the exporter) 3. The name and address of the consignee (importer) or order 4. The name and address of the notify party (the person to be notified on arrival of the

shipment, usually the importer or an agent) 5. The name of the carrying vessel 6. The names of the ports of shipment and discharge 6A. The names of the places of receipt and final delivery of the goods 7. The marks and numbers identifying the goods 8. A brief description of the goods (possibly including weights and dimensions) 9. The number of packages10. Whether freight is to be paid or has been paid11. The number of originals in the set12. The date on which the goods were received for shipment13. The signature of the ship’s master or his agent14. Carriers terms and conditions


BILL OF LADING (COMBINED TRANSPORT SHIPMENT OR PORT TO PORT SHIPMENT)

---------------------------------

---------------------------------

---------------------------------


ShipperTian Power Tools40 Fuchengmen Nei DajieBeijingChina

B/L No: 45969648

Booking Ref: 1234567

Shipper Ref. Job

ConsigneeTo Order

NotifyParty/AddressWolf Vegla ProfesionaleJosip Rela Street Nr 256PrishtinaKosova

Place of Receipt

___________

Place of Delivery _________

Intended Port of LoadingShanghai

Intended Port of DischargeThessalonica

Marks and Nos. Container Nos. Number and kind of Packages, description of Goods Gross Weight

Measurement

TPT 5 Wooden Cases 950 2.376 124 ContainingSHANGHAI 400 ELECTRIC1/5 POWER DRILLS

Model LM 4252 Speed (900RPM/2400RPM)425 Watt high - torque motor2 chucks - 12.5 mm and8 mm supplied with each drill

ABOVE PARTICULARS ARE DECLARED BY SHIPPER

1

2

3

4

5

6 6

6A

6A

20


* Total No of Containers/PackagesPackages or Packets 5

MovementLCL Depot/LCL Depot

Freight and Charges (indicate whether prepaid or collect)Origin zone transport charge

PREPAIDOrigin Terminal Handling/LCL Service Charge PREPAIDOcean Freight PREPAIDDestination Terminal Handling/LCL Service Charge PREPAIDDestination zone transport charge PREPAID

Received by the Carrier from the Shipper in apparent good

order and condition (unless otherwise noted herein) the total

number or quantity of Containers or other packages or units,

indicated*, stated by the Shipper to comprise the Goods

specified above, for carriage subject to all the terms hereof

(INCLUDING THE TERMS ON THE REVERSE HEREOF

AND THE TERMS THE CARRIER'S APPLICABLE

TARIFF) from the Place of Receipt or the Port of Loading,

whichever is applicable the Port of Discharge or the Place of

Delivery, whichever is applicable in accepting this Bill of

Lading the Merchant expressly accepts and agrees to all its

terms, conditions and exceptions, whether printed, stamped

or written or otherwise incorporated, notwithstanding the

non- signing of this Bill of Lading by Merchant. When this

document calls for Combined Transport it is negotiable

Combined Transport Document the terms of which are based

upon the Uniform Rules for Combined Transport Document

(ICC Publication No. 298).

Number of Original Bills of Lading Two (02)

Place and date of issue: London 01/08/20xx

IN WITNESS of the contract herein contained the number of originals stated opposite has been used one of which being accomplished the others to be void.

For the Carrier E A Lindores

7 8

9

10

12

Place and date of issue: Shanghai 10/08/20xx 12

IN WITNESS of the contract herein contained the number of originals stated opposite has been used one of which being accomplished the others to be void.

For the Carrier E A Lindores 13

11

14

21

5.6.5 Short Form Bill of Lading Operates like an ordinary (‘Long Form’) Bill of Lading except that the terms and conditions of the contract are not printed on the reverse of the form.The terms and conditions (normally identical to those on a Long Form Bill of Lading) under which the goods are being shipped are, instead, available for inspection at the Shipping Company’s office and reference to this is made on the reverse of the Bill of Lading.

5.6.6 Common Short Form Bill of LadingThe main difference between this and the ordinary Short Form Bill of Lading is that the Shipping Company’s name is not pre-printed in the top right-hand corner. The Shipper would insert this before the Bills were presented for signing. The prime purpose of this document is to avoid the need for shippers to keep supplies of Bills of Lading for each carrier they use.

5.6.7 Through Bill of LadingA Bill of Lading which covers the shipment of goods on two separate vessels, i.e. where no direct service is available and the goods have to be transhipped during the voyage, from one vessel to the other.

5.6.8 Liner Bill of LadingIssued when goods are being carried on a vessel working a regular trade defined route with reserved berths at scheduled ports of call.

5.6.9 Combined Transport Bill of LadingCovers transport of goods on two or more different modes of transport, e.g. road – sea – road.Unlike the traditional ‘Port-to-Port’ Bill of Lading, the Combined Transport Bill of Lading is used to cover the whole journey, for example, from the Seller’s warehouse (place of acceptance) to the Buyer’s warehouse (place of delivery). The Carrier is responsible for the goods on the whole of the journey beginning at the time the goods are collected at the place of acceptance.

5.6.10 FIATA Combined Transport Bill of LadingOperates like the standard Combined Transport Bill of Lading except that it is issued by a Forwarding Agent acting as a Carrier, and is a document of title to the goods.

FIATA – The International Association of Freight Forwarders.

5.6.11 FIATA Forwarder’s Certificate of ReceiptIssued by a Forwarding Agent. It indicates that they have received the goods for delivery, to or at the disposal of a named Consignee. It is only a document of title as far as the Forwarding Agent is concerned, as it cannot be used to obtain goods from the Shipping Company.

5.6.12 Forwarding Agent’s Bill of LadingIssued by a Forwarding Agent, showing that goods have been sent to a named Consignee by the method of transport indicated.

If the goods had been sent by sea, the original Bills of Lading issued by the Shipping Company would be retained by the Forwarding Agents and used by them to arrange for the collection of the goods at the destination. The Certificate of Transport is only a document of title as far as the Forwarding Agent is concerned.

5.7 Air Waybill/Air Consignment NoteCompleted and signed by the Shipper, or their Agents. When the goods are delivered to the airline, they or their agents sign it as a receipt for the goods. It may further indicate the dispatch of the goods with the addition, by the airline, of a flight stamp indicating flight day, time and number. The AWB is not a document of title.


5.8 Consignment Note/Lorry Waybill (Issued by a Road Haulier) CMR – ‘Convention de Merchandises


Shippers Name and AddressTian Power Tools40 Fuchengmen Nei DajieBeijingChina

Consignee's Name and Address

Wolf Vegla ProfesionaleJosip Rela Street Nr 256PrishtinaKosovo

It is agreed that the goods described herein are accepted in apparent good order and condition (except as noted) for carnage SUBJECT TO THE CONDITIONS OF CONTRACT ON THE REVERSE HEREOF THE SHIPPER'S ATTENTION IS DRAWN TO THE NOTICE CONCERNING CARRIER'S LIMITATION OF LIABILITY Shipper may increase such limitation of liability by declaring a higher value for carnage and paying a supplement charge if required . Carrier is not liable for the goods until they are

received at its town terminal or airport office.

Issuing Carrier’s Name and City

Beijing Air ForwardersBeijing

Accounting Information

Agent's IATA Code93-5-221

Account NoTPT 123456

Airport of Departure (Add or first Carrier) and Requested Routing

BeijingTo By first Carrier To By To by Currency

EURODeclared for Carriage

Declared value for Customs

Airport of Destination

PrishtinaFlight date

1. 8. 20xx.Amount of Insurance

Euro 18Handling Information 5 cases

TPT124Shanghai

No of pieces RCP

GrossWeight

Kglb

Rate class Chargeable Weight

Rate

Charge

Total Number and Quantity of Goods ( Dimension or Volumes)

Commodity item no

5 950 k 4401 1000 kg 0.80c 800.00 5 Wooden Casescontaining400 ELECTRICPOWER DRILLModel LM 4252 Speed (900RPM/2400RPM)425 Watt high -torque motor2 chunks-12.5 mm and 8 mm supplied with each drill

5 950Prepaid Weight Charge Collect

800.00Other charges

Total other Charges Due Agent

0,75Shipper certifies that the particulars on the face hereof are correct and that that insofar as any part of the consignment contains restricted articles, such part is properly described by name and is in proper condition for carriage by air according to the International Air Transport Association’s Restricted Articles Regulations.Total other Charges due to Carrier

2.00

Total prepaid

802.75Total collect M J Lao

p.p. Beijing Air Forwarders

Executed on 1. 8. 20xx (Date) Signature of Issuing Carrier or its Agent

Currency Conversion Rates cc charges in Dest. Currency

For the Carriers Use only At Destination

Charges at Destination Total Collect Charges

Not negotiable Air Waybill(Air Consignment Note)Issued by

23

par Route’

A set of rules agreed at an international convention covering international road haulage. It only covers goods, which are travelling by road between countries. The goods must remain on the lorry at all times, i.e. not off-loaded onto another means of transport and back into a truck again.


1. Pošiljalac (ime, adresa, zemlja)Expediteur (nom, adresse, pays)

MEDUNARODNI TOVARNI LISTLETTRE DE VOITUREINTERNATIONALE

Ce transport est soumis, nonobstant toute clause contraire a la Convention

relative au contrat de transport International de merchandises per

route (CMR).

CMR

Na ovaj prijevoz će se primjeniti Konvencija o ugovoru za medunarodni

prijevoz robe cestom, bez obzira na bilo koje suprotne propise.2. Primalac (ime, adresa, zemlja)

Destinataire (nom, adresse, pays)

3. Mjesto isporuke (mjesto, zemlja, datum)Lieu prevu pour la livrasion de la marchandise (lieu, pays date)

4.Mjesto i datum preuzimanja posiljke na prijevoz (mjesto, zemlja)Lieu et date ide la prise en charge de la marchandise (lieu, pays)

5. Popratne liste Documents annexes

16. Prijevoznik (ime,adresa, zmelja)Transporteur (nom,adresse, pays)

17. Ostali prijevoznici (ime, adresa, zemlja)

18. Primjedbe i ogranicenja prijevoznika Reserves et observations du transporteur

6. Oznaka i broj 7. Broj Koleta 8. Vrsta ambalaze 9. Vrsta robeMargues et numeros Nature de l'emballage Designation de

marchandises

10. Statisticki broj No. statistique

11. Bruto tezina kg. Poids brut kg

12. Zapremnina m3

Volume m3

Razred Broj Slovo ADR* Classe Chiffre Lettre

13. Uputstva posiljalaca (za carinske i druge radnje) Instructions de l'expediteur

14. Odredbe o placanju vozarine Prescriptions d-affranchissement □ Placa posiljalac/Franco

21. Ispostavljeno u Etabile a

22.Potpis i pecat posiljaocaSignature et timbre

23. Potpis i pecat prijevoznikaSignature et timbre de transporteur

24. Posiljku preuzeo Marchandises recues:

Mjesto Lieu dana le 20Potpis i pecat primalacaSignature et timbre de destinataire

19. Posebni dogovori Conventions particulieres

20. Placa A Payer par

Prijevozni troskoviPrix de transportSnizenje Reductions

OstatakSoldeDodatakSupplementsOstali troskovi +Frais accessoires

UKUPNOTOTAL

15. Poduzece Remboursement:

PosiljalacExpediteur

ValutaMonnaie

PrimalacLe destinataire

24

5.9 Parcel Post ReceiptA receipt issued by the Post Office. It usually bears a date stamp including the branch name of the Post Office. It is not a document of title.

5.10 Rail Consignment Note/Rail Waybill Issued by the Rail Authorities and evidences the transport of goods by rail. It is not a document of title.

5.11 InsuranceIt is a matter for negotiation between the exporter and the importer as to who is responsible for insuring the goods during their journey from the exporter’s premises to the importer’s premises. In some transactions, it may be agreed that the seller will insure the whole journey and in others the onus may be on the buyer. It is also possible for the agreement to say that the seller must cover part of the journey, and the buyer must arrange cover for the rest.

For the moment, let us consider the position of an exporter who is responsible for the insurance of goods.

When an exporter sells goods on a regular basis, he will normally arrange an open policy of insurance to cover all his exports during a specific period. This provides insurance cover at all times within agreed terms and conditions. Each time a shipment is made; the exporter declares the details and pays a premium to the insurer. A certificate of insurance is then issued by the exporter, who sends one copy to the insurance company for its records.

The benefit of the open cover system is that it avoids the need to negotiate insurance terms each time a shipment is made, and it avoids the necessity of issuing a separate policy for each individual shipment.

Every consignment, however dispatched, runs the danger of loss or damage from a variety of risks: Fire Theft Explosions Leakage Spoilage, etc.

It is, therefore, normal for either Buyer or Seller (depending on the terms of contract) to take out insurance cover against any risks that are likely to be encountered.

Written evidence of this is provided in two main forms: Insurance policy Insurance certificate

5.11.1 Insurance policy Issued only by an Insurer. The main legal document. Must be signed by, or on behalf of the Insurer. It must show the name of the insured and be endorsed by him so that the right to make a claim can

be transferred to another party.

5.11.2 Insurance certificate


An Insurance Policy is taken out by the ‘insured’ to cover all his export/import shipments. As goods are shipped, the insured (Exporter/Importer) himself issues Certificates in accordance with the main policy.

Certificates are more common than policies but do not give full details of terms and conditions. Can be assigned by endorsement.

Note: Do not get involved in details of insurance with customers. Refer them to an insurance company or the insurance department of your bank.

Levels of coverThere are three basic levels of cover which can be obtained to cover Marine/Air/Parcel Post risks as applicable. In descending order of the extent of the cover provided they are: Institute Cargo Clauses (ICC) (A) Institute Cargo Clauses (ICC) (B) Institute Cargo Clauses (ICC) (C)

Two specific types of cover are also available: Institute War Clauses Institute Strikes Clauses

All of these clauses can be tailored by the insurance company to individual customers needs. However, the important point to bear in mind is that there is no type of insurance available which will cover ‘All Risks’ which are likely to be encountered on a voyage.

The next page contains a specimen Insurance Certificate which is issued under Lloyds of London open cover policy and relates to a shipment of goods by Tian Power Tools as evidenced by the invoice in Section 5.3 and the Bill of Lading in Section 5.7.


ORIGINAL LLOYD’S This certificate requires endorsement

Lloyd’s Agent at Kosovo Exporters reference Job No. 5678is authorized to adjust and settle on behalfof the Underwriters, and to purchase onbehalf of the Corporation of Lloyd’s inaccordance with Lloyd’s StandingRegulations for the Settlement of ClaimsAbroad, any claim which may arise on this

Certificate.

Certificate of Insurance No. C 8700/10051This is to Certify that there has been deposited with the Committee of Lloyd’s an Open Cover effected by East China Insurance Brokers International

acting on behalf of Tian Power Tools with Underwriters at Lloyd’s, dated the First day of January 20XX, and that the said Underwriters have undertaken to issue to by

East China Insurance Brokers International Policy/Policies of Marine Insurance at Lloyd’s to cover, up to USD100.000 in all by any one steamer or sending by air

and/or road and/or rail and/or conveyance Power Drills, other Interest held covered, to be shipped on or before the Thirty-first day of December 20XX from any port

or ports, place or places in China to say any port or ports, place or places in the World, other voyages held covered and that Tian Power Tools are entitled to declare

against the said Open Cover the shipments attaching thereto.

for the Committee of Lloyd’s

Alan N Other

Conveyance From

Cardigan Bay ShanghaiVia/to To INSURED VALUE/Currency

Thessalonica Euro8800

Marks and Number Interest

TPT 5 Wooden Cases124 containing SHANGHAI 400 ELECTRIC1/5 POWER DRILLS

Model LM 4252 Speed (900RPM/2400RPM)425 Watt high/torque motor2 chucks / 12.5 mm and8mm supplied with each drill

We hereby declare for Insurance under the said Cover interest as specified above so valued subject to the terms of the Standard Form of Lloyd’s Marine Policy providing for the settlement of claims abroad and to the special conditions stated below and on the back hereof. Institute Cargo Clauses (A) (1 1 82) or Institute Cargo Clauses (Air) (excluding sendings by post (1 1 82) as applicable.Institute War Clauses (Cargo) (1 1 82) or Institute War Clauses (Air Cargo) (excluding sending by Post) (1 1 82) or Institute War Clauses (sendings by Post) (1 1 82) as applicableInstitute Strikes Clauses (Cargo) (1 1 82) or Institute Strikes Clauses (Air Cargo) (1 1 82) as applicableGeneral Average and Salvage Contribution payable in full irrespective of insured or contributing values

Underwriters agree looses, if any, shall be payable to the order of Tian Power Tools on surrender of this Certificate.

In the event of loss or damage which may result in a claim under this Insurance, immediate notice should be given to the Lloyd’s Agent at the port or place where the loss or damage is discovered in order that be may examine the goods and issue a survey report.(Survey fee is customarily paid by claimant and included in valid claim against Underwriters.)

This Certificate not valid unless the Declaration is signed byTIAN POWER TOOLS Dated at Beijing 1. Aug 20XX

p.p. Tian Power Tools

Signed H TianBrokers: East China Insurance Brokers International - 1 Zhangqian Xilu, Shanghai, China


5.12 Movement Certificate – EUR 1An EC document signed and completed by the exporter and countersigned by the Customs of the exporting EC country. Export is to a country with which the EC has a preferential trade agreement.This would allow the importer to pay a preferential rate of import duty.

5.13 Certificate of OriginSigned, usually by a Chamber of Commerce certifying the true origin of the goods. Required by the Customs Authorities in the importing country.

1. Consignor Tian Power Tools40 Fuchengmen Nei DajieBeijingChina

No. AA 000001 ORIGINAL

2. Consignee

Wolf Vegla ProfesionaleJosip Rela Street Nr 256PrishtinaKosova

CERTIFICATE OF CHINESE ORIGIN

3. Country of OriginPeoples Republic of China

4. Transport details (Optional)

Seafreight

Remarks

Item number; marks, numbers and kind of packages; description of goods Weight Measure 950 2.376

THE UNDERSIGNED CERTIFIES THAT THE GOODS DESCRIBED ABOVE ORIGINATE INTHE PEOPLES REPUBLIC OF CHINA

BEIJING CHAMBER OF COMMERCE AND INDUSTRY

Place and date of issue; name signature and stamp of competent authority

5th August 20XX Jian K Liang

BEIJING Chamber of Commerce and Industry


TPT124Shanghai1/5

5 Wooden Cases Containing400 ELECTRICPOWER DRILLSModel LM 4252 Speed (900RPM/2400RPM)425 Watt high - torque motor2 chucks - 12.5 mm and8 mm supplied with each drill

BeijingChamber of Commerce京亱㈱㈣

28

6. METHODS OF SETTLEMENTContent6.1 Methods of Settlement6.2 Open Account6.3 Documentary Collections6.4 Documentary Letters of Credit6.5 Cash with Order/Advance Payment

ObjectivesOn completion of this chapter the student should be able to:

Explain what is meant by terms of payment Distinguish between the four basic terms of payment Appreciate which terms of payment are more secure for the exporter and which terms are more

favourable to the importer

6.1 Methods of Settlement

Before any goods are shipped the importer and exporter will, of course, agree upon the terms of the transaction, e.g. price, insurance, freight, dates of shipment etc. which will be incorporated in a commercial contract. Methods of payment under a contract vary widely according to the types of business, market standing of the customer and so on, but are broadly covered by the following methods:

Open Account Documentary Collection Documentary Letters of Credit Cash with Order/Advance Payment.

6.2 Open Account

Under this method the documents of title are sent direct to the importer who pays by issuing his cheque or by money transfer (either by mail or telegraphically). This system has serious risks for the exporter as he loses control of the goods once they have left his possession and payment from the buyer may not be forthcoming, due to insufficient funds or because some regulation has restricted the transfer of money.

Trading under ‘open account’ usually takes place only when there is a strong business relationship between the two parties, and the exporter is satisfied as to the creditworthiness of the importer.

6.3 Documentary Collection

Under this system the exporter despatches the goods and sends the documents to his bank for onward transmission to an overseas bank and thence to the importer. Settlement is effected by the importer paying bills of exchange drawn on him by the exporter.

The Bills of Exchange are drawn either: At sight – documents released to the Drawee/Buyer against paymentOR At a fixed (e.g. 9th August 1998) or determinable future date (e.g. 60 days sight)

– documents are released to the Drawee/Buyer against Acceptance of the Bill of Exchange

The exporter is protected to a degree, as the documents proving title to the goods are only released


against acceptance or payment by the importer. The importer can benefit from having a period of credit within which to pay for the goods and, if he ultimately fails to pay, the exporter can sue on the Bill of Exchange without having to go to the trouble of proving the contract of sale.

However, should the importer fail to pay a sight draft or accept a tenor draft (there could be various reasons for this, not only due to his being unable to pay but also due to import restrictions or suspension of payment because of political upset in the importer’s country). The exporter incurs additional expenditure from storage charges, legal fees, finding a new buyer and so on.

6.4 Documentary Letters of Credit

A Documentary Credit is an instrument by which a bank undertakes to pay a seller for his goods providing he complies with the conditions laid down in the Documentary Credit. At the same time the buyer has the comforting knowledge that he will not have to part with his money until he is presented with documents evidencing that the stipulated conditions have been fulfilled.

Broadly speaking, the benefit of the Documentary Letter of Credit system is that providing the exporter complies with all the terms of the credit, payment is guaranteed. There is no risk of non-payment in the event of the insolvency of the buyer or through exchange difficulties as the establishment of the credit signifies that Exchange Control regulations in the country of the importer have been complied with.

6.5 Cash with Order/Advance Payment

The best and most secure method of payment for an exporter would be to receive an advance payment of the full contract value before any shipments are made. This method of payment, often called ‘Cash with Order’, is extremely rare in connection with overseas trade. It is quite usual, however, for the buyer to make a deposit, i.e. 10%, upon signing the contract with the balance being paid by other methods.


7. OPEN ACCOUNT TERMS

Content7.1 The Major Risks that Apply to Exports on Open Account Terms7.2 How an Exporter can reduce the risks under Open Account Terms

Objectives

On completion of this chapter the student should be able to: Describe the major risks that apply to exporters who sell on open account terms Explain how an exporter can reduce the risks inherent in open account terms

7.1 The Major Risks that Apply to Exports on Open Account Terms

These risks can be classified under three main headings:

a) Buyer RiskThis is also known as the ‘credit risk’ and it covers the danger that the buyer may not pay for the goods because of insolvency or wilful default.

Remember that the exporter lost control of the goods at the moment he dispatched them.

b) Country RiskThe importer may be perfectly willing and able to pay, but the importer’s government may introduce laws, often called exchange controls, which prevent payment from being made.

The reason for the imposition of exchange controls can be political. Alternatively, exchange controls can simply result from financial pressures, such as the Third World debt problem, which mean that the importer’s country cannot afford to pay for imports.

c) Transit Risk Goods travel much farther in international trade than they do in a domestic deal, and therefore there is more danger of loss or damage to goods on their journey from seller to buyer.


Exporter

Importer Commercial

Contract

GoodsPayme

31

7.2 How can the Exporter reduce the risks under Open Account Terms?

a) Reduction of Buyer Risk The exporter can obtain a status report on the buyer, and such reports should be updated at regular intervals. Alternatively, organizations such as the Department of Trade and Industry can supply more detailed reports on potential buyers. A favourable status report does not guarantee that the importer will pay his debts, but it does serve as a useful indication of his creditworthiness and integrity. In addition, the exporter can insure against non-payment by the importer.

b) Reduction of Country RiskMost UK banks provide political and economic reports that comment on the situation in various overseas countries. These reports can give full details of current exchange control regulations in the overseas country, and can help the exporter to assess whether any additional restrictions are likely. In addition, insurance can be taken out to cover loss because of newly imposed exchange controls.

c) Reduction of Transit RiskThe obvious remedy is for appropriate insurance cover to be taken. If an Incoterm has been specified in the sale contract, it will be quite clear where the exporter’s obligation ends and where the importer’s obligation begins. In addition, the exporter can take out seller’s interest insurance to cover him against damage to goods if the importer has failed to insure under terms such as CFR.

Freight forwarders are firms that specialize in organizing overseas transport. Most freight forwarders are capable of arranging appropriate transport, insurance and documentation, if they are given a copy of the sale contract.

The exporter’s bank can recommend suitable freight forwarders, and the bank can arrange appropriate insurance of the goods, if required.


8. DOCUMENTARY COLLECTIONS

Content8.1 Introduction & Flowchart8.2 Uniform Rules for Collection8.3 Financial Documents8.4 Legal Framework8.5 Formal Requirements8.6 Import collections8.7 Export Collections

Objectives On completion of this chapter the student should be able to:

Explain what is meant by bills of exchange Explain the difference between sight drafts and term drafts Describe the detailed operation of documentary collections – for Imports and Exports Explain the risks when non-title transport documents are used Explain the significance of the various clauses on a collection instruction Explain the meaning and purpose of Uniform Rules for Collections Describe the checks which a remitting bank makes before it sends the documents abroad Describe the checks which a collecting bank makes on receipt of instructions and documents from

a Remitting bank Describe the risks to an exporter with documentary collections and how these risks can be reduced Explain the difference in security between D/P and D/A

8.1 Introduction and Flowchart

Where it is not possible in the contract between exporter and importer to agree that payment should be made under a documentary letter of credit, an alternative for the exporter is to send the documents on a collection basis.

Using this method, the exporter ships the goods and arranges with his bank for the documents, e.g. Bills of Lading, Invoices, and if appropriate, the Insurance Policy or Certificate, usually together with a Bill of Exchange, to be despatched to a suitable overseas correspondent bank.

This allows the exporter to maintain control of the documents until he is paid or receives the importer’s undertaking (acceptance) to pay at a future date. However, control over the goods can only be retained when the documents include a full set of Bills of Lading. Shipment by any other means generally results in the goods being consigned direct to the importer and loss of control.

The exporter’s documents must be accompanied by a signed collection order which is a standard form of authority enabling the exporter to include specific instructions to his bank regarding the handling of the documentary collection.

After the Commercial Contract is signed, the resulting sequence of events takes place as illustrated in


the following flowchart:

1. Goods are shipped to the importer abroad.2. The supporting documents and collection instructions are sent by the exporter to his bank 3. His bank (the Remitting Bank) will check the instructions and forward the documents to a correspondent bank in the country of import, requesting them to present the documents to the importer for payment or acceptance of a bill of exchange.4. The correspondent bank (collecting bank) will present the documents in accordance with the

instructions received. 5. The importer will eventually make payment to the collecting bank in under the terms of the

collection.6. The collecting bank will send payment to the remitting bank.7. The remitting bank will pay the exporter.

Documentary Collection Flowchart


Exporter

Importer

Remitting

Bank

Collecting

Bank

Commercial Contract

Documents &Instruction

Documents

ReleasedAgainst

Payment or

Acceptanc

Payment

Payment

Goods

2

Documents & Instructions Paymen

t 6

3

45

7

1

34

8.2 Uniform Rules for Collections (URC)

Most banks throughout the world handle collections in accordance with the standardised code of practice formulated by the International Chamber of Commerce.

The purpose of the Uniform Rules for Collections, Publication No 522 (1995 Revision) is to assist banks in their collection operations and to codify the international rules to be applied. They are also intended to lay down the conditions governing the presentation for payment of clean and documentary collections, thus attempting to lessen the difficulties likely to be encountered by banks and their customers when attempting to reconcile the difficulties in phraseology and commercial practice that exists in international trade.

The Uniform Rules for Collections No.522 (1995 Revision) are detailed at the end of this chapter the Appendix.

General provisions and definitions

A Collection as defined by URC is ‘the handling by banks, on instructions received, of financial and/or commercial documents in order to:

a) Obtain acceptance and/or as the case may be payment, orb) Deliver commercial documents against acceptance and/or as the case may be against payment, orc) Deliver documents on other terms and conditions.

Financial Documents are defined as Bills of Exchange, promissory notes, cheques, payments receipts or other similar instruments used for obtaining the payment of money.

Commercial Documents are defined as invoices, shipping documents, documents of title or other similar documents or any other documents whatsoever, not being financial documents.

Clean Collection means the collection of financial documents not accompanied by commercial documents.

Documentary Collection means the collection of (a) financial documents accompanied by commercial documents (b) commercial documents not accompanied by financial documents.

The ‘parties’ to a collection are:

a) The Principal who entrusts the handling of a collection to a bank.b) The Remitting Bank which is the bank to which the principal has entrusted the handling of a

collectionc) The Collecting Bank which is any bank, other than the remitting bank, involved in processing

the collectiond) The Presenting Bank which is the Collecting Bank making presentation to the drawee.e) The Drawee is the one to whom presentation is to be made in accordance with the collection

instruction.

8.3 Financial Documents


Before we look at the processes for handling a documentary credit, we will consider two financial documents which play an important role in facilitating payment in international trade:

1. Bill of Exchange 2. Promissory Note

Negotiable instruments such as bills of exchange (also known as drafts) and promissory notes are a frequent feature of export sales throughout the world. They are employed both as a means of extending credit - usually on a short-term basis - to the buyer, and as a device to provide the, seller with a negotiable security for payment.

For example, an exporter in a country may contract to ship machine parts to a buyer in another country. Payment is to take place 60 days from the date of shipment. The seller dispatches the goods and sends the buyer the shipping documents, which may include a bill of exchange drawn on the buyer payable to the seller at the end of the 60-day period and signed by the seller as drawer.

A Bill of Exchange is a written instrument which:

(a) contains an unconditional order whereby the drawer (EXPORTER) directs the drawee (IMPORTER) to pay a definite sum of money to the payee (EXPORTER) or another named party) or to his order;

(b) is payable on demand or at a definite time; (c) is dated; (d) is signed by the drawer.


Sight Bill of Exchange

Euro 8000 Shanghai 11 August 20XX

AT SIGHT OF THIS FIRST OF EXCHANGE (SECOND OF THE SAME TENOR AND DATE BEING UNPAID) PLEASE PAY TO OUR ORDER (PAYEE) THE SUM OF EURO EIGHT THOUSAND ONLY.

FOR VALUE RECEIVED

(DRAWEE)Wolf Vegla Profesionale Josip Rela Street Nr 256PrishtinaKosova

(DRAWER)Tian Power ToolsH TianDirector

36

In our specimen bill of exchange, we see that a Chinese Exporter, Tian Power Tools (TPT) has drawn a Bill of Exchange on Wolf Vegla Profesionale (WVP) – a Hong Kong Importer - which is a legal claim upon them. Under a bill of exchange, the drawer (TPT) writes out and signs the bill instructing the drawee (WVP) to pay a specified sum of money either to a third party or to themselves (known as the ‘payee’). The bill may either call for payment on presentation (a sight draft) or on a specified future date or event (a tenor or usance draft). The payment order must be unconditional.

A tenor draft may be presented to the drawee for acceptance. The drawee accepts the draft by signing on the front. Acceptance constitutes an unconditional undertaking to pay the draft on maturity i.e. the due date for payment

A Promissory Note also has most of the same features as the bill of exchange. The essential difference is that it is not an order to another party to pay but a direct promise of payment by the person who signs the note (the maker). In the same way as the bill of exchange it must be drawn up in unconditional terms.

A promissory note is a written instrument which:

(a) contains an unconditional promise whereby the maker undertakes to pay a definite sum of money to the payee or to his order.

(b) is payable on demand or at a definite time; (c) is dated; (d) is signed by the maker.


Date 2nd March 2005

I Martin Allen promise to pay Diane Drain --------------------------------

The sum of GB Pounds 200 (Two Hundred Pounds Only)-----------------

on 23rd August 2005.

Martin Allen

37

8.4 Legal framework Negotiable instruments and the rights of parties to them are governed by detailed legislation in most countries. This varies from one country to another though a set of international conventions drawn up in Geneva in the 1930’s provide a common form for a large number of European systems. Britain applies its own legislative rules which have influenced other countries whose systems are based on English legal principles.

In the USA, the Uniform Commercial Code provides detailed law on negotiable instruments. These sources provide the main sets of rules on negotiable instruments. In addition, the United Nations Commission on International Trade Law (UNCITRAL) has developed a model law for international negotiable instruments.

8.5 Formal requirements Negotiable instruments have special legal effects which concern the rights and obligations of third parties as well as the parties who originally created the instrument. For this reason, documents have to conform to strict formal requirements in order to be legally accepted as negotiable instruments.

These requirements are established in national legislation and in the applicable international conventions. Typically, the requirements include written form, signature, and the need for the payment undertaking or order to be expressed in unconditional terms.

8.6 Import collections

All collections received in respect of imports must be accompanied by instructions sent from the remitting bank in the form of a Collection Order. Do remember, however, that when your bank receives a collection order from a correspondent bank, it assumes the role of collecting bank and as agent for the correspondent bank must comply strictly with their instructions.

Any deviation from these instructions, even at the request of the importer will result in the collecting bank (your bank!) being held responsible.

The instructions of the remitting bank override any banking relations that may exist between the drawee (Importer) and the collecting or presenting bank.

Look at the specimen Collection Schedule on the next page. All bank collection schedules should contain the same information, but will only be different in design.


THE BANK OF CANTON LTD. CABLE ADDRESS “CANTONESE”

6 Des Voeux Road, Hong Kong TELEX: HX3471 CANBANK

The Manager SUBJECT TO UNIFORM RULESTrade Operations FOR COLLECTIONS(1995 Revision)Kosovo International Bank ICC Publication No.522190 UCK Street Pristina Kosovo

BEIJING: 5 th September XXXX Dear SirsWe enclose herewith the undermentioned Bills and Documents in accordance with the instructions indicated below by an ‘X’. Please acknowledge receipt.

DOCUMENTS AIRMAILED TO YOU SPECIFIED BELOW

Draft Invoice Packing List

Cert of Origin

Insurance Pol / Cert

Air Waybill Weight List

SurveyReport

Original 1/2 1/2 1/2 1/2 1/2 1/1 X X

Duplicate 1/2 1/2 1/2 1/2 1/2 X X X

INSTRUCTIONS:X Deliver documents against ACCEPTANCE X Protest for Non-Acceptance and / or Non-Payment

X In case of dishonour, please advise us immediately by telex/SWIFT giving reasons. Store and Insure the goodsCollect our commission at ___________ % and charges _________________

X In case of need please notify ___________________________________________________ “Case of Need” has no authority to change our instructions

Collect interest at ______________ % P.A. as per clause on Bills X Your charges and all other expenses, if any, are to be collected from draweesX When accepted; please advise us of the due date by telex / SWIFTX Payment / Acceptance may be deferred until the arrival of the goods

Please collect interest at _________% from the drawees from_____________________After Receiving Payment PleaseX Credit our account with the proceeds under advise to us by telex / SWIFT

X When accepted, please hold the accepted bill of exchange and present the same to the drawees for payment at maturity

Yours faithfully

Bank of Canton Ltd

T Chen


DRAWEE:New Age Electronics59 Rexhep Luci Street Pristina, Kosovo

TENOR:

120 days D/A

AMOUNT:

Euro 3000

OUR REFERENCE NO: 68212

DRAWER:Raj Watch Industries97 East Kowloon RoadHong Kong

AGAINST SHIPMENT OF:

67 ctns. Assorted digital alarm clocks and electronic personal organisers

DESPATCHED:29th August XXXXFROM:Hong Kong to London

39

8.6.1 Collecting Bank’s procedures

1. On receipt of a collection from a bank or a third party abroad, the documents must be checked to ensure that they are as listed on the schedule. No other document checks are required. Also read the instructions from the Remitting Bank to ensure that your bank is able and willing to carry out their requirements. If there are any problems, contact the Remitting Bank immediately for clarification.

2. Record details of the collection in a register which must show your bank reference number, the date, Drawee’s name, Remitting Bank’s name and reference number, Drawer’s name, amount, date paid.

3. Prepare a suitable ‘presentation notice’ using a pre-printed bank form if possible and send it to the drawee (importer) for payment of a sight bill, or acceptance of a term bill. Do not attach any of the commercial documents at this stage, but retain them securely at the Bank.

4. Ensure that the Remitting Bank and the ‘case of need’ (if appropriate) is advised of the fate of the collection. Failure to do this could result in the bank being held negligent.

5. Upon receipt of an Accepted Term Bill or authority to Pay a Sight Bill, refer to Instructions on the Collection Order Form regarding release of documents.

6. Accepted Term Bills All accepted bills must be checked for correctness. (See example ‘Acceptance’ below.) Refer to instructions on Collection Order for handling Accepted Bill of Exchange. If

instructions are to ‘Hold until Maturity’, hold securely and diarise for maturity. In good time, for example 7 days before maturity, present Accepted Bill of Exchange to

Drawee for agreement/authority to pay on the due date.

7. When Sight Bill or Tenor Bill is paid, ensure proceeds are sent promptly to the Remitting Bank in accordance with instructions on Collection Order.

8. If Bill Unaccepted or Unpaid Refer to Collection Order for instructions regarding Protest. Inform Remitting Bank immediately and give reasons for non- acceptance/non-payment.

(Article 20.iii.c) Pay close attention to Principal’s instructions regarding storage and insurance of the

goods. If in doubt, contact Remitting Bank immediately.

Protest is legal evidence issued by a Notary, of non-acceptance/non-payment of a bill of exchange.

Ensure protest procedures are carried out within local timescales, usually only one, maximum two, days after non-payment. Timescales may vary between different countries.

Pass ‘Protest’ documents to Remitting Bank with your request for reimbursement of your own charges/expenses plus the Protest charges. (Article 22 and 23)

8.6.2 AcceptanceAcceptance of a bill of exchange is an unconditional undertaking by the drawee to pay the bill at maturity.The drawee should not, when accepting the bill: Impose any conditions on payment Accept for a lesser amount Make it payable on a different date.


These are referred to as ‘qualified acceptances’ and would not be acceptable to the Remitting Bank.

The bill may be accepted payable at a place other than the Acceptor’s address, normally at his Bank. This practice should be encouraged, as the procedure for obtaining payment at maturity is greatly simplified. The bill need only be presented at the bank counters for payment, or for protesting if necessary.

Example of an Acceptance domiciled at the Bank/Branch.

‘Accepted payable at Barclays Bank PLC, Regent Parade, London, SW1.

For and on Behalf of XYZ Ltd.

Director (Signature)............................ Director (Signature)............................

Sighted (Date)....................................

The titles of the signatories must be stated. For branch customers, the signatories must conform to the current mandate.

Where the Drawee is not a customer, the branch has no responsibility for ensuring that the signatures are correct, or that (for corporate drawees) the signatories have authority to sign on behalf of the company. The Acceptance must be ‘in proper form’, e.g. signatories on behalf of a company must be ‘on behalf of ABCD’, and must state their title. Strict control must be maintained over an Accepted Bill.

8.6.3 Avalising

The term avalising is a corruption of the French phrase ‘pour aval’ (‘for support’) and occurs when the Drawee’s Bank guarantees payment at maturity by adding its name to a Bill of Exchange or a Promissory Note. Avalising a bill involves the Drawee’s bank in a liability and therefore great care must be taken when such requests are received from a Remitting Bank.

8.7 Export collections

The documents presented by your customer (Exporter) may represent full title to the goods (full set of Bills of Lading) or on the other hand may provide evidence that the buyer has obtained or is likely to be able to obtain the goods without necessarily requiring the documents accompanying the collection schedule. Where documents of title are presented, control can be exercised over the goods on behalf of the exporter.

Release of documents to the importer will be made in accordance with the terms of the contract and could be as follows:a. With a Bill of Exchange drawn at sight – documents against payment (D/P)b. With a Bill of Exchange drawn at a fixed or determinable future time (term bill) – documents

against acceptance (D/A)c. Commercial documents only – cash against documents (CAD)d. As (b) but documents to be released only against payment.

The customer must be encouraged to submit documents with a correctly completed and signed collection order which must be checked to ensure that:


Example collection order form (see next page) – guide to completion

The Collection Order will usually contain the following information:

1. Name and address of the Principal (normally your customer – the Exporter) 2. Principal’s reference number 3. Name and address of the Drawee (usually the Importer) 3A. Name and address of the Consignee (if different to the Drawee) 4. Name and address of the Drawers (Exporter) Banker 4A. Name and address of ABC Bank’s International Dept. 5. Quantity of Financial & Commercial documents sent for collection 6. Whether documents are to be released against Acceptance or Payment 7. Instructions concerning Protest if unaccepted or unpaid 8. Instructions concerning the protection of goods – Warehouse/Insure goods 9. Instructions concerning bank and other charges10. Whether Acceptance/Payment may be deferred until arrival of goods11. Remittance of proceeds by Collecting Bank12. Brief description of the goods and name of vessel13. Any special instructions and name of Drawee’s (Importers) Bankers14. Name and address (and if possible telephone number) of the drawer’s or principal’s agent, if any,

in the importing country, indicating his powers ‘for guidance’ indicates that the ‘case of need’ will mediate between the parties, but has no

power to vary the terms of the collection accept their instructions’ indicates that the ‘case of need’ may give direct orders to the

overseas collecting bank e.g. to release documents free of payment.15. Amount, Tenor and Date of Bill of Exchange16. Details of special clauses on Bill of Exchange, e.g. payment of interest17. Application of Proceeds by Remitting Bank18. Name and Address of the Collecting Bank19. Remitting Banks ‘Disclaimer Clause’20. Date and Customers (Exporter) signature

8.7.2 Remitting Bank procedures

1. Check that all documents listed in the Customers Collection Order have been received and that endorsements have been completed where needed, e.g. on Bill of Exchange, Bill of Lading, Insurance document. There is no requirement for the documents to be checked any further.

2. Complete sets of Bills of Lading are tendered where appropriate; if one is missing it is important for the bank to query this fact with the customer. The missing bill may have been sent directly to the buyer, retained by the customer or lost in transit.

3. Exchange control and other regulations (e.g. export licence and completion of exchange control forms) are observed.

4. Send documents with Collection Order to foreign correspondent bank who will act as the ‘Collecting Bank’.

5. Send regular enquiries to the Collecting Bank regarding the status of the collection and always keep your customer (Principal) appraised of the current situation. Losses have often been incurred by banks due to negligence in this area of responsibility.

6. Upon receipt of proceeds, ensure Principal/Exporter is paid without delay.


PLEASE COLLECT THE UNDERMENTIONED FOREIGN BILL AND/OR DOCUMENTS


Full Name and Address of Drawer/ExporterSpeirs and Wadley LtdAdderley RoadHackney E8 1XYEngland

Consignee - Name and Address

‘To Order’

3A

TO: ABC Bank Ltd – International Dept54 Lombard StreetLondon EC3P 3HP

For Bank Use Only Date: International Dept. Collection No.

Drawers reference (to be quoted on all correspondence) For Bank Use Only Due Date: Correspondents Reference:

Drawee (if not Consignee) – Full Name and AddressWoldal LtdNew Road – Kowloon Hong Kong

For Bank Use Only

Fate Dates:

Drawers Bankers: ABC Bank Ltd 96 Commercial RoadLondon E8 2XJ

Account No. 12345678 Ref No: PLEASE FORWARD DOCUMENTS SHOWN BELOW BY AIRMAIL. FOLLOW SPECIAL INSTRUCTIONS AND THOSE MARKED X

Bill of Exchange

2Comm’l Invoice

2Cert’d/Cons. Inv Ins’ce Pol/Cert

2Bill of Lading Parcel Post Recpt Air Waybill Combined Transport Doc.

2

Other Documents and whereabouts of any missing Original Bill of Lading

RELEASE DOCUMENTS ON

ACCEPTANCE:PAYMENT: X

If documents are not taken up on arrival of goods

Warehouse Goods:

X Do Not Warehouse:

Insure Against Fire:

XDo Not Insure:

Collect ALL Charges Yes: No:

Collect Correspondents Charges ONLYYes: X No:

Goods and carrying vessel: Assorted Fitness Equipment per Crystal Palace

If unaccepted

and advise reason by

If unpaid

and advise reason by

Protest: Do Not Protest:

Cable: Airmail:

Protest:

XDo Not Protest:

Cable: Airmail:

Acceptance/Payment may be deferred until arrival of goods

Yes: X No:

After final-payment remitproceeds by Cable: X Airmail:

For Bank Use Only

In case of need refer to: K. Willshire, 18 Newmarket Road, Kowloon, Hong Kong For Guidance:

XAccept their Instructions:

SPECIAL INSTRUCTIONS 1. Represent in arrival of goods if not honoured on first presentation

Date of Bill of Exchange:11th August 20xx

Tenor: Sight Amount of Collection:GBP 4108

Bill of exchange claused:

For Bank Use Only

Please apply proceeds of this collection as indicated with an ‘X’

Credit us in Euro/Sterling

Credit our Foreign Currency Account No.

Apply to Forward Contract No.

X

I/We agree that you shall not be liable for any loss, damage, or delay however caused which is not directly due to the negligence of your own officers and servants.Any charges and expenses not recovered from the drawees including any costs of protecting the merchandise may be charged to us. Subject to Uniform Rules for Collections (1995 Revision) International Chamber of Commerce Publication No.522

Date & Signature 11th August 20XXp.p. Speirs and Wadley Limited – Signature Martin Speirs

21

3

4A4

5

6

7

8

9

10

111

2

13

14

15

16

17

1819

20

43

9. DOCUMENTARY LETTERS OF CREDIT

Content9.1 Definition of a Documentary Credit9.2 Uniform Customs and Practice for Documentary Credits9.3 Parties to Documentary Credit9.4 Types of credit9.5 Payment Terms9.6 Import Credits9.7 Examination of Documents9.8 Export Credits

ObjectivesOn completion of this chapter the student should be able to:

give a clear and accurate definition of a ‘documentary credit’ explain briefly who the parties to a credit are, and describe their main responsibilities explain the meaning of revocable/irrevocable and unconfirmed/confirmed; acquire an overview of how a documentary credit operates explain the meaning of ‘payment’, ‘acceptance’, ‘negotiation’, and ‘deferred payment’ explain the meaning and purpose of Uniform Customs and Practice for Documentary Credits; describe the benefits and drawbacks of documentary credits for exporters describe the risks that a bank undertakes when issuing a documentary credit on behalf of an

importer explain how some of these risks can be reduced; understand and explain the technicalities that must be resolved to ensure that the documentary

credit is logical and workable; understand and explain the effects of Uniform Customs and Practice for Documentary Credits on

the issuing of the credit and the responsibilities of the applicant and issuing bank describe the main characteristics of ‘specialised’ credits

9.1 Definition of a Documentary Credit

A documentary credit can be simply defined as a conditional guarantee of payment made by a bank to a named beneficiary, guaranteeing that payment will be made, provided that the terms of the credit are met. These terms will state that the beneficiary must submit specified documents i.e. financial and commercial, usually to a stated bank and by a certain date.

However, before considering how documentary credits operate and the responsibilities of the various parties involved, it is important that students become familiar with the more detailed definition taken from the Uniform Customs and Practice:

For the purposes of these Articles, the expressions ‘Documentary Credit(s)’ and ‘Standby Letter(s) of Credit’ hereinafter referred to as Credit(s)), mean any arrangement, however named or described, whereby a bank (the ‘Issuing Bank’) acting at the request and on the instructions of a customer (the ‘Applicant’ or on its own behalf,i. is to make a payment to or to the order of a third party (the Beneficiary’), or is to accept and pay

bills of exchange (Draft(s)),

OR

ii authorises another bank to effect such payment, or to accept and pay such bills of exchange (Draft(s)


iii authorises another bank to negotiate, against stipulated document(s),provided that the terms and conditions of the Credit are compiled with Bankers and Customers alike, when dealing in Letters of

Credit must be mindful of the following practice:

‘In Credit operations all parties concerned deal with documents, and not with goods, services and/or other performances to which the documents may relate.’

9.2 Uniform Customs and Practice for Documentary CreditsThe Uniform Customs and Practice for Documentary Credits, 2007 Revision, ICC Publication no. 600 (“UCP”) are rules that apply to any documentary credit (“credit”) (including, to the extent to which they may be applicable, any standby letter of credit) when the text of the credit expressly indicates that it is subject to these rules. They are binding on all parties thereto unless expressly modified or excluded by the credit.

9.3 Parties to a Documentary Credit

9.3.1 ApplicantThe importer or applicant is responsible for setting up the credit and will complete a bank application form detailing the terms and conditions which the beneficiary will have to meet to obtain payment. The terms and conditions will generally consist of: How much is to be paid and when A description of the goods A list of shipping documents to be presented by the beneficiary Dates within which goods must be shipped and documents presented.

The application is the request by the Applicant for the Issuing Bank to undertake to pay the Beneficiary on his behalf.

9.3.2 Issuing BankThis will normally be the Applicant’s own bank. Initially the Issuing Bank must decide if it is prepared to issue an undertaking on behalf of its customer. Once the credit has been issued it will have to pay, providing all terms and conditions have been complied with by the Beneficiary, even if the Applicant cannot pay.

The Issuing Bank will also check the application to make sure: The terms and conditions are clear and concise. That its own rules, and any exchange control rules have been satisfied.

Once this has been done, the Letter of Credit addressed to the Beneficiary will be produced which will be sent through a branch, subsidiary or correspondent bank as close as possible to the Beneficiary.

A contract now exists between the Applicant and the Issuing Bank under which the bank has given an undertaking to pay no matter what happens to the Applicant, and the Applicant undertakes to pay the issuing bank provided the terms and conditions have been complied with.

9.3.3 Advising Bank


This is the bank which receives details of the Credit from the Issuing Bank. At this stage, there is no contractual agreement between the two banks, but purely a relationship of principal and agent.

The advising bank will check the credit for:

Authenticity Workability Exchange control regulations

Before advising the credit to the Beneficiary.

9.3.4 BeneficiaryThis is the exporter (or seller of the goods) who probably insisted on a credit in the first place. On receipt of the credit, he should check that it agrees with the underlying contract, and that he can comply with the conditions. If he wants something changed, he must contact the applicant who will arrange for an amendment.

The Beneficiary should now have in his hands an undertaking by a bank that payment will be made. However, he will only benefit provided he can meet the terms and conditions of the credit.


Documentary Credit Flowchart


Issues the Credit

Advises theCredit

Will pay against good

Documents

Sends Documents

Examines & pays against

good Documents

Gives Documents to Applicant and debits their

account

2

3

7

Importer

Exporter

Commercial

Submits an Application for

Applicant Beneficiary

Issuing Bank

Advising Bank

Presents Docume

1

4

5

6

8

Goods

4

47

1. Importer submits his Application for issue of the credit2. Issuing Bank checks Application and issues the Credit via a Correspondent Bank

(Advising Bank) in the country of import3. The Advising Bank passes on the Credit to the Exporter (Beneficiary)4. The Beneficiary will present documents to the Advising Bank for payment5. The Advising Bank will usually pay the beneficiary against good documents6. The Advising Bank will then send the documents to the Issuing Bank and claim reimbursement7. The Issuing Bank will check the documents and reimburse the Advising Bank if no discrepancies are

found8. The Issuing bank will then debit their customers account and give them the documents

9.4 Types of credit

Credits are classified as Irrevocable.

IrrevocableAn irrevocable credit constitutes a definite undertaking by the Issuing Bank to make payment without recourse, provided all the terms have been complied with. Irrevocable credits can only be amended or cancelled with the agreement of all parties and in particular the beneficiary.

Irrevocable credits can be either confirmed or unconfirmed by the advising bank Irrevocable Credit unconfirmed by the Advising Bank

This is when the advising bank passes on the credit to the beneficiary without giving any undertaking of its own. The applicant and the issuing bank bear the responsibility of the credit, and the advising bank would not have to pay if it could not get reimbursement itself.

Irrevocable Credit confirmed by the Advising Bank

An irrevocable credit which has been confirmed by the advising bank gives the beneficiary the added protection of a second undertaking. The advising bank would have to pay even if it could not obtain reimbursement from the issuing bank. The main reason for confirmation is to lessen any doubts the beneficiary may have concerning the issuing bank or the issuing bank’s country.

The advising bank assumes the same responsibility and liability as the issuing bank, and therefore before adding its confirmation will make sure the issuing bank is a good risk.

9.5 Payment terms

Credits can be issued allowing for payment as soon as documents are presented or, if the exporter has allowed the importer credit, they can be issued allowing for payment on a date after presentation of documents.

9.5.1 Sight CreditsThese allow for payment to be made as soon as documents are presented.

9.5.2 Term/Acceptance CreditsThese are a very different category and the term Bill of Exchange, sometimes called a Term Draft, is a vital document and payment is made at a specified future time, e.g. 30 days after presentation of documents.

This type of credit enables the applicant to get the goods before having to pay for them. He obtains


credit and buys time.

9.5.3 Negotiation CreditsA credit may be available for Negotiation with the Advising Bank as opposed to being available for acceptance and/or payment. This depends on whom the Bills of Exchange are to be drawn.

9.5.4 Deferred Payment CreditsThis type of credit is becoming increasingly popular. It allows for payment at a future date without calling for a Bill of Exchange.

9.6 Import Credits

9.6.1 Initial ConsiderationsAn application from a customer asking us to issue a Documentary Credit should be treated in the same way as an application for a loan. The bank is undertaking to pay away money, and therefore must look at the risks involved and should consider taking some form of security.

Security may be taken in the form of, stocks and shares, life policies, charges over land or other assets etc.

Security may be taken in the form of cash. (See Cash Security below) The bank however, may consider a customer to be creditworthy and choose not to take any

security.

In addition, the bank may take into account the specific terms in an application as they will affect the risk the bank is taking.

Some of the points worth considering are: The type of credit; revocable/irrevocable. The validity of the credit; the length of time the bank is at risk. Whether the documents give title to the goods? The nature of the goods:

easily resalable? perishable? subject to price fluctuations?

The terms of contract: Goods shipped on an FOB basis may mean the bank has to pay heavy charges

(freight and other) to obtain the goods, should the need arise. Are the goods subject to heavy import duties? Is Insurance cover satisfactory to the bank? The bank requires cover from a reputable insurance company which must include:

transit from warehouse to warehouse at final destination marine and war risks strikes, riots and civil commotions other clauses appropriate for a particular commodity.

Once these points have been considered, a ‘limit’ will be given to a customer. This is the value of the credits the Issuing Bank is prepared to issue for the customer. This limit may be sanctioned under the manager’s discretionary limit or it may need to be sanctioned by the Controlling Office.

9.6.2 Cash securityA customer’s creditworthiness may not be sufficient for the bank to issue a credit without taking some


cash prepayment in advance. When this is required, full or partial prepayment is held either on a: Cash Account for Credits (Bank’s Internal Account) if in local currency, or Foreign Currency Cash Account for Credits (Bank’s Internal Account) if in a foreign currency.

9.6.3 Example of how an Import Documentary Credit is issued

Let us assume that the two companies Wolf Vegla Profesionale (WVP) and Tian Power Tools (TPT) have agreed that payment terms will be by way of an irrevocable, confirmed documentary credit.

The procedures that now occur are as follows:

a) WVP request their bankers, Kosovo International Bank (KIB), to issue an irrevocable credit in favour of TPT and to request confirmation by Bank of China (BOC).

SEE CUSTOMER APPLICATION FORM ON (Page 61) COMPLETED BY (WVP)

b) KIB, the issuing bank, issues the Letter of Credit by telex and requests BOC to advise the beneficiary of the details. BOC are asked to confirm the credit, and we shall assume that they agree to this.

SEE LC ISSUED BY (KIB) VIA TELEX ON (Page 67/68)

c) BOC, as advising bank, will pass on to the beneficiary (TPT) the details of the Letter of Credit as received from KIB.

SEE ADVICE OF LC SENT TO BENEFICIARY BY (BOC) (Page 69)



Applicant: Wolf Vegla Profesionale Josip Rela Street Nr 256Prishtina - Kosovo

a

Beneficiary: Tian Power Tools40 Fuchengmen Nei DajieBeijing - China

Date of Application 15th July 20XX Expiry Date and Place for Presentation of DocumentsExpiry Date: 30th August 20XXPlace of Presentation: Beijing

Confirming Bank/Advising Bank: Bank of China, Hing Min Street,Amount in figures and words:Euro 8000 - Eight Thousand Euros

Credit available with Nominated Bank:

by payment at sight

by deferred payment at:

by acceptance of drafts at:

by negotiation

Against the documents detailed herein:

and Beneficiary’s draft(s) drawn on:

issue by (air) mail with brief advice by teletransmision

issue by teletransmission (see UCP 500 Article 11)

Transferable Credit – as per UCP 500 Article 48

Confirmation of the Credit:

Not requested Requested Authorised if requested by Beneficiary

Partial shipments allowed not allowed

Transhipments allowed not allowedPlease refer to

Insurance will be covered by us

Shipment as defined in UCP 500 Article 46

From: ShanghaiFor transportation to: Thessalonica

Not later than: 15th August 20XX

Terms:

FAS CIF

FOB Other terms

CFR as per Incoterms

Goods (Brief description without excessive details – See UCP 500 Article 5):

400 Electric Power Drills – Model LM425

Commercial Invoice signed - original(s) and One copy(ies)Transport Document

Multimodal Transport Document, covering at least two different modes of transport - original(s) and copy(ies)

Marine/Ocean Bill of Lading covering port-to-port shipment - Full Set original(s) and copy(ies)

Non-Negotiable Sea Waybill covering a port-to-port shipment - original(s) and copy(ies)

Air Waybill, original for the consignor - original(s) and copy(ies)

Other transport documents

to the order of Shipper endorsed in blank

marked freight prepaid payable at destination

notify: Wolf Vegla Profesionale - Josip Rela -Street Nr 256 –Prishtina- KosovoInsurance Document:

Policy Certificate Declaration under an open cover Covering the following risks: All Risks Other

Certificates:

Origin

Analysis

Health

Other

Other documents:

Packing List - original(s) and copy(ies) Other - original(s) and copy(ies)

Weight List - original(s) and copy(ies)

Documents to be presented within 15 days after the date of shipment but within the validity of the Credit

Additional Instructions We request that you issue on our behalf and for our account your Irrevocable Credit in accordance with the above instructions (marked (x) where appropriate. This crerdit is subject to Uniform Customs and Practice for Documentary Credits (1993 Revision, Publication No. 500 of the International Chamber of Commerce, Paris, France)., insofar as they are applicable. We authorise you to debit our account no.____12345678__ for the amount of margin and for amount of your commissions and commission of confirming bank (if applicable).

Name, signature and stamp of the Applicant Wolf Vegla Profesionale – J Gashi, DIRECTOR

CUSTOMER

APPLICATION

FORM

1 2

34

5 6

7

8

9 10

11

12 13

14

15

16

17

51

9.6.3. A Guide to completion of documentary credit application form(Numbers correspond with numbers on the form.)

1. Name of Applicant 2. Name of Beneficiary 3. Date of application. 4. Expiry date and place of presentation of documents. 5. Method by which credit to be transmitted. 6. Confirming/Advising Bank 7. Applicants request for Confirmation of LC by Advising Bank 8. Amount in figures and words 9. Partshipments/Transhipment Allowed/Not Allowed10. Availability of the Credit11. Responsibility for Insurance12. Shipment FROM/TO13. Delivery Term (Incoterm)14 Description of Goods

Clear concise details of the goods should be given, but customers should be discouraged from including excessive detail. Credits should not be established which refer to the goods solely as ‘per Order No’ or as ‘per proforma invoice of (date)’, as it may involve goods with which the bank would not wish to be associated. A brief description of the goods therefore should also be given.

15 Documents required The number of invoices required should be inserted – for example, ‘in duplicate’, plus special

requirements for form and content. Indicate the appropriate mode of transport and then the notify party/consignee as Applicable If the goods are to be insured by the exporter, insert percentage over invoice value for which

goods must be insured and specify the risks to be covered. If further documents are to be presented, these should be listed. It should also be stated who is

to issue the document and what information that document is to contain. 16. Number of days after date of the transport document within which documents are to be presented17. The authorised signatures of the customer in accordance with the held bank mandate

Remember: Any Credit established must be workable for all parties to the Letter of Credit. Customers will seek your advice concerning completion of the application form, and whilst we

can be of assistance, remember that the conditions of the Credit should be established by the customer as these are in effect his requirements and protections.


9.6.3. B Vetting/Issuing proceduresThe customer application form used for Documentary Credits must be checked for:

Verification of signatures Limits Exchange Control/other local regulations.

Once this is done, the application must be checked to ensure that it is workable. The instructions must be clear, concise and unambiguous.

Consider the following: Do the terms and conditions agree? Is the language clear and simple? Avoid additional terms that are already covered in UCP. Protect your customer. Think about what you will accept when the documents are presented.

A reference number should now be allocated, and details of the LC entered into the appropriate computerised or manual system.

Exchange Control/Import LicenceObserve any local exchange control regulations before issuing or amending the Documentary Credit.

Where local regulations require import licences, ensure a valid licence is held by the customer and is seen. It is preferable to keep a copy in the branch records.

Check the licence against the application form to verify that the following is in order: Terms of the Documentary Credit Goods Expiry date.

Where necessary, mark the licence with the: Date the Documentary Credit was established Documentary Credit number Documentary Credit amount.

InvoiceThese should be in the form and quantity required by the customs regulations of the importing country, e.g. a Consular Invoice may be an additional requirement.


Bills of Lading Usually a full set of original Bills of Lading is delivered and the credit need only stipulate the number of originals if less than a full set is required or acceptable.

Bills of Lading should not be drawn or endorsed to the order of the bank unless exchange control regulations in the exporting country require this. If the Bank’s name appears, then the

Bank becomes a party to the Bill of Lading, rendering it liable to the shipping company and for General Average, should this be declared. It is preferable for the Bills of Lading to be drawn ‘To Order’ and blank endorsed. If the Bank’s name has to appear, an Indemnity must be taken from the applicant similar to that quoted under Air Waybills, suitably amended. (See ‘Air Waybills’ below.)

A ‘Through Bill of Lading’ (or ‘Transhipment Bill of Lading’) is issued when the carrying vessel does not travel to the final destination, so that the goods have to be transhipped to a second vessel for the final part of the journey. There are additional risks because the goods may remain at the transhipment point for some time and the second carrying vessel may be a small local vessel. Ensure transhipment is allowed in the application.

A ‘Combined Transport Bill of Lading’ is issued where part of the journey is inland. There are additional risks because speedy clearance through the ocean port of loading is needed and security is dependent upon the integrity of the forwarder.

A ‘Charter-Party Bill of Lading’ does not provide security.

A ‘Standard Liner Waybill’ is not a document of title but works in the same way as an Air Waybill. (See ‘Air Waybills’, below.)

Parcel Post ReceiptA parcel post receipt is not a document of title. The goods cannot be regarded as security, since for this to happen the bank would have to be shown as consignee.

Air WaybillsAir Waybills and Air Consignment Notes are not documents of title. The goods cannot be regarded as security just as for parcel post items.

If the bank is named on the Air Waybill or Consignment Note (a practice the bank does not normally favour) the Bank is liable to the Air Carrier, and the applicant must give an Indemnity to the bank to cover this in the following suggested form:

‘In consideration of you permitting your bank or your Correspondents to be shown from time to time as consignor and/or consignee on Air Waybills covering goods in connection with which you may from time to time be affording me/us banking facilities, I/we jointly and severally undertake to hold you and your Correspondents indemnified from and against all claims and proceedings which may be made or brought against you or your Correspondents in consequence thereof and I/we agree to pay you on demand all losses, charges, costs and expenses suffered or incurred by you or your Correspondents in connection therewith.

I/we acknowledge that your Bank (or your Correspondents) shall be the only person entitled to dispose of the Air consignments and I/we undertake and/or guarantee that such consignments will always be effected in accordance and in compliance with the Laws and Regulations applicable thereto.

Furthermore, I/we irrevocably agree that you are authorised, if at any time you think it desirable, to


disclose to anyone the fact that in all or any such transactions your name, or that of your Correspondents, appears as consignor and/or consignee on the Air Waybills on my/our responsibility.’

InsuranceThe risks covered should be appropriate to the method of transport. Descriptions such as ‘Usual’, ‘First Class’, etc. should be avoided, as they are often misinterpreted. Where merchandise is looked to as security, take particular care that cover is satisfactory.

The normal practice is to stipulate a blank endorsed Insurance Policy or Certificate.If transhipment is allowed, the insurance should cover this.

Applications must not specify ‘all risks’ insurance as some risks cannot be covered. Instead customers should be requested to specify Institute Cargo Clause (A) for sea journeys. However, this still excludes certain risks which should be carefully considered.

For Air journeys, specify Institute Air Cargo Clauses.

If the Documentary Credit does not call for insurance to be sought by the beneficiary, the applicant must produce a satisfactory insurance policy or certificate covering the appropriate risks.

Description of goodsThe description of goods should be set out clearly and briefly.Note: It is not sufficient to refer to goods only as ‘per Order No. …’ or ‘Per Proforma Invoice of (date)’ as the subsequent presentation of documents has sometimes shown to represent goods with which the bank would not want to be associated. A brief description of the goods therefore should also be stated.

Expiry dateThe expiry date should not exceed 12 months without the specific sanction of the Issuing Bank’s Controlling Office. Branches should, of course, be guided by local regulations regarding the validity of letters of credit and the terms of the import licence.

ConfirmationIf the applicant (usually at the request of the Beneficiary) needs the Documentary Credit to be confirmed by the Advising Bank: His instructions must be given on the application form An additional paragraph must be added to the Documentary Credit requesting the Advising Bank accordingly There must be a clear indication as to who is to pay the confirmation commission.

Revenue stampsApplication forms must be stamped in accordance with local law.

Alterations to application formAny alterations or deletions must be initialled by the Applicant.

AmendmentsIt may be necessary from time to time to make amendments to the credit. Usually the amendments have been agreed between the applicant and the beneficiary beforehand.

Normally most amendments are in the beneficiary’s favour, e.g. the validity/latest shipment date may need to be extended.However, remember that with irrevocable credits, amendments must be agreed by all parties. If we are asked to send an amendment which has a detrimental effect on the credit, we must ask the advising bank


to obtain the beneficiary’s written agreement, and inform us when they have received it. Until we are advised that the beneficiary has agreed to the amendment, we must assume that the original instructions still stand, and we must not yet amend any liability entries.

When asked to amend a credit, check the following points: The signatures of the Applicant requesting the amendment are authorised and in accordance with the Bank’s mandate. Limits have not been exceeded if the amount of the credit has been increased. The credit instructions remain workable. If necessary, adjustments are made to liability, and cash cover entries.

If amendment is made by telex, issue the amending telex including an advice to the reimbursing branch or bank, where appropriate. Both the telex and the advice must be authenticated by the Issuing Bank.

Increase in amountWhere the amount of a Documentary Credit is to be increased, the amendment should be worded:‘Credit amount increased by the sum of … (amount in words) … making a total in all of … (amount in words) … for which this credit has been established’.

ChargesLevy charges in accordance with the approved tariff.


LC ISSUED BY TELEX

TO: BANK OF CHINABEIJING TELEX NO 227543 BOCBJ

FROM: KOSOVO INTERNATIONAL BANK - 190 UCK Street – Pristina - Kosovo

DATE: 16th July 20XX

WE OPEN IRREVOCABLE CREDIT REFERENCE KIBDC 50678

APPLICANT: WOLF VEGLA PROFESIONALE JOSIP RELA STREET Nr 256PRISHTINA - KOSOVO

BENEFICIARY: TIAN POWER TOOLS

40 FUCHENGMEN NEI DAJIEBEIJINGCHINA

FOR: EURO 8000 (EURO EIGHT THOUSAND))

AVAILABLE AGAINST PAYMENT AT SIGHT FOR 100% OF THE CIF INVOICE VALUE ACCOMPANIED BY THE FOLLOWING DOCUMENTS:-

1. SIGNED INVOICE IN ORIGINAL PLUS ONE COPY

2. FULL SET OF CLEAN “TO ORDER” BLANK ENDORSED MARINE BILLS OF LADING MARKED "FREIGHT PAID” AND NOTIFY WOLF VEGLA PROFESIONALE - JOSIP RELA STREET Nr 256 - PRISHTINA - KOSOVO

3. INSURANCE POLICY OR CERTIFICATE (IN DUPLICATE) ENDORSED IN BLANK FOR THE INVOICE VALUE OF THE GOODS PLUS 10 PER CENT COVERING: ‘ALL RISKS’

4. PACKING LIST

5. CERTIFICATE OF ORIGIN ISSUED BY BEIJING CHAMBER OF COMMERCE

DOCUMENTS TO BE PRESENTED WITHIN 15 DAYS OF SHIPMENT BUT IN ANY EVENT WITHIN THE VALIDITY OF THE CREDIT

CREDIT AVAILABLE FOR PAYMENT IN BEIJING UNTIL 30TH AUGUST 20XX

COVERING THE FOLLOWING GOODS:

400 ELECTRIC POWER DRILLS - MODEL LM425

SHIPMENT FROM: SHANGHAI, CHINA TO: THESSALONICA, GREECE

NOT LATER THAN 15TH JULY 19XX.


LC ISSUED BY TELEX

PARTSHIPMENTS NOT ALLOWED TRANSHIPMENT NOT ALLOWED

THIS LETTER OF CREDIT IS SUBJECT TO UNIFORM CUSTOMS AND PRACTICE FOR DOCUMENTARY CREDITS 1993 REVISION ICC PUBLICATION 500.

PLEASE ADVISE THE BENEFICIARIES AFTER ADDING YOUR CONFIRMATION. THISCABLE IS THE OPERATIVE INSTRUMENT.

WE ARE NOT SENDING A MAIL CONFIRMATION.

UPON RECEIPT BY US DOCUMENTS COMPLYING WITH THE CREDIT TERMS WE WILL REMIT PROCEEDS BY MAIL TRANSFER/DRAFT TO THE CORRESPONDENT BANK NOMINATED BY YOURSELVES.

SHOULD YOU WISH THE PROCEEDS TO BE REMITTED BY TELEGRAPHIC TRANSFER THE ADDITIONAL COST OF ANY CABLES WILL BE FOR YOUR ACCOUNT.

ALL REIMBURSING CHARGES ARE FOR ACCOUNT OF BENEFICIARY.

ALL CHARGES OUTSIDE KOSOVO ARE FOR ACCOUNT OF THE BENEFICIARY. A FEE OF EURO 65 (OR EQUIVALENT) WILL BE CHARGED BY US IF DOCUMENTS CONTAINING DISCREPANCIES ARE PRESENTED FOR PAYMENT/REIMBURSEMENT UNDER THIS DOCUMENTARY CREDIT.

THIS FEE WILL BE CHARGED FOR EACH SET OF DISCREPANT DOCUMENTS PRESENTED WHICH REQUIRES US TO OBTAIN ACCEPTANCE FROM OUR CUSTOMER.

REGARDS

KIB DOC CREDITS DEPT



ADVICE OF LC SENT TO BENEFICIARY

IRREVOCABLE CREDIT No. BOC 65/432

Dear Sirs

In accordance with instructions received from Kosovo International BankWe hereby issue in your favour a Documentary Credit for Euro 8000 (say) Eight Thousand Euro available at sight for the 100% CIF invoice value accompanied by the following documents:-

1. Signed invoice in Original and one copy

2. Full set of clean “to order” blank endorsed marine Bills of Lading marked “Freight Paid” and notify:Wolf Vegla Profesionale - Josip Rela Street Nr 256- Prishtina - Kosovo

3. Insurance Policy or Certificate in duplicate, covering “All Risks” for the invoice value of the goods plus 10%

4. Packing List

5. Certificate of Origin issued by the Beijing Chamber of Commerce

Covering the following goods:

400 Electric Power Drills Model No. LM425

To be shipped form Shanghai to Thessalonica C.I.F.

not later than 15th August 20XX

Partshipment not permitted Transhipment not permitted

This credit is available for presentation to us until 30TH August 20xx

Documents to be presented to us within 15 days of shipment but within the credit validity.

“We add our confirmation to this credit and undertake that draft(s) (if required) and documents drawn under and in

conformity with the terms thereof will be honoured if presented to us”

Co-signed Thomas Wu Signed Lee Cheng

Bank of ChinaHing Min StreetBeijingChina

18th July 20XX

Beneficicry(ies)Tian Power Tools40 Fuchengmen Nei DajieBeijing China

ApplicantWolf Vegla Profesionale Josip Rela Street Nr 256Prishtina Kosovo

59

9.7 Examination of documentsAfter receiving the Letter of credit from Bank of China, the beneficiary will present documents under the LC which will eventually be received at the offices of KIB in Kosovo for examination and payment or rejection depending on any discrepancies found.

The responsibilities of the banks in checking documents are clearly stated in Article 14 of the Uniform Customs and Practice for Documentary Credits, No. 600.

Article 14 (a) A nominated bank acting on its nomination, a confirming bank, if any, and the issuing bank must examine a presentation to determine, on the basis of the documents alone, whether or not the documents appear on their face to constitute a complying presentation.

To help in checking documents, it can be useful to develop a system that you always follow. It can help to avoid mistakes and to speed up the process.

9.7.1 A typical system for examining documents could be: Check type/quantity of documents against the schedule. Read credit, and check file for any amendments. Check individual documents against the terms of the letter of credit. Most people end up checking the documents in a particular order, such as:

Invoice, Bill of Exchange Transport document Insurance Others

Only when all the individual documents have been checked are they then checked against each other to see if they are consistent.

The following checklist is a guide which may help you to check documents. You should also make reference to UCP Articles `17–28.

InvoicesSee UCP Article 18.

Issued by the beneficiary named in the credit? Addressed to applicant named in the credit? Signed, certified or notarised as required? Is the amount within the total amount of the credit? Is the description of goods exactly as stated in the letter of credit? Have additional goods been included? Does the value differ from the Draft/Bill of Exchange amount? Are the terms of contract stated (‘FOB’ etc.)? Have any changes been included which are not specified in the credit?

InsuranceSee UCP Articles 28.

Has the correct document been presented? Is the policy/certificate signed and endorsed where necessary? Are the goods correctly described? Are the correct risks covered? Is the amount of cover correct? Is the currency the same as the credit? Is the name of the ship, or other form of transport shown?


Are ports of departure/destination correct?Is the policy/certificate dated after date of shipment shown on Bill of Lading? (If risks include a warehouse to warehouse clause, insurance can be dated after date of shipment.)

Bills of LadingSee UCP Articles 19–25.

Issued by a named carrier or his agent? Are they dated on or before the latest shipment date specified in the credit? Has a full set been presented? What kind of Bills of Lading have been presented? Are they clean? Are they blank endorsed if drawn ‘to order’? Are they made out ‘to order’ when the credit stipulated direct to consignee or vice versa? Is the description of goods consistent with the invoices? Do they include additional goods? Is any ‘on board’ notation signed or initialled, and dated? Have the goods been shipped ‘on deck’? Is the name of the ship shown? Do the ports of departure and destination agree with those stipulated in the credit? Are they marked ‘freight paid’ under CFR and CIF contracts? Are alterations authenticated by the carriers or their agents?

Special documentsDocuments such as a Certificate of Manufacture, Health/Inspection/Analysis Certificates, Certificate of Origin, Weight Note etc, must conform exactly with the Documentary Credit terms.

The bank will accept the documents presented, at face value, when the Documentary Credit does not specify the following:

By whom the documents must be issued The wording The data content.

Part shipmentPartial shipments are allowed, unless the Documentary Credit specifically states otherwise. Shipments made on the same ship and for the same voyage (even if the Bills of Lading evidencing shipment ‘on board’ bear different dates, and/or indicate different ports of shipment) will not be regarded as partial shipments.

General Have all the documents been presented? Do they all relate to the same transaction (based on shipping marks and other data provided in the

documents)? Do the quantity of goods, number or parcels, gross and net weights, etc agree on all the

documents? Have all dates been met and documents been presented within 21 days of shipment or such period as specified in the credit? No additional goods should be shown in any of the documents.

9.8 Export Credits


IntroductionYour bank will receive requests from other banks to advise Documentary Letters of Credit to beneficiaries who may or may not be your customers. The advising bank will also be frequently asked to add its confirmation to the credit. All Documentary Credits advised by a bank are subject to Uniform Customs and Practice for Documentary Credits (ICC Publication No. 600, 2007 Revision).

The terms of the Documentary Credit should accord with the terms of the underlying contract or order. It is the responsibility of the Applicant to ensure that this is so, and on receipt, the Beneficiary should check to ensure that the terms of the credit are exactly as agreed with the Applicant. If the terms are not as expected, the Beneficiary should contact the Applicant direct to arrange amendments to the credit terms.

When an Inward Credit is received by us, we act as agents for the Issuing Bank and advise the Beneficiary of the Credit terms, although we may or may not be the Beneficiary’s bankers. As we are expected to act strictly in accordance with instructions received, the advising procedure will vary according to the type of credit.

When we advise a credit, we do so without engagement on our part. This means that if the Beneficiary presents documents to us which conform to the terms of the credit, we are not obliged to pay and will send the documents on to the Issuing Bank for payment.

All advices for credits, amendments and clarification must bear the following clause:‘Subject to Uniform Customs and Practice for Documentary Credits (2007 Revision): International Chamber of Commerce Publication No. 600’.

Documentary Credits received from correspondents may not necessarily refer to their being subject to UCP. In these cases the correspondent’s forms (Mail credit) or text of transcription of the electronic communication must not be altered in any way. The advices enclosing the mail forms or text of the Documentary Credits where the correspondent does not provide a copy for the beneficiary, as well as acknowledgements to the correspondents, should state that the credits will be handled subject to ‘UCP’.

Initial procedureOn receipt of a Documentary Credit in any format an official must follow the procedures below:

Verify signatures on mail credits and initial alongside If credit received by telex, mark off test number Ensure that credit terms are capable of performance and that the instructions are clear and

unambiguousCredits received by SWIFT are automatically authenticatedNote: If the terms of the export credit are incomplete or unclear, inform the Beneficiary of this by telephone and contact the Issuing Bank for further instructions by SWIFT or telex without delay. The credit may be advised to the Beneficiary as non-operative providing management approval is received.

The following clause must be added to the advice used.‘This Letter of Credit is forwarded to you for information only and must be considered non-operative until such time as we revert to you. We have contacted the Issuing Bank requesting amendment/clarification in respect of … (enter reason).’

Any documents presented before a response from the Issuing Bank has been received will be handled on an inspection basis only. This means that we the advising bank will send the documents directly to the Issuing bank and will await their decision on payment or rejection of the documents.


Register the credit into a computer or manual system which will produce: an acknowledgement to the Issuing Bank an advice to the Beneficiary which will be sent out with copy of the Letter of Credit.

9.8.1 Unconfirmed creditsWhen an Inward Credit is received but there is no request to add your bank’s Confirmation, the following clause should be added to the advice to the Beneficiary.

9.8.2 Confirmed creditsWhen an Inward Credit is advised to the Beneficiary and Confirmed by your bank, a liability must be recorded in the name of the Issuing Bank.

The following clause must be added to the advice to the Beneficiary.‘We add our confirmation to this credit and undertake that drafts and documents drawn under and in strict conformity with the terms thereof will be honoured on presentation to us’

Where the bank decides not to add its Confirmation to the Credit, the following clause must be added to advices to the Beneficiary.‘Kindly note that whilst our Principals request that we add our confirmation to this credit, we regret that on this occasion we are not prepared to do so, and we have advised them accordingly telegraphically. In accordance with Article 9 of Uniform Customs and Practice (2007Revision) ICC Publication 600, we are nevertheless advising the credit to you, but you will appreciate that it does not bear our confirmation and is, therefore, without undertaking, responsibility or engagement on our part and that the question of any payment/acceptance against your draft and documents drawn hereunder will depend solely on the position at the time of presentation, and any presentation should incorporate disposal instructions regarding the documents if we are unable to effect such payment/acceptance.’

9.8.3 Examination of DocumentsThe Advising Bank is not obliged to examine the documents presented by the Beneficiary unless it has already confirmed the Credit. In practice, many banks will in fact, examine and pay documents which conform to the terms of the Credit. The Advising bank will then claim reimbursement from the Issuing Bank in accordance with the payment terms indicated in the Credit.

If the Advising Bank decides not to pay the Beneficiary immediately, then payment will only be made after authorisation is received from the Issuing Bank.

9.8.4 Assignment of ProceedsA Beneficiary is permitted to assign some or all of the anticipated proceeds from a Credit to a third party. However the assignment only applies to future monies due under the credit and cannot become an


assignment of rights under the Credit. The assignment of any monies is reliant upon the agreement of the Advising/Confirming Bank who will require the Beneficiary (Assignor) to irrevocably commit to any assignment in writing. Article 39 of UCP 600 permits such assignments.

9.9 Specialised credits

IntroductionThe Letter of Credit is a very versatile instrument and over the years, several variations on the basic LC have been developed. These ‘specialised’ Credits assist bankers and customers alike to take a more flexible approach when providing finance and negotiating contracts with counterparties.

The most commonly used Credits in this category are:1. Red Clause2. Standby3. Revolving/Reinstatement4. Transferable5. Back to Back

9.8.1 Red Clause CreditsThe so called ‘Red Clause’ credit incorporates a special concession to the beneficiary allowing the advising bank to advance a percentage of the total credit amount before presentation of shipping documents. The clause was originally written in red ink to draw attention to this special condition.


Letter of AssignmentTo

LETTER OF CREDIT NO OF

Our Reference

We have received an irrevocable instruction (of which a copy is attached) from the beneficiary of the above credit to pay to you £ (amount in both figures and words) from the proceeds of the credit provided the terms of the instructions are complied with.If you have any query regarding when the credit will be complied with by the Assignor, please contact him direct and not through ourselves.

BARCLAYS BANK PLC

Branch

For Manager

Date

64

This type of credit is of value to middlemen and dealers in areas of commerce that require a form of pre-financing. It was used, for example, by Australian wool exporters who needed finance to buy the wool at auctions before exporting but were not able to raise the finance locally.

The general principles are as follows: A formal letter of request must be submitted to the Issuing Bank by the Applicant with the

application form, detailing the exact requirements of the clause, and undertaking to repay any advances not recovered if documents are not presented by the beneficiary.

The advising bank is then authorised at its discretion to make any advances, but is not authorised to debit our account immediately. It will be repaid out of the proceeds when documents are presented. However, The Issuing Bank must give an indemnity to the Advising bank, which assures them of repayment if documents

The beneficiary will normally obtain the advance by means of presenting a simple signed receipt, and an undertaking to present the correct shipping documents in due course. It is possible that in addition to a simple receipt, such documentation as warehouse receipts and insurance documents should be requested. To be of value, as security, these documents would have to be issued to the order of the advising bank.

The beneficiary should now present his shipping documents within the validity of the credit.

The advising bank would then claim reimbursement from the issuing bank and pay the beneficiary deducting the amount of the advance, and any interest due to them.

Note: If the beneficiary fails to ship the goods, the advising bank has the right to demand repayment of the advance together with all interest and charges outstanding from the issuing bank, which has a similar right of recourse against the applicant.

‘Red Clause’ Documentary Credits are subject to the usual considerations and the following more specific instructions: ‘Red Clause’ instructions are to be accepted only from applicants of high financial standing and

integrity. Customers wanting to establish ‘Red Clause’ Documentary Credits must complete a formal letter of

request at the time of arranging for the opening of the Documentary Credit. Negotiation should be restricted to a nominated bank.

SEE Page 66 for example of a ‘Red Clause’


9.8.2 Revolving creditsA revolving credit allows the amount available under the credit to be renewed or reinstated without the need for specific amendments to the credit. The purpose of a revolving credit is to replace a series of credits to the same beneficiary, and be able to control the size of shipments at any one time. An importer may use a revolving credit if he orders goods in quantities beyond his immediate needs to take advantage of a good price.

The revolving clause in a credit can vary depending on the particular requirements, but will normally take one of the following forms:1. A credit for Euro 2000 per month non-cumulative expiring in four months.

If all the drawings are made, the total value of the goods covered by the credit is Euro 8000 - which will be the liability recorded. Being non-cumulative, if the beneficiary fails to make a drawing in any month, he cannot claim for two shipments the following month. He can however, claim Euro 2000 over each subsequent remaining month.

2. A credit for Euro 2000 (current at any one time) valid for four months.The total amount available under this credit would only be limited by the number of drawings of £2000 which could be made within the validity of the credit and would therefore require clear instructions as to the manner in which re-instatement may be made.

When applications for credits of this type are received, they should contain clear instructions as `to © W A WISE – [email protected]

Red Clause

You are authorised at your discretion, to make available to the beneficiaries on request, as an integral part of the credit, an advance or advances on separate account in local currency subject to the total amount of such advances at any one time not exceeding the local currency equivalent of USD 16200 (UNITED STATES DOLLARS SIXTEEN THOUSAND TWO HUNDRED) from the amount of this credit.

You are in no way responsible for the application of the monies so advanced and it is understood that the granting of any advance is optional on your part.

In consideration of your making such advances under the credit, we hereby undertake to repay you on your first demand in writing, any sum owing to you by the said beneficiaries in respect of such advances which have not been repaid from the proceeds of negotiations or by cash refunds plus interest and we agree that your statement of account shall be regarded as conclusive proof of such indebtedness.

66

the manner in which reinstatement may be made:1) ‘The amount of this credit is automatically reinstated after presentation of documents in

conformity with the terms of the credit.’The above clause would involve the bank and the applicant in an incalculable liability, and so it is usual to give a degree of control by limiting the reinstatement in some way as described below:

2) ‘The amount of this credit is automatically reinstated after presentation of documents in conformity with the terms of the credit up to a total of ……….’, or

3) ‘It is understood that the amount of this credit will be reinstated after presentation of documents in conformity with the terms of the credit, but such reinstatement only become operative upon receipt by you of our advice to this effect.’


This Credit is REVOLVING to the extent that as soon as documents in conformity with the terms of the credit are received in Sheffield the amount of the relative draft drawn on the Tokai Bank Ltd., Tokyo again becomes available always provided that the amount available under the Credit at anyone time does not exceed Japanese Yen 5,000,000-. This is without engagement on the part of Barclays Bank PLC, and such reinstatements become operative only upon receipt by you of our advice to this effect.

67

9.8.3 Standby CreditsThe term Standby Letter of Credit is also within the generic description of "credits". Standby letters of credit are used to underwrite a wide variety of commercial and financial operations. They adopt the same basic forms as commercial documentary credits, but the intention is often that the beneficiary in whose favour a standby is issued draws on the credit only in case of default on the transaction to which the standby relates.

Thus, unlike a commercial documentary credit, a standby letter of credit acts as a guarantee if there is failure to perform a contractual undertaking such as the obligation of the buyer to pay or of the seller to deliver. The traditional commercial documentary credit normally provides a means of payment in the ordinary course of the transaction.

Standby letters of credit were initially developed because banks in the USA had limited legal authority to issue guarantees. This restriction was based on the view of US regulatory authorities that issuing guarantees - which involves promising to perform someone else's obligation in the case of default - is not a normal function of a commercial bank. Standby letters of credit avoided falling foul of this restriction because they were issued instead in the form of an undertaking to pay a sum of money. Today, except under limited circumstances, the restriction on the issuance of guarantees no longer exists in the USA.

The key elements within the above text are that payment/acceptance or negotiation is conditional upon: the presentation of stipulated documents

and provided that the terms and conditions of the credit are complied with

These two key elements are present in the credit product irrespective of whether the product is termed a letter of credit, a commercial credit, documentary credit or a standby credit

9.8.4 Transferable creditsThis is the only type of specialised credit which is fully covered by the Uniform Customs and Practice for Documentary Credits.

A transferable credit is one that can be transferred by the original beneficiary to one or more second beneficiaries. It is normally used when the first beneficiary does not supply or manufacture the goods himself, but is a middleman and therefore wishes to transfer part, or all of his rights to the actual supplier or manufacturer.

The transferable credit enables the middleman to give the supplier an undertaking from a bank to pay, against which they would probably be prepared to supply the goods. Without a transferable credit, a middleman of little financial standing would probably not be able to get a bank to issue such an undertaking, and so the deal would probably fall through.

A credit can only be issued as a ‘transferable’ on the specific instructions of the applicant and the issuing bank. Both the application form, and the credit itself must clearly show that the credit is transferable. Only an irrevocable credit can be issued in this form.

This type of credit can only be transferred once, i.e. the second beneficiary does not have the right to transfer the credit to anyone else - but it can be transferred by the first beneficiary to more than one second beneficiaries.

The transfer must be affected within the terms of the original credit, with the exception of the following:


Name of the first beneficiary may be substituted for that of the original applicant except where incorporated in a clause calling for it to appear in a document

Amount of the credit and any unit prices may be reduced. Period of validity, shipment date and number of days allowed for presentation of documents may all be

shortened. Place of payment/acceptance or negotiation may be changed.

When documents are presented by the second beneficiary, they are examined and if in order, payment is made. The first beneficiary now has the right to substitute only his own invoices, and bill of exchange where appropriate. These should be examined, and if in order, the first beneficiary is paid the difference between the value of his invoice and the invoice of the second beneficiary.

9.8.5 Back to Back and Counter CreditsThe expression ‘Back to Back’ or ‘Counter’ is a feature used in special transactions involving two irrevocable credits. The special transaction arises when a credit is issued by a bank in favour of the beneficiary who is not the supplier, and who is unable to obtain a transferable credit.

The beneficiary may approach his bank and ask them to issue an irrevocable credit in favour of the supplier; the terms of this second credit being based on the terms of the first credit.

Under the ‘Back to Back’ concept, the beneficiary of the first credit offers it as ‘security’ to the advising bank for issuance of the second credit. As the applicant for the second credit, the first beneficiary is responsible for reimbursing the bank for payments made under the second credit, regardless of whether or not he himself is paid under the first credit. It is for this reason that many banks do not want to get involved in ‘Back to Back’ credits.

In the case of the ‘Counter’ credit, the procedure is the same except that the first credit is not offered as security for the second credit. The bank issues the second credit within the terms of an existing credit limit for their customer (the ‘middleman’) or against ‘cash cover’.

Various types of technical problems can arise in both ‘Back to Back’ and ‘Counter’ credits and the facility is not normally encouraged by banks. Two important concepts to remember are that unlike a Transferable Credit, the second credit must make no mention of the first, and that the place of payment/acceptance or negotiation should be the same as the first credit.


10. CONTRACT GUARANTEES

Content10.1 What is a Guarantee?10.2 The role of Contract Guarantees in International Trade10.3 ‘On Demand’ Guarantees and Conditional Guarantees10.4 Surety or default bonds10.5 Main types of Guarantees10.6 The procedure for issuing guarantees10.7 Wording of Guarantees10.8 Problems for Exporters10.9 Reducing the Risks

Objectives

On completion of this chapter the student will to: Understand the role of contract guarantees and bonds in international trade Describe the various types of bonds Distinguish between on demand and conditional bonds Describe the procedures for issuing guarantees Appreciate the problems that bonds cause for exporters Understand how these problems can be reduced

10.1 What is a Guarantee?A guarantee has many definitions – some simple, whilst others are complex and legalised. Here is a list of a few definitions which might help your understanding:

1) To assume the liability for such debts of another in the event of his default.2) A contract to pay someone else’s debt if they don’t pay it.3) A promise by one person to carry out the contractual commitments of another in the event of

default. It must be in writing.4) A written assurance that some product or service will be provided or will meet certain specifications5) A collateral agreement to answer for the debt of another in case that person defaults

However, it is also necessary to consider a more formal definition and the essential difference between a guarantee and an indemnity:

1. A guarantee is a written promise made for a specified amount by one party to be collaterally answerable for the debt or default of another. The guarantor is secondarily liable i.e. the giving of the guarantee does not release the original debtor from his liability: the guarantor merely promises to pay if the debtor fails to do so.

2. An indemnity or undertaking to pay renders the party giving it primarily liable; i.e. he promises to see that payment is made and promises himself to pay under certain circumstances.


Guarantee - includes indemnities and undertakings to payGuarantor - the party issuing the guarantee i.e. the Bank Customer - the party on whose behalf and for whose account a guarantee is issued (also known

as Principal or Applicant) Beneficiary - the party guaranteed as named in the guarantee

10.2 The role of Contract Guarantees in International TradeA Guarantee is issued by a guarantor, usually a bank or an insurance company, on behalf of an exporter. It is a guarantee to the buyer that the exporter will fulfil his contractual obligations. If these obligations are not fulfilled, the guarantor undertakes to pay a sum of money to the buyer in compensation; this can be anything from 1% to 100% of the contract value.

If the guarantee is issued by a bank, the exporter is asked to sign a counter-indemnity which is a very formal legal document authorising the bank to debit his account with any money paid out under the guarantee.

Guarantees are usually required in connection with overseas contracts, or with the supply of consumer goods, capital goods and services. When there is a buyer’s market, the provision of a guarantee can be made an essential condition for the granting of the contract. Historically, guarantees were commonly required by countries in the Middle East but nowadays, this trend also extends to many other parts of the world. International Aid agencies like the World Bank, the European Development Fund, the Asian Development Bank plus most government purchasing organisations in the developing world and major purchasers of goods and services in the oil sector now require guarantees from sellers.

The demand for such instruments have increased greatly during the last few years, particularly as more and more buyers seek to protect themselves from dishonest, unreliable and less creditworthy suppliers. This need has put banks under increasing pressure to provide these guarantees without which their seller/contractor customers would struggle to compete in a tough market.

We are going to look at the different types of guarantees available, the underlying risks and the methods for minimising such risks.

10.3 On Demand’ Guarantees and Conditional Guaranteesa) ‘On Demand’ GuaranteesSometimes known as ‘unconditional guarantees’, they can be called at the sole discretion of the buyer. The bank must pay if called upon to do so, even in circumstances where it may be clear to the exporter that the claim is wholly unjustified. U.K. courts have often ruled that the bank must honour claims under on demand bonds. Banks often refer to these guarantees as “You Call – We Pay”

If the bank has to pay under the guarantee, it will debit the customer’s account under the authority of the counter-indemnity. The exporter will then be left with the difficult task of claiming reimbursement in the courts of the buyer’s country.

It must be stressed that banks never become involved in contractual disputes. If payment is called, which conforms to the terms of the guarantee, the bank must pay.

b) Conditional Guarantees


These can be divided into two types:i) conditional guarantees requiring documentary evidence;ii) conditional guarantees that do not require documentary evidence.

Conditional guarantees requiring documentary evidence give maximum protection to the exporter. Payment can be called for by the buyer only against production of specified documents such as a certificate of award by an independent arbitrator. Unfortunately, this type conditional guarantee is often unacceptable, particularly in the case of Middle East buyers.

On the other hand, conditional guarantees which do not require documentary evidence are better than on demand guarantees from the exporter’s point of view. Such guarantees often specify that payment must be made in the event of default or failure on the part of contractor to perform his obligations under a specific contract mentioned in the guarantee.

10.4 Surety or default bondsThese types of guarantees are normally issued by Insurance companies as they contain specific responsibility by the guarantor for: undertaking remedial work or finding another contractor deciding whether a default has occurred, i.e. adjudicating between beneficiary and Prime contractor.

Banks will not normally issue surety or default bonds as their main function as guarantors is to compensate the beneficiary by payment of money.

10.5 Main types of guaranteesThe main types of bonds or guarantees which banks are requested to issue on behalf of contractors or suppliers for large overseas projects are:

Tender (or bid) guarantees Performance guarantees Advance payment guarantees Retention money guarantees Maintenance guarantees

Tender (or bid) guaranteesSellers are often required to submit a guarantee with their ‘Tender’ for a contract, commonly for an amount between 2% and 5% of the contract price. The purpose of a Tender Guarantee is to indicate to the buyer that the Tender is a serious offer and that the party submitting it will sign the contract if his Tender is accepted.

The issue of such a guarantee is also an indication to the buyer that the seller is financially competent to enter into the contract. The buyer can also be assured that if the contract is awarded, then subsequent guarantees to secure performance or advance payments will also be issued.

When approached to issue Tender Guarantees, we must also ask the customer if other types of guarantees will be required by the buyer. If the ‘Tender’ is successful then almost certainly a Performance Guarantee will be required. If the bank then refuses to enter into these further guarantees, the Tender Guarantee will be called. This is because the customer will not be in a position to accept the contract without providing a Performance Guarantee and is therefore considered to be in default.

Performance guarantees Performance guarantees are usually for between 5% and 10% of the contract value. Their purpose is to


ensure performance by the seller in accordance with his contractual obligations.

These are the most commonly used type of guarantees and usually become effective on the expiry of Tender Guarantees. The wording of Tender Guarantees frequently provides that a claim will be made unless a Performance Guarantee is issued within a specified period. A Performance Guarantee is normally issued in addition to an Advance Payment guarantee and not in substitution for it.

Advance payment guarantees If an advance payment is offered by the buyer to meet the seller’s initial costs, this type of guarantee will normally be required as security for the money released. The amount of an advance payment is commonly between 10% and 20% of the contract price and it is desirable for these guarantees to be written to make them effective only upon receipt by the seller of the agreed Advance Payment.

It is also quite common for these guarantees to contain a reducing liability clause. Under its terms, the guarantee liability reduces in line either with the delivery of goods, as evidenced by shipping documents, or by the completion of work on site, as evidenced by specified completion certificates. It is most important that the wording of the guarantee makes it clear how reductions in liability are to be effected.

Retention money guarantees Some contracts provide for a percentage of each payment to be withheld until the project has been completed and accepted by the buyer. A Retention Money Guarantee enables the seller to receive the total amount of each payment while assuring the buyer that these funds will be reimbursed in the case of a failure of performance.

Maintenance guarantees Maintenance Guarantees are normally requested in connection with construction contracts. Their purpose is to ensure that once the construction has been completed, the contractor will fulfil his obligations during the maintenance period.


CONDITIONAL DEMAND PERFORMANCE GUARANTEE


Our guarantee number………………………….

We are informed that ………………………………………………………………………………………………………………………………….

(hereinafter called the Seller) have entered into a contract with you

dated……………………………………………...

for the supply of ……………………………………………………………...

and that a bank guarantee for (amount) being % of the contract is required.

On behalf of the seller we Barclays Bank PLC (branch) hereby give you our guarantee and undertake to pay you any amount or amounts not exceeding in total a maximum of (amount) on receipt of your first demand in writing provided either that it is counter-signed by the Seller as being a demand that is agreed by you both or that it is supported by a copy of an award relating to the above contract and to this guarantee made under the rules of conciliation and arbitration of the International Chamber of Commerce. Any claims must bear the confirmation of your bankers that the signatures thereon are authentic.

This guarantee is valid for written demands received by us on or before (date) after which date our liability to you under this guarantee will cease and this guarantee will be of no further effect provided always that neither you nor the Seller shall on or before the above date have given us written notice at our above address of an intention to resort to the arbitration procedure since in that event this guarantee will remain in force and effect until receipt by us of a notice of an arbitration award as provided above, or alternatively of a notice signed by or on behalf of both you and the Seller stating that a resort to arbitration has otherwise been terminated.

This guarantee is personal to you and is not assignable.

This guarantee shall be governed by English law.

74

SIMPLE DEMAND PERFORMANCE GUARANTEE


Our guarantee number………………………….

We are informed that……………………………….

(hereinafter called the Seller) have entered into a contract with you

dated……………..

for the supply of…………………………..

and that a bank guarantee for (amount) being % of the contract is required.

On behalf of the Seller we Barclays Bank PLC (branch) hereby give you our guarantee and undertake to pay you any amount or amounts not exceeding in total a maximum of (amount) on receipt of your first demand in writing. Any claims must bear the confirmation of your bankers that the signatures thereon are authentic. This guarantee is valid for written demands received by us on or before (date) after which date our liability to you under this guarantee will cease and this guarantee will be of no further effect.

This guarantee is personal to you and is not assignable.

This guarantee shall be governed by English law.

75

10.6 The Procedure for Issuing Guarantees

If the bank is satisfied that issuing a guarantee is justified, it would prefer to issue its guarantee direct to the buyer. However, in certain countries, notably the Middle East, laws or customs prevent buyers (beneficiaries) from accepting guarantees issued directly by the seller’s bank. In these circumstances, the seller’s bank will provide a counter-indemnity to a bank domiciled in the buyer’s country and instruct that bank to issue a guarantee in the form and custom applicable. (SEE DIAGRAM BELOW)

At the same time as the guarantee is issued, the seller will complete the counter-indemnity and authorise the bank to debit his account with the cost of any payments under the guarantee.

The bank will charge for this service, usually a stated annual percentage of the bond’s value. This percentage usually varies between 0.5% and 1.5% a year, payable quarterly in advance. In addition, if a local bank is involved, it will charge between 2% and 3% per annum. 10.7 Wording of guarantees

Many banks have lost large sums of money by incorrectly wording their guarantees.

Also, many draft proposals for guarantees include wording that is unacceptable to the bank which can cause delays for the customer in the negotiation of the underlying commercial contract.

Care must therefore be taken with the wording of guarantees and you must consider the following points:

Terms must be clear and unambiguous (the majority of disputes arise from the use of wording which leaves the guarantee terms open to misinterpretation).

Name and address of the Beneficiary.

Workability

The expiry date must be clearly stated in order that our liability will cease after this time.Note: The laws of some countries override the written expiry date.

The bank’s maximum liability under the guarantee must be clearly specified.

The bank will normally only issue guarantees where its commitment is clearly limited to paying away © W A WISE – [email protected]

SELLERCOUNTER-INDEMNITY SELLERS BANK

COUNTER-INDEMNITYLOCAL BANK

Issues GuaranteeBENEFICIARY

SELLERCOUNTER-INDEMNITY SELLERS BANK

Issues GuaranteeBENEFICIARY

76

money up to a specified amount against presentation of clearly specified documents. Customers must be made aware of this.

Time period during which claims must be received.

Where possible the guarantee should be subject to the law of the issuing country.

Guarantee is non-assignable.

How and with whom claims should be lodged.

Many banks have standard wording which has been agreed with their legal department, for the issuance of the most common types of Guarantee, both Simple and Conditional Demand Guarantees.

10.8 Problems for Exporters

a) The effect of Guarantees on the credit rating of the exporterBanks treat the issue of guarantees in exactly the same way as they would treat any lending facility. If payment is called for within the terms of the guarantee, the bank must pay, irrespective of whether its customer has funds to honour the counter-indemnity commitment. For this reason, banks would normally wish to reduce a customer’s maximum borrowing facilities euro for euro by the same amount as the bond.Tender guarantees present the worst problems. The average success rate is often said to be one in eight for tenders, so the average contractor may at any one time have eight tenders outstanding. If each of these tenders involves a tender guarantee of, say, 2%, then the exporter’s total potential borrowing facilities are reduced by 16% of his overall tender volume.

b) Unauthorized Extension of GuaranteesSome countries, such as Syria, have laws that prevent local banks from cancelling the guarantee without the buyer’s specific authority. This prohibition applies even if the guarantee contains an expiry date.Sometimes the local bank will threaten to call for payment unless the guarantee is formally extended. The usual result is that the local bank is able to persuade the foreign issuing bank to extend the guarantee, and therefore, annual bank commissions for providing guarantee services continue to be taken by both banks.Sometimes tender guarantees are not cancelled, even after the contract has been awarded and a performance guarantee has been issued.

c) Unfair Calling of GuaranteesThe buyer may call for payment, even when such a call is unjustified. If the call conforms to the terms of the guarantee, the bank must pay and will debit the exporter’s account under the terms of its counter-indemnity. The exporter can be left with the task of claiming reimbursement from the buyer via the overseas courts.There is also a danger that advance payment or retention guarantees could be called, even though the advance payment or retention monies have never been paid over to the exporter in the first place.

10.9 Reducing the risks© W A WISE – [email protected] 77

a) InformationThe seller should obtain the most detailed commercial and financial information available on the prospective buyer and the market. Banks can assist in this matter by using their correspondent banking relationships to obtain market information and status reports on the buyer. Chambers of Commerce and government departments dealing with trade issues can also be approached for assistance.

b) AgentThe seller should also consider employing a good local agent in markets where there are many contracts require the issue of guarantees. An agent can be particularly useful in obtaining the return of an expired guarantee so that formal cancellation can be effected. Many foreign banks continue to charge commission on bonds that have been issued against an indemnity from a seller’s bank even though the expiry date has passed. Only on formal return and cancellation do they cease to charge. In addition, the seller’s bank must continue to record a guarantee liability against the seller pending formal return of the expired/unused guarantee. Thus an agent who could obtain the return of a guarantee on its expiry date would be very useful in helping to reduce the liability and commissions being charged to the seller.

c) Build Cost into PriceThe cost of providing guarantees can be built into the contract price negotiated by the seller. When tender guarantees are required, a contract could turn out to become uneconomic if a buyer takes too long to make a decision on the choice of contractor. A penalty clause in the commercial contract which increases the price if the buyer delays should be considered, as without it seller has the unhappy choice of completing an uneconomic contract or declining the contract and being made to pay under the tender guarantee.

d) Sub-contractorsEnsure that if the exporter acts purely as a sub-contractor, any guarantee relates only to the part of the work for which he is sub-contracted.

e) InsuranceIn some countries, the seller is able to take out government backed or private-sector insurance against unfair calling of the guarantee.


11. Export Finance

Content11.1 Introduction11.2 The difference between Pre & Post Shipment Finance11.3 ‘With Recourse’ and ‘Without Recourse’ Finance11.4 Types of finance

OBJECTIVES

At the end of this Chapter the Student will be able to:

Explain what is meant by “SHORT TERM FINANCE”. Distinguish between “PRE-SHIPMENT” and “POST-SHIPMENT” finance for Exporters. Explain the significance of “WITH RECOURSE” and “WITHOUT RECOURSE” finance. Describe the various types of Short Term Finance available to customers.

11.1 IntroductionExport Finance is the lending to exporters specifically to cover the ‘gap’ between the shipment of goods and the receipt of payment. This form of finance is necessitated by the need by buyers for longer credit terms added to the greater distances involved which will cause inevitable payment delays.

By knowing which method of settlement is being used, it is possible to identify the potential market for the specific export finance product.

No legal definition of “Short Term Finance” exists, but it is usually considered that any facility which would normally be repaid within two years to be of a short term nature.

Facilities, which cover a two-to-five year period, are usually classed as ‘Medium term’ facilities and any period in excess of five years is normally classed as ‘Long term’

11.2 The difference between Pre & Post Shipment FinancePost-Shipment Finance is money required to finance the Exporter between despatch of goods and receipt of payment. Usually this period is longer for exporters than for businesses, which sell purely in the domestic market, and special schemes have been developed to meet the needs of exporters.Pre-Shipment Finance is the money required to finance the business between the commencement of the manufacturing process and the despatch of goods. This period will be identical for the exporter and the non-exporter.

11.3 ‘With Recourse’ and ‘Without Recourse’ FinanceIf finance is provided “With Recourse” then the Exporter is legally responsible for repayment of that money. If finance is provided “Without Recourse”, it means that the lender has agreed to look to someone other than the exporter for repayment. “With Recourse” finance must be shown on the customer’s balance sheet as a liability, whereas subject to the agreement of the company’s auditors, “Without Recourse” finance will not appear there.

11.4 Types of finance


Many banks are quite happy to make loans and overdrafts available to exporters as working capital, when in fact; they should really be focusing on the specific export and offering suitable products as an overall ‘export finance facility’ or on a case by case basis.

We are going to examine some of these products and the advantages/disadvantages for the customer.

11.4.1 Advances against Bills for Collection (AABC)

Earlier in this manual, we looked at the Documentary Collection process, where a bank handles documents on behalf of customer in order to get payment from a buyer abroad. Quit often, some of these exporting customers will require finance before their collections are paid. In these circumstances, the bank may be prepared, subject to normal lending considerations, to make finance available to the customer (usually up to 85% of the invoice value).

Firstly, the bank will want to ensure that the collection documents are in good order and that the credit terms offered by the exporter not exceed 180 days. Interest charges and other commissions are taken when the advance is repaid which is usually when the Collection is paid by the buyer.

These advances are with full recourse to the exporter and will only be made against Bills of Exchange which are drawn payable abroad and not subject to exchange control restrictions in the country of import. A satisfactory status report on the buyer (drawee), not more than six months old and renewed at regular intervals, is strongly recommended. The bank will also insist that the ‘collection schedule’ contain an instruction to ‘Protest for non-payment/non acceptance’

Where advances are made against a sight bill (documents against payment) collection, the bank will take a letter of pledge/hypothecation from the customer as security which in effect gives the bank control of the goods and authority to sell the goods to cover any losses.

However, under a term bill (documents against acceptance) collection, the goods will be delivered to the buyer on his acceptance of the bill so that, instead of the goods, the bank is relying on the creditworthiness of the buyer. In both cases, the bank will carefully examine the documents to ensure that it has recourse to the goods and is covered by adequate insurance prior to acceptance/payment of the collection.

As finance is made ‘with recourse’, the bank can recall the advance at any time, even before the underlying ‘collection’ is paid by the buyer e.g. the bank is informed that there could be government restrictions on the release of payment from abroad or that the buyer is facing financial difficulty.

11.4.2 Negotiation of Bills When a customer sells on Documentary Collection terms, he may be able to arrange a negotiation facility with his bank. Negotiation means the giving of value for Bills of Exchange and/or document(s) by a bank. A negotiation facility is a lending facility and normal lending criteria apply.

The bank’s basic considerations when asked to grant a negotiation facility are:

Creditworthiness and ability of the exporter, since this finance is ‘with recourse’. The buyer (drawee) provided he has accepted the bill of exchange. The goods provided that they have not been released to the importer. Under a

D/P collection, goods will not have been released, but under D/A terms, the goods will have been released to the importer on acceptance of the bill.

Existence of exchange control regulations in Importer’s country. Saleability of goods if D/P terms. Whether the terms are D/P or D/A, D/P being much more secure.


Whether there is an agreement for “ACCEPTANCE POUR AVAL” on D/A terms. Whether the documents give full control of the goods.

The facility works as follows:

1) The exporter submits shipping documents and a bill of exchange to his bank, but instead of signing a collection order, he signs a “NEGOTIATION REQUEST”, which is very similar to the collection order. This form requests the bank to negotiate and gives the exporter’s bank the right to deal with the documents in any way it thinks fit, to ensure repayment. The bank will treat each request on a case-by-case basis. By negotiating, the bank is legally buying the Bill of Exchange and shipping documents from the exporter and therefore collects the proceeds in its own name.

2) If the bank agrees to negotiate the procedure is as follows:

o If the bill of exchange is drawn in Euro, the bank immediately credits the customer’s current account with the full face value. If the Bill is drawn in a foreign currency i.e. US dollars, the bank will credit the current account with the Euro equivalent at the exchange rate on the day, assuming the customer does not maintain an account with the bank denominated in US dollars.

o The bank will debit a negotiation account with the face value of the bill of exchange. If the bill is drawn in Euro then a Euro negotiation account is debited and if the bill is drawn in foreign currency, then a foreign currency account is debited.

3) The exporter’s bank then sends the collection to the collecting bank in the usual way. The standard customer authority gives the exporter’s bank the right to vary the customer’s instructions on the collection order should it so wish. Generally speaking, the exporter’s bank will wish to


General Letter of Hypothecation

To: A Bank Plc

I/We hereby agree that all Bills and/or Documents which I/We may from time to time hand

you for discount or for negotiation or against which you may make me/us advances, and the

goods thereby represented and all insurances thereon, and the proceeds thereof, are to be held

by you as a continuing security for the payment by me/us on demand of the said bills so

discounted or negotiated and of all advances, banking accommodation and/or expenses which

you may make, afford or incur to or for me/us in connection therewith and for all my/our

other liabilities to you present or future, certain or contingent, and that you are to be at liberty

to exercise all our rights (if any) as unpaid sellers of the said goods.

I/We agree that you shall not be liable for any loss, damage or delay, however caused, which

is not directly due to the negligence or default of your own officers or servants.

Date… .20XX Signature...

81

include “PROTEST” instructions, even if the customer prefers not to do so. As far as the collecting bank is concerned, the collection is received and dealt with in the same way as any other Documentary Collection. The exporter’s bank completes its own standard collection order, so the collecting bank will not know of the negotiation facility.

4) On receipt of the proceeds, the negotiation account is cleared. Interest is calculated, and then debited to the current account. If the negotiation account is denominated in currency, then the interest is calculated in currency and the customer’s current account is debited with the Euro equivalent at the bank’s current exchange rate. Naturally the rate of interest will be based on the inter-bank rates for the relevant currency.

5) Under a ‘Negotiation’ the bank cannot legally recall the monies paid to the exporter until the bill of exchange is dishonoured by the buyer (drawee) – even if the bank knows before the due date of payment that there are problems with the buyer/importing country which could result in a default.

11.4.3 Acceptance Credit Lines

The merchant banking division of a bank, or an Accepting House merchant bank or foreign bank might offer an exporter or an importer an acceptance credit line as a means of providing finance. (This is sometimes referred to as accommodation finance). Acceptance credit lines are used in conjunction with either open account trade or else with documentary collections for obtaining payment from importers/foreign buyers

A definition of an acceptance credit arrangement is that it is an arrangement whereby a bank agrees to accept bills drawn upon it by its customer against the security of a trade bill. The trade bill should be due to mature before or at least by the date of maturity of the accommodation bill accepted by the bank.Under an agreed acceptance credit line:

a) an exporter instructs the bank to make a documentary collection of a trade bill. The documents are pledged by the exporter to the bank;

b) the exporter then draws a draft on the bank for an agreed proportion of the trade bill (say 85%) to mature a little later than the trade bills. This bank bill is known as a ‘clean’ bill or an accommodation bill;

c) the bank accepts this draft and then discounts it. The proceeds from the sale on the discount market are paid to the exporter less acceptance commission;

d) payment is received from the overseas buyer on the exporter's trade bill in time for the bank to meet its acceptance on its own accommodation draft;

e) when the bank's bill matures, the bank debits the exporter's account with the amount of the clean bill;

f) credits the exporter with the proceeds of the trade bill (in the event of non-payment of the trade bill by the overseas buyer, the bank has a right of recourse to the exporter).

The cost of an acceptance credit line is: the cost of discounting the finance bills; plus the bank's acceptance commission.

The advantages of an acceptance credit to the customer are as follows:


A bill accepted by the bank will obtain a 'finer' rate, i.e. a better rate when discounted than a trade bill. In some cases, it may not be possible to find anyone willing to discount the trade bill.

This means that acceptance credits might be a cheap source of short-term finance for the customer, even though the bank will charge an acceptance fee for the service.

Note'Acceptance credits' is also a term which might be used to describe documentary credits where the beneficiary draws term bills on the issuing bank or a named bank (ea. the advising bank). The bank then accepts the bills, and returns them to the beneficiary who may then discount them to obtain immediate payment.

This is a rather different definition of acceptance credits, from 'accommodation finance' described above. The term 'documentary acceptance credits' may therefore be used to distinguish this type of short-term financing.

11.4.4 Avalisation

Avalisation can be defined as:

"the adding of a bank's name to a bill of exchange with the intention of guaranteeing payment at maturity"

Avalisation involves a contingent liability and a bank will consider the granting of such a facility in the same way as it considers a lending facility. In other words, the bank will consider the creditworthiness of its customer.

If the bank avalises a bill of exchange it will require the customer to complete an authority where the bank is irrevocably authorised to debit the customer's account upon presentation of the bill at maturity.

Large losses have resulted in banks caused by the failure of staff to recognise the words aval, pour aval and avalisation appearing on inward collection schedules, received from banks abroad and subsequently releasing documents to the drawee merely against his acceptance and without the banks agreement to avalise accepted bills of exchange. If the drawee does not pay at maturity, the collecting bank will be held responsible.


11.4.5 Pre-shipment Finance

There are many occasions when an exporter will ask a bank to advance funds (prior to shipment of goods) against a letter of credit under which he is the beneficiary.

Bearing in mind that the Bank wants to ensure that payment is made under the Letter of Credit then the following points need consideration prior to any Agreement:

CONCLUSION: ENCOURAGE your customer to involve the bank prior to receipt of the Letter of Credit. This will help to ensure that the Letter of Credit is opened in a format acceptable to us after all the issues mentioned

above have been considered. Examine the Letter of Credit when it arrives to check that it is as required. Obtain what documents

you can from the beneficiary prior to the advance - or at least be happy that the beneficiary can present them in order.

You may need to contact any other parties involved, i.e. Freight Forwarders, Shipping Companies, Insurance Companies, Inspection Agencies, and Chambers of Commerce etc.

You may need to inform your Trade Dept. responsible for examining documents that finance has been given against the Letter of Credit.


What is the customer’s track record?

Has the customer been dealing with Letters of Credit for any length of time

What is his record for presenting documents without any discrepancies?

Is the Letter of Credit Irrevocable? It needs to be!

Where is the Letter of Credit payable? If we are to control the payment, the credit needs to be payable at our counters so that the decision to pay is ours.

Who is the Issuing Bank? Does the Letter of Credit need to be confirmed?

Is the Letter of Credit workable? If it isn't, payment is not guaranteed.

What type of documentation is required?

Are there any specialised documents requested which may prove difficult to obtain.

are they obtainable in advance do we need to talk to 3rd parties

Who holds the original Letter of Credit? If the Letter of Credit is freely negotiable, should it be held by us?

84

11.4.6 Factoring

Factoring simply means the purchasing of a debt for a discount. In effect, the factor buys the book debts of a client company for a price and arranges to pay the client company either when the debt is finally paid or, more often, by paying a proportion of the invoice value (between 70% and 80% immediately) and the balance less any expenses when the debt is collected. The factor provides a full sales administration service and charges a fee for this.

Naturally if the client company wishes to ‘draw down’ up to 70% - 80% of an invoice value immediately the invoice is processed, it will have to pay for the cost of borrowing, which can be up to 3% above a bank’s base rate or a finance-house rate.

Many large commercial banks have established subsidiary companies which specialise in the factoring business and quite often existing customers are directed to the factoring companies when they are unable to increase borrowing facilities at their local branches.

The management of the companies ‘sales ledger’ is handled by the factor, including book-keeping and sending out statements and reminders. This enables the client company to release staff for other duties as the credit control is taken over on its behalf. This should prevent strains on cash flow and, since payments tend to be collected more quickly than by the company’s own staff, the bank balance should improve.

There are principally two types of factoring: without recourse and with recourse factoring. As the terms imply, without-recourse factoring means that the factor agrees to provide debt insurance, usually for 100% of the invoice value. This means that the seller of goods or services has security of payment because if the buyer overseas refuses to pay the debt on the due date, the factor usually settles the outstanding debt and pays its client company on an agreed future date. This can be between 120 and 180 days from the date when the debt falls due. This solves one of the biggest headaches for many small companies selling overseas. Sales can be on open account or by means of bills of exchange, or even by letter of credit.

With-recourse factoring is exactly the opposite in that although that factor may agree to advance monies to client companies, there is no debt insurance and the client company stands the credit risk. Factoring can be internal for domestic debts or external in respect of export debts.

The great advantage of factoring is the administration of the sales ledger and the credit control that applies, but cash-flow considerations often mean that a smaller company can take advantage of without-recourse factoring fairly quickly. Some factors will provide an invoice discounting service that may or may not apply to overseas debts, whereby in effect factoring is undertaken on a ‘hidden’ basis so that the sales and administration ledger continue to be undertaken by the client company but the factor agrees possibly to underwrite the debt and advance monies against invoice values.

It is important to remember that client companies can only borrow money when a debt is in existence and an invoice drawn up. This is simply because factors principally purchase existing debts, not fictitious ones.

When looking at export factoring there are a number of points worth considering, and these are as follows:

a) The factoring company might be a subsidiary company of a major bank and therefore has a respectable name behind it.


b) Sales ledger administration and credit control is taken over from the client company and is usually handled expeditiously.

c) With export factoring, payment of the invoice amount is guaranteed without recourse to the exporter, unless naturally the exporter agrees that the factoring should be with recourse, thus bearing the debt risk himself.

d) Finance up to an agreed limit of between 70% and 80% of the invoice value is paid immediately the invoices are drawn up by way of advance payment, the balance being paid to the company upon settlement of the invoice debt.

e) The overseas agent of a factor actually underwrites the debt, guaranteeing that the foreign importer will pay. If any difficulty then arises, the communication is with a factoring agent in the importer’s country who can deal with the importer in accordance with local customs and in a local language.

f) The overseas agent of a factor makes credit investment reports on foreign importers so that a speedy report on the acceptability of a debt to the factor is readily available.

g) If bank collections are involved, they are usually routed through the parent bank on a normal documentary collection basis, and the exporter is usually happy with these arrangements, rather than going through a third-party bank.

h) The cost of factoring is reasonable and is split into two classes:

(i) The

commission charged by the factor handling the sales ledger is somewhere between a 0.5% and © W A WISE – [email protected]

EXPORT FACTORING INVOICE DISCOUNTING

1. 1. The bank’s customer sends his invoices t2. the factor (most factoring companies offer3. invoice discounting services).

1. The bank’s customer sends his copy invoices to the factor.

2. 2. For approved debts, the factor will advance up to 80% of the invoice at once. The factor then collects the debt himself.

2. The factor will advance up to 80% of the invoice value. The customer collects the debt himself.

3. 3. The debtor receives an invoice from the factor and sends his remittance to the factor.

3. The client’s debtor pays the client in the usual way.

4. 4. The factor then pays over the balance to the Exporter, less interest and charges.

4. The client settles with the factor when the debtor’s remittance is received.

5. 5. The factor takes over the sales ledger administration of the Exporter.

5. The Exporter is responsible for sales ledger administration.

6. Factoring is disclosed to the debtor. 6. Invoice discounting is not disclosed to the Importer.

7. 7. Charges are between 1% and 3% of turnover, plus interest on any advances.

7. Interest is charged on amounts advanced. The administration fee is relatively small, because the factor is not involved in any sales ledger administration.

8. 8. The factor will deal with every invoice of

9. the Exporter. In other words, the factor takes over the sales ledger administration

8. With invoice discounting the factor only deals with invoices against which an advance has been made.

9. Factoring will be applicable if the Exporterdoes not have the personnel to handle salesledger administration.

9. Invoice discounting is applicable when the customer wishes to continue to handle sales ledger administration himself.

10. Usually bad debt insurance is included as part of the package, and the facility is without recourse.

10. Usually bad debt insurance is included as part of the package and the facility is without recourse.

86

2% handling charge, depending upon the amount of work involved and the spread of risk in various countries, the number of debtors and the value of invoices.

(ii) The interest charged for lending the money to the factor’s clients, which, as mentioned previously, is somewhere up to 3% over a bank’s base rate or a finance-house rate.

i) If factoring is to be without recourse on an undisclosed basis, this can be done by means of Invoice Discounting so that the purchaser is unaware that a factor is involved.

j) The strain on cash flow can be eased, enabling companies with a rapid rise in turnover to survive in a competitive market.

CONDITIONS WHICH WOULD APPLY

1) Both facilities are applicable to fast growing companies with good quality debtors. The minimum annual turnover varies between factoring companies.

2) The terms of trade must be simple, with no complex documentary requirements. With factoring, normally only open account terms will apply, although documentary collection would be appropriate for invoice discounting.

3) The factor must approve the debtors. Debtors should be well spread, and the factor may be keener to cover the export business if the UK Exporter has a good spread of domestic business, which is offered as well.

CUSTOMER BENEFITS OF FACTORING

1) Sales ledger administration. (With overseas debtors the factor can handle correspondence in the language and even the dialect of the overseas debtor).

2) Protection against bad debts is available for an extra fee.

3) The client has the benefit of the factor’s computerised credit reference system.

4) Cash flow is more predictable because the client knows that he can claim up to 80% as an immediate advance against his invoices.

5) Debtors settle more quickly because the factor is more efficient at collecting the debt. Some clients use the factor purely for this reason and do not utilise the right to advances against the invoice.

6) Saving in management time. All overdue debts are “CHASED” by the factor.

7) Advice on trading terms in export markets.

8) Local collections and assistance with the resolution of disputes.

9) Protection against exchange risk when invoicing in foreign currency.

10) Swifter transfer of funds to the Export Factor.

11) Expert local knowledge of overseas buyers’ creditworthiness.

12) Financial facilities available in Euro or major currencies.© W A WISE – [email protected] 87

CUSTOMER BENEFITS OF INVOICE DISCOUNTING

1) As for factoring, except that the client must run his own sales ledger administration.

2) Invoice discounting is not disclosed to the debtors of the factor’s client.

3) Useful if the client has an efficient sales ledger team of his own.

4) This is a very fast growing service for Exporters.

Using these export services means that the Exporter can spend more time developing a positive sales relationship, with export customers. He can adopt a more aggressive approach to his marketing in the knowledge that collection problems and bad debts will be taken care of.

Export factoring/invoice discounting is particularly suitable for exports to the USA or to the EU. These facilities are not always appropriate for exports to Third World countries.

Finally do remember that factoring will only apply to goods sold on credit terms up to 180 days. These goods are usually consumer items or consumer durables and sales are usually revolving in that this facility is on a continuous basis; to some extent it is similar to an overdraft. Where capital goods are involved, other methods by which an exporter can obtain debt insurance and finance outside credit risk insurance schemes have to be considered.

11.4.7 FORFAITING

Forfaiting is the purchase by a bank of an exporters medium term trade receivables (usually evidenced by Accepted Bills of exchange or Promissory notes), which the bank either retains for presentation at maturity dates or sells to another bank in the Forfait market.

It is primarily a method of providing fixed rate non-recourse finance in support of the sale of capital and semi capital goods i.e. trucks, machinery, usually over credit periods of maximum 5 years (with repayment by instalments). It can also be used to provide short-term credit for non-capital goods.

It is used for export sales, where payments will be made over a number of years. Forfaiting deals average about Euro 2 million in value, but can be for deals as low as Euro150,000

Forfaiting works as follows:

a. An exporter of capital goods finds an overseas buyer who wants medium term credit to finance the purchase. The buyer must be willing to pay the contract values in regular instalments (perhaps every six months) normally for the agreed period usually between 3-5 years. Regular instalments are normally a condition of forfait finance.

b. The buyer will either: issue a series of promissory notes; or accept a series of drafts with a final maturity date of, say, five years ahead but providing for

regular payments over this time. In other words, a promissory note might mature every six months over a 5-year period. Promissory notes were at one time more commonly used in forfaiting than bills of exchange.


c. If the buyer has a very good credit standing, the exporter might not ask for the promissory notes (or drafts) to be guaranteed. In most cases, however, the buyer will be required to find a bank which is willing to guarantee (avalise) the notes or bills.

d. At the same time, the exporter must find a bank that is willing to be a ‘forfaiter’. Some banks specialise in this type of finance. The bank will want to know the amount of credit involved and the period of time, whether the buyer has a good credit standing or whether the buyer has found a bank of satisfactory credit standing willing to avalise his promissory notes etc. It will then either:

refuse to act as a forfeiter; indicate a willingness in principle to be a forfeiter (no charge); commit itself to be a forfeiter (at a fee to the exporter).

e. Forfaiting is the business of discounting (negotiating) medium-term promissory notes or bills. Discounting is normally at a fixed rate, notified by the bank (forfeiter) to the exporter when the financing arrangement is made. If the exporter arranges forfaiting with a bank before the export contract is signed with the buyer, the exporter will be able to incorporate the cost of discounting into the contract price.

f. The exporter will deliver the goods and receive the avalised promissory notes or accepted bills. He will then sell them to the forfeiter, who will purchase them without recourse to the exporter.

g. The forfeiter must now accept the risk: i.e. risks of non-payment. ‘The immediate advantage to the exporter is twofold. Not only does he get

cash for credit, but he does not have to worry about carrying contingent liabilities in his accounts, should the buyer default in three or four years’ time on the promissory note’. The forfaiting bank has protected itself against this risk, of course, by requiring that the promissory notes or bills be avalised by the importers bank;

political risks in the buyer’s country; the transfer risk that the buyer’s country might be unable to meet its foreign exchange

obligations; the foreign exchange risk. The forfeiter holds the promissory notes and has paid cash to the

exporter, and therefore it is the forfeiter who accepts the exchange risk. Most forfeiters will protect themselves by only agreeing to purchase (negotiate) notes or bills in currencies which they can readily refinance on a matched basis (e.g. US dollars, Swiss francs, Euro).

h. Financing costs are sometimes considered to be high because they must cover: cost of the funds provided; insurance cover against interest rate movements; insurance cover against commercial and political risks; cost of hedging against a currency which carries a high exchange risk. forfeiters profit.

By these arrangements: the forfaiting bank forfeits its right of recourse to the exporter; the buyer obtains credit for up to five or so years; the exporter obtains immediate cash from the discounted notes or bills; the forfeiter is repaid gradually as the notes or bills mature.

The currencies used in forfaiting are normally US Dollars, Euro, or Swiss francs.


I. The process of forfaiting therefore provides the exporter with immediate payment for exports and the foreign buyer obtains medium-term instalment credit from the forfaiting bank. The forfaiting bank must have confidence in the guarantee of the avalising bank, which in turn must have confidence in the creditworthiness of the buyer.

j. Promissory notes are now more popular than bills of exchange in forfaiting because by endorsing promissory notes to the forfeiter ‘without recourse’ the exporter will be freed from further liability. This is not legally the case with bills of exchange, which are drawn by the exporter himself, and the exporter must rely on the promise of the forfeiter not to take proceedings against him in the event of non-payment by the acceptor and avalising bank.

BENEFITS OF FORFAITING TO THE EXPORTER

1) The facility is flexible. The documentation can be set up in a matter of hours, whereas buyer credit facilities can take up to three months to arrange. In suitable cases, the forfait facility can cover the full amount of the contract price.

2) The rate of discount applied by the forfeitist is fixed, and subsequent changes in the general level of interest rates do not affect the discount.

3) The finance is without recourse, so there is no need for any contingent liability on the Exporter’s balance sheet. Forfaiting does not affect any other facilities, e.g. Overdraft.

4) All exchange risks, buyer risks, and country risks are removed.

5) The Exporter receives cash in full at the outset.

6) The finance costs can be passed on to the buyer if the Exporter is in a strong position to bargain.

7) Administration and collection problems are eliminated.

DISADVANTAGES OF FORFAITING

1) Costs can be high, and there is no interest rate subsidy.

2) It may be difficult to find an institution, which will be prepared to guarantee the Importer’s liabilities. Sometimes the guarantor institution may charge a high commitment fee if the buyer is not considered undoubted.


12. Principles of foreign exchange

Content12.1 The Foreign Exchange Market12.2 What is Exchange Risk?12.3 Rates of Exchange12.4 Spot Rates

ObjectivesOn completion of this chapter the student will to: Explain briefly how the foreign exchange market works Define a rate of exchange and appreciate how rates are quoted; Explain the concept of exchange risk Differentiate between the Bank’s Buy and Sell Rates Understand the difference between Fixed Forward Exchange Contracts and Option Forward

Exchange Contracts Understand the contractual position between a bank and a customer as regards forward contracts;

12.1 The Foreign Exchange Market

The Foreign Exchange Market smoothes the progress of the cross-border movement of payments related to international trade, capital movements and financial speculation. There are links too between the Worlds principal debt and equity markets and the foreign exchange market.

Often referred to as the one truly global 24-hour, 7 day-a-week market that spans the World. The trading day starts with the morning’s opening in New Zealand, travelling on through Australia, Japan and the remainder of Asia, into the Middle-East and finishes on the Pacific Coast of America. Governments, Banks, Companies and Individuals use it. Their motivations for access may differ, profit, speculation, trade payment or personal finance but all are affected directly and indirectly by the changing values of currencies. Commodity prices will change as a result of movements in currency rates. For example oil prices change as a result of movements in the dollar as this will affect transport costs, impacting on raw material, production and finished goods prices.

With an estimated daily turnover in the World Forex market of approximately USD 1.9 trillion (USD1,900,000,000,000) the volumes dwarf the other financial markets. London continues to handle the largest segment of the business, followed by New York, Tokyo and Singapore. Between them these four centres account for 80% of the total turnover.


Principal players in the market are;

Central Banks (as agents of Government). Their actions are primarily related to capital account transfers and the occasional intervention to support a currency.

International Commercial Banks are present as market makers to provide prices and the essential liquidity, their presence is for their own account as traders, risk managers and profit makers as well as providing a point of access to the markets for their clients.

Investment banks are users of the market for their own account and for the clients on whose behalf they provide debt and equity raising services.

The large Pension, Insurance and Hedge Funds are present for investment and speculative purposes. Multi-National Corporations are there to meet their own international financial commitments, manage balance sheet and P & L exposures as well as cover payables and receivables in foreign currencies. Some multi-nationals are also known to be speculators in foreign exchange, taking foreign exchange positions that are not necessarily directly linked to their business needs and are intended to be purely profit driven.

The market is split into two segments for maturity purposes, spot and forward.

We shall discuss spot and forward rates later in the section

12.2 What is Exchange Risk?Whenever businesses trade in overseas markets, the commercial contracts will include amongst other things, a price for the goods/services being provided. This price will be expressed in either local or foreign currency, depending on the negotiating skills of the parties involved and market skills.

Let us assume that an importer in Kosovo is contracted to buy goods at a price of USD 5000 – payment to be made 30 days after receipt of goods. When the contract was first drawn up, he would have anticipated paying an equivalent price in local currency of say Euro 4075 at the current exchange rate of Euro 1 = US$ 1.23. If however, he does nothing for 30 days to cover his exchange exposure and the rate moves to Euro 1 = US$ 1.20 on the date of payment of the invoice, he would have to pay Euro 4166. Therefore, making his import more expensive.

As a definition of exchange risk we could say:

‘Exchange risk exists whenever there is a commitment to pay or receive foreign currency at a future date when in the intervening period the value/cost of this currency in domestic terms will fluctuate’.

We shall look at ways in which exchange risk can be managed in Section 12.5

12.3 Rates of exchangeA Rate of Exchange is the price of one currency in terms of another. In Kosovo and most of Europe, rates of exchange are quoted as the number of units of domestic currency, which are equivalent to one unit of overseas currency e.g. 1 USD = Rates of Exchange are subject to supply and demand and are affected by interest rates, political and economic factors and Central Bank intervention. As exchange rates can be extremely volatile it is vital that foreign exchange transactions are handled promptly within the banks.

Banks offer different rates of exchange depending upon the underlying transaction. And these can be © W A WISE – [email protected] 92

divided into 2 categories:

Foreign Currency Note rates Commercial rates.

Note ratesThe rates of exchange for these transactions have a higher mark-up in comparison with commercial rates. This mark-up allows for the additional cost of holding, transporting and insuring the notes which have no value except back in their own country.

Commercial ratesThese rates are used for all transactions not involving foreign notes or coins.All commercial rates will be dealt at spot (see below) unless otherwise stated. The rates will also vary according to the size of the transaction.Customers will often ask the bank for a rate of exchange for the following purpose:

Firm DealCustomers instruct the bank to buy/sell currency, direct or through the completion of an application for a particular transaction, e.g. an overseas payment order

QuotationFor large transactions, a customer may seek a quotation as a basis on which to make a firm deal if the rate offered is acceptable.

In this situation, consider the following: You and your customer must understand that the rate given is not a firm booking at the moment. How long can the quotation be held open. Is your customer aware of the need for a quick decision and reply? Is the quotation for a valued customer, could a more favourable rate be obtained?

IndicationCustomers may ask for indication rates for their own book-keeping purposes. Such rates will not form the basis of any future firm deal.

12.4 Spot RatesBank dealers normally quote two Rates of Exchange, one the Buying Rate and the other the Selling Rate. Since the bank wishes to make a profit on the “TURN” (i.e. the difference between the two rates), it will use the higher rate for buying and the lower one for the selling.

Let us imagine that the bank is quoting their rates for US$1/Euro as 0.8146(WE BUY) – 0.8195 (WE SELL). You, the customer in Kosovo want to buy USD 500 and to pay in Euro - what rate will you get? The answer is 0.8195. Why? Because for every dollar the bank sells to you they will want Euro 0.8195, so the total cost to you will be Euro 409.75. Similarly if you were selling USD500, the bank would quote you a rate of 0.8146, and pay you Euro 407.43. The reason for this is quite logical. The bank wants to receive as many Euros as possible for each dollar it sells and the bank wants to give out as few Euros as possible in exchange for every dollar it buys.

The spot market is for transactions for delivery of the currency two business days after deal date. This convention has been established for many years and gives time for settlement (and time for correction of © W A WISE – [email protected] 93

possible errors) to be made between financial centres - allowance has to be made for the fact that there are time zone differences and thus the accounting centres for the currencies traded may not be open at the same time. There are settlement periods other than two days; for example, it is possible to get next day delivery between Canada and US banks. In trades concerning Middle Eastern currencies it is possible to get split delivery dates around weekends as the non-business days differ between centres.

12.5 Exchange Risk ProtectionExchange risk exists whenever there is a commitment to pay or receive a foreign currency at a future date when in the intervening period the value/cost of this currency in domestic terms will fluctuate.The most common bank services available to help lessen the exchange risk are:

Forward Exchange Contracts Currency Accounts.

12.5.1 Forward exchange contractsA Forward Contract is a firm and binding undertaking between the Customer and the Bank to exchange one currency for another at an agreed rate of exchange.This can be either:

On a specified date in the future – (fixed contract), or Between two specified dates in the future – (option contract).

Fixed contractThis will be arranged when the date of the transaction (buy or sell) is precisely known. The contract must be exercised on that date.

Option contractNote: This option is ‘when’ not ‘whether’.Option contracts will be arranged when the date of the transaction (buy or sell) is not precisely known. The option period, within which the contract must be exercised, can start from the date the contract is agreed (effectively today) or from a date in the future. These dates are chosen by the customer.

Examples1 Contract arranged 1/2/05

Option period 3/2/05 (spot value) to 23/4/052 Contract arranged 1/2/05

Option period 10/8/05 to 10/11/05

The customer chooses when to utilise the contract either in one or more drawings.

The only proviso is that all drawings up to the full amount of the contract must be completed within the option dates.

The maximum option period is normally three months although longer periods may be available in certain circumstances.

12.5.2 Forward exchange ratesForward rates are not determined by forecasts of future exchange rate movements but by the difference in the interest rates between the two currencies concerned.


Currencies with interest rates lower than the domestic currency (Euro) will be at a ‘premium’ and therefore more expensive to buy forward.

Currencies with interest rates higher than the domestic currency (Euro) will be at a ‘discount’ and therefore cheaper to buy forward.

The greater the interest differential between the currencies concerned, the larger will be the margin.Dealers calculate the forward rates by taking the spot rate and adding or subtracting the forward margin for the currency/period of the contract.

The margin may be at a: ‘Premium’: add to the spot rate; ‘Discount’: subtract from the spot rate.

The following examples describe one simple method by which a Bank would cover its forward contract commitments and as a result quote a margin as either a premium or discount.

Bank selling US$ to customerOn 1 March the Bank is requested to enter into a three month fixed forward contract to sell US$10,000 to a customer.

To avoid any exchange risk at maturity of the contract, the bank would:1. Purchase US$10,000 at the spot rate and place it on deposit for three months.2. Borrow the equivalent amount in Euro for three months to pay for the purchase.

At maturity, the bank would:1. Pay to the customer the US$10,000 which was held on deposit2. Receive the Euro equivalent and repay the Euro loan.

If on 1 March the US interest rates are higher than the Euro, the bank would pass on the benefit of interest to the customer by selling the dollars at a discount (cheaper for the customer). The difference between the two interest rates being the margin which when added to the spot rate will give the customer more dollars for each Euro.For example:Spot rate 0.8169Deduct three month margin 0.0038Three Month Fixed Forward Rate = 0.8131

Bank buying US$ from customerOn 1 March the Bank is requested to enter into a three month fixed forward contract to buy US$10,000 from a customer.To avoid any exchange risk at maturity of the contract, the bank would:


1. Borrow US$10,000 for three months2. Sell the dollars at the spot rate and place the euro equivalent on deposit for three months.

At maturity, the bank would:1. Receive US$10,000 from the customer and repay the dollar loan2. Pay the customer the euro equivalent previously held on deposit.

If on the 1 March the US interest rates are higher than the Euro, the bank would pass on the loss in interest to the customer by buying the dollars at a discount (more expensive for the customer). The difference between the two interest rates being the margin which when deducted from the spot rate will mean the customer giving less dollars for each pound sterling he receives from the bank.

For example:

Spot buying rate 0.8146

Deduct three month margin 0.0038

Three Month Fixed Forward Buying Rate = 0.8108

Features of forward contracts

Advantages Disadvantages

Rate fixed now for future transactions.

Firm contractual agreement by Bank and customer regardless of spot rate movements.

No cash is exchanged until maturity

Delivery can be on a fixed date or during a specified option period

Delivery on any working day

Options Forward Contacts allow partialdelivery

To some degree inflexible as it is bindingupon both parties.

Customer cannot take advantage if rates move in his favour.

Facility Limit required from bank

Delayed delivery might involve closing out or extension costs
