The sale of goods and services to foreign buyers entails additional and greater risks than domestic business transactions. With export orders, such risk can crop up at any point from the purchase of raw materials, through the manufacturing and storage of goods, to delivery and payment within the agreed time. That is why securing performance, risks and payment in foreign trade is more important.
Buyer and Seller
This article does not deal with the actual risks that may occur, but explains how the interests of buyers and sellers can be protected. For the buyer, compliance with the terms of the performance is of primary importance, while for the seller, prompt payment is the priority.
Risks
The risks involved are accentuated in foreign trade transactions since the buyer is less able to judge the reliability of a foreign supplier than that of a domestic one. In case if the terms of the contract are not fulfilled, it is much more difficult to bring legal action.
The same applies, of course, to the seller or exporter, who not only incurs additional transport risks but also the increased risk of not receiving the payment. Furthermore, difficulties may arise in appraising the country risks involved (currency and transfer risks, the threat of social, political and military conflicts).
Instruments for securing performance and payment
How the buyer can secure performance?
The buyer wants to be certain that the seller is in a position to honour his commitment as offered or contracted. Which can be achieved with the following guarantee instruments provided by a bank.
- The bid bond guarantees that the seller considers his bid to the buyer binding until the contract is awarded. The buyer thus protects himself from the seller backing out of the offer prematurely.
- The performance bond is a financial instrument guaranteeing that the seller fulfils his performance obligations in the agreed manner and within the agreed time frame.
How the buyer can secure payment?
Mostly contracts are for the seller to receive the advanced payment. This is intended to allow the seller to purchase raw materials or to cover initial production costs. To ensure that such funds are not used for the purpose other than those stated in contract, the buyer may demand that an advance payment guarantee be provided by the bank.
How the seller can secure payment?
Payment methods based on degree of security:
- Open account
- Acceptance of a draft
- Documentary collection
- Unconfirmed documentary credit
- Confirmed documentary credit
- Payment guarantee (issued by buyer’s bank)
- Confirmed standby letter of credit
- Advanced payment
Open account
If the amount involved is fairly small and the mutual trust exists between the two parties to the transaction, a foreign business deal may under certain circumstances best be effected on an open account basis. This method does not give any special security for the payment but has advantage that the administrative work involved with a transaction can be kept to a minimum. On the other hand, it would be irresponsible for a company to supply the goods or services to a foreign buyer if a relationship of mutual trust is lacking or if the country involved presents too many risks for this type of settlement.
Acceptance of a draft
If the seller grants a period of time before the buyer needs pay, the seller can secure payment by means of a draft accepted by the buyer. However, the degree of security this provides very much depends on the law governing bill of exchange in the buyer’s home country. Greater security is provided if the draft is also accepted and/or guaranteed by a third party, e.g. the buyer’s bank.
Documentary collection
Documents against payment
In the case of a documentary collection against payment, the collecting bank may release the shipping documents only when the invoiced amount has been paid. This is, however, a means of payment to be used only in reliable circumstances and if there is absolute trust between the contractual parties.
Documents against acceptance
This is a special type of documentary collection. As a rule, the shipping documents are sent via the seller’s bank to the importer’s bank, with instructions to release the documents only upon the acceptance of the accompanying draft. In such case the buyer accepts the draft.
This procedure has the disadvantage that the buyer can take possession of the goods before actual payment is made. The buyer has commitment to pay, but it is not always easy to collect the sum represented by the draft in the buyer’s country. It is there for an advantage if the collecting bank or any other prime bank guarantees payment of the draft as an additional security.
Unconfirmed documentary credit
In the case of an unconfirmed documentary credit, the issuing bank (usually the buyer’s bank) assumes an irrevocable commitment to honor when the proper documents are provided with in the time and on the terms stipulated in the documentary credit. No commitment on the part of second bank exists because it can lead to difficulties in countries where substantial political or a transfer risks are involved.
Confirmed documentary credit
A confirmed documentary credit means that in addition to the issuing bank, a second bank (the confirming Bank) assumes the irrevocable commitment to honor or negotiate without recourse, provided the terms of the credit are fulfilled. In most cases, the seller thus avoids the credit and country risks associated with the unconfirmed documentary credit.
Payment guarantee
When it uses a payment guarantee, a bank promises to pay exporter on the first demand if the latter presents a statement to the bank confirming that he has not been paid for the goods and services supplied. Such a guarantee is subject to time limits and is particularly suitable for trade in consumer goods.
Confirmed standby letter of credit
A standby letter of credit is essentially a variant of the payment guarantee. It is subject to the uniform customs and practice for documentary credits. Confirmed standby letter of credits are usually honored or negotiated without recourse in return for a declaration stating that the amount owed has not been paid.
