Modes of Payment in International Business

Modes of payment in International Business

1) Documents against payment (DP) / Cash against document (CAD) –

After the goods are shipped to the importer, the documents are sent to the importer’s bank via exporter’s bank. The importer’s bank then calls the importer and asks for payment against collection of document, sent by exporter for collection of goods from the port in importer’s country (document reaches in 3 days well before goods reach on port of importer).

Risk – Importer doesn’t go to collect the document only. Importer’s bank can’t debit any money from importer’s account in DP – no liability for importer’s bank to pay the exporter’s bank.

Still, the control of the goods has not passed over to the importer – in favor of exporter. But now the goods are at importer’s port.

Scenario - Another buyer comes and proposes to buy the goods arrived at 50% discount. The exporter will see whether selling the goods at 50% is profitable or taking back the goods via ship (return freight) and selling it in own market is profitable. Also, exporter has to see whether goods are standardized or made specific for importer’s market (customized goods) like apparels.

Corollary 1- But the buyer is actually a friend of importer and importer only asked him to go and strike a deal @ 50% discount, with exporter having nowhere to go (the warehouse at importer’s country will cost a lot to keep the goods till a buyer comes – In case, the goods are perishable like Banana, then it needs to be sold immediately or its prices because of warehouse cost, is going to hit the roof).

Corollary 2 – All – Importer, exporter and new buyer, are hand in glove. Exporter only told importer not to collect document so that exporter can show he has sold his goods at a huge discount and has thus, incurred a loss. In this way, he will get rebate from Government on his exports. Also, for the balance 50%, he will keep that money outside his country as black money. Only thing is exporter can’t do this mischief every time with Govt. or FEMA can get hold of him and he won’t be in a position to do any financial transaction (like paying vendors, office staff etc) for sustaining his business.

Where DP is done – Between subsidiaries, where promoters are same. Like between Unilever & Hindustan Lever.

2) Documents against acceptance (DA) –

It is riskier than DP.

Similar to above, the importer’s bank will give all the documents to the importer without payment. Also, they will give one more document called as bill of exchange (BOE). Importer will sign BOE promising to pay the exporter the agreed contracted sum of money 1 month from the date of shipment. The document will be handed over to importer’s bank who in turn will keep a copy for records and send it to exporter’s bank who in turn will give it to the exporter. As mentioned above, based on BOE signed copy, importer’s bank will handover the documents to importer. Importer then goes to the port, clear goods and now will pay exporter after 1 month.

(Credit is always calculated from date of shipment or date of bill of lading – lading means to carry. Bill of lading is given by the shipping company. If importer has bill of lading, it means he owns the goods. Bill of lading is title of ownership).

Risk – Goods are gone – taken by importer and importer is not obliged to pay. But in DP, at least goods were in possession of exporter.

In both DP and DA, banks are spectators. The liability of payment does not lie with exporter’s or importer’s bank. They only charge a small amount for handling the documents (fees of DA can be as low as 0.01% - 0.05% of the contractual value in India – fees is paid by both importer and exporter to their respective banks).

3) Open Account – Bank doesn’t come in between. The truck driver carries the document along with goods from one country to another (say within Europe or between US & Canada). Bank is always a far better institution than a truck driver to call and reply upon in case of an arbitration / litigation / dispute. It is the RISKIEST. Only done between subsidiaries.

4) Letter of Credit (LC) –

Less risky, but not totally riskless.

Process of LC - Importer will go to his bank to open a LC. Bank will check the credibility of the importer (repayment capacity). Importer also has to give letter of intent obtained from his distributors / sellers whom he will sell the imported goods – just to show that importer is a genuine buyer. Bank will ask for Collateral (gold, house, mutual funds etc. – Collateral value should be double than the value of LC). But in case importer already has an account (both personal and business) with the bank, which has a good repayment record, then bank may not ask for all of the above.

Bank will ask one question – Which is the bank of exporter. (Importer’s bank can directly pass on LC to exporter’s bank or it can pass it through its local partner bank in that country)

There are 3 banks involved in this transaction –

1) Importer’s bank in importer’s country – Opening Bank (Opens the LC); Issuing Bank (Issues the LC)

2) Importer’s bank branch in exporter’s country –Corresponding Bank

3) Exporter’s bank - Receiving Bank (Receives the LC); Beneficiary bank; Negotiating Bank (Negotiates documents which needs to be sent for custom’s clearance by exporter on behalf of exporter)

What is LC – It is nothing but a letter (guarantee / promissory note) issued by an opening bank (Importer’s bank) to the negotiating bank (exporter’s bank) telling the negotiating bank to pay the beneficiary (exporter) a sum of $XXX as mentioned in the contract provided beneficiary fulfills the terms and conditions fulfilled by the letter.

DA and DP is an understanding between importer and exporter and banks were just doing job of Courier Company. LC on the other hand is an undertaking given by importer’s bank to exporter’s bank asking exporter’s bank to pay the beneficiary a sum of $XXX as mentioned in the contract provided beneficiary / exporter fulfills the terms and conditions of letter of credit.

What are the terms & conditions – Documents, as mentioned above (like Bill of Lading, invoice etc.). Everything should be as per description / text in LC and may or may not be as per contract (Last date of shipment etc.).

If all the documents as per LC are in order and is received by the importer’s bank, they will immediately debit importer’s bank account and will send the money to exporter’s bank to be credited into beneficiary’s account.

Even if the importer becomes insolvent, the importer’s bank has collateral and will recover after paying the exporter’s bank.

What happens if validity of the LC expires and document has still not been submitted by exporter to his / her bank – The importer has to make amendments in LC. But importer may or may not agree to it. Importer can ask now that he wants to do a DA (as material would have left the port in exporter’s country but by the time document were submitted, LC expired).