FINANCING OF THE TRADE CONTRACT

Refers to the ability to give and willingness to accept credit. Some important factors to be considered by the seller in making decisions about financing : i) The need for financing to make the sale existed; ii) The length of time the product is being financed (duration); iii) The cost of different modes of financing; iv) The risks associated with financing the transaction; v) The strength of the currency involved; and vi) The goodwill and loyalty of parties involved. Exporter / seller would prefer to be paid for the goods as soon as they are put on board ship & importer/buyer prefer to delay payment until arrival.

Contd
 Sellers

concern : Getting early payment from the buyer when goods are shipped.  Risk faced by seller : Buyers ability to pay & securing payment from buyer.  Buyers concern : Have to raise funds for payment before goods arrived.  Risk faced by buyer : If payment is made first, goods are not delivered.

METHODS OF PAYMENT
BUYER S OWN CHEQUE BANKER S DRAFT INT L MONEY ORDER

MAIL / TELEGRAPHIC TRANSFER

SWIFT TRANSFER

BILLS OF EXCHANGE

IDD

DOCUMENTARY CREDIT

DOCUMENTARY CREDIT
 Also known as letters of credit / documentary letter of credit /

commercial letter of credit.  Refers to an arrangement whereby the applicant (the importer) requests and instructs the issuing bank (the importer s bank) or the issuing bank acting on its own behalf.  Particularly useful when the seller is not too certain of the buyer s creditworthiness and financial standing.  Method of payment; that is ensures that the exporter trading on a cash basis receives a payment upon shipment of the goods.  Source of finance in international trade; that is the terms of a documentary credit may stipulate payment at a fixed date, at which time the exporter is certain of payment.

Contd
 The

system entails the involvement of a bank prepared to give an undertaking that the sale will be paid for following the delivery and tendering of the conforming documents.  In bygone days, when foreign trade was merely the buying and selling of goods by the masters of the vessels of the big trading houses, there was no need for documentary credits.  As foreign trade grow in complexity, the documentary credit becomes a useful and increasingly popular method of payment.  Today, it is used extensively and employed, particularly when the exporter is unfamiliar with the importer, and thus, reluctant to dispatch the goods without being certain of receiving payment.

Contd
 The

i)

ii)

iii)

procedure works as follows : The bank (known as the issuing bank) acting at the request of its customer (the buyer) undertakes to pay the beneficiary (the seller) directly or by acceptance and paying bills of exchange drawn by the seller or by authorizing another bank or to pay or negotiate credit for the seller. Payment is to be made only against conforming documents and where all the conditions of the letter of credit are met. The bank stands between the seller and the buyer not simply as a medium through funds could pass but which a pledge to pay the seller.

ADVANTAGES
Allows the company to expand its market share with limited risks; % Minimal paperwork; % Quick turnaround time; % No importer underwriting; % Allows the company to provide flexible credit terms to international buyers that can increase its export sales; and % Provides a source of funding for companies that may not qualify for traditional financial backing of its foreign receivables.
%

Contd
 System

involves bank giving an undertaking that payment will be made upon delivery & presentation of conforming documents.  Seller obtains payment from the bank as soon as he tenders conforming documents to the bank.

 Greater

security governed by Uniform Customs & Practice for Documentary Credits (1993) UCP. global unification achieved through efforts of ICC (International Chambers of Commerce) which set up UCP. needs to be specifically incorporated to be applicable in a country as it does not have the force of law. an express term in the contract contradicts the UCP terms, the terms of contract prevails. of documentary credit Article 2 of UCP.

 Near

 UCP

 If

 Definition

NATURE & ADVANTAGES OF DOCUMENTARY CREDIT

 Payment

through a reliable paymaster (bank).  Payment through presentation of documents.  Seller is assured of payment.  Bank in parties respective countries same jurisdiction in case of default.  Buyer needs not use own money first can raise funds through strength of documents.

of payment through letter of credit is found in the case of Soproma SpA v Marine & Animal By-Products Corp. Held : - Letter of credit is of advantage to the seller because he is given a reliable paymaster generally in his own country whom he can sue. - It is of advantage to the buyer because he can make arrangements with his bankers for the provision of necessary funds, his banker retaining the drafts & documents for making payment to the seller and the buyer being freed from necessity of having to keep the funds available to make payment against presentation of documents to him at an uncertain time

 Essence

STAGES IN DOCUMENTARY CREDIT

1
SELLER

Contract of Sale
BUYER

5 6

Seller ship the goods

4
Notification of credit

2
Instruct to open credit

8
Pass document & get paid

Document tendered to the bank. (Effect payment)

3
ADVISING BANK

Authorization to confirm credit

ISSUING BANK

Forward documents & be reimbursed

8 STAGES IN A DOCUMENTARY CREDIT TRANSACTION

Stage 1 : - Parties to the contract of sale agree to settle by way of a documentary credit. Stage 2 : Buyer / applicant applies to his bank in his own country (issuing bank) to open a credit in favor of the seller / beneficiary. Buyer / applicant will give details of the documents required ( e.g. commercial invoices, insurance policies, transport documents, certificate of quality / origin to the bank).

Stage 3 : - Issuing / opening bank instructs the correspondent bank (confirming / advising bank bank in seller / beneficiarys country) to advise the buyer of the opening of the documentary credit. Stage 4 : The correspondent / advising / confirming bank will inform beneficiary of opening of the credit. Stage 5 : - Seller will ship the goods, provided that the documentary credit conforms with what was agreed in the sale contract.
-

Stage 6 : On shipment, seller will obtain the transport documents (B / L, consignment note, certificate of quality / origin and other documents as required under the letter of credit.
-

These documents must be presented to the correspondent / advising / confirming bank.

Stage 7 : - The correspondent / advising / confirming bank will make the payment, provided that the documents are in order properly.
-

Such payment will depend on what has been agreed in the credit, either : a) payment at sight; b) deferred payment; c) acceptance credit / term credit; or d) negotiation credit.

Stage 8 : - Advising bank / confirming bank will forward the documents to the issuing bank.
-

Issuing bank reimburse advising bank and pass the documents to the buyer. With the documents, buyer can collect the goods when they arrive.

OPENING LETTER OF CREDIT / DOCUMENTARY CREDIT

 It

is the buyers duty to open letter of credit in time to enable shipment of goods.  Garcia v Page Co. Ltd (1936) Held : is a condition precedent to the sellers duty to ship goods.  Thus, if the date for the opening of the credit is stipulated in the contract, the buyer must comply with the said date.  Failure to comply with : Breach of contract (may be discharged).  The letter of credit must be made available to the seller at the beginning of the shipment period (assurance on the seller to be paid on the shipment).

Contd
Pavia & Co SpA v Thurmann- Nielsen [1952] Held : at the beginning of shipment period.  Plasticmoda SpA v Davidsons (Manchester) Ltd Held : If the shipment date is stated in contract, letter of credit must be opened by the buyer at a reasonable time before that date (calculated back from the first date of the shipment; not to be calculated from the time the contract was first made between the parties).  The duty to open the letter of credit must be strictly followed.  AE Lindsay & Co. Ltd v Cook [1953] Held : The buyers were not excused even though their failure was caused by circumstances beyond their control.


 Glencore

Grain Rotterdam BV v Lebanese Organisation for International Commerce [1997] Held : In the absence of special agreement, the seller in FOB contract were entitled to see a conforming letter of credit before they began shipment.  Article 44(a) UCP : If the letter of credit expired on a day the banks were closed, the date of expiry is extended to the 1st following day on which the bank was opened.  Article 44(c) UCP : The bank to which the presentation was made on such business day must provide statement that documents were presented within the time limit as extended.

TYPES OF LETTER OF CREDIT

Revocable, irrevocable, confirmed credits Article 6 UCP :  A credit may either be revocable or irrevocable  If there is no stipulation, it is deemed to be irrevocable.  Type of credit used is usually stated in contract.


Irrevocable credit
Increased security for seller because there is undertaking of Issuing Bank that payment will be made so long as conditions of letter of credit are met : Article 9 (a). - Cannot be amended / cancelled without the consent of the issuing bank, the confirming bank, if any; and the beneficiary : Article 9 (d). - The words irrevocable documentary credit or irrevocable credit may be indicated in the letter of credit.  Primary obligation is the undertaking of the issuing bank / confirming bank to pay against the documents.  Obligations of banks are in respect of documents, not goods.  As long as documents are in order, banks must fulfill obligations.
-

Contd
 Any

dispute between seller & buyer in respect of contract of sale will not affect the documentary credit.  Separation of letter of credit transaction from sale transaction : Articles 3 & 4 of UCP.  DISCOUNT RECORDS v BARCLAYS BANK LTD  Payment of the bank does not affect the buyers rights under the contract of sale. Buyer can always sue seller for breach of contract in the event of not receiving goods or receiving substandard goods.  Where there is fraud or illegality in the underlying transaction, no obligation exists to pay on a documentary credit.  UNITED CITY MERCHANTS (INVESTMENTS) LTD v ROYAL BANK OF CANADA

Revocable Letter of Credit

Can be amended or cancelled by the issuing bank at any time without the consent of the beneficiary.  There is no security of payment.  The words this is credit is subject to any cancellation without notice, revocable documentary credit or revocable credit are usually indicated.  Nowadays, it is rarely been applied in the international trade (not popular).  Revocable credit is least secure for seller as the buyer can cancel it any time by instructing Issuing Bank without prior notice to the beneficiary.


Confirmed Letter of Credit



The exporter / importer pays an extra charge called the confirmation fee.  This fee may vary from bank to another bank within a country.  This fee is added to the exporters account.  The exporter may indicate in the sales contract that the confirmation fee and other charges outside the sellers country are on the buyers account.  Sometimes, it is also called as an irrevocable instrument.  What constitutes a confirmation is strictly construed (ambiguities would lead to indicate it as unconfirmed credit)

EFFECTS OF FAILURE TO OPEN LETTER OF CREDIT

 If

buyer fails to open a credit as stated in the contract of sale, the seller can sue the buyer for damages (breach of contract).  Measure of damages : Difference between the contract price and the market price.  The damages awarded would include the profit the seller would have made had the contract been successfully completed subject to the rule of remoteness of damage.

Trans Trust SPRL v Danubian Trading Co Ltd

Facts :  The contract was for the purchase of steel.  The buyer did not open the letter of credit on time and the seller claimed loss of profits as damages.  The buyer argued that the seller could only claim nominal damages since the seller could have sold the steel at a profit in a market that was rising. Held : - The seller could recover the lost profits since the credit arrangement was not simply a mode of paying the seller but a mechanism which provided the seller with security & opportunity of raising credit for the purchase of materials he may need to fulfill the sale contract.

 If

the buyer fails to open a credit or the terms of the credit do not conform to the terms agreed by the parties in the contract, the seller may still decide to ship the goods  This will be regarded as a waiver on the part of the seller.  However, if seller has waived a requirement, he can reinstate the requirement by giving reasonable notice.

PAYMENT ON OPEN ACCOUNT

Occurs when a seller ships the goods and all the necessary shipping and commercial documents directly to a buyer who agrees to pay a sellers invoice at a future date. It may take place if the relationship between the buyer and seller is good. It is a norm between the parties who have been trading with each other for a long time (implicit trust). Parties agree on cash with order terms or sometimes on sight payment. Sometimes, sight payment used when the exporter sells goods to his own overseas branch or subsidiary. In CIF or FOB contracts, direct payment by the buyer is not the normal method of payment.

WASSALAMu