Exporting can greatly expand a small business, providing the exporter gets paid! Bob Ronai explains how to ensure payment using an L/C—letter of credit—and what an exporter needs to do to meet the requirements of this agreement.
Before shipping goods to an overseas buyer, you need to make sure the deal won’t spring a leak and drown you in unpaid invoices and the frustrating, time-wasting, and costly business of chasing that money.
Documentary credits, more commonly called ‘letters of credit’ or ‘L/Cs’, are an excellent mechanism for exporters to ensure they get paid, but most exporters are afraid of them.
Of course, the best way of being paid for an export sale is to receive the money before sending the goods overseas. While this works fine for a small exporter with one-off sales made over the internet direct to consumers, it puts any serious exporter at a distinct disadvantage in international markets.
Where the exporter has a product in high demand and can call the tune, he may be able to insist on being paid up-front. Smaller Australian exporters are unfortunately unlikely to be in this position. They will find that many overseas customers will balk at handing over payment prior to shipment because they may not know the exporter or because they don’t want to lose the use of their funds until the last possible moment. The exporter will quite likely be competing for the sale against the buyer’s local suppliers who might offer credit terms, or against other exporters who might offer the opportunity to pay by L/C.
An exporter has several issues to resolve, including how to know that the buyer is genuine about this order; whether the buyer really will pay; when will they pay; and can they take the risk to start producing this special order? This is where an L/C comes into play. Instead of relying on nebulous promises from the buyer to the exporter to ‘trust me!’, the buyer has his bank issue an L/C to the exporter. This helps the exporter by:
• reassuring the exporter that the order is genuine
• knowing there is a firm commitment to pay before shipping
the goods
• replacing the buyer’s creditworthiness with that of the
issuing bank
• knowing the L/C is irrevocable, it can’t be cancelled by the buyer or even the issuing bank.
Covering Risk
There is a further step which the exporter can take by asking a bank at this end to ‘confirm’ the L/C. The bank will charge a fee for this based on how they see the risks and the period of time involved. There are three distinct risks to cover:
• country risk—such as political issues
• bank risk—the creditworthiness of the issuing bank
• document risk—if the confirming bank is satisfied that the documents are correct it will pay the exporter even if the issuing bank later alleges a discrepancy and refuses to pay.
As well, the exporter should make sure that they obtain the confirming bank’s written agreement to ‘discount’ the transaction, so that when they are satisfied that the exporter documents comply with the L/C, they will pay the value to the exporter. The bank will later debit the exporter with interest for the period of time between paying the exporter and being reimbursed by the overseas bank. Therefore, the maximum period, normally no more than 15 days, should also be stated in the confirming bank’s agreement.
An L/C is a promise by the issuing bank that, contingent upon the exporter presenting complying documents, payment will be made. It will consist of several sections of information, sometimes spread around the document and sometimes grouped together. These are:
Dates:
• L/C number, and issue date
• expiry date and place of expiry—being the last date on which documents can be presented for payment, normally in the exporter’s country
• latest shipment date—if none is shown then that is the same as the expiry date
• presentation period—if none is shown then it is 21 days after the shipment date
Main parties:
• issuing bank—almost always being the buyer’s bank
• advising bank—the bank that passed the L/C on to the exporter, for an advising fee
• the applicant—normally the buyer who applied to his bank for issue of the L/C
• the beneficiary—being the exporter or seller who benefits from the L/C
Transport:
• port or country from which the shipment will be made
• destination port or country
• whether partial shipments are allowed (either when not all the quantity of goods are shipped or goods are despatched in two or more shipments)
• whether trans-shipment is allowed (where goods are shipped by more than one vessel enroute to the destination; for example, Sydney to Singapore on one ship, then Singapore to Dubai by another subsequent ship)
Goods:
• a description of goods in minimum but essential detail, normally quantities, a brief description of the items, prices, and reference to a contract or order (this whole description must appear in full on the commercial invoice but all other documents can show a brief general description)
Documents required:
• commercial invoice
• packing list
• bill of lading for sea freight, air waybill for airfreight
• other documents such as Certificate of Origin, Insurance Certificate
Additional conditions:
• instructions regarding extra information to appear on documents, such as L/C number
• instructions to the bank to which the documents are presented (the negotiating bank) about how the documents are to be sent to the issuing bank
• various other instructions and conditions
Reimbursement and charges:
• instructs the negotiating bank how to claim payment
• instructs who pays bank charges outside the issuing country, normally paid by the beneficiary
Rules & Guidelines
All L/Cs are issued in accordance with international rules issued by the International Chamber of Commerce (ICC) commonly known as UCP500, and it is against these 49 rules that banks will judge whether the documents comply with the L/C or not. There is a new set of guidelines known as the ISBP645 published by the ICC. They are intended to resolve some issues but this has not found huge favour with banks yet.
When the exporter first receives the L/C, he should immediately read and analyse the L/C’s wording, and if necessary instruct the applicant if certain items need to be amended. And when L/Cs are issued in countries where their command of English is less than perfect, instructions may be unclear or ambiguous. Should the exporter have any doubts about the meaning of any part of an L/C he should query it with his bank, keeping in mind that the bank is just that, and the commercial aspects are for the exporter to decide. Sometimes an exporter will refer an L/C to his freight forwarder but, unfortunately, the great majority of forwarders don’t know the UCP500 rules or even that they exist. And so, seeking advice only from this quarter is not particularly reliable. In the end, the exporter should be totally satisfied that they will be able to present complying documents to their bank before taking the next steps of producing and shipping the goods.
The onus is on the exporter to ensure their documents comply absolutely and strictly with the requirements of the L/C. Once the L/C is acceptably worded and understood by the exporter, then it becomes an excellent means by which they will be paid, and they can proceed to production and then shipment.
* Bob Ronai is a director of Import-Export Services and also operates the Export Document Service. He can be contacted on (02) 9440 3900, or visit www.exports.com.au
