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Your bank here in the United States will issue such a L/C
per your instructions, to contain a set of conditions you
specify, but will do so only once you either give them the funds, say
$25,000, a sum the Seller indicated/you agreed to pay the Seller as
purchase price.
In other words, your bank will not enter into a
contractual obligation with the Seller’s bank - and L/C is in
essence a contractual agreement between the Seller’s and Buyer’s banks -
unless your bank will either collect the money from you up front or puts
lock on it in your account.
For that simple reason, it’s best that you will keep an
account in a bank that does import/export financing as oppose to having
to give up the funds for the entire course of the contract - until your
order arrives and your bank will have to pay the draft.
In such a case, you may open a special CD account in your
bank where your money will at least keep earning interest all the while
your bank has got a hold on it as oppose to parting from your money and
having your bank use it any which way they may and you earn no interest.
Letter of Credit issued by your bank will clearly show
the amount to be paid on delivery and compliance, date of expiration and
list of conditions you demand to be fulfilled by the Seller.
Customarily, an L/C will ask for specific documents to accompany the
shipment, or for all the necessary documents for the Buyer/you to clear
the US Customs.
In any case, however, Letter of Credit does not guarantee
the quantity and quality of goods shipped!
Special Conditions would be those that can guarantee
count, quality, and packing! This is covered in depth in the Letter of
Credit publication and the course on tapes.
To summarize:
-Buyer tells his bank
-the nature of the
transaction/goods he is buying
-the maximum invoice
amount to be paid
-the documents the
beneficiary (exporter) must present in order to receive payment
-the latest date for
presentation of the Shipping Documents
-the expiration date for
the credit
-your bank then
instructs its correspondent bank in the country of the exporter to
inform the beneficiary that the L/C has been issued in his favor
When your order arrives
at your destination, the documents come to your bank for so called
negotiation, a process whereby your bank reviews the documents and
makes sure that all of your conditions you specified were met.
Once again, beware: when
Documents arrive to your bank, bank will examine the Documents, but does
not itself guarantee the quality and quantity of goods shipped!
To guarantee yourself
not only the quantity but also the quality of the goods shipped, you
should employ the use of a document called Certificate of Inspection.
Without this document,
your bank could pay the draft, release the documents to you, you would
take them to your Customhouse Broker to clear US Customs only to find
out thereafter that your order is short on count and instead of blue you
received green!
Certificate of
Inspection is an instrument where you ask for an inspection of
the shipment to guarantee yourself quantity and quality of goods
shipped.
This inspection is
typically done just prior to shipment from the country of origin.
If you asked for such a
document and the document is not enclosed with the rest of the documents
upon arrival, your bank isn’t obligated to pay the draft and the L/C
contract becomes void.
Naturally, a seller
would probably negotiate with you a discount on the shipment so
that he would not have to pay for the goods to be shipped back to the
point of origin at his cost, a most likely loss for the Seller.
Once again, if a
Draft is presented for payment after expiration of the L/C, the
Documents arrive late, the L/C would not be paid, Documents would be
returned to the shipper and the Seller would have to provide for the
return of his goods back at his expense. At this point, Seller and Buyer
may negotiate a discount on the existing L/C. If an agreement is
reached, the existing L/C must be amended, Buyer will be purchasing
discounted goods, and his bank pays the discounted draft.
The other scenario, when
your bank would not be obligated to pay the draft, is if both the
shipment and the documents would arrive at the Buyer’s bank after the
expiration of the L/C. Typically, sellers will ask, however, for
date of expiration to be well past their estimated date of delivery so
that such a case would not happen.
The Draft is called
Documentary Draft because it is to be accompanied by Documents to be
delivered to the Drawee/you/the Buyer on Payment, or on Acceptance of
the Draft.
-L/C may involve either
Sight or Time Drafts:
-Sight Draft are payable
on presentation
-Time Drafts are payable
at some specified future date
Letter of Credit is
either Revocable or Irrevocable.
-Revocable: may be
amended or canceled at any time, without approval by the Beneficiary
-Irrevocable: cannot be
amended or canceled without the consent of all parties
In closing, it is
necessary to point out that Letter of Credit, no matter how secure the
transaction, is today an expensive method of payment. The banks
charge upwards of $500-$600 to issue and negotiate a letter of credit
plus a percentage to pay the draft and wire the money to the Seller’s
bank.
In other words, it’s not
in your favor, the Buyer, to pay for your goods by a Letter of Credit
unless you are buying at least $5-$6,000 worth of goods, otherwise your
inherent costs entailed in the L/C will constitute too high a percentage
of your invoiced value of purchases.
On the other hand, if
a secure transaction and time is of essence, then payment by an L/C
is recommended, regardless of the high costs.
Let’s say that you want
your order to arrive no later than December 1 because you intend to
market the goods only before Christmas. The date of expiration on the
Letter of Credit will assure you that you’ll either have the goods on
time and sell them before Christmas or you don’t have to take the goods
if the shipment should be late.
Documentary Draft for
Collection
Documentary Draft for
Collection is also referred to as D/P, commonly known also as
Documents against Payment.
A Draft is an
unconditional order in writing, signed by the Seller, the Drawer,
addressed to the Buyer, the Drawee, ordering him to pay on presentation
- Sight Draft, or at future date, Time Draft.
A Draft is
"documentary" because it is accompanied by documents delivered to
the drawee on payment (or acceptance) of the draft. Hence it is known
also as "bill of exchange."
A Draft indicates
payment is to be made usually to the Seller's bank which handles the
collection on behalf of the Seller. Thus Seller keeps control of the
merchandise through the Collecting Bank until the Buyer has paid.
Here lies the difference as compared to the Letter of Credit.
Under the L/C, the
Seller is not looking to you, the Buyer, for the payment but directly to
your bank. Under the D/P, the Seller is looking directly to you, the
Buyer, for the Payment.
Thus under L/C, the
Seller has the maximum protection that he gets paid whereas under the
D/P he does not. If your bank can’t collect money from you, the Seller
won’t get paid and will have to provide for the return of his goods at
his expense.
Under the L/C, there was
a contractual agreement between two banks. Under the D/P there is none.
Seller’s bank merely uses the Buyer’s bank to collect the money but the
collecting bank is under no contractual liability to the Seller’s bank.
Under the international
guidelines for the collection of documentary credits (see
publication, Letter of Credit), the collecting bank is merely to
exercise caution and act to the best of their ability. To use the exact
words: under the D/P, “banks are only to act in good faith and exercise
reasonable care” (as governed by Documentary Credit Collection
guidelines issued by the International Chamber of Commerce).
In other words, the
difference between selling against an Irrevocable L/C and selling
against a Documentary Draft for Collection lies in the degree of
protection that these methods give to the Seller/the Exporter!
-Under the L/C banks
have committed themselves to pay.
-Under the Drafts for
Collection banks merely act as “collecting agents” on behalf of the
Seller, who must look to the Drawee/the Buyer for the actual payment of
his Drafts!
Under the D/P, the
collecting bank is not obligated to check if all Documents are present,
nor whether any Special Conditions are fulfilled (as is the case under
L/C) for there were none specified to begin with!
In summary, Documentary
Draft for Collection is the best instrument for you, the Buyer, for it
does not tie up your available credit!
Because it is not a 100%
secure instrument for the Seller to get paid, no seller will sell you
goods using the D/P alone but typically will ask for a sizeable deposit
up front to assure himself that you, the Buyer, will come up with the
rest of the money when the goods arrive to your destination and the
documents to your bank with the draft for your bank to collect on.
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