Import Export Financing: Documentary Draft for Collection
Other than paying cash for your import purchases or using Letter of Credit financing, using Documentary Draft for Collection is another popular method how to pay for your import orders. Documentary Draft for Collection is also referred to as D/P, commonly known also as Documents Against Payment. This term implies that the export Seller uses his bank to send the shipping documents to you, the importer, or rather to your bank, which then collects the necessary funds from you before releasing the documents to you so you can finish customs clearance. Once your bank collects the funds from you, they wire transfer the money to the Seller’s bank, paying the Draft requested by the Seller’s bank.
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. You may remark why would the Seller entertain the idea to sell to you and ship the goods to your country if he has no guarantee you the Buyer / importer will have the money upon delivery of the goods at your destination, the country of importation. That is a valid assumption and for this reason most exporters will not ship orders by D/P without a deposit, say 30% to 50% of the order’s invoice amount. Once other possibility may be that the Seller and the Buyer have a good working relationship and the Seller trusts the Buyer will have funds to pay the Draft upon delivery; in essence this form of financing is similar to COD / Cash on Delivery shipments.
One important point to understand is the liability issue between banks under the scenario of Documentary Draft for Collection. Under the L/C financing, 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, 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 financing 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 financing) for there were none specified to begin with, or rather there is no point in requesting inspection as your bank is not obligated to verify that the inspection was done before paying the Draft.
In summary, Documentary Draft for Collection is the best instrument for you, the Buyer, for it does not tie up your available credit! However, as noted above, because it is not a 100% secure instrument for the Seller to get paid, few sellers will sell you goods using the D/P alone but typically will ask for a sizable deposit up front to assure themselves 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. Needless to say, D/P financing has its merits for both parties – the Sellers are able to sell and Buyers to buy provided their individual cash flow needs can accommodate the transaction timeline.