FINANCING FOREIGN TRADE SHIPMENT

International Trade
By G. Miranda

• In financing foreign trade shipment, the terms of sale are a matter of

arrangement between buyers and sellers, and these terms are generally
influenced if not actually circumscribed by such factors as custom, credit
standing of the buyer, exchange control measures, if any, and whether the
customer is old or new.
• Generally speaking, four distinct methods may be used, such as:
consignment, open account, drafts and commercial letters of credit. For our
purpose however, we shall focus our attention only on two: commercial
letters of credit and bills of exchange or drafts.

COMMERCIAL LETTER OF CREDIT

In the Philippines, in accordance with Circular No.44 issued by the Central Bank
of the Philippines on June 12, 153, payment for imports into this country shall be
effected through letters of credit with certain exceptions.

LETTER OF CREDIT (LC)

[Link] retrieved 9/15/2020

A Letter of Credit is a payment term generally used for international sales

transactions. It is basically a mechanism, which allows importers/buyers to offer secure
terms of payment to exporters/sellers in which a bank (or more than one bank) gets
involved. The technical term for Letter of credit is 'Documentary Credit'. At the very
outset one must understand is that Letters of credit deal in documents, not goods. The
idea in an international trade transaction is to shift the risk from the actual buyer to a
bank. Thus a LC (as it is commonly referred to) is a payment undertaking given by a
bank to the seller and is issued on behalf of the applicant i.e. the buyer. The Buyer is
the Applicant and the Seller is the Beneficiary. The Bank that issues the LC is referred
to as the Issuing Bank which is generally in the country of the Buyer. The Bank that
Advises the LC to the Seller is called the Advising Bank which is generally in the country
of the Seller.
 The specified bank makes the payment upon the successful presentation of the
required documents by the seller within the specified time frame. Note that the Bank
scrutinizes the 'documents' and not the 'goods' for making payment. Thus the process
works both in favor of both the buyer and the seller. The Seller gets assured that if
documents are presented on time and in the way that they have been requested on the
LC the payment will be made and Buyer on the other hand is assured that the bank will
thoroughly examine these presented documents and ensure that they meet the terms
and conditions stipulated in the LC.

Typically the documents requested in a Letter of Credit are the following:

 Commercial invoice
 Transport document such as a Bill of lading or Airway bill
 Insurance document
 Inspection Certificate
 Certificate of Origin
 But there could be others too
Letters of credit (LC) deal in documents, not goods. The LC could be 'irrevocable' or
'revocable'. An irrevocable LC cannot be changed unless both the buyer and seller
agree. Whereas in a revocable LC changes to the LC can be made without the consent
of the beneficiary. A 'sight' LC means that payment is made immediately to the
beneficiary/seller/exporter upon presentation of the correct documents in the required
time frame. A 'time' or 'date' LC will specify when payment will be made at a future date
and upon presentation of the required documents.
Essential Principles Governing Law Within the United States, Article 5 of the Uniform
Commercial Code (UCC) governs L/Cs. Article 5 is founded on two principles: (1) the
L/C,s independence from the underlying business transaction, and (2) strict compliance
with documentary requirements.

1) Strict Compliance
How strict compliance? Some courts insist upon literal compliance, so that a misspelled
name or typographical error voids the exporter's/beneficiary's/seller's demand for
payment. Other courts require payment upon substantial compliance with documentary
requirements. The bank may insist upon strict compliance with the requirements of the
L/C. In the absence of conformity with the L/C, the Seller cannot force payment and the
bank pays at its own risk. Sellers should be careful and remember that the bank may
insist upon strict compliance with all documentary requirements in the LC. If the
documents do not conform, the bank should give the seller prompt, detailed notice,
specifying all discrepancies and shortfalls.

2) The Independence Doctrine

Letters of credit deal in documents, not goods. L/Cs are purely documentary
transactions, separate and independent from the underlying contract between the Buyer
and the Seller. The bank honoring the L/C is concerned only to see that the documents
conform with the requirements in the L/C. If the documents conform, the bank will pay,
and obtain reimbursement from the Buyer/Applicant. The bank need not look past the
documents to examine the underlying sale of merchandise or the product itself. The
letter of credit is independent from the underlying transaction and, except in rare cases
of fraud or forgery, the issuing bank must honor conforming documents. Thus, Sellers
are given protections that the issuing bank must honor its demand for payment (which
complies with the terms of the L/C) regardless of whether the goods conform with the
underlying sale contract.

3 Most Common Reasons why Letters of Credit Fail

1) Time Lines:
The letter of credit should have an expiration date that gives sufficient time to the seller
to get all the tasks specified and the documents required in the LC. If the letter of credit
expires, the seller is left with no protection. Most LC s fail because
Sellers/Exporters/Beneficiaries were unable to perform within the specified time frame in
the LC. Three dates are of importance in an LC:

a) The date by when shipment should have occurred. The date on the Bill of Lading.
b) The date by when documents have to be presented to the Bank
c) The expiry date of the LC itself.

A good source to give you an idea of the timelines would be your freight forwarding
agent. As a seller check with your freight forwarding agent to see if you would be in a
position to comply.

2) Discrepancy within the Letter of Credit:

Letters of credit could also have discrepancies. Even a discrepancy as small as a
missing period or comma can render the document invalid. Thus, the earlier in the
process the letter of credit is examined, the more time is available to identify and fix the
problem. This is another common reason why LCs fail.

3) Compliance with the Documents and Conditions within the Letter of Credit.
Letters of credit are about documents and not facts; the inability to produce a given
document at the right time will nullify the letter of credit. As a Seller/Exporter/Beneficiary
you should try and run the compliance issues with the various department or individuals
involved within your organization to see if compliance would be a problem. And if so,
have the LC amended before shipping the goods.

Types and Features of Letters of Credit

[Link]
[Link] retrieved 9/15/2020
Most letters of credit are import/export letters of credit, which, as the name implies,
are letters of credit that are used in international trade. The same letter of credit would
be termed an import letter of credit by the importer and an export letter of credit by the
exporter. In most cases, the importer is the buyer and the exporter is the beneficiary.
There are also other types of letters of credit. The revocable letter of credit can be
changed at any time by either the buyer or the issuing bank with no notification to the
beneficiary. The most recent version of the UCP, UCP 600, did away with this form of
letter of credit for any transaction under their jurisdiction. Conversely, the irrevocable
letter of credit only allows change or cancellation of the letter of credit by the issuing
bank after application by the buyer and approval by the beneficiary. All letters of credit
governed by the current UCP are irrevocable letters of credit.
A confirmed letter of credit is one where a second bank agrees to pay the letter of
credit at the request of the issuing bank. While not usually required by law, an issuing
bank might be required by court order to only issue confirmed letters of credit if they are
in receivership. As you might guess, an unconfirmed letter of credit is guaranteed
only by the issuing bank. This is the most common form with regard to confirmation.
A letter of credit may also be a transferrable letter of credit. These are commonly
used when the beneficiary is simply an intermediary for the real supplier of the goods
and services or is one of a group of suppliers. It allows the named beneficiary to present
its own documentation but transfer all or part of the payment to the actual suppliers. As
you might guess, an un-transferrable letter of credit does not allow transfer of
payments to third parties.
A letter of credit may also be at sight, which is payable as soon as the documentation
has been presented and verified, or payment may be deferred. Deferred letters of credit
are also called a usance letter of credit and may be put off until a certain time period
has passed or the buyer has had the opportunity to inspect or even sell the related
goods.
A red clause letter of credit allows the beneficiary to receive partial payment before
shipping the products or performing the services. Originally, these terms were written in
red ink, hence the name. In practical use, issuing banks will rarely offer these terms
unless the beneficiary is very creditworthy or an advising bank agrees to refund the
money if the shipment is not made.
Finally, a back-to-back letter of credit is used in a trade involving an intermediary,
such as a trading house. It is actually made up of two letters of credit, one issued by the
buyer's bank to the intermediary and the other issued by the intermediary's bank to the
seller.

Documentation Requirements
In order to receive payment, the beneficiary must present documentation of completion
of their part in the transaction to the issuing bank. The documents that the issuing bank
will accept are specified in the letter of credit, but may often include:

 Bills of exchange
 Invoices
 Government documents, such as licenses, certificates of origin, inspection
certificates, embassy legalizations, and phytosanitary certificates
 Shipping and transport documents, such as bills of lading and airway bills
 Insurance policies or certificates, except cover notes

Risks in Letter of Credit Transactions

Letter of credit transactions are not without risks. The risks inherent in these types of
transactions include:

 Fraud risk, in which the payment is obtained through the use of falsified or
forged documents for worthless or nonexistent merchandise
 Regulatory risk, in which government action may prevent completion of the
transaction
 Legal risk, in which legal action prevents completion of the transaction
 Force majeure risk, in which completion of the transaction is prevented by an
external force, such as war or a natural disaster
 Failure of the issuing or collecting bank
 Or insolvency of the buyer or beneficiary

You may also watch the video: [Link]

 BILLS OF EXCHANGE OR DRAFTS

[Link] retrieved 9/15/2020

By MARSHALL HARGRAVE
 Reviewed By SOMER ANDERSON 
 Updated Jul 14, 2020

What Is a Bill of Exchange?

A bill of exchange is a written order used primarily in international trade that binds one
party to pay a fixed sum of money to another party on demand or at a predetermined
date. Bills of exchange are similar to checks and promissory notes—they can be drawn
by individuals or banks and are generally transferable by endorsements.

 
Bill of Exchange
KEY TAKEAWAYS

 A bill of exchange is a written order binding one party to pay a fixed sum of
money to another party on demand or at some point in the future.
 A bill of exchange often includes three parties—the drawee is the party that pays
the sum, the payee receives that sum, and the drawer is the one that obliges the
drawee to pay the payee.
 A bill of exchange is used in international trade to help importers and exporters
fulfill transactions.
 While a bill of exchange is not a contract itself, the involved parties can use it to
specify the terms of a transaction, such as the credit terms and the rate of
accrued interest.
How a Bill of Exchange Works
A bill of exchange transaction can involve up to three parties. The drawee is the party
that pays the sum specified by the bill of exchange. The payee is the one who receives
that sum. The drawer is the party that obliges the drawee to pay the payee. The drawer
and the payee are the same entity unless the drawer transfers the bill of exchange to a
third-party payee.

Unlike a check, however, a bill of exchange is a written document outlining a debtor's

indebtedness to a creditor. It's frequently used in international trade to pay for goods or
services. While a bill of exchange is not a contract itself, the involved parties can use it
to fulfill the terms of a contract. It can specify that payment is due on demand or at a
specified future date. It's often extended with credit terms, such as 90 days. As well, a
bill of exchange must be accepted by the drawee to be valid.

Bills of exchange generally do not pay interest, making them in essence post-dated

checks. They may accrue interest if not paid by a certain date, however, in which case
the rate must be specified on the instrument. They can, conversely, be transferred at a
discount before the date specified for payment. A bill of exchange must clearly detail the
amount of money, the date, and the parties involved including the drawer and drawee.

 
Bills of exchange are useful in international trade because they help buyers and sellers
deal with the risks associated with exchange rate fluctuations and differences in legal
jurisdictions.

Types of Bills of Exchange

If a bill of exchange is issued by a bank, it can be referred to as a bank draft. The
issuing bank guarantees payment on the transaction. If bills of exchange are issued by
individuals, they can be referred to as trade drafts.

If the funds are to be paid immediately or on-demand, the bill of exchange is known as
a sight draft. In international trade, a sight draft allows an exporter to hold title to the
exported goods until the importer takes delivery and immediately pays for them.
However, if the funds are to be paid at a set date in the future, it is known as a time
draft. A time draft gives the importer a short amount of time to pay the exporter for the
goods after receiving them.

Bill of Exchange vs. Promissory Note

The difference between a promissory note and a bill of exchange is that the latter is
transferable and can bind one party to pay a third party that was not involved in its
creation. Banknotes are common forms of promissory notes. A bill of exchange is
issued by the creditor and orders a debtor to pay a particular amount within a given
period of time. The promissory note, on the other hand, is issued by the debtor and is a
promise to pay a particular amount of money in a given period.

Example of a Bill of Exchange

Let's say Company ABC purchases auto parts from Car Supply XYZ for $25,000. Car
Supply XYZ draws a bill of exchange, becoming the drawer and payee in this case. The
bill of exchange stipulates that Company ABC will pay Car Supply XYZ $25,000 in 90
days. Company ABC becomes the drawee and accepts the bill of exchange and the
goods are shipped. In 90 days, Car Supply XYZ will present the bill of exchange to
Company ABC for payment. The bill of exchange was an acknowledgment created by
Car Supply XYZ, which was also the creditor in this case, to show the indebtedness of
Company ABC, the debtor.

Related Terms

Sight Draft
A sight draft is a type of bill of exchange, in which the exporter holds the title to the
transported goods until the importer receives and pays for them. 

Understanding Checks
A check is a written, dated, and signed instrument that contains an unconditional order
directing a bank to pay a definite sum of money to a payee.
 
Allonge
An allonge is a sheet of paper that is attached to a negotiable instrument, such as a bill
of exchange, to provide space for additional endorsements.

Drawee
A drawee is the party directed by a depositor to pay a certain sum of money to the
person presenting the check or draft.

Order Paper
An order paper is a negotiable instrument that is payable to a specified person or its
assignee. 

IMPORTANT DOCUMENTS

The Documents most frequently required to be attached together with the

documentary draft include: bill of lading, consular invoice, commercial invoice, marine
insurance policy certificate and certificate of origin. Other documents which the
exporters may have to provide his importer may include, depending upon the nature of
his merchandise , other important documents as: health or sanitary inspection
certificate, and material manufacturer’s certificate.

A bill of lading is “a written amount of goods shipped by any person, signed by the
agent of the owner of the vessel or by its master, acknowledging receipt of the goods,
and promising to deliver them safe at the place directed, damages of the sea excepted.”

Funct\
ions :
1. It conveys title to the merchandise;
2. It is a receipt of acknowledgment of the goods signed by the carrier;
3. It serves as a contract of transportation between shipper and the carrier.

Classification:

1. Straight and order

2. On-board and received for shipment
Bank Guarantee – the importer not infrequently avails of the services of his bank for the
issuance of a bank guarantee by filing a bill of lading bond. Once approved, the bank issues
then importer a document known as a bank guarantee, which is invariably term as “a letter of
guarantee.” This is jointly executed y the bank and the importer.

Trust Receipt- may be defined as “a receipt given by an importer to the bank who has loaned
money upon imported goods, or guaranteed the release of the goods, vesting title in the lender
although the goods are in the possession of the importer.”

Under the terms of this instrument, the importer permitted to take physical possession of
the merchandise although legal title of ownership remains with the bank. The importer binds
himself to the terms of the trust receipt.

Consular Invoice - The consular invoice when required by the importing country is by far the
most exacting document an exporter is likely to meet. It must, therefore, be prepared
meticulously. It consists of a form calling for a detailed description of the merchandise imported
into a country. In accordance with section 1308 of our Tariff and Customs Code, articles
imported into the Philippines shall be described in a consular invoice.

Consular invoice shall at or before the shipment of the articles, or as soon thereafter as
conditions will permit, be produced for certification to the consular official of the Philippines of
the consular district in which articles were manufactured or purchased, or from which they are
shipped as the case may be.

Commercial Invoice- shall be produced to support the entry of imported merchandise into the
country together with other requisite documents. In the case of importation into the Philippines,
the export value of which does not exceed five hundred pesos, a commercial invoice shall be
required and presented in lieu of a consular invoice without prejudice to the discretion of the
Collector of Customs in requiring the importer to present said consular invoice.

Certificate of Origin- , when required by the government of importing countries, are generally
intended to support the entry of merchandise, under preferential treatment by reason of the
provisions of certain trade agreement between the governments of the exporting and importing
countries.
Marine Insurance Policy certificates - goods transported across the seas, are subjected or
exposed to great risks caused by perils of the sea. This being the case, it follows that some
form of protection is indeed desirable to recover or at least mitigate the losses and/or damages
that may be sustained on the merchandise, if any, by the importer.

For this reason, goods exported from one country to another are generally covered by
marine insurance. The coverage of such marine insurance may vary, the terms and conditions
of which are generally stipulated on the face of the marine insurance policy certificate.

Other Documents

Other documents may be required by the government of the importing country, in

accordance with the nature of the imported merchandise or in view of the requirements of
certain existing laws, rules and regulations.

Thus , in the case of foodstuffs and drug products, their entry into the Philippines coming
from abroad must be accompanied by the presentation of a document known as “Declaration by
Shipper of Food and Drug Products” in accordance with our Pure Food, Drugs and Cosmetic
Act.