D/P, D/A and Their Use in International Sales Transactions

Most sellers are very familiar with Open Account (O/A) and Letter of Credit (L/C) transactions. In the
international arena, open account sales are regarded as having the most risk; letter of credit
transactions as having the least.

Between these two poles, however, are two lesser-known transaction types: Documents against
Payment (D/P) and Documents against Acceptance (D/A). These represent risk levels lower than an O/A,
but greater than an L/C. Both rely on an instrument widely used in international trade called a bill of
exchange ordraft.

Bills of Exchange / Draft

A bill of exchange, or draft, is a negotiable instrument that is both drawn up by and made payable to the
exporter/seller. Although written by the seller, it has the equivalent effect of a check written by the
buyer.

It is generally a three-party instrument consisting of a:

1. Drawer – the party issuing the bill of exchange; usually the exporter/seller.
2. Drawee – the recipient of the bill of exchange for payment or acceptance; usually the buyer.
3. Payee – the party to whom the bill is payable; usually the seller’s bank.

Bills of exchange are either payable at sight (sight drafts) where the bank pays the full amount upon
presentation, or payable at some future date (time or term drafts).

Here’s how they work with Documents against Payment (D/P) and Documents against Acceptance (D/A)
transactions. (Click to view a PDF process map of the D/A and D/P process.)

D/P – Documents against payment

The D/P transaction utilizes a sight draft. Payment is on demand.

After the goods are shipped, the exporter sends the sight draft to the clearing bank, along with
documents necessary for the importer/buyer to obtain the goods from customs. The buyer has to settle
the payment with the bank before the documents are released and he can take delivery of the goods. If
the buyer fails or refuses to pay, the exporter has the right to recover the goods and resell them.

On the surface, D/P transactions seem fairly safe from the seller’s perspective. However, in practice
there are risks involved.

 The buyer can refuse to honor payment on any grounds.

 When the goods are shipped long distances, say from Hong Kong to the United States, it is
usually impractical and too expensive for the seller to ship them back home. Thus, the seller is
forced to sell the goods in the original country of destination at what is usually a heavy discount.
 In cases of shipments by air freight, it is possible that the buyer will actually receive the
goods before going to the bank and paying for them.
D/A – Documents against Acceptance
The D/A transaction utilize a term  or time draft. In this case, the documents required to take possession
of the goods are released by the clearing bank only after the buyer accepts a time draft drawn upon him.
In essence, this is a deferred payment or credit arrangement. The buyer’s assent is referred to as a trade
acceptance.

D/A terms are usually after sight, for instance “at 90 days sight”, or after a specific date, such as “at 150
days bill of lading date.”

As with open account terms, there are some inherent risks in selling on D/A:

 As with a D/P, the importer can refuse to accept the goods for any reason, even if they are in
good condition.
 The buyer can default on the payment of a trade acceptance. Unless it has been guaranteed by
the clearing bank, the seller will need to institute collection procedures and/or legal action.

Advantages for the Seller in D/P and D/A Transactions

Despite the risks listed above, utilizing D/P and D/A transactions does have a number of advantages for
the seller.

 The bill of exchange facilitates the granting of trade credit to a buyer.

 It can provide the seller access to financing.
 The bill of exchange is formal, documentary evidence, acceptable in most courts, confirming
that the demand for payment (or acceptance) has been made to the buyer.

Recourses for Dishonored Bills of Exchange

It is possible for the seller to dispute an unpaid/unaccepted (called dishonored) bill of exchange, sue the
buyer, and potentially receive payment. The seller disputes a dishonored bill of exchange via a formal,
usually two-step, and process.

Step #1 Noting: A bill of exchange is noted in order to obtain official evidence that it has been
dishonored. A Notary Public presents the bill/draft to the drawee (buyer) for acceptance or payment
and notes on the bill the reason given for dishonor. Noting is often followed by a formal protest.

Step #2 Protesting: The Notary Public produces a formal deed of protest bearing his seal. This document
provides formal evidence of the presentation of the bill to the drawee and the reason for the dishonor.
The protest is accepted by most courts in the world as evidence that the bill has been dishonored.

Should the buyer fraudulently obtain possession of the documents, or the goods, without paying or
accepting the bill of exchange, it is possible to seek satisfaction from the clearing bank or the customs
warehouse. ABC-Amega made and won such a claim for a fireworks manufacturer in the People’s
Republic of China. (Note: the names of the parties have been changed.)
Real-Life Case Study
The Parties
Exporter: China Fireworks Co., Anywhere, China

Importer: U.S. Fireworks Co., Anytown, USA

Clearing/Importer's Bank: First Commercial Bank, New York USA

Terms of Sale: D/P (Documents Against Payment)

The Issue

China Fireworks Co. sold a container load of fireworks to U.S. Fireworks on D/P terms.

The exporter prepared the paperwork for the transaction, including an original Bill of Lading (B/L), a Bill
of Exchange (in this case, sight draft), and an original invoice. The Bill of Exchange would be payable
through the exporter's bank and would be drawn on First Commercial Bank (the importer's bank).

The exporter faxed a copy of the Bill of Lading and the invoice to the buyer with confirmation that the
goods would be shipped via United Shipping on the freighter Morristown on May 16th. The fireworks
were to arrive at the bonded warehouse in New York City on June 15th.

The goods were picked up from the exporter by United Shipping. United Shipping's representative
signed and stamped the original bill of lading and returned it to the China Fireworks representative, Mr.
Zhang. Mr. Zhang then took the entire package of documents to this bank, where the Documentary
Credit's Clerk personally placed the necessary items, along with explicit instructions on the terms of the
transaction, into a courier package. The package was sent to First Commercial Bank in the USA.

On June 22nd, a week after the shipment was to have arrived in New York City, China Fireworks
contacted their bank to determine if payment had been received. Payment had not been made and the
Chinese bank wired First Commercial Bank inquiring about the transaction. Did the buyer accept the bill
of exchange? Did the buyer receive the original bill of lading?

In the meantime, China Fireworks' U.S. representative heard that U.S. Fireworks had indeed picked up
the goods from the warehouse. In fact, they had already been used in a spectacular July 4th celebration
on Coney Island.

On November 15th, a full five months after the goods arrived in the U.S., China Fireworks, which had still
not received payment or any correspondence from the U.S. bank, placed the account with ABC-Amega
for collection.

ABC-Amega’s collector immediately attempted contact with U.S. Fireworks. However, the phone
number had been disconnected. Further research turned up the fact that U.S. Fireworks had filed
Chapter 7 and was now out of business. The next call was to United Shipping’s warehouse in New York
City, which did, in fact, have a bank-endorsed original bill of lading on file for the transaction. The next
logical step was to contact First Commercial, the buyer's bank.

After some research by the documentary collections clerk, ABC-Amega found that the bank's file did still
contain the bill of exchange, which had not been signed by the buyer. The clerk also informed the
collector that the bank had foreclosed on the buyer's account to recoup their security interest.
Therefore, there would be no payment for the fireworks.

Recourse

Obviously, First Commercial Bank had not followed appropriate D/P procedures. It had given the buyer
the original bill of lading, which was filed at the warehouse, without collecting payment for immediate
remittance to China Fireworks. ABC-Amega's affiliate attorney recommended suit against the bank for:

1. Breach of fiduciary trust

2. Negligence
3. Actual damages of $1.2 million (the value of the goods)

Suit requirements (costs) were sent to China Fireworks along with instructions as to what else would be
needed to mount their claim against the U.S. Bank. These included:

1. A notarized and legalized affidavit from Mr. Zhang of China Fireworks attesting to the
documents he prepared.
2. A notarized and legalized affidavit from the Documentary Credits Clerk of the Chinese bank,
attesting to the instructions he prepared for First Commercial Bank, as well as the fact that he
personally placed those items in a courier envelope sent to First Commercial Bank in New York
City. (The collector had already received copies of the air bill and proof of delivery for the
envelope.)
3. Assurance from both China Fireworks and the Chinese bank that the two gentleman involved
would, if necessary, appear as witnesses at trial.

The Results

First Commercial Bank, not surprisingly, mounted strong opposition to the case. Ultimately, it went to
trial, the two Chinese gentlemen had to fly to the U.S. to testify, testimony of expert witnesses on both
sides was taken, and considerable money was expended on both sides.

At the conclusion, the court granted Judgment to China Fireworks:

 $1.2 million actual damages (cost of the fireworks)

 $4.8 million punitive damages
  $10,000 interest
 $550,000 attorney’s fees
 $2,200 costs

Needless to say, China Fireworks was pleased with the outcome.

Conclusion
When documented fully and correctly, D/A and D/P transactions provide a means for exporters to
extend some level of credit facilities to their customers, while at the same time protecting their legal
rights to payment.

Addendum: Rules Governing Bills of Exchange

Most countries have adopted codified laws on Bills of Exchange following, in general, those set forth in
the League of Nations' Geneva Conventions (1930).

 The United Kingdom Bills of Exchange Act 1882 is the basis for rules governing Bills of Exchange
in Ireland, U.K. and Commonwealth countries that were part of the British Empire.
 In the United States, Article 3 of the Uniform Commercial Code governs the issuance, transfer
and enforcement of negotiable instruments including bills of exchange. 

The United Nations Commission on International Trade Law (UNCITRAL) has designed a Convention to

harmonize the various country laws. This Convention, called the United Nations Convention on
International Bills of Exchange and International Promissory Notes, was adopted and opened for
signature by the UN General Assembly in 1988. It has not yet received the 10 signatures required for
ratification. This Convention only applies if the parties use a particular form of a negotiable instrument
indicating that the instrument is subject to the UNCITRAL Convention.