Payment methods

PAYMENT METHODS

Objectives:

Get familiarized with specific terminology in written formal documents

Improve correct use of specific vocabulary in writing

Nations, companies and individuals have engaged in trade for centuries and from the beginning have searched for the best financing alternative. Financing the flows of goods and services has become a key component of maximizing profit from trade. Today sellers have different alternatives to get paid for the goods shipped or services rendered. But each alternative addresses certain risks for the buyer and the seller. Trade payment methods have been used effectively to expand markets for goods and services and to facilitate a variety of financial transactions, either as a method of payment or as a credit enhancement, within as well as across the borders of sovereign states. They provide powerful leverage for importing and exporting customers. Trade solutions are customized to the customers' needs, integrating different methods of payment to form a truly end-to-end trade proposition.

If one of the following payment methods is selected by the business partners, documents covering shipment of the merchandise are handled outside banking channels. The banking system is involved only in the remittance of funds.

Cash in advance: the seller receives cash from the buyer prior to shipment. The seller ships the goods when convenient while using the buyer's funds. The buyer has no control over the goods, as the seller may refuse to ship them.

Open account: Goods are shipped to the buyer and payment is made on terms negotiated in advance with the seller. The buyer has full control over the goods and can pay when convenient, even refuse.

On consignment: The seller ships goods to the buyer, but retains ownership. Payment is made if and when the buyer sells the goods, i.e. payment is contingent upon sale of goods.  

However, if the seller selects payment under a Collection or a Letter of Credit, a bank adds its service and documentary expertise on behalf of either the buyer, the seller or both.

4. Collection: the goods are shipped to the buyer. The seller's draft and documents covering the shipment are presented through the buyer's bank for payment, so the title documents are in control of the bank, although the buyer may refuse to pay or accept the draft.

Trade involves buyers and sellers seeking to exchange goods or services despite their differences in language, national custom, credit procedures and accounting practices. Historically, merchants have sought ways of minimizing these differences and facilitating trade. The special protection and opportunities offered by Letters of Credit apply to both domestic and international trade.

Letter of Credit. If the contract of sale establishes Letter of Credit as method of payment, the buyer must apply to its bank for a Letter of Credit in favor of the seller. The application and the agreement with the bank is separate and distinct from the underlying contract of sale between the buyer and the seller. The contract between the buyer (as Applicant) and its bank evidences the buyer's reimbursement obligation and responsibility to its bank and sets forth the terms and conditions to be included in the Letter of Credit. The Applicant is obligated to the bank for any amount paid under the Letter of Credit. Therefore, the Applicant must use sound business judgement when entering into a contract with a party in whose favor the Letter of Credit will be issued. The buyer's bank (Issuing bank) undertakes to the Beneficiary (seller) and provides a specialized service. The seller presenting the documents must comply strictly with the terms of the Letter of Credit to have the right to receive payment from the bank. This right is not contingent upon the seller's actual compliance with the underlying contract of sale but rather upon the bank's determination of complying documents. By the Letter of Credit the seller may be requested to present quality and quantity certificates of the goods (laboratory testing certificates, inspection certificates) along with other documents. The buyer and the seller must agree beforehand on the responsibility for payment of these services, as the buyer's and seller's integrity are paramount in any exchange of goods or services regardless of payment methods.

The parties to the Letter of Credit are:

Applicant: the party that makes the application for the Letter of Credit to the Issuing bank, usually the buyer or the importer

Beneficiary the party in whose favor the Letter of Credit is opened, usually the seller or the exporter

Issuing Bank the Applicant's bank, the bank that undertakes to the Beneficiary to issue the Letter of Credit

Paying Bank the bank entitled to make the payment to the Beneficiary

Negotiating Bank the bank entitled to negotiate against strictly complying documents by the terms and conditions of the Letter of Credit

Confirming bank the bank that can add its own undertaking to that of the issuing bank, on request In most of the transactions, there are at least two banks involved a bank in the country of the buyer and another one in the country of the seller. A bank may play several roles in a single transaction. If the Issuing bank sends the Letter of Credit to the Beneficiary, payable at its own counters, then the bank is playing the role of both Advising Bank and Paying Bank.

The formal language used in the Letter of Credit depends on the type of the document, so it is important to understand them.

Letters of Credit may be issued under the form of 'revocable' or 'irrevocable' and either 'confirmed' or 'unconfirmed'. A Revocable Letter of Credit may be amended or canceled by the issuing Bank at any time or without prior notice to, or agreement of, the Beneficiary, An Irrevocable Letter of Credit cannot be amended or canceled without the agreement of the Issuing Bank, the Confirming Bank and the Beneficiary. An Irrevocable Letter of credit is a definite undertaking by the Issuing Bank to pay, provided the Beneficiary complies strictly with the Letter of Credit. Once the payment is made by the Paying Bank the authority to pay becomes an irrevocable obligation on the part of the Issuing Bank to reimburse the Paying Bank. The paying Bank is thus protected and will receive funds from the issuing Bank in accordance with the Letter of Credit.

Beneficiaries do not always rely on the stability of an Issuing Bank, particularly when that bank is in another country or is unknown to the Beneficiary. Consequently, a Beneficiary may request that the Applicant instruct the Issuing bank to have its Irrevocable Letter of Credit confirmed by a Bank in the Beneficiary's country. A Confirming Bank is the bank which, at the request or with the consent of the Issuing bank, adds its own irrevocable undertaking to that of the Issuing Bank. The Confirming Bank must be satisfied with the Issuing Bank's financial stability and with the political stability of the country in which the bank resides. This is mandatory, since failure of the Issuing Bank to fulfill its irrevocable obligation (because of political restraint, war, insolvency or other reasons) will not relieve the Confirming Bank of its irrevocable obligation to pay the Beneficiary.

If the Letter of Credit is issued in negotiable form, the Beneficiary can present the draft and documents either directly or through a local bank to the Paying Bank, in order to obtain funds before actual payment. When negotiations are made with recourse, the Beneficiary receives funds either for full or partial value of the drafts drawn on the Paying Bank, i.e. similarly to cashing a check at a bank other than the bank on which it is drawn.

Letters of Credit sometimes provide for negotiation without recourse. Under such instructions, the Negotiation bank has no recourse to the Beneficiary after it has honored the Beneficiary's draft.

Many different types of Letters of Credit were developed to meet the needs and requirements of buyers and sellers throughout the world.

Revolving Letter of Credit is more efficient and cost effective when the Applicant and the Beneficiary agree to ship goods on a continuing basis. A special Letter of Credit for handling multiple shipments, renewable over an extended period of time, a Revolving one, may operate automatically

Installment Letter of Credit incorporates a schedule for shipment or drawings. If the Beneficiary fails to present strictly complying documents for a scheduled shipment or drawing, the Beneficiary will not be entitled to draw under the Letter of Credit for that or any future shipment or drawing.

Red Clause Letter of Credit is used when an Applicant wants to advance cash to the Beneficiary to purchase the goods or effect shipment under the Letter of Credit. It restricts negotiation or payment to a specific bank. It is referred to as a 'red clause' simply because the clause is sometimes printed or typed because the clause is sometimes printed in red ink. A 'red clause' is typically used when there is a close business relationship between the Applicant and the Beneficiary.

Back-to back Letter of Credit is used when the Beneficiary of an Irrevocable Letter of Credit seeks to use the instrument issued in its favor as a basis for requesting a bank to issue a companion Irrevocable Letter of Credit in favor of the manufacturer or supplier of those goods needed for shipment under the fist Letter of Credit. The Beneficiary of the Irrevocable Letter of Credit (a broker or a middleman) will become the Applicant of the second Letter of Credit using the first as collateral for the issuance of the second Letter of Credit. The two Letters of credit used jointly to facilitate the purchase of the same goods are called Back to back Letters of credit.

Transferable Letter of Credit is used by the beneficiary to request it to be available to one or more partners, named transferee, but only once. If partial shipments are not prohibited, portions of the Transferable Letter of Credit may be transferred separately, but the amount transferred cannot exceed the amount of the original Letter of Credit (Master).

Exercises:

I. Fill in the blanks the missing word in the following Letter of Credit

1. installment; 2. schedule, 3. law; 4. statement; 5. expiration

World Development Bank

56-70 Wall Street, New York, 1002

March, 3, 2005

Irrevocable Standby Letter of Credit

Refine Realty Corp.

230 May, South Drive

Chicago, Il, 12003

Sirs:

By order of our client Hotel Macedonia Corporation, New York we hereby issue our Irrevocable le Standby Letter of Credit nr 825 in your favor, for an amount not exceeding in the aggregate U.S.$2,ooo,ooo effective immediately and expiring at our office on September 30, 2006.

Funds under this letter of Credit are available to you against draft(s) drawn on us, mentioning thereon our Letter of Credit no 825, in accordance with the following a). of payments:

1. U.S. $1,000,000 beginning on 1 May 2005 and up to an including May 30, 2006 accompanied by your signed b).. that 'the amount of said draft represents the first installment for the purchase of the hotel 'New California', Los Angeles.

2. U.S. $1,000,000 beginning on June 1, 2005 and up to an including June 25, 2006, accompanied by your signed statement that 'the amount of said draft represents the final c) for the purchase of the hotel 'New California', Los Angeles.

We hereby undertake with you to honor each draft drawn under and in compliance with the terms of this Letter of Credit, if duly presented together with the documents specified at this office on or before the stated d).. date.

Except as may be otherwise stated, this Letter of Credit is subject to the International Chamber of Commerce's Uniform Customs and Practice for Documentary credits in effect on the date this Letter of Credit is issued and is subject to and governed by New York State and U.S. Federal e)., without, regard to principles of conflicts of law.