1. 1 Lecture 10 Methods of Payments p. 1

2. 2 AGENDA: 1.Methods of Payment – Introduction 2.Payment on Open Account 3.Negotiable Instruments 4.Bills of Exchange (B/E) 5.Claused Bills 6.Documentary Bills 7.Discounts 8.Avalised Bills 9.Collection arrangements

3. 3 Methods of payment Most frequent payment methods are: - Collection arrangement - Letters of Credit (L/C) In both cases, the interposed bank or banks use documents of title as collateral security

4. 4 Methods of payment Collection arrangement A bank receives instructions from the seller, the exchange of documents of title representing the goods and the payment of the price is normally done at the place where the buyer carries on business

5. 5 Methods of payment Letter of Credit The instructions to the bank come from the buyer, the exchange of documents of title and the price is normally effected at seller’s place of business. In some cases, the bank (instructed by the buyer) promises to accept, honor or negotiate bills of exchange drawn by the seller

6. 6 Methods of payment There are methods where the banks are not involved: the buyer makes direct payments to the seller Payment on Open Account A simple arrangement where the parties agree on “cash with order” terms, this reducing financial risks for the exporter “Sight payment” is another method: -The buyer has to remit the purchase price when presented with the documents of title for the goods sold -This method is used when the seller knows well buyer’s financial status

7. 7 Methods of payment -The exporter sends the documents to the buyer who remits the agreed price by means of telegraphic transfer (T/T), mail (M/T) or SWIFT transfer, remittances being carried by buyer’s bank -It is used when the exporter sells to his own overseas branch or subsidiary When the exporter is not familiar with the financial status of the buyer, “cash against documents” or “cash on delivery” can be arranged (the latter also used when goods travel by land, subject to the CMR) In f.o.b. or c.i.f. direct payment is not common, instead payments are done through bank using a collection arrangement or letter of credit

8. 8 First, what is a Negotiable Instrument? Contracts in writing that are transferable by endorsement or by delivery and to which the holder takes title free from any defenses or objections to their validity that might have been good against the transferor They include promissory notes and B/Es In order to be negotiable, an instrument must meet several qualifications: -it must be in writing -it must contain an unconditional promise to pay a certain sum in money, on demand or at a fixed and determinable future time; -it must be made payable to bearer or order; -and it must be signed by the maker of a promissory note or the drawer of a bill of exchange

9. 9 Extra information: Negotiable Instruments - examples Promissory Note In the law of negotiable instruments, a written instrument containing an unconditional promise by a party, called the maker, who signs the instrument, to pay to another, called the payee, a definite sum of money either on demand or at a specified or ascertainable future date The note may be made payable to the bearer, to a party named in the note, or to the order of the party named in the note A promissory note differs from an IOU in that the former is a promise to pay and the latter is a mere acknowledgment of a debt A promissory note is negotiable by endorsement if it is specifically made payable to the order of a person

10. 10 Extra information: Negotiable Instruments - examples Drafts (finance) Written order for the payment of money drawn by one person, directing a second person or financial institution to pay a third person A draft is called a check when it is drawn on a bank When money is transferred between institutions in different countries, a draft is called a B/E Whereas B/Es are always negotiable, drafts may be nonnegotiable A draft is payable on sight or on demand; however, in some transactions drafts are often payable at a stated date in the future

11. 11 What are B/Es? Unconditional order in writing, signed and addressed by one person (the drawer) to another (the drawee), requiring the drawee to pay on demand, or at a determinable or fixed future date, a specified sum of money to a third person (the payee) The payee is frequently the same person as the drawer of the bill. The term B/E usually refers to foreign exchanges, rather than domestic transactions On accepting a B/E, the drawee becomes the party primarily responsible for paying it. B/Es are negotiable and constitute one of the principal forms of commercial documents in most countries. The most common bill of exchange is the check. The use and legal status of B/Es vary from country to country: In USA their use is governed by the Uniform Negotiable Instruments Law, prepared in 1897 and, by 1927, adopted with little change by all the states.

12. 12 Payment by Bill of Exchange (B/E) Normally the price is not remitted by the buyer to an open account, allowing the exporter to draw a B/E on him Advantages: the exporter obtains a negotiable instrument that can be turned into cash and the buyer is allowed a definite period of credit for settlement unless B/E is payable at sight If no such arrangements are made, payment by B/E or payment on open account is determined by the practice / usage in that trade

13. 13 Bills of Exchange (B/E) There are 3 parties to a B/E: the drawer, the drawee and the payee The drawer and the payee or the drawee and the payee may be the same person B/E does not represent an individual obligation, but contains a number of obligations that are interconnected Thus, all 3 parties must honor the document: drawer by drawing it, drawee by writing his acceptance on or across the bill, whereby he becomes the acceptor and the payee by indorsing the bill when negotiating it, whereby he becomes the indorser

14. 14 B/E: Some details Every person signing the bill (including the “backer” of the bill) incurs liability The drawer or an indorser can negative his liability by adding “without recourse” (sans recours) to his signature The drawer, indorser or acceptor can negative his liability by adding word to his signature indicating that he signs for or on behalf of a principal or in a representative capacity The primary liability to pay lies on the drawee The drawer and indorsers are only liable on recourse (if the drawee dishonors the bill and they have received notice about this by the holder or a subsequent indorser)

15. 15 More details Sight bill (term bill) is payable on demand A Time bill (usance bill) is payable at fixed future time or at a determinable future time (if the time is uncertain, from the legal perspective, is not a B/E anymore) B/Es must be presented for payment by holder or by some person authorized to receive payment on his behalf, at the proper place, to the person designated by the bill as the payer or to a person authorized to pay or refuse payment on his behalf

16. 16 UN Convention on International Bills of Exchange and International Promissory The law of B/Es is divided into 2 legal families: 1.The Geneva system, founded on the Geneva Conventions, adopted in civil law jurisdictions 2.The Anglo-American system, applied in UK, most Commonwealth countries, USA and other common law jurisdictions To reconcile the 2 systems, UNCITRAL prepared the Convention on B/Es and International Promissory Notes (1998) Its provisions apply only if the instrument in question is designated “International B/E (UNCITRAL Convention)” or “International Promissory Note (UNCITRAL Convention)”. This must appear in the heading and the text of the instrument

17. 17 Claused bill Usually B/Es are not simple and have certain clauses These clauses are very important and must be understood properly Some clauses are customary in the trade with particular countries, while other a used in that particular trade (ex.: “exchange as per indorsement” is used the seller wishes to discount the bill to bank, then the bank includes its discount in the sum payable when converting the stipulating currency into the local currency of the drawee) Another example is “pay without loss in exchange”, designed to protect the drawer against loss caused by an adverse alteration of the rate of exchange

18. 18 Extra information: Discounts In finance, discounts are premiums or considerations given on the purchase of promissory notes, B/Es, or other forms of negotiable commercial paper in advance of their maturity dates Such discounts make up deductions from the face value of the discounted paper and are made at the time of purchase The principal agencies engaged in discounting commercial paper are commercial banks and, in a few countries, financial institutions that specialize in that practice When discounted paper is again put into circulation by a bank or discount house and is discounted again, it is said to be rediscounted

19. 19 Extra information: Discounts When discounted paper matures, the holders of such bills and notes receive the full face value of the commercial paper they present for payment; therefore, the practice of discounting bills and notes is, in effect, a means of extending credit in the form of loans; the discounts are regarded as advance collections of interest on the loans. Rates for discounting and rediscounting commercial paper are established by commercial banks and discount houses in accordance with the relative supply of money available for commercial loans In countries in which the banking system is organized on a centralized basis, discount and rediscount rates are determined in large part by the central banks; in USA, these rates are established in part by the Federal Reserve System to control the volume of credit and thus stimulate or slow the economy

20. 20 Documentary bill When the seller attaches to the B/E, the B/L to the goods sold The purpose is to ensure that the buyer will not receive the B/L and with it, the right of disposal of the goods, unless he has first accepted or paid the attached B/E according to the arrangement between the parties If the buyer fails to honor the B/E, he must return the B/L

21. 21 Avalised bills An aval is the signature on a B/E by a person who wants to “back” it and to guarantee its payment to the holder in due course Details: -Avaliser incurs liabilities of an indorser to a holder in due course, BUT he is NOT in the position of an indorser; he is a guarantor -He may guarantee payment by the acceptor, or by one of the indorsers, or payment by all immediate parties, the acceptor and those liable on recourse -Only time bills can be avalised & an original party to the B/E cannot avalise a bill, as he is liable anyway

22. 22 Avalised bills -As a rule, bills are avalised only after they have been accepted by the drawee -Usually bills are avalised by the banks, but this is not a rule (commercially, it is better what a bill is avalised by a bank of good standing) -Avals can be used in connection with transport documents: if under a collection agreement the documents are to be presented to the acceptor of the bill, it may be a condition precedent of release of the documents to him that he obtains a good aval

23. 23 Bills drawn in a set The seller presents the buyer with several sets of transport documents The seller draws the B/E as a part of a set and attaches a part of the bill to every set of transport documents which he dispatches The part of a set may be indorsed to different persons, but only one part is accepted by the drawee

24. 24 Collection Arrangements When the parties have not arranged for payment of the purchase price to take place in seller’s country, the question is who will present the B/E drawn by the seller on the buyer at his residence and, if it is a documentary bill, who is to deliver the transport documents to him when he accepts of pays the draft? Usually the exporter asks his bank to arrange for the collection of the price i.e. the acceptance or payment of the bill, and the bank will carry out this task through its own branch office abroad or a correspondent bank in the buyer’s country

25. 25 Collection Arrangements Sometimes the seller entrusts this to his representative or subsidiary if he is represented in buyer’s country Sellers instructions must be precise and complete and deal the various contingencies that might arise in the course of execution, thus the banks will ask the customers to issue instructions on a documentary bill lodgment form This form is a table covering all the contingencies that occur in the ordinary course of business

26. 26 Uniform Rules for Collection Banking practice relating to collection is standardized by the Uniform Rules for Collection (1995 Revision) sponsored by the International Chamber of Commerce (ICC) The apply only if incorporated into the contract by the parties Collection means the handling by the banks, in accordance with instructions received, of documents in order to: -Receive payment and/or acceptance -Deliver documents against payment and/or acceptance -Deliver documents on other terms and conditions

27. 27 Uniform Rules for Collection Documents means financial and commercial docs Clean collection: collection of financial documents not accompanied by commercial documents Documentary collection: (i) collection of financial documents accompanied by commercial documents and (ii) commercial documents not accompanied by financial documents

28. 28 Uniform Rules for Collection The parties to transaction are: “principal” (usually the seller) entrusting the handling of a collection to a bank “drawee” is the party to whom presentation is to be made in accordance with the collection instruction “collecting bank” is any bank other than the remitting bank involved in processing the collection “presenting bank” is the collecting bank making presentation of the documents to the drawee

29. 29 Uniform Rules for Collection All documents sent for collection must be accompanied by a “collection instruction” incorporating the Rules and giving complete and precise instructions The Collecting bank may only act upon instructions contained in this instruction In case of a documentary collection, the exporter must instruct the remitting bank and the latter mush instruct the collecting bank as to whether the documents shall be delivered to the buyer on acceptance of the bill (D/A terms), on actual payment (D/P terms) or in accordance with special instructions (must be stated) Instruction must state if the documents can be handed to a representative in case of need and what are the powers of that representative The bank must establish if the documents received correspond to how they are listed in the collection instruction (if not, it has to notify the party that gave the collection instruction)

30. 30 Details Collection instruction must indicate the steps to be taken in the event of dishonor of the B/E The absence of this does no oblige the bank to have the documents protested If the collecting bank releases the documents to the buyer contrary to instructions, it is liable in damages to the seller for breach of contract and for conversion of documents Sometimes the bank realizes that it takes considerable risks by releasing the documents (B/L) without insisting on the performance of the conditions set in the collection instruction, but the buyer is its customer. In such situation, documents can release the documents prematurely under a trust receipt Under this receipt, a genuine trust is constituted, the buyer being the trustee, the bank – the beneficiary, the trust property being the B/L There are 2 situations: in one the trustee can sell the goods and repay the bank from the resources obtained from the sale; in another, he must warehouse them in bank’s name and present the receipt to the bank