IF YOU CAN’T DODGE A RISK, HEDGE IT Mitigating Risks in International Payment and Collection September 19, 2007 National Association of Credit Managers Gateway Regional Conference Presented By: Jennifer Schwesig Armstrong Teasdale, LLP

INTRODUCTION Laws applicable to bankruptcy, insolvency, security interests, and creditor and debtor rights vary drastically from country to countryLaws applicable to bankruptcy, insolvency, security interests, and creditor and debtor rights vary drastically from country to country Problems involving collections are more readily avoided before credit is extendedProblems involving collections are more readily avoided before credit is extended

KEY ISSUES IN INTERNATIONAL TRADE FINANCING Arranging for and receiving payment Arranging for and receiving payment Foreign exchange risks and controls Foreign exchange risks and controls Collections Collections

MINIMIZING INTERNATIONAL CREDIT RISKS Risk of non-payment and collection increases in international transactions Risk of non-payment and collection increases in international transactions May be difficult to check overseas buyer for creditworthiness May be difficult to check overseas buyer for creditworthiness Goal is to minimize or eliminate the risk of non-payment or inability to receive payments Goal is to minimize or eliminate the risk of non-payment or inability to receive payments Determining the payment method, financing and other key terms is important Determining the payment method, financing and other key terms is important

MINIMIZING INTERNATIONAL CREDIT RISKS Credit Risk Reduction Methods: Credit Risk Reduction Methods:  Credit Checks  Payment Types  Export Credit Guarantees and Insurance  Proper Documentation/Agreements

MINIMIZING CREDIT RISKS Credit Checks Credit Checks  Know the exact entity or individual you are dealing with  Check buyer’s credit history (if possible) Reliable up-to-date information may be difficult to find Reliable up-to-date information may be difficult to find  Suggestions: Department of Commerce International Company Profile (ICP) Department of Commerce International Company Profile (ICP) Local U.S. embassies (commercial divisions) Local U.S. embassies (commercial divisions) Private credit reporting services Private credit reporting services

MINIMIZING CREDIT RISKS The type of payment works to increase or decrease credit risks The type of payment works to increase or decrease credit risks Types of payments Types of payments Open AccountOpen Account Advance paymentAdvance payment Documentary SalesDocumentary Sales Letters of CreditLetters of Credit Bills of Exchange (Draft)Bills of Exchange (Draft) Trade & Bank AcceptancesTrade & Bank Acceptances Conditional Sales ArrangementsConditional Sales Arrangements

MINIMIZING CREDIT RISKS Open Account Open Account Least secure methodLeast secure method Seller sends goods with invoice for paymentSeller sends goods with invoice for payment AdvantagesAdvantages reduction in transaction costs reduction in transaction costs works well with high volume shipping works well with high volume shipping DisadvantagesDisadvantages Perform significant credit checks on buyer (credit risks) Perform significant credit checks on buyer (credit risks) Seller loses control of goods when dispatched (shipping terms imp.) Seller loses control of goods when dispatched (shipping terms imp.) Buyer may refuse to accept delivery Buyer may refuse to accept delivery Seller must wait for payment until after the buyer has received goods Seller must wait for payment until after the buyer has received goods No risk to buyer No risk to buyer Supplement rights with title retention clauseSupplement rights with title retention clause

MINIMIZING CREDIT RISKS Best Practices for Open Account Best Practices for Open Account SellerSeller No open account when buyer is new or cannot determine risk and reliability of buyer No open account when buyer is new or cannot determine risk and reliability of buyer Goods are delivered before 1 st payment Goods are delivered before 1 st payment Make sure to supply goods or services consistent with a good contract dealing with disputes and non- payment Make sure to supply goods or services consistent with a good contract dealing with disputes and non- payment Insist on an electronic transfer (cleared funds) instead of a bank draft or check Insist on an electronic transfer (cleared funds) instead of a bank draft or check Define credit terms Define credit terms BuyerBuyer Inspect goods before making a payment Inspect goods before making a payment Make payment within agreed credit terms Make payment within agreed credit terms

MINIMIZING CREDIT RISKS Advance Payment Advance Payment Time of payment: before shipmentTime of payment: before shipment Goods available to buyers: after paymentGoods available to buyers: after payment Risk to exporter: noneRisk to exporter: none Risk to importer: relies on exporter to ship goods as orderedRisk to importer: relies on exporter to ship goods as ordered Best Practices for Advance Payment Best Practices for Advance Payment SellerSeller Provide clear payment instructions (SWIFT) Provide clear payment instructions (SWIFT) Avoid accepting bank drafts or company checks Avoid accepting bank drafts or company checks BuyerBuyer Avoid this arrangement, use letter of credit instead Avoid this arrangement, use letter of credit instead

MINIMIZING CREDIT RISKS Documentary Sales Documentary Sales 2 types2 types documents against payments documents against payments documents against acceptance documents against acceptance Helps avoid some risks in open account transactionHelps avoid some risks in open account transaction Seller uses carrier to withhold delivery of goods until buyer pays or signs a negotiable instrument to paySeller uses carrier to withhold delivery of goods until buyer pays or signs a negotiable instrument to pay TransactionTransaction Seller ships goods and forwards draft & bill of lading (BOL) Seller ships goods and forwards draft & bill of lading (BOL) Correspondent of seller’s bank notifies buyer of receipt of goods Correspondent of seller’s bank notifies buyer of receipt of goods Buyer pays depending on sight draft or time draft Buyer pays depending on sight draft or time draft Correspondent delivers BOL to buyer for buyer to claim goods Correspondent delivers BOL to buyer for buyer to claim goods The BOL allows for title transfer only after payment is receivedThe BOL allows for title transfer only after payment is received

MINIMIZING CREDIT RISKS Documents Against Payments Documents Against Payments Time of payment: on presentation of draftTime of payment: on presentation of draft Goods available to buyer: after paymentGoods available to buyer: after payment Risk to exporter: If draft unpaid, must dispose of goodsRisk to exporter: If draft unpaid, must dispose of goods Risk to importer: relies on exporter to ship goods as describedRisk to importer: relies on exporter to ship goods as described Documents Against Acceptance Documents Against Acceptance Time of payment: on maturity of draftTime of payment: on maturity of draft Goods available to buyer: before paymentGoods available to buyer: before payment Risk to exporter: relies on buyers to pay draftsRisk to exporter: relies on buyers to pay drafts Risk to importer: relies on exporter to ship goods as described in documentsRisk to importer: relies on exporter to ship goods as described in documents

MINIMIZING CREDIT RISKS Bills of Exchange (Draft) Bills of Exchange (Draft) Unconditional order directing buyer to pay a fixed sum on a determined date (like check, except gives title to goods)Unconditional order directing buyer to pay a fixed sum on a determined date (like check, except gives title to goods) Usually used in conjunction with documentary saleUsually used in conjunction with documentary sale By accepting the draft, the buyer acknowledges the obligation to payBy accepting the draft, the buyer acknowledges the obligation to pay Common payment terms days after sightCommon payment terms days after sight Seller presents draft and any documents to bank in order to obtain endorsement, use of overseas bank correspondent and collection facilities.Seller presents draft and any documents to bank in order to obtain endorsement, use of overseas bank correspondent and collection facilities. Common documents with draft = BOL, commercial invoice, packing list, insurance etc.Common documents with draft = BOL, commercial invoice, packing list, insurance etc.

MINIMIZING CREDIT RISKS Best Practices Documentary & Bills of Exchange Best Practices Documentary & Bills of Exchange SellerSeller Make sure satisfied with buyer and country risks Make sure satisfied with buyer and country risks Make sure goods and services supplied in accordance with contract terms Make sure goods and services supplied in accordance with contract terms Make sure collection instructions clear and identical to terms agreed upon in the contract Make sure collection instructions clear and identical to terms agreed upon in the contract BuyerBuyer When asked to pay or accept bill of exchange, make sure consistent with contract When asked to pay or accept bill of exchange, make sure consistent with contract Make sure satisfied with goods or services before instructing bank to pay or accept bill of exchange Make sure satisfied with goods or services before instructing bank to pay or accept bill of exchange Make sure correct documents received to obtain goods Make sure correct documents received to obtain goods

MINIMIZING CREDIT RISKS Letters of Credit Letters of Credit Most widely used method of international paymentMost widely used method of international payment Different types (documentary/commercial, standby etc.)Different types (documentary/commercial, standby etc.) Instrument whereby a bank furnishes credit in place of the buyer’s creditInstrument whereby a bank furnishes credit in place of the buyer’s credit Autonomous document separate from the contractAutonomous document separate from the contract ProcedureProcedure Underlying contract provides payment to seller via LOC Underlying contract provides payment to seller via LOC Buyer arranges for bank to open LOC for the benefit of the seller Buyer arranges for bank to open LOC for the benefit of the seller LOC has precise instructions which provide payment against the delivery of a full set of documents LOC has precise instructions which provide payment against the delivery of a full set of documents Payment made upon delivery of documents Payment made upon delivery of documents

MINIMIZING CREDIT RISKS Documentary LOC (Commercial LOC) Documentary LOC (Commercial LOC) Bank makes payment on presentment of documents detailed in LOCBank makes payment on presentment of documents detailed in LOC Normally BOL, Insurance, draft & certificate of originNormally BOL, Insurance, draft & certificate of origin Standby LOC (used in lieu of bank guarantee) Standby LOC (used in lieu of bank guarantee) Payment made in the event buyer fails in obligation to pay Payment made in the event buyer fails in obligation to pay Seller provides documents evidencing default Seller provides documents evidencing default Cost =1-3% of the transaction Cost =1-3% of the transaction Forms Forms Revocable v. IrrevocableRevocable v. Irrevocable Revocable not enforceable, don’t use Revocable not enforceable, don’t use Confirmed v. UnconfirmedConfirmed v. Unconfirmed Confirmed if unfamiliar with overseas bank Confirmed if unfamiliar with overseas bank Back-to-BackBack-to-Back Issued upon the security of an existing LOC Issued upon the security of an existing LOC

MINIMIZING CREDIT RISKS Best Practices LOC Best Practices LOC SellerSeller Make sure local bank as authenticated the LOC Make sure local bank as authenticated the LOC Examine the LOC carefully for consistency with sales contract Examine the LOC carefully for consistency with sales contract Make sure to present all documents named Make sure to present all documents named BuyerBuyer Check credit for LOC Check credit for LOC Consistency with contract Consistency with contract All necessary documents All necessary documents Insist on terms to protect interests such as late payment dates etc. Insist on terms to protect interests such as late payment dates etc.

MINIMIZING CREDIT RISKS Other Payment MechanismsOther Payment Mechanisms  Title Retention Best if goods easily identifiable and not incorporated into a finished product Best if goods easily identifiable and not incorporated into a finished product Seller retains ownership of goods until purchase price is paid in full Seller retains ownership of goods until purchase price is paid in full Pay attention to INCOTERMS Pay attention to INCOTERMS  Conditional Sales If buyer defaults seller may rescind contract If buyer defaults seller may rescind contract  Security Interest  Seller is granted a security interest in goods (more common when sale is financed, but local laws vary)  Promissory Note  Buyer’s obligation documented by promissory note  Still may be difficult to physically reclaim goods

MINIMIZING CREDIT RISKS Trade and Bank Acceptances Trade and Bank Acceptances Promise by drawee of the draft to pay instrument when it maturesPromise by drawee of the draft to pay instrument when it matures Provides short-term fixed rate financingProvides short-term fixed rate financing Trade acceptanceTrade acceptance Bank as drawee Bank as drawee Before acceptance drawee has no obligations Before acceptance drawee has no obligations Holder can only enforce the draft is the draft is dishonored Holder can only enforce the draft is the draft is dishonored Once acceptance occurs, drawee primarily liable to holder Once acceptance occurs, drawee primarily liable to holder Bank AcceptanceBank Acceptance Non-interest bearing draft drawn by company on bank Non-interest bearing draft drawn by company on bank Acceptance occurs by stamp approval with signature of bank Acceptance occurs by stamp approval with signature of bank If bank honors acceptance, buyer must put funds in bank before payment is due If bank honors acceptance, buyer must put funds in bank before payment is due

MINIMIZING CREDIT RISKS Conditional Sales Arrangements (Contractual) Conditional Sales Arrangements (Contractual) Seller retains ownership of goods until purchase price is paid in fullSeller retains ownership of goods until purchase price is paid in full If buyer defaults seller may rescind contractIf buyer defaults seller may rescind contract Seller often granted a security interest in goodsSeller often granted a security interest in goods Buyer’s obligation documented by promissory noteBuyer’s obligation documented by promissory note Useful where buyer is end user and goods sold are easily identifiable & nonperishableUseful where buyer is end user and goods sold are easily identifiable & nonperishable Still may be difficult to physically reclaim goodsStill may be difficult to physically reclaim goods

MINIMIZING CREDIT RISKS Export Credit Insurance Export Credit Insurance Involves insuring exporters againstInvolves insuring exporters against Commercial risks Commercial risks Non-acceptance of goods by buyerNon-acceptance of goods by buyer Failure of buyer to pay debtFailure of buyer to pay debt Failure of banks to honor documentary creditsFailure of banks to honor documentary credits Political risks Political risks War, riots etc.War, riots etc. Change of government policy or political partyChange of government policy or political party Blockage of foreign exchange (i.e. exchange controls)Blockage of foreign exchange (i.e. exchange controls) Currency devaluation (i.e. Argentina)Currency devaluation (i.e. Argentina)

MINIMIZING CREDIT RISKS Export Credit Guarantees Export Credit Guarantees Issued by financial institution (banks) or government agency (EXIM Bank in U.S.)Issued by financial institution (banks) or government agency (EXIM Bank in U.S.) Assistance for companies without sufficient track records to obtain credit from banks for exportsAssistance for companies without sufficient track records to obtain credit from banks for exports Instruments to safeguard export- financing banks from losses that may occur from providing funds to exportersInstruments to safeguard export- financing banks from losses that may occur from providing funds to exporters

AGREEMENTS/DOCUMENTATION INCOTERMS (2000) ICC INCOTERMS (2000) ICC Standard trade definitions most commonly used in international sales contracts.Standard trade definitions most commonly used in international sales contracts. Uniform Customs and Practice for Documentary Credits Uniform Customs and Practice for Documentary Credits UCP500 is the standard practices guideline for letters of creditUCP500 is the standard practices guideline for letters of credit Standards to be followed by banks in examining LOCsStandards to be followed by banks in examining LOCs Applies only to LOCs referencing UCP textApplies only to LOCs referencing UCP text eUCP eUCP In November 2002, ICC published a new guide called eUCP to supplement UCP500 for electronic transactionsIn November 2002, ICC published a new guide called eUCP to supplement UCP500 for electronic transactions International Standby Practices (ISP98) International Standby Practices (ISP98) Governs standby LOCs in place of UCP which focuses more on commercial letters of creditGoverns standby LOCs in place of UCP which focuses more on commercial letters of credit

AGREEMENTS/DOCUMENTATION Important to document transaction whether it is in the form of a simple purchase order or formal contract (attention to both sales and purchase forms) Important to document transaction whether it is in the form of a simple purchase order or formal contract (attention to both sales and purchase forms) Signed and notarized by both parties Signed and notarized by both parties Key clauses that can affect payments: Key clauses that can affect payments:  Title  Payment (currency)  Choice of Law  Choice of Forum  Assignability of account

AGREEMENTS/DOCUMENATION  Title  Passage (Where do you want title to pass & is that consistent with the INCOTERM used?)  Retention (include specific language in contract)  Assignment of Accounts  Allow for assignment by seller and look for purchaser prohibitions  Payment  Note currency of contract to avoid exchange risks  Be specific in description of payment terms ($ recommended)  Choice of Law (Provision that specifies applicable law is essential) Avoid uncertainty as to applicable laws Avoid uncertainty as to applicable laws Usually enforceable if reasonable nexus Usually enforceable if reasonable nexus Certain issues still decided by local law Certain issues still decided by local law  Choice of Forum  Litigation or binding arbitration?  Designate arbitration body and applicable rules which differ from internal rules (ICC, AAA etc.)

FOREIGN EXCHANGE RISKS In addition to forms and types of payments, collection efforts are also significantly affected by: In addition to forms and types of payments, collection efforts are also significantly affected by: Foreign Exchange RisksForeign Exchange Risks Foreign Exchange ControlsForeign Exchange Controls

FOREIGN EXCHANGE RISKS General Foreign Exchange Risk General Foreign Exchange Risk Risk of loss on account of change in Forex rates during a particular period of timeRisk of loss on account of change in Forex rates during a particular period of time Liability to make a future payment in foreign currencyLiability to make a future payment in foreign currency Asset denominated in foreign currencyAsset denominated in foreign currency Overseas subsidiaries Overseas subsidiaries Debt payable in foreign currencyDebt payable in foreign currency Risk for both creditor and debtor Risk for both creditor and debtor

FOREIGN EXCHANGE RISKS Corporate Forex Risks Corporate Forex Risks Transaction ExposureTransaction Exposure Input material of component denominated in foreign currency, manufactured domestically or finished product is for export Input material of component denominated in foreign currency, manufactured domestically or finished product is for export Operational ExposureOperational Exposure Effect of exchange rate on revenue and expenditures and income statement Effect of exchange rate on revenue and expenditures and income statement Profits earned outside U.S. and converted to $ Profits earned outside U.S. and converted to $ Translation ExposureTranslation Exposure Multinationals risk associated with foreign assets & liabilities Multinationals risk associated with foreign assets & liabilities Consolidated statements in common representative currency Consolidated statements in common representative currency Forex value of assets and liabilities must be translated into reporting currency Forex value of assets and liabilities must be translated into reporting currency

FOREIGN EXCHANGE RISKS Hedging Foreign Exchange Risks Should the risk be hedged? Hedging Foreign Exchange Risks Should the risk be hedged? Size of the risk/transaction Size of the risk/transaction Amount of time involved Amount of time involved Amount of money Amount of money Stability of foreign currency involved Stability of foreign currency involved Presence of exchange controls Presence of exchange controls

FOREIGN EXCHANGE RISKS Basic Hedging Techniques Basic Hedging Techniques Payment and sales in U.S. $ or home country currency, risk is transferred to other partyPayment and sales in U.S. $ or home country currency, risk is transferred to other party Internal hedgeInternal hedge Purchase amount of foreign currency needed for transaction at the time the transaction is consummated Purchase amount of foreign currency needed for transaction at the time the transaction is consummated Acquire asset denominated in foreign currency that equals liabilityAcquire asset denominated in foreign currency that equals liability

FOREIGN EXCHANGE RISKS Basic Hedging Techniques (cont) Basic Hedging Techniques (cont) Forward Exchange ContractsForward Exchange Contracts Agreement between 2 parties that obligates them to exchange at a specified future date (settlement date) at an agreed upon price Agreement between 2 parties that obligates them to exchange at a specified future date (settlement date) at an agreed upon price Different than futures contracts which have standard contract sizes, time periods, settlement procedures and are traded on regulated exchanges throughout the world. Different than futures contracts which have standard contract sizes, time periods, settlement procedures and are traded on regulated exchanges throughout the world. Forward exchange clause within a contract Forward exchange clause within a contract Examples: Examples: Date is determined (end of month, specific date etc.)Date is determined (end of month, specific date etc.) Rate is fixed (watch out for transfer pricing with related partiesRate is fixed (watch out for transfer pricing with related parties If rate fluctuates parties will renegotiate pricesIf rate fluctuates parties will renegotiate prices

FOREIGN EXCHANGE CONTROLS Risk regarding access to foreign currency Risk regarding access to foreign currency Government controls the availability or use of foreign currency for capital transfers & payment for current transactions Government controls the availability or use of foreign currency for capital transfers & payment for current transactions Forms: Forms: Laws, regulations & other measures by stateLaws, regulations & other measures by state typically through the central banktypically through the central bank Restricts availability or use of forex (directly or indirectly)Restricts availability or use of forex (directly or indirectly) Domestic interest rates high to attract foreign capital and vice versaDomestic interest rates high to attract foreign capital and vice versa Result: Result: May have restrictions on access to forexMay have restrictions on access to forex Inability to pay in dollarsInability to pay in dollars May lose dollar denominated contracts (Argentina)May lose dollar denominated contracts (Argentina)

DEALING WITH DEFAULT  Collecting payments overseas can be difficult and expensive  Negotiate with the customer first  Consider formal collection actions when: Other remedies have been exhausted Other remedies have been exhausted The amount involved enough to warrant collection efforts The amount involved enough to warrant collection efforts

DEALING WITH DEFAULT  Common Collection Actions:  Legal proceedings (vary throughout the world)  Arbitration (preferable from an international collection standpoint)  File Claim

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