Managing payment risks in commercial transactions

SELLER’S EXPECTATIONS AND RISK FACTORS Not fully conversant with the financial status of the buyer To receive payment as early as possible without disturbing his funds flow If required, to avail credit facilities with financial institutions at the cheapest interest rates against the receivables If it is an export - Not fully aware about the legal formalities prevailing in buyer’s country If it is a service provider – delayed settlement of receivables To receive correct amount - in the desired currency - in his own place at the right time

Buyers expectations and risk factors To receive the same consignment at the right place Not to pay until the consignment is received at his end to defer the payment as far as possible to avail cheapest credit facility from any financial institution at concessional rate of interest for the payables…

UNCERTAINITIES AT BOTH THE ENDS….. With all these risks and uncertainties, trade is continuously growing with no boundaries Who takes the risk .. the buyer, the seller or both or the intermediaries ? How do they manage the receivables and the outstanding ? At what cost….

METHODS OF MANAGING THE RECEIVABLES Documentary collection Clean collection Direct collection Documentary credit / letters of credit Guarantees Post Dated Cheques Factoring / Forfaiting Advance Payment

Commercial contractual terms seller Commercial contractual terms buyer

Features of a commercial contract… Sale / purchase contract is a document recording the terms of delivery and terms of payment Who will bear the expenses / risk factors up to which stage Whether transport charges will be for the buyer or seller’s account Transit risk will be covered by marine insurance at whose expense At which stage transfer of title of the goods will take place

COMMERCIAL CONTRACT buyer Seller Remitting Bank Collecting bank 1 3 Submission of documents Documents Presented 2 Documents forwarded Remitting Bank Collecting bank

SALE CONTRACT Remitting Bank Collecting Bank seller Buyer 1 6 4 3 Submission of documents Payment made to Exporter Payment made Documents Presented 5 Payment Transferred 2 Remitting Bank Documents forwarded Collecting Bank

RISK FACTORS To offer discount If the buyer refuses to accept the documents and not paying – Seller To offer discount To search for an alternate buyer offering the goods with or without discount If alternate buyer not found, goods are to be re-booked Expenses – transport charges, freight charges, bank charges….Cost of funds Or abandon the goods….. Documents are safe but payment not assured

1 Goods consigned directly seller buyer SALE CONTRACT

SALE CONTRACT 2 Buyers Bank Sellers Bank 1 Goods consigned directly 4 Submission of Draft / Bill of Exchange Documents Presented Documents forwarded 3 Sellers Bank Buyers Bank

SALE CONTRACT 2 Buyers Bank Sellers Bank 1 Goods consigned directly 7 5 4 Submission of Draft / Bill of Exchange Payment made to Exporter Payment made Documents Presented 6 Payment Transferred 3 Documents forwarded Buyers Bank Sellers Bank

CLEAN COLLECTION.. RISK FACTORS Seller should have absolute faith and confidence on the buyer… since goods are directly consigned. Payment on due date by buyer If defaulted…. No assurance Has to resort to legal procedures

SALE CONTRACT buyers Sellers Bank Bank 1 seller Goods consigned directly with documents buyer SALE CONTRACT 4 2 Payment made to Exporter Payment made on the agreed date 3 Payment Transferred buyers Bank Sellers Bank

DIRECT COLLECTION.. RISK FACTORS No control on the goods since it is directly consigned to buyer Documents are also forwarded directly to the buyer … Only if the Seller has absolute confidence on the buyer’s capacity to pay..this method will be suitable; Otherwise… this will be more risky

Legal aspects of credit collection Transaction is covered under Indian Contract Act 1872. Bank is appointed as an agent for collection by the seller Bank does not assume any responsibility for credit protection Seller has to proceed against the buyer for non-fulfillment of contractual obligations under civil suit. In case of exports – no legal support except ICC Paris guidelines on collection documents

Advance payment Payment made in advance through the bank seller buyer Commercial contract Goods consigned

ADVANCE PAYMENTS… Buyer remits the payment in advance Receiving the consignment or getting back the payment if shipment never takes place will be the risk for the buyer Seller enjoys buyer’s funds

Letter of credit and guarantees To manage the receivables with lesser risks corporate may opt for any of these payment methods: Letter of Credit / Documentary Credit Inland / Foreign Guarantees / Standby credits

Establishing Letter of Credit buyer seller 1 2 3 ISSUING BANK CONFIRMING / ADVISING BANK SALE CONTRACT LC application submitted by the applicant to the issuing bank LC established by issuing bank through their correspondent bank with a request to pay on their behalf against submission of prescribed documents by the beneficiary LC advised- with /without confirmation

NEGOTIATION OF DOCUMENTS UNDER CONFIRMED CREDIT 2 seller buyer 6 4 3 1 5 CONFIRMING BANK ISSUING BANK

NEGOTIATION OF DOCUMENTS IN UNCONFIRMED CREDITS 2 seller 6 buyer 4 1 3 5 NEGOTIATING BANK ISSUING BANK

DOCUMENTARY CREDIT….. An arrangement whereby a bank acting at the request and on instructions of a customer i.e., the applicant / buyer To make payment to a third party (the beneficiary) by themselves or authorize other bank to pay or negotiate Against stipulated documents Provided Terms and conditions of the credit are complied with

Inland letter of credit - discounting buyer 6 4 seller 2 5 3 1 Sellers Bank Issuing bank

Documents under LC Bill of Exchange Commercial Invoice Transport document Inspection certificate Insurance Certificate of origin (in foreign trade)

Payment demanded on due date and defaulted by 1 Goods consigned directly seller buyer Payment demanded on due date and defaulted by importer 2 3 6 Standby credit 8 7 Submission of Draft / Bill of Exchange Payment made to Exporter Payment made Documents Presented 5 Payment made 4 Documents forwarded Issuing Bank Exporter’s Bank

STANDBY CREDITS Promise to honour beneficiary’s presentation of a document indicating the default of the applicant Act as a standby arrangement in case the obligation is not fulfilled by the applicant

STANDBY CREDITS MORE USEFUL IN COLLECTION INSTRUMENTS. TO PRESENT A COPY OF COMMERCIAL INVOICE & UNPAID BILL OF EXCHANGE

STANDBY CREDITS.. In respect of any debt,obligation or any liability by the overseas party in connection with bonafide trade transaction As a back up instrument for collection ICC 500 & ISP 98 are the governing guidelines

guarantees Guarantee issued Issuing bank application contract buyer seller contract

Guarantee invocation Issuing bank Stage 2 - invocation Recovery buyer seller Non performance Default stage i

GUARANTEES INLAND/FOREIGN FINANCIAL / PERFORMANCE /DPG DIFFERENCE BETWEEN FIN/PERF GUARANTEES TYPES OF GUARANTEES –RECEIVABLES AND PAYABLES CHECK POINTS

GUARANTEES - CHECK POINTS PURPOSE – SPECIFIC VALIDITY PERIOD CLAIM PERIOD VALUE LIMITATION CLAUSE REASONS FOR INVOKING – SPECIFIC HOW TO EXTINGUISH THE LIABLITY

INLAND GUARANTEES TYPE STATUS OF THE IB DOCUMENTARY CONDITIONS DOCUMENTS TO BE SPECIFIED REINSTATEMENT CLAUSE CHARGES INTEREST FACTOR

Post dated Cheques Advantages Wrongful dishonour Rightful dishonour Implications of dishonour Criminal N I law (Amendment) Act 1988

CRIMINAL LIABLITY IPC 415 CHEATING IPC 417 PUNISHMENT FOR CHEATING IPC 420 CHEATING AND DISHONESTLY INDUCING FOR DELY OF PROPERTY – 7YEARS SEC 2 & 11 DEFINES ‘PERSONS’ – CO, ASSNS, BODY OR PERSONS WHETHER INCORPORATED OR NOT

CRIMINAL LIABLITY Sec 138 – dishonour of cheques For insufficient balance Exceeds arrangement Account closed Payment stopped by drawer Issuing notice by the drawer to the payee not to present the cheque – but the payee presents the cheque – dishonoured – can the drawer prosecuted? Modi cements vs Kuchil kumar -1998 Drawer can easily get rid of the consequences.. Hence stop payment will not preclude action under Sec 138 Non cognizable offence

CONDITIONS Cheque to be presented within 6 months or expiry date whichever is earlier Payee or holder in due course makes a demand to drawer within 30 days from date of receipt of the returned instrument Drawer’s failure to pay within 15 days of receipt of notice Non-payment leads to ‘cause of action’ Complaint to be registered within one month of the ‘cause of action’ Period of one month should be from the day immediately following the day on which the period of 15 days from the date of receipt of the notice by the drawer expired.. Supreme Court judgement in Prem Chand Vs Yashpal Singh No court lower to that of Metropolitan Magistrate or Judicial Magistrate of I class will try the offence

GUIDELINES Complaint in writing With dishonoured cheque / return memo / copy of notice / evidence for receipt of notice by the drawer Sec 146 conveys ‘Bank’s slip prima facie evidence of certain facts – court will presume the fact of dishonour of such cheques until such fact is disproved’ Sec 147 – every offence punishable under this act is compoundable To be filed either where cheque is issued / dishonoured With metropolitan magistrate/ judicial magistrate/ I class magistrate

Cause of action Drawer can be punished only if he could not pay during the notice period Not for dishonour of cheque Punishment Twice the cheque value Two years imprisonment

Liability of Directors… Sec 141 of NI Act – every person of a company in charge of and responsible for business shall be deemed guilty Recent Supreme Court judgment by Arun Kumai in Appeal by SMS Pharmaceuticals Only directors responsible for the particular deal would be liable under NI Act No universal rule that a director of a company is in charge of its every day affairs… Depends upon the respective roles assigned to the officers in a company