1. 1 Lecture 14 More International Business Transactions

2. 2 AGENDA: 1.Introduction 2.Factoring 3.Types of Factoring 4.Forfaiting 5.International Financial Leasing 6.Bonding & Counter Trade 7.Barter & Compensation Deals 8.Buy-back Arrangements

3. 3 Factoring, Forfaiting, Financial Leasing and other types of merchant finance 2 of these methods are subject to international Conventions: international factoring & international financial leasing These Conventions have been prepared by UNIDROIT (International Institute for the Unification of Private Law in Rome) and were adopted by a Diplomatic Conference at Ottawa on May 28 1988

4. 4 Factoring Means selling export debts for immediate cash, thus the exporter shifts the problems of collecting payment for completed orders over to organizations (factors) that specialize in credit management and finance Ideally, the exporter should go to a factor before the contract is signed or shipment is made and secure its willingness to buy the receivables

5. 5 Factoring The factors verifies the credit rating of the prospective buyer, the factor acting like a credit approval agency, a facilitator and guarantor of the payment The factor does not usually buy export debts on term exceeding 120 days There is a charge for factoring service (around 0.75 – 2.5% of the sales value)

6. 6 Factoring The essence of factoring is: a finance house called the factor agrees to relieve the exporter of the financial burden of the export transaction (the collection of the price due from overseas buyer) so that the exporter can concentrate of his real business (selling & marketing of his products) It is like a division of labor: exportation including dispatch of goods, the documents and the transfer of transport documents is done by the exporter (seller), while the credit management is the responsibility of the factor

7. 7 Factoring International factoring is thus important in international trade, helping ease the cash flow of exporter’s business If on a non-recourse basis, factoring affords protection against bad debts

8. 8 Factoring: various aspects When you have a factoring agreement, there are 2 legal points you have to pay attention to: 1.What is the legal form of factoring agreement? i.e.: disclosed/undisclosed: -If it is disclosed, then the buyer is notified (or can be notified) of this arrangement -If undisclosed, the arrangement between the seller and the factor is confidential

9. 9 Factoring: various aspects 2. Does the factor have a claim of recourse against the exporter if the buyer fails to pay or is it on a non-recourse basis? -If on non-recourse basis, the factor alone bears the risk if he cannot collect the payment -If on a recourse basis, in case the collection cannot be collected, the factor may be entitled to indemnities

10. 10 Direct vs. Indirect Factoring Direct Factoring: There is only one factor, i.e. the export factor in exporter’s (seller’s) country with whom the exporter has concluded a factoring agreement After assigning the claim for the price, the factor is in direct contractual relationship with the buyer

11. 11 Direct vs. Indirect Factoring Indirect Factoring: There are 2 factors, the export and the import factor, the latter being in importer’s (buyer’s) country The buyer makes the payment to the import factor in his country. Then, the latter pays to the export factor There is no contractual relations between the factors Has the advantage that each factor deals with the local customer, thus being able to verify more precisely the credit rating of its client

12. 12 Direct & Indirect Factoring Remember: The factoring contract is separate from the export sales contract The law applying to the factoring contract is normally that of the place at which the factor carries on its business In case the exporter sends non-conforming goods or otherwise breaches the sales contract and the buyer rightfully refuses to pay, then the factor is entitled to recourse, even if it is a non- recourse arrangement

13. 13 Disclosed Factoring The collection of price is done in the following way: The factor enters into the factoring contract with the exporter and agrees to purchase certain short-term debts (“approved receivables”) When the exporter sells the goods, the claim for the price is assigned to the factor and the overseas buyer is asked to pay him The buyer is thus notified the price will not in fact be paid to the exporter “Unapproved receivables” are purchased on a recourse basis Usually the term of the factoring agreement is “whole turnover”, meaning the export seller offers all his receivables

14. 14 Disclosed factoring The Factor may also carry some other functions like credit management services (handling, sales accounting (ledgering) etc.) The factor may also finance the transaction, in addition to providing price collection and/or credit management services When the factor finances the transaction, he will use the services of an import factor in overseas buyer’s country Obviously, there will be a charge for such services and it will be usually higher that banks’ charges

15. 15 Undisclosed Factoring Most common type is invoice discounting There is an arrangement between the exporter and the factor, but it is not disclosed to the buyer who will pay the price to the export seller The exporter receives the money as a trustee of the factor and then places them into an account nominated by the factor Invoice discounting is on a recourse basis In some instances, the seller has to sell the goods to the factor, then the latter allows the seller to resell the goods to the buyer (this is done on credit terms)

16. 16 UNIDROIT Convention on International Factoring This Convention applies when the seller and the buyer are in different countries The Convention is aligned to the CISG Its application may be excluded by the parties to the factoring contract or sales contract The Convention applies to both disclosed and undisclosed factoring Indirect Factoring is also regulated

17. 17 Forfeiting The essence of forfeiting is: Debtor’s obligation which matures at some future date can be turned by the creditor into cash by selling that obligation to the forfeiter who agrees to the purchase of the obligation on a non-recourse basis only if secured by a third party Forfeiting is used in 2 situations: 1.In a financial transaction to make long-term financial facility liquid 2.In an export transaction to help cash flow of the export who has allowed the overseas buyer credit !!!We will cover only the 2 nd type!!!

18. 18 Forfeiting A finance method developed in Switzerland in the 1950s, the term coming from French language It is an arrangement whereby exporters of capital goods (ex. machinery) can obtain medium-term finance (1-7 years) The exporter has a buyer that wants to buy the capital goods by means of a medium-term credit The buyer will pay at once a part of the price and further pays the balance in regular installments over next several years The advantage is that there is immediate cost for the exporter and up to 100% of the contract value can be financed

19. 19 Forfeiting: details The export seller will obtain from the overseas buyer time bills of exchange or promissory notes maturing at specified future dates These negotiable notes will be avalised by a bank in the importer’s country or that bank will guarantee their performance

20. 20 Forfeiting: details The negotiable instrument se secured will then be negotiated by the export seller to his own bank, without recourse by that bank to him, this exporter’s bank acting as the forfeiter The forfeiting arrangement has to be agreed upon in the underlying contract between the seller and the buyer, but normally after the agreement is first obtained from the banks in each country (for the exporter that the bank will forfeit the negotiable instruments, for the buyer that the bank will avalise or guarantee them)

21. 21 A typical forfeiting transaction An exporter sells machinery that is going to be paid by 10 promissory notes from the buyer maturing at 6 month intervals over the next 5 years Banks prefer promissory notes, but bills of exchange are also accepted

22. 22 RECAP: Remember negotiable instruments?? Negotiable Instruments - 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

23. 23 RECAP: Negotiable Instruments Promissory Notes In the law of negotiable instruments, 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

24. 24 International Financial Leasing Bank and financial houses are sometimes asked to provide financial assistance to international leasing transactions Again, these concern capital goods (ships, aircrafts, containers or heavy equipment) The lessee who whishes to use these goods pays the lessor a rental Here are great risks involved, especially when the time of leasing is long.

25. 25 International Financial Leasing A.If the owner of the equipment accepts the risk, he may become lessor by himself. This it is a 2 party agreement between the lessor and lessee B.If the owner does not want to bear the risks, a financial leasing transaction is created where a bank of a financial house is interposed between the initial 2 parties: the owner sells the goods to the finance house (the creditor) and the latter acts as a lessor towards the user (lessee). This is a 3 party agreement

26. 26 Financial Leasing: details There are 2 types of Financial Leasing: -In the pure leasing transaction, the possession returns to the owner after the period of leasing is over -Under the other type, the lessee has the option of acquiring the property of the leased goods (here, a differed price component is included in the rental) UNIDROIT Convention on International Leasing: applies when the lessor and lessee are from different countries -The parties may exclude its application -Convention applies to both types of International Leasing -Convention distinguished between: supply agreement (lessor and supplier) and leasing agreement (lessor and lessee)

27. 27 Leasing: Conclusion Exporters thus can arrange: 1.Cross-border leases directly from a bank or leasing company to the foreign buyer 2.Obtain local leasing facilities through overseas branches or subdivisions or international banks of international leasing associations The exporter will receive prompt payment from leasing company It is better to set up the leasing facility at an early stage when the exporter receives the order for example

28. 28 Bonding & Counter-trade Bonding: In some instances, contracts are cash or short-term This in principle is excellent for the seller, but at buyer’s expense as the latter has to release his cash fast A solution is a bond or a guarantee (in writing) which is issued by an acceptable third party (bank or insurance company) that guarantees compliance Counter-trade: Arrangements under which the seller provides the buyer with goods and agrees to reciprocal purchasing obligation for the original sales value

29. 29 Barter & Compensation deals Barter: Exchange of goods without any money transfer Bilateral barter is rather uncommon, while trilateral or with even more parties involved is sometimes used (trading chain) Compensation deal: This is export of goods in one direction, payment being split into 2 parts: Part payment of cash by the importer For the rest of payment, the exporter makes an obligation to purchase some of buyer’s goods

30. 30 Buy-back arrangements Sale of machinery or equipment to the buyer’s production is financed, in part, by exporter’s purchase of some of the resultant output Buy-back arrangements are long-term arrangements