Switching from Letters of Credit to Collections

By Chris Lidberg

In a previous article I suggested that companies should perform an annual review of payment terms for each of their customers. A company’s credit- worthiness and/or their country’s risk factors may improve or decline over time, and you may need to adjust their payment terms accordingly.

Let’s assume that you’ve been selling goods to a particular buyer for the last couple of years on a letter of credit basis. All in all, everything is going well. Whenever discrepancies are discovered, your customer cooperates and provides the appropriate waivers in a timely manner and payment is made. The buyer knows that you’ll ship on time and present the required documents. You’ve established a business relationship that appears to be working.

Since the letter of credit process is the most expensive and most structured payment method you can choose, you may want to consider an alternative payment term:  the collection.

If you never incur any discrepancies when using a letter of credit, you can be absolutely assured that you’ll receive payment from the issuing bank. A collection offers no such assurance. However, if you have experienced discrepancies in a letter of credit, your risk in switching to a collection is not dramatically different.

Whether you use a letter of credit that has some discrepancies or a collection, your risk of not getting paid is about the same. In both cases you must wait for the beneficiary to approve payment.

Let me explain the process of a collection using a sight draft. First, the buyer and seller must agree that the collection is an appropriate payment term. The seller ships the goods to the buyer and then sends all documentation to the buyer’s bank using the seller’s bank’s direct collection form.

When the buyer’s bank receives the documentation, they will follow the instructions on the direct collection form. In this case, they will release the documentation to the buyer only upon receiving payment. The buyer will receive a copy of the invoice from their bank and then must decide to authorize payment. Once this is done, the buyer’s bank then transfers the payment to the seller’s bank. Last, but not least, the seller’s bank makes payment to the seller.

It all sounds pretty easy!

But a collection does have some risk. When the buyer receives the invoice from their bank, they may decide not to authorized payment and instead delay, or even worse, refuse payment.

At this point, the seller has three options:

(1)   Negotiate for payment. Find out what is wrong and try to come to an understanding that will result in being paid.

(2)   Find another buyer. If the buyer can’t be persuaded to make payment, the seller can try to find another buyer. Ideally, the seller will find a new buyer in the same country as the old buyer so the goods don’t have to be moved again.

(3)   Have the goods returned. This is not the best solution since the seller has already incurred a lot of expenses with no hope of recovering them. However, that may be a better alternative than writing off the entire cost of the goods.

An alternative to the sight draft is a time draft, which is always drawn on the buyer. When a time draft is being use, the collections process is a little different. When the buyer’s bank sends the copy of the invoice to the buyer, they also enclose a time draft telling the buyer that they will need to accept the draft and return it to their bank in order to obtain the documents. By accepting the draft, the buyer makes a promise to make payment when the draft comes due. However, they are not yet authorizing payment.

Once the buyer accepts the draft and returns it to their bank, the bank releases the documents to the buyer enabling them to get the merchandise. When the time draft matures, hopefully the buyer will instruct their bank to make payment. However, they still have the right to refuse payment if they wish.

Unlike the sight draft that gave the seller three options if the buyer refuses do pay, a time draft only gives them one: negotiate for payment. The buyer has the merchandise, so the seller can’t try selling it to someone else, nor can they have the goods returned. For this reason, a time draft collection is considered one step away from open account.

Ms. Lidberg's bio

Other Resources:

• Why is it taking so long to get paid? Part 1 by Chris Lidberg.
• Why is it taking so long to get paid? Part 2 by Chris Lidberg.
• Export Letters of Credit & Drafts, an IBT reference book.
• Letters of Credit - Export & Import, a GTC seminar.

Preparing a Foreign Representation Agreement

By Joe Robinson

To enhance export marketing and sales growth, it is important to appoint good local representation. Assuming that initiating a representation arrangement is based on sound fundamental business principals and good relationship building, the next part of the process is to establish a written understanding referred to as a contract of representation.

From a long-term human relations point of view, I prefer the term "agreement" rather than "contract." This establishes the psychology from the beginning that both parties intend to agree to assist each other to enhance their business and generate income respectively.

I am not an attorney and by no means should you consider this article to offer legal advice. I would like to offer a few points you may wish to include in preparing your representation agreement.

Begin by writing down topics you want covered in your agreement. Then have your legal counsel incorporate these and other generally accepted practices into your agreement.

The fact that both parties agree on a written document cannot guarantee that disagreement will not arise in the future; however, having a written document is a useful technique for avoiding or at least minimizing conflicts.

The following suggestions are not all-inclusive but offer a few points for your consideration.

The exporter is the principal and, therefore, should be the party that prepares the representation document. It is generally not good practice for an exporter to sign a representative agreement provided by the overseas rep or agent as this psychology sets the stage for lack of control and reduces your negotiating leverage should a dispute arise in the future.

If you like an agreement provided by the potential foreign representative, I suggest you retype it on your own stationery with appropriate additions, deletions and/or modifications that you want to be covered.

Some suggested points to include:

• Do initial due diligence before appointing your representative.

• Make provision to exclude house, direct or U.S. military accounts if this applies to your business.

• Clearly explain non-compete policies established by your company and be sure that these comply with legal requirements of the local country.

• If English and the local language are both used, state that English is the prevailing language.

• Specify conditions under which cause for termination will apply and establish a time period and procedure accordingly. For example, if you put a minimum sales quantity in your agreement that is consistently not achieved because of lack of performance or effort (as opposed to economic factors beyond anyone's control such as radical currency devaluation or economic downturn) then state that the agreement can be terminated within a specified number of days (60 or 90 days are common) from date of written notice of termination.

• Register your name, trademark and logo in the local language as well as in English. Failure to do so may enable a shrewd rep/agent to do so on his own without your knowledge. In the event of a future dispute or termination, the “ownership” and control of your name, trademark and logo in the local (read this “official”) language of that country may give a disgruntled representative enormous power in negotiating and, in some cases, prohibiting you from exporting to that country as violating his local ownership rights. I witnessed this in Japan in the early 1970’s and again in Mexico in the late 1980’s.

• Incorporate a provision that in the event your rep makes any improvement or enhancement to your product that this improvement belongs to your company because the representative would not have been able to make this improvement without having gotten into a relationship with you in the first place.

• Be sure to state the commission structure and payment conditions to include “split” commissions, if they apply in your case.

Some suggested points to avoid:

• Do not make your agreement an indefinite or “evergreen” arrangement. Instead, consider a calendar year coverage period that requires renewal of the agreement on January 1 or other convenient annual renewal date.

• State clearly in your agreement that your representative is not authorized or allowed to legally sign binding agreements on your behalf.

• Be sure to state that your local representative is prohibited to pay bribes on your behalf to any government official, politician or related organization whether elected or appointed.

• Do not permit the representative to accept and acknowledge orders bindingly on your behalf. You must retain the ultimate right to accept or reject all purchase orders and should not relinquish this control.

• Include a statement that the representative is not allowed to incur expenses on your behalf without prior approval from an authorized staff of your company.

Mr. Robinson's bio

Other Resources:

• Growing Your International Business with a Local Presence by Joe Robinson.
• Export Sales Agents & Distributors, an IBT reference book.
• Export Sales and Marketing Manual, an IBT reference book.