Some export financing basics—or, terms of payment

AgExporter, June, 2002 by William S. Hawkins

Before undertaking export transactions supported by the Supplier Credit Guarantee Program (SCGP) or other assistance, the U.S. supplier or seller must assess the potential financial risk inherent in the sale. Once the seller has determined the risks that his or her company can afford, a method of payment is agreed upon between buyer and seller.

When considering which terms of payment will suit your sale, remember that every transaction involves two commodities: the product and the money Because of the intense competition for export markets, offering the buyer attractive payment terms (low transaction costs, deferred payment terms, lower interest rates) is often essential to export success. Here are definitions of the terms used in this issue, especially as they relate to export credit programs.

Promissory note issued by the importer to the exporter is the payment instrument used in the SCGP. The promissory note must be payable in U.S. dollars. Participants should carefully review the provisions of the note. No changes can be made to the note, nor can another form of note be used.

Documentary letter of credit is a commitment from the issuing bank to pay the seller (as beneficiary) a specified amount, provided terms and conditions of the letter of credit are met. The U.S.-dollar-denominated letter of credit is the payment instrument used in the GSM-102 and GSM-103 Export Credit Guarantee Programs.

Letters of credit are generally irrevocable. Once the letter of credit is established, it cannot be revoked or changed without the consent of all parties, unless the original letter of credit specifically states that it is revocable.

The letter of credit distributes risk between the seller and buyer. The seller is assured of payment when the conditions of the letter of credit are met; the buyer is assured that he or she won't have to pay for goods if the documented conditions are not met. It is a common method of payment, especially in new seller/buyer relationships.

The letter of credit is, however, not without drawbacks. If, after shipment, discrepancies exist in the required documents that cannot be corrected by the seller, the buyer has the option to approve the discrepancies and pay for the shipment--usually at a discount--or to reject it. If the shipment is rejected, the seller retains title to the goods. A rejected shipment means that the seller must quickly renegotiate with the buyer, locate a new buyer (usually at a lower price) or pay for the shipment to be returned. Also, costs of a letter of credit add to the price of the product and can tie up the buyer's working capital or credit.

You, your banker and your freight forwarder should scrutinize the letter of credit to determine whether it is legitimate and whether terms and conditions can be met. Bankers and forwarders can also help prepare documentation and reduce the chance of discrepancies.

It is sometimes preferable to get a letter of credit confirmed by a U.S. bank if you are concerned the foreign bank may not be willing or able to pay you after shipment. A confirmation guarantees to the seller that the U.S. bank will pay the seller if the documents conform to the requirements of the letter of credit regardless of whether the foreign bank pays.

Another issue to consider is transferability. If the seller is acting as a broker for, or shipper of, the goods, and the seller does not wish to take title to the goods, the letter of credit can be transferred to the supplier, so both exporter and supplier get paid at the same time after shipment.

Standby letter of credit, like the documentary letter of credit, is a commitment or promise from the buyer's bank to pay the seller only if another business transaction specified in the standby letter of credit is not performed. For example, if the buyer and seller have agreed to an open account sale and the buyer defaults, the seller could present documentation to the buyer's bank certifying that the buyer failed to pay for the shipment secured by the standby letter of credit, and collect payment from the buyer's bank.

A standby letter of credit is frequently used as performance security when a seller bids on an international tender by a state trading company In this case, the buyer may require the seller to open a standby letter of credit; if the seller is unable to perform the contract, the buyer can draw on the value of the standby letter of credit as a penalty.

Open account is a transaction in which the seller agrees to provide the goods to the buyer, who agrees to make payment at a specified future date. Payment by the buyer is typically made by wire transfer or check.

Open account is a high-risk method of payment for the seller. The seller must be confident that the buyer is well-established, has a long and reputable payment record, has good credit and is able to convert currency into U.s. dollars. Collection on delinquent payments may be difficult--and costly--if the obligation of the buyer to pay the seller is not well documented. Even when well documented, collection on delinquent open account sales usually requires legal action in the buyer's country.