ShareThis

Letters of Credit

The most secure and most often used method of payment in export/import transactions is the documentary letter of credit. A letter of credit is a document issued by a bank on the instruction of a buyer of goods (importer), authorizing the seller (exporter) to draw a specified sum of money under specified terms, usually the receipt by the bank of certain documents within a given time.

Before payment, the bank responsible for making payment on behalf o the buyer verifies that all documents are exactly as required by the letter of credit.

If a U.S. exporter is unfamiliar with the credit risk of the foreign bank, or if there is concern about the political or economic risk associated with the country in which the bank is located, it is advised that a letter of credit issued by a foreign bank be "confirmed" by a U.S. bank. This means that the U.S. bank adds its pledge to pay to that of the foreign bank. Letters of credit that are not confirmed are called "advised" letters of credit. The local Department of Commerce district office or an international banker will help exporters determine whether a confirmed or advised letter of credit is appropriate for a particular transaction.

Letters of credit may be irrevocable (cannot be changed unless both the buyer or seller agree) or revocable (either party can make changes). An "at sight" letter of credit means that payment is made immediately upon presentation of documents. "Time" or "date" letters of credit specify when payment is to be made in the future.

Changes made to a letter of credit are called amendments. The fees charged by the banks involved in amending the letter of credit may be paid either by the buyer or the seller, but the letter of credit should specify which party is responsible. Since changes are costly and time-consuming, every effort should be made to get the letter of credit right the first time.

An exporter is usually not paid until the advising or confirming bank receives the funds from the issuing bank. To expedite the receipt of funds, wire transfers may be used. Bank practices vary, however, and the exporter may be able to receive funds by discounting the letter of credit at the bank, which involves paying a fee to the bank for this service. Exporters should consult with their international bankers about bank policy on these issues.

Other Methods of Payment for International Transactions

Cash in Advance (CIA)

Usually used only for small purchases and when the goods are built to order.

Draft (or Bill of Exchange)

An unconditional order in writing from one person (the drawer) to another (the drawee), directing the drawee to pay a specified amount to a named drawer at a fixed or determinable future date. May be date, sight, or time draft.

Credit cards

Used mainly in transactions where the dollar value of the items sold is low and shipment is to be made directly to the end user.

Open Account

The exporter bills the customer, who is expected to pay under agreed terms at a future date. Some of the largest firms abroad make purchases only on an open account, which is a convenient method of payment if the buyer is well established and has demonstrated a long and favorable payment record.

Consignment Sales

Exporter delivers goods to an agent under agreement that the agent sell the merchandise for the account of the exporter. The agent sells the goods for commission and remits the net proceeds to the exporter.

Countertrade/barter

Sale of goods or services that are paid for in whole or in part by the transfer of goods or services from a foreign country.

Payment Problems

The best solution to a payment problem is to negotiate directly with the customer. If negotiations fail and the sum involved is large enough to warant the effort, obtain the assistance of your bank, legal counsel, and other qualified experts. If both parties can agree to take their dispute to an arbitration agency, this step is faster and less costly than legal action. The International Chamber of Commerce handles the majority of international arbitrations and is usually acceptable to foreign companies because it is not affiliated with any single country.

For more information on these issues, contact the U.S. Council for International Business, American National Committee of the ICC, (212) 354-4480; American Arbitration Association, (212) 484-4000; Trade Remedy Assistance Office International Trade Commission, (202) 205 2200.