IF YOU CAN’T DODGE A
RISK, HEDGE IT
Mitigating Risks in International
Payment and Collection
September 19, 2007
National Association of Credit Managers
Gateway Regional Conference
Presented By:
Jennifer Schwesig
Armstrong Teasdale, LLP
INTRODUCTION
• Laws applicable to bankruptcy, insolvency,
security interests, and creditor and debtor
rights vary drastically from country to
country
• Problems involving collections are more
readily avoided before credit is extended
KEY ISSUES IN INTERNATIONAL
TRADE FINANCING



Arranging for and receiving payment
Foreign exchange risks and controls
Collections
MINIMIZING INTERNATIONAL
CREDIT RISKS

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Risk of non-payment and collection
increases in international transactions
May be difficult to check overseas buyer for
creditworthiness
Goal is to minimize or eliminate the risk of
non-payment or inability to receive
payments
Determining the payment method,
financing and other key terms is important
MINIMIZING INTERNATIONAL
CREDIT RISKS
•
Credit Risk Reduction Methods:
 Credit
Checks
 Payment Types
 Export Credit Guarantees and Insurance
 Proper Documentation/Agreements
MINIMIZING CREDIT RISKS
•
Credit Checks
 Know the exact entity or individual you are dealing
with
 Check buyer’s credit history (if possible)
 Reliable up-to-date information may be difficult
to find
 Suggestions:
 Department of Commerce International
Company Profile (ICP)
 Local U.S. embassies (commercial divisions)
 Private credit reporting services
MINIMIZING CREDIT RISKS


The type of payment works to increase or
decrease credit risks
Types of payments
• Open Account
• Advance payment
• Documentary Sales
• Letters of Credit
• Bills of Exchange (Draft)
• Trade & Bank Acceptances
• Conditional Sales Arrangements
MINIMIZING CREDIT RISKS

Open Account
• Least secure method
• Seller sends goods with invoice for payment
• Advantages


reduction in transaction costs
works well with high volume shipping
• Disadvantages





Perform significant credit checks on buyer (credit risks)
Seller loses control of goods when dispatched (shipping
terms imp.)
Buyer may refuse to accept delivery
Seller must wait for payment until after the buyer has
received goods
No risk to buyer
• Supplement rights with title retention clause
MINIMIZING CREDIT RISKS

Best Practices for Open Account
• Seller





No open account when buyer is new or cannot
determine risk and reliability of buyer
Goods are delivered before 1st payment
Make sure to supply goods or services consistent with
a good contract dealing with disputes and nonpayment
Insist on an electronic transfer (cleared funds)
instead of a bank draft or check
Define credit terms
• Buyer


Inspect goods before making a payment
Make payment within agreed credit terms
MINIMIZING CREDIT RISKS

Advance Payment
•
•
•
•

Time of payment: before shipment
Goods available to buyers: after payment
Risk to exporter: none
Risk to importer: relies on exporter to ship
goods as ordered
Best Practices for Advance Payment
• Seller


Provide clear payment instructions (SWIFT)
Avoid accepting bank drafts or company checks
• Buyer

Avoid this arrangement, use letter of credit instead
MINIMIZING CREDIT RISKS

Documentary Sales
• 2 types


documents against payments
documents against acceptance
• Helps avoid some risks in open account transaction
• Seller uses carrier to withhold delivery of goods until
buyer pays or signs a negotiable instrument to pay
• Transaction




Seller ships goods and forwards draft & bill of lading (BOL)
Correspondent of seller’s bank notifies buyer of receipt of
goods
Buyer pays depending on sight draft or time draft
Correspondent delivers BOL to buyer for buyer to claim
goods
• The BOL allows for title transfer only after payment is
received
MINIMIZING CREDIT RISKS

Documents Against Payments
•
•
•
•

Time of payment: on presentation of draft
Goods available to buyer: after payment
Risk to exporter: If draft unpaid, must dispose of goods
Risk to importer: relies on exporter to ship goods as
described
Documents Against Acceptance
•
•
•
•
Time of payment: on maturity of draft
Goods available to buyer: before payment
Risk to exporter: relies on buyers to pay drafts
Risk to importer: relies on exporter to ship goods as
described in documents
MINIMIZING CREDIT RISKS

Bills of Exchange (Draft)
• Unconditional order directing buyer to pay a fixed sum
on a determined date (like check, except gives title to
goods)
• Usually used in conjunction with documentary sale
• By accepting the draft, the buyer acknowledges the
obligation to pay
• Common payment terms 30-90 days after sight
• Seller presents draft and any documents to bank in
order to obtain endorsement, use of overseas bank
correspondent and collection facilities.
• Common documents with draft = BOL, commercial
invoice, packing list, insurance etc.
MINIMIZING CREDIT RISKS

Best Practices Documentary & Bills of
Exchange
• Seller
 Make sure satisfied with buyer and country risks
 Make sure goods and services supplied in accordance with
contract terms
 Make sure collection instructions clear and identical to
terms agreed upon in the contract
• Buyer
 When asked to pay or accept bill of exchange, make sure
consistent with contract
 Make sure satisfied with goods or services before
instructing bank to pay or accept bill of exchange
 Make sure correct documents received to obtain goods
MINIMIZING CREDIT RISKS

Letters of Credit
• Most widely used method of international payment
• Different types (documentary/commercial, standby etc.)
• Instrument whereby a bank furnishes credit in place of
the buyer’s credit
• Autonomous document separate from the contract
• Procedure




Underlying contract provides payment to seller via LOC
Buyer arranges for bank to open LOC for the benefit of the
seller
LOC has precise instructions which provide payment
against the delivery of a full set of documents
Payment made upon delivery of documents
MINIMIZING CREDIT RISKS

Documentary LOC (Commercial LOC)
• Bank makes payment on presentment of documents detailed
in LOC
• Normally BOL, Insurance, draft & certificate of origin

Standby LOC (used in lieu of bank guarantee)

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Payment made in the event buyer fails in obligation to pay
Seller provides documents evidencing default
Cost =1-3% of the transaction
Forms
• Revocable v. Irrevocable

Revocable not enforceable, don’t use
• Confirmed v. Unconfirmed

Confirmed if unfamiliar with overseas bank
• Back-to-Back

Issued upon the security of an existing LOC
MINIMIZING CREDIT RISKS

Best Practices LOC
• Seller

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Make sure local bank as authenticated the LOC
Examine the LOC carefully for consistency with sales
contract
Make sure to present all documents named
• Buyer

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Check credit for LOC
Consistency with contract
All necessary documents
Insist on terms to protect interests such as late
payment dates etc.
MINIMIZING CREDIT RISKS
• Other Payment Mechanisms
 Title Retention



Best if goods easily identifiable and not incorporated into a
finished product
Seller retains ownership of goods until purchase price is
paid in full
Pay attention to INCOTERMS
 Conditional Sales

If buyer defaults seller may rescind contract
 Security Interest
 Seller is granted a security interest in goods (more
common when sale is financed, but local laws vary)
 Promissory Note
 Buyer’s obligation documented by promissory note
 Still may be difficult to physically reclaim goods
MINIMIZING CREDIT RISKS

Trade and Bank Acceptances
• Promise by drawee of the draft to pay instrument when
it matures
• Provides short-term fixed rate financing
• Trade acceptance

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Bank as drawee
Before acceptance drawee has no obligations
Holder can only enforce the draft is the draft is dishonored
Once acceptance occurs, drawee primarily liable to holder
• Bank Acceptance



Non-interest bearing draft drawn by company on bank
Acceptance occurs by stamp approval with signature of
bank
If bank honors acceptance, buyer must put funds in bank
before payment is due
MINIMIZING CREDIT RISKS

Conditional Sales Arrangements
(Contractual)
• Seller retains ownership of goods until
purchase price is paid in full
• If buyer defaults seller may rescind contract
• Seller often granted a security interest in
goods
• Buyer’s obligation documented by promissory
note
• Useful where buyer is end user and goods sold
are easily identifiable & nonperishable
• Still may be difficult to physically reclaim
goods
MINIMIZING CREDIT RISKS

Export Credit Insurance
• Involves insuring exporters against

Commercial risks
• Non-acceptance of goods by buyer
• Failure of buyer to pay debt
• Failure of banks to honor documentary credits

Political risks
• War, riots etc.
• Change of government policy or political party
• Blockage of foreign exchange (i.e. exchange
controls)
• Currency devaluation (i.e. Argentina)
MINIMIZING CREDIT RISKS

Export Credit Guarantees
• Issued by financial institution (banks) or
government agency (EXIM Bank in U.S.)
• Assistance for companies without
sufficient track records to obtain credit
from banks for exports
• Instruments to safeguard exportfinancing banks from losses that may
occur from providing funds to exporters
AGREEMENTS/DOCUMENTATION

INCOTERMS (2000) ICC
• Standard trade definitions most commonly used in
international sales contracts.

Uniform Customs and Practice for Documentary
Credits
• UCP500 is the standard practices guideline for letters of credit
• Standards to be followed by banks in examining LOCs
• Applies only to LOCs referencing UCP text

eUCP
• In November 2002, ICC published a new guide called eUCP to
supplement UCP500 for electronic transactions

International Standby Practices (ISP98)
• Governs standby LOCs in place of UCP which focuses more on
commercial letters of credit
AGREEMENTS/DOCUMENTATION
•
•
•
Important to document transaction
whether it is in the form of a simple
purchase order or formal contract
(attention to both sales and purchase
forms)
Signed and notarized by both parties
Key clauses that can affect payments:


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Title
Payment (currency)
Choice of Law
Choice of Forum
Assignability of account
AGREEMENTS/DOCUMENATION

Title

Assignment of Accounts

Payment

Choice of Law (Provision that specifies applicable law is
essential)
 Passage (Where do you want title to pass & is that consistent with the
INCOTERM used?)
 Retention (include specific language in contract)
 Allow for assignment by seller and look for purchaser prohibitions
 Note currency of contract to avoid exchange risks
 Be specific in description of payment terms ($ recommended)


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
Avoid uncertainty as to applicable laws
Usually enforceable if reasonable nexus
Certain issues still decided by local law
Choice of Forum
 Litigation or binding arbitration?
 Designate arbitration body and applicable rules which differ from
internal rules (ICC, AAA etc.)
FOREIGN EXCHANGE RISKS

In addition to forms and types of
payments, collection efforts are also
significantly affected by:
• Foreign Exchange Risks
• Foreign Exchange Controls
FOREIGN EXCHANGE RISKS

General Foreign Exchange Risk
• Risk of loss on account of change in
Forex rates during a particular period of
time
• Liability to make a future payment in
foreign currency
• Asset denominated in foreign currency

Overseas subsidiaries
• Debt payable in foreign currency

Risk for both creditor and debtor
FOREIGN EXCHANGE RISKS

Corporate Forex Risks
• Transaction Exposure

Input material of component denominated in foreign
currency, manufactured domestically or finished product is
for export
• Operational Exposure


Effect of exchange rate on revenue and expenditures and
income statement
Profits earned outside U.S. and converted to $
• Translation Exposure



Multinationals risk associated with foreign assets &
liabilities
Consolidated statements in common representative
currency
Forex value of assets and liabilities must be translated into
reporting currency
FOREIGN EXCHANGE RISKS

Hedging Foreign Exchange Risks
Should the risk be hedged?

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Size of the risk/transaction
Amount of time involved
Amount of money
Stability of foreign currency involved
Presence of exchange controls
FOREIGN EXCHANGE RISKS

Basic Hedging Techniques
• Payment and sales in U.S. $ or home
country currency, risk is transferred to
other party
• Internal hedge

Purchase amount of foreign currency
needed for transaction at the time the
transaction is consummated
• Acquire asset denominated in foreign
currency that equals liability
FOREIGN EXCHANGE RISKS

Basic Hedging Techniques (cont)
• Forward Exchange Contracts

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
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Agreement between 2 parties that obligates them to
exchange at a specified future date (settlement date)
at an agreed upon price
Different than futures contracts which have standard
contract sizes, time periods, settlement procedures
and are traded on regulated exchanges throughout
the world.
Forward exchange clause within a contract
Examples:
• Date is determined (end of month, specific date etc.)
• Rate is fixed (watch out for transfer pricing with related
parties
• If rate fluctuates parties will renegotiate prices
FOREIGN EXCHANGE
CONTROLS



Risk regarding access to foreign currency
Government controls the availability or use of foreign
currency for capital transfers & payment for current
transactions
Forms:
•
•
•
•

Laws, regulations & other measures by state
typically through the central bank
Restricts availability or use of forex (directly or indirectly)
Domestic interest rates high to attract foreign capital and vice
versa
Result:
• May have restrictions on access to forex
• Inability to pay in dollars
• May lose dollar denominated contracts (Argentina)
DEALING WITH DEFAULT
 Collecting payments overseas
can be difficult and expensive
Negotiate with the customer first
 Consider formal collection actions
when:
Other remedies have been exhausted
 The amount involved enough to warrant
collection efforts

DEALING WITH DEFAULT
 Common Collection Actions:
Legal proceedings (vary throughout the
world)
Arbitration (preferable from an
international collection standpoint)
File Claim
Jennifer Schwesig
Armstrong Teasdale, LLP
One Metropolitan Square
211 N. Broadway, Suite 2600
St. Louis, MO 63102
(314) 259-4710
[email protected]
www.armstrongteasdale.com
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Practical Strategies for Dealing with the Foreign Debtor