In an international trade transaction, there is a time lag between the transfer of goods by the exporter to the importer, and transfer of payment by the importer to exporter. To protect both parties from counter-party risk, a number of documents are created and used.
These are listed below:
1. Bill of Exchange
2. Bill of Lading
3. Letter of Credit
4. Certificate of origin of goods
5. Inspection certificate
6. Packing weight list
7. Consular invoice
8. Insurance document
Each of these is discussed in the following section:
1. Bill of Exchange:
It is an agreement signed by the buyer of the goods to pay the seller a certain sum of money on a specified future date. Each international trade transaction generates its own bill of exchange. The bill is drawn by the exporter and sent to the importer. Once the importer accepts the bill and returns it to the exporter, the importer is legally bound to make payment, and the bill is legal evidence of a contractual obligation for payment. A bill of exchange is a negotiable instrument.
The exporter can hold the bill till its maturity, transfer it to another party through endorsement, or get the bill discounted with a bank. The advantage of discounting is that the exporter gets cash well ahead of the date on which he was due to get the payment from the importer. The holder therefore can be the exporter, another party (to whom it has been endorsed) or a bank (if it is discounted). There are different types of bills of exchange.
i. Banker’s Acceptance (Bank Bill):
It is a bill of exchange accepted by a bank. When an exporter draws a bill of exchange on an importer, and the bill is accepted by the importer’s bank, it is called a Banker’s Acceptance. A bank earns fee for a Banker’s Acceptance, since it takes on the credit risk.
ii. Clean Bill:
When a bill of exchange is not accompanied by any documents that are generated in an international trade transaction, it is called a Clean bill.
iii. Documentary Bill:
When a bill of exchange is accompanied by documents that are generated in an international trade transaction it is called a Documentary bill. The documents include the commercial invoice, Bill of Lading, warranty of title, Letter of Credit, Certificate of origin of goods, Inspection certificate, Packing weight list, Export declaration, Consular invoice, and the insurance document. A warranty of title is given by the exporter to the importer, in which the exporter attests that the title to the goods is good and hence the transfer is legally rightful. Usually all bills in an international trade are documentary bills.
iv. Sight Bill:
It is a bill of exchange that can be presented by the holder of the bill to the importer for payment on any day before the maturity date. It is also called a Demand bill.
v. Usance Bill:
It is a bill of exchange that can be presented by the holder of the bill to the importer for payment only on the maturity date. If the bill states that the importer has to pay the holder only after a specified period (such as 30 days), the importer will make payment only on the due date. A usance bill is also called a Time bill, or a Tenor bill.
There are two dates from which this specified period is calculated:
a. If the specified period is calculated from the date appearing on the bill, it is called an after-date usance bill.
b. If the specified period is calculated from the date on which the bill was accepted by the importer, the bill is called an after-sight usance bill.
vi. Documents against Acceptance (D/A) Bill:
It is a bill of exchange in which all documents are released on acceptance of the bill. D/A stands for ‘documents against acceptance’. If the bill of exchange specifies that all documents pertaining to the shipment of goods will be handed over to the importer when he accepts the bill, it is called a D/A bill.
As soon as the importer accepts the bill and sends it to the importer’s bank, the bank releases all documents pertaining to the shipment of goods to the importer (such as the Bill of Lading, Certificate of origin of goods, Inspection certificate, Packing weight list, Export declaration, Consular invoice, and Insurance document). Once the importer is in possession of these documents, he has the right of ownership over the goods. The holder of a D/A bill faces the risk of non-payment, since the importer has possession and ownership of the goods before making payment for the goods.
vii. Documents against Payment (DIP) Bill:
If the bill of exchange specifies that all documents pertaining to the goods will be handed over to the importer only when he pays the amount mentioned in the bill, it is called a D/P bill. D/P stands for documents against payment. The holder of a D/P bill does not face the risk of non-payment.
A usance bill of exchange dated April 10 was accepted by the importer on April 15, and is payable after 30 days. When can it be presented for payment if it is (a) an after-date usance bill (b) an after-sight usance bill (c) If the bill has been discounted with a bank, who becomes the holder and who can present it for payment on the due date?
a. The due date for an after-date usance bill is May 10 (April 10 + 30 days).
b. The due date for an after-sight usance bill is May 15 (April 15 + 30 days).
c. The bank becomes the holder of the bill.
2. Bill of Lading:
Also known as BOL or B/L, a Bill of Lading is evidence of a contract between the carrier (transporter) and the exporter to deliver the goods to a designated party (the importer, called the named consignee) at a specified destination in the importer’s country.
It is an extremely important document in international trade, and has the following features:
a. It is a document to title of the goods being transported.
b. It is a receipt for the goods.
c. It is an acknowledgement that the carrier (shipping company) has received the goods to be delivered to the importer.
d. It describes the goods received for transportation, the name of the port where they were loaded and the name of the port where they will be unloaded.
e. The holder of a Bill of Lading has the title to the goods. The exporter gives the Bill of Lading (through his bank) to the importer who can take possession of the goods from the carrier when the goods reach his country only by submitting it.
The different types of Bill of Lading are discussed below:
i. Clean Bill:
If the goods received by the carrier (shipping company), are undamaged and in good condition, the carrier does not note the Bill of Lading. This is known as a Clean B/L.
ii. Foul Bill:
If the goods were received in a damaged condition, the carrier (shipping company) notes this on the bill. This is known as a Foul or Dirty or Claused Bill of Lading. The exporter’s bank or the importer’s bank (or both) can reject such a B/L.
iii. On Board Bill:
When the carrier (shipping company) issues a Bill of Lading after the goods have been loaded onto the ship, it is called an ‘On Board’ B/L.
iv. Received for Shipment Bill:
When the carrier (shipping company) issues a Bill of Lading on receipt of the goods but before loading has commenced, it is called a Received for Shipment’ B/L. Once the goods have been loaded, it is stamped as On Board.
v. Straight Bill:
It is also called a consignment bill. It is a Bill of Lading that mentions a specific party (the importer) to whom the goods will be delivered by the carrier. The bill is non-negotiable, and is not transferable by endorsement and delivery. Therefore, mere possession of the bill by any party other than the importer does not confer title to the goods. The Straight bill states that the carrier has undertaken to hand over the goods to the importer when the latter presents identification to that effect.
vi. Order Bill:
The exporter may not want title of the goods to pass to the importer when he holds the document. Therefore, the Bill of Lading states that the goods are made deliverable to the exporter himself, or the shipping company or ‘order’ (this may be the importer’s bank).
As a result title to the goods does not pass on to the importer unless the bill is endorsed by the holder (who is the exporter himself, or the shipping company, or the importer’s bank, as the case may be). This is known as an Order B/L. Here, the shipping company has to notify the importer that the goods have arrived in the importer’s country. The importer has to present the endorsed Bill of Lading, and only then will he be permitted to take possession.
vii. Port-to-Port Bill:
If the goods have to be transported by more than one carrier (multi-modal transport) until the goods reach the importer’s country, then all the carriers are responsible for the safe delivery of the goods to the destination. The Bill of Lading given by the first carrier to the exporter, is enough to fix the responsibility for transportation by subsequent transporters. This is known as a Port-to-Port B/L.
viii. Airway Bill:
It is a non-negotiable bill for transport of goods by air. It does not transfer title to the goods to the holder.
There are a few differences between a Bill of Exchange and a Bill of Lading. The Bill of Exchange originates from the exporter. It is drawn by the exporter on the importer. When the importer accepts the bill, he is legally obligated to make payment in accordance with the terms of the bill. On the other hand, a Bill of Lading originates from the transporter. It is a document evidencing receipt of goods by the transporter. It imposes a legal obligation on the transporter to transport the goods to the destination specified.
3. Letter of Credit (L/C):
An L/C is an undertaking given by the importer’s bank (called issuing bank) acting upon the request of the importer, that it will make payment to a beneficiary (the exporter). An L/C involves a minimum of four parties – the importer, importer’s bank(issuing bank), exporter and the exporter’s bank (advising bank).
An L/C imposes the superior creditworthiness of the importer’s bank over that of the importer, and protects the exporter from credit risk and risk of non-payment.
There are different types of L/Cs and they are described below:
i. Clean L/C:
If the issuing bank agrees to make payment to the exporter under the terms of the L/C without any documents relating to the international trade transaction being presented to it, the L/C is called a clean L/C.
ii. Documentary L/C:
If the issuing bank will release payments only when the exporter submits all relevant documents, it is called a documentary L/C.
iii. Fixed L/C:
The L/C limit gets reduced as and when Bills of Exchange are presented by the exporter for payment. It is also called non-revolving L/C. If the L/C was opened for Rs. 1 million, and a bill of exchange for the Rs. 400,000 was presented by the bank to the exporter, then the L/C gets reduced to Rs. 600,000.
iv. Revolving L/C:
The L/C limit gets renewed after payment is released by the issuing bank. Taking the above example of an L/C opened for Rs. 1 million, if a bill of exchange for Rs. 400,000 was presented by the bank to the exporter, then the L/C gets restored to the original amount of Rs. 1 million. This is called restoration of utilized amount. A new L/C does need to be opened even when the entire Rs. 1 million is used up. The number of utilizations and the time period is specified in the L/C. The bank’s advantage from a revolving L/C is that it will not have to incur costs (and therefore has cost savings) on making changes (called ‘amendments’) in a non-revolving L/C.
v. Confirmed L/C:
Though the issuing bank guarantees payment to the exporter under an L/C, the exporter might want his bank to offer further guarantee that he will receive the payment. A confirmed L/C is one in which the advising bank (exporter’s bank) gives an additional undertaking to make the payment.
vi. Unconfirmed L/C:
It is an L/C that does not carry the additional guarantee by the advising bank.
vii. Transferable L/C:
The exporter informs his bank that the payment should be made by the issuing bank to a specified third party (the new beneficiary), and this is noted on the L/C. Such an L/C is called a transferable L/C or a transferred credit.
viii. Non-Transferable L/C:
The exporter cannot transfer the beneficiary status to someone else. If nothing is mentioned in the L/C, it is deemed to be non-transferable. Countervailing credit is the term used when the exporter’s bank issues a separate L/C in favour of the new beneficiary.
ix. Revocable L/C:
If the issuing bank has the right to cancel or amend the L/C any time after its issue without informing the exporter of the cancellation, it is called a revocable L/C or a revocable credit. For the exporter, a revocable L/C carries the risk of cancellation, and offers him no safety. So it is rarely used in international trade.
x. Irrevocable L/C:
If the issuing bank cannot cancel or change the L/C after it has been issued unless the exporter agrees to the cancellation or the changes as the case maybe, it is called an irrevocable L/C.
The International Chamber of Commerce published Uniform Customs and Practices (UCP) for an L/C in 1933. The UCP rules are used all over the world and have led to standardization of practices. They were amended in 1951, 1962, 1974, 1983, 1993, and 2006. The latest rules, called UCP 600 came into effect in July 2007. Since an L/C is standardized and can be structured to be irrevocable, transferable, and confirmed, it is a very popular method of short-term finance in international trade.
The importer’s bank has opened an L/C for Rs. 10 million. The importer has accepted two Bills of Exchange drawn by the exporter, one for Rs. 3 million and the other for Rs. 7 million. Show what the limits would be as and when the bills are presented in (a) non-revolving L/C (b) revolving L/C.
(a) Non-Revolving L/C:
When the exporter presents the bill of exchange for Rs. 3 million and the issuing bank releases payment, the L/C limit is reduced to Rs. 7 million. When the second bill of exchange is presented and paid, the limit is reduced to zero.
(b) Revolving L/C:
When the exporter presents the bill of exchange for Rs. 3 million, the issuing bank makes the payment, and the limit is reinstated to Rs. 10 million.
4. Certificate of Origin of Goods (COO):
The certificate of origin is an instrument that establishes the origin of goods imported into a country. The rules of ‘origin’ were framed by the WTO. Sometimes the importer’s country may ban the import of goods from specific countries. If the country of origin is not on the ‘banned’ list of countries, the certificate of origin enables the importer to bring the goods into his country. Similarly, if the importer’s country gives tariff concessions to goods imported from specified countries, the COO is proof that the goods are eligible for this tariff reduction, since they have been imported from one of the specified countries.
There are two categories of COO:
i. A preferential COO extends tariff concessions. Developed countries use it to give tariff concessions to developing countries. For example, India’s trade agreement with Singapore requires a COO to claim tariff concessions.
ii. A non-preferential COO does not give any tariff concessions, but merely provides evidence of origin.
So important is the COO in Free Trade Agreements (FTAs), that several paragraphs in an FTA contain details about the COO issue process, the validity of a COO, and the care that a country should take in issuing COOs. MERCUSOR was a treaty signed in 1991 by four countries—Argentina, Brazil, Paraguay and Uruguay—to improve their inter country trade. It now has ten Latin American signatory countries—Argentina, Brazil, Bolivia, Chile, Columbia, Ecuador, Paraguay, Peru, Uruguay, and Venezuela.
India’s free trade agreement with MERCUSOR contains the following provisions with respect to the COO:
i. The COO is valid for only one importing operation concerning one or more goods.
ii. The original COO should be included in the documentation to be presented at the customs authorities of the importing signatory party.
iii. The issue and control of COO is the responsibility of a government office in each signatory party.
iv. The Origin Certificate shall be issued not later than five working days after the request presentation. It is valid for a period of 180 days from the date of its issue.
5. Inspection Certificate:
This is issued by an independent third party (such as an independent inspection agency, or the supplier of the goods) stating that the goods have been inspected and conform to the quality/specification/other contractual terms.
6. Packing List:
When the goods are in packages, the packing list gives details of the goods in each package.
7. Consular Invoice:
It is an invoice that describes the goods being transported. The exporter authenticates the accuracy of the invoice by appearing before the Importer country’s Consul who is stationed in the exporter’s country.
8. Insurance Document:
To protect goods in transit from loss or damage from the time they leave the exporter’s warehouse and until they reach the importer’s warehouse, the goods are insured by the importer. The insurance cover must specify the value insured (such as CIF), the risks covered, the date from which the insurance cover is effective, and the currency in which the insurance document is expressed. All details regarding the goods in the insurance document must conform to those given in other documents such as the bill of Lading, or the consular invoice.