The Nuances of Payment Terms, Currencies & Risk Management in International Trade ~ Prof Archie D’Souza

  

Terms of Payment/Currencies/Risk Management

Payments and currencies do not come strictly in the realm of logistics or transportation. However, carrier and forwarder representatives sometimes get into situations which they could avoid if they follow certain rules and understand them. Our world is becoming smaller and flatter and international trade is growing in leaps and bounds. But the paperwork (electronic documentation in this day and age) should be understood and done correctly. Methods of entry into foreign markets, terms of payment and currencies used, risks involved in international transactions and the role of international bankers is something an international trader and those who service them need to know.

One of the greatest challenges that an exporter, not just a first-time one but a regular one also, faces is to secure payments for the merchandise supplied to a customer abroad. Although this challenge also concerns domestic traders, it is more so for those dealing with buyers in foreign countries. An international transaction entails more risks than domestic ones, with the risk of non-payment being topmost one. At the same time there are risks for the importer as well. what they ordered for.

We will be discussing here certain methods that an exporter can use to ensure timely payment for their goods. We will also learn how exporters and importers can tailor their international terms of payment to adjust to the risks - perceived or otherwise, country characteristics and other factors, including tolerance for risk-taking. The methods that we will be discussing here are universally accepted, though a bit complicated to execute. There is also ample international jurisprudence available in case of disputes.

Some of the reasons why it is difficult to secure international payments are:

• Lack of available and reliable credit information
• Lack of personal contact between buyer and seller
• Expensive and difficult collection
• Cumbersome legal recourse
• High litigation costs
• Lack of trust
• Cultural differences

Choosing a payment method for a shipper/consignee generally depends on factors like buyers' credit standing, any exchange restrictions in the country of import and most important competition faced by the seller.  The main methods available are as follows:

Cash in advance is the safest method of exporting, especially when the credit of the overseas buyer is doubtful

An open account system is at the other end of the spectrum.  In other words it is the riskiest method of exporting as there is no guarantee for payment

Besides these, two other methods are available like letters of credit (LC) of different kinds, documentary collection like sight drafts, time drafts and date drafts.  Finally, there exist various types of trade cards.

Before we go into the details of these methods, we shall briefly look at various alternative methods of entry into foreign markets and risks involved in international transactions, and how to combat them.

Method of Entry into Foreign Markets

When an organization that has been focusing in the domestic market wishes to start exporting, it needs careful planning and thoughtful strategic thinking. 

An organization may go in for indirect exporting by using the services of an export trading company or an export management corporation.  It may alternatively go in for active exporting by appointing an agent or distributor or even setting up its own representative office in a foreign location.  Joint ventures and franchising are other methods available.

Before the organization does actively venture into exports, the following information should be sought:

• The size of the market
• The growth potential of the market
• The exporter's potential market share
• What type of after sales support the product requires and how they will adhere to it
• Whether a change in marketing strategy is required
• The levels of development of infrastructure in the said market
• The ability of potential buyers to handle imports

All these factors must be looked into before a company that was predominantly selling in the domestic market goes for exports.  A core study in this area will give good insights into the potential hazards of getting into foreign markets.

Before entering into foreign markets an exporter should learn the rules and regulations and ensure that these are adhered to.

Risks Involved in International Business and How to Manage Them

When a person involves themselves in international trade they get involved in certain risks.  Though every business transaction is risk prone, there are more variables involved in an international transaction than a domestic one and also the number and types of risks too differ.  We shall look into the reasons for these risks, the different types of risks involved and how to tackle them.  Some of these risks are:

• Lack of credit information
• Lack of personal contact with the buyer
• In case of default:

-       collections are difficult and expensive

-       legal recourse is not easy

-       litigation costs are high

• mistrust

Some types of risks are:

Country Risks, i.e. not getting paid by the creditor due to political conditions in the importing country.  In 1989, India faced a severe shortage of foreign exchange which, resulted in the government overnight putting severe restrictions on release of payments.  The breakup of the Soviet Union is another situation which, caused suffering to many.  Certain countries have fraudsters that are very prudent and banks refuse to discount any documents to these countries.  As the World Economy integrates, country risks diminish to a great extent.

Currency Risks are of two types, one, risks due to currency fluctuations and two, risks due to the currency not being convertible.  We shall be dealing a little in detail on the choice of currency and managing risks.

Commercial Risk is when a creditor does not pay his dues either because he has run out of cash or makes an excuse for not paying.  This is a risk in domestic trade also.

Exposure is when due to delayed payment by importer, an exporter is faced with cash-flow problems.

How do we deal with these risks?  Hedging, taking credit insurance and choosing the right terms of payment are ways of dealing with the risks.  The first two we shall be looking into when we deal with the topic Insurance.  We shall now look at various terms of payment here.

Terms of Payment

The methods available to make payments for imports are:

• Cash in Advance
• Open Account
• Documentary Collection
• Letters of Credit and Trade Card. 

Let us look at each of these with their advantages and shortcomings.

Cash in Advance is where the exporter takes advance payment from the importer.  This could be in the form of an inter-bank transfer.  Payments through credit cards will also come under this category.  Cash in advance should be used where country risks are high, also for one time orders.  It should not be used where an exporter wishes to build a long-term relationship with an importer especially in a developed country.

Open Account is similar to conducting business locally on credit.  The exporter and importer negotiate the price and the terms of trade.  The exporter sends an invoice and the importer settles the amount either on an agreed date or within a reasonable period of time.  Conceptually it is the opposite to a Cash in Advance situation.  Here an exporter shows complete trust in his buyer.  The recourse available in case of default is legal action in the importing country which can be time consuming and expensive.

However, just as domestic traders rarely do business without some types of credit terms to their buyers, in international business if a long-term relationship is to be developed, one has to do business on open account terms.  The exporter is however advised to check the credentials of the buyer first.

Non-payment and delayed payments are two of the possible problems that an exporter could face.  The former could be tackled by taking an International Commercial Credit Insurance.  Here, the insurance company covers the risk of non-payment by the importer.  Commercial Insurance will be dealt with when we deal with the topic Insurance.

Delayed payments or even payments within the agreed credit terms may cause serious cash-flow problems for exporters.  For example, the buyer makes payments after ninety days but the working capital the exporter has only allows a thirty day period.  This would adversely affect the exporter's ability to pay his own suppliers as well as, at times, statutory payments.

International Factoring is a way to deal with this situation.  Here a Factoring House which, could be a subsidiary or division of a bank, finances the international receivables of the exporter.  The exporter sells or discounts his receivables to the factoring house who in turn collects the face value from the importer.  The factoring house pays a discounted value to the exporter.

International factoring is not as simple as it seems.  The factoring house in the exporting country may enter into an agreement with a factoring agency in the importing country and thus cover his own dues.  The main reasons for involving a second factoring house in the importing country are to check the credit-worthiness of the importer and to act as a collecting agent also.  The latter too would demand its pound of flesh making factoring an expensive means of finance.

Factoring Agreements could be with or without recourse.  In case of a without recourse transaction the factor takes the entire responsibility to collect the amount from the importer. He cannot turn to the exporter if he is unable to collect.  In case of a with recourse transaction the exporter is still responsible for collection.  The factor is not just a financier but a collecting agent also in case of without recourse factoring.

Letters of Credit (LC)

An open account system and cash in advance are two extreme terms of payment in international trade.  The first puts the risk entirely on the exporter, while the second on the importer.  Neither is advisable from a long term point of view although an exporter deciding to have a long term relationship with his buyer may opt for an open account system.

Letters of Credit (LCs) are one of the main options available to international traders where they can secure their payments without an advance payment.  Let us see how this system works.

An LC is a document in which payment for goods supplied or services rendered are guaranteed by the buyer's bank.  On fulfilling certain documentary requirements, the import's bank will transfer the amount agreed to, which in all probability would be the value invoice, to the exporter's bank.  The creditworthiness of the bank is substituted for the creditworthiness of the importer.  This puts the exporter at ease as most of the dealings would be with an international bank of repute.

• Before we look at the workings mechanisms of an LC we need to look at a few definitions.
• Issuing Bank: The bank providing the LC to the importer.  The Issuing Bank has a contractual obligation to pay the invoice amount to the beneficiary (next definition)  should the importer refuse or be unable to pay the amount.  This is provided the exporter fulfils the conditions laid down on the LC and provides the documents necessary for the same.
• Beneficiary:  The mentioned in an LC as the one to whom the issuing bank will make payment.  In almost all cases the beneficiary is the exporter.
• Applicant:  The firm asking the issuing bank for an LC.  In almost all cases the beneficiary is the exporter.
• Advising Bank:  The bank that determines the bonafides of the issuing bank and the appropriateness of the terms offered on the LC.  The advising bank could be the exporter's regular bank or a bank more experienced in foreign exchange dealings to whom the exporter's bank will delegate the task.
• Proforma Invoice:  This is dealt with in detail when we deal with the topic on documentation.  A proforma invoice is a quote provided by the exporter to the importer for the purpose of obtaining an LC.  It should be remembered that it is a quotation not an invoice.
• Margin Money:  This is the amount that the applicant deposits with the issuing bank before the latter issues the LC.  This could be from zero (no margin money) to 100% (full amount to be deposited in advance).
• Discrepancy:  A difference between the documents required by the letter of credit and the document provided by the exporter.
• Amendment: A change made to an LC, generally following a discrepancy, to which all parties, i.e. the applicant, beneficiary, issuing and advising bank, agree.
• Confirming Bank:  A bank providing an additional level of security of payment to the beneficiary.  The confirming bank guarantees to pay the LC amount in case of a default by the applicant or issuing bank.
• Correspondent Bank:  A foreign bank with which a local bank has a preferred business relationship.

How an LC Works

We shall now look at the mechanisms of the working of an LC and different kinds of LCs.  The Letter of Credit is a contract between the issuing bank and the beneficiary.  This should be kept in mind.  It has nothing to do with any agreement between the exporter and importer.  The only things that matter are the documents relating to the exporter-importer transactions.

Under an LC agreement the issuing bank promises to transfer to the beneficiary's bank account the amount equal to the invoice value of the items sold.  The concept, however, is a little more complicated than this.  The promise is not contingent upon the exporter meeting certain conditions or for that matter the importer not meeting certain conditions.  As we have seen in the previous paragraph the payment is made on handing over the documents relating to the transaction.  It is for this reason that an LC is often called a documentary letter of credit (DLC).

The issuing bank is under no obligation to pay even when delivery of goods has been made and the importer has taken control of the merchandise or on the other hand the it is not allowed to stop payment even if the merchandise is shoddy and not fit for sale.  The bank is obligated to pay only if the documents are in order.  That is why extreme care must be taken in preparing and handling the documents pertaining to the LC.  Any mistake in documentation will trigger expensive and time-consuming amendments and corrections.

A transaction conducted under an LC is almost as good as a cash-in-advance transaction.  The exporter will definitely get paid.  However, it involves going through a number of processes and paying a good deal of banking fees.  Further, it involves a number of steps, ten in all, from the time the negotiation takes place between the exporter and the importer till such time as the amount is transferred to the exporter's bank account and the exporter notified.

These steps are divided into two parts, pre-shipment and post-shipment.

Pre-shipment

Step I - Negotiation:  The exporter and importer negotiate and enter into an agreement for supply of goods or services under an LC.  The exporter sends a proforma invoice to the importer.  Remember today, all these documents can be electronic.  Even electronic signatures are valid in international transactions.

Step II - Application:  The importer, who is also the applicant, requests his bankers, i.e. the issuing bank to open a letter of credit on his behalf, naming the exporter as a beneficiary.  The issuing bank may ask for margin money from the importer which, could be any amount from zero to cent percent depending on their relationship with each other.

This poses two problems, one for the importer and one for the exporter.  The problem as far as the importer is concerned is blocking funds for the margin money demanded by the issuing bank.  The issuing bank will charge a fee ranging from 0.5 to 3 percent which, the exporter will have to pay.

Step III - Transmission:  The issuing bank sends the LC to the exporter's bank mostly electronically.  The exporter's bank may use the services of an advising bank or itself act as one.  The advising bank checks the following:

1. The legitimacy of the issuing bank
2. Whether the LC's contents must meet the exporter's requirements
3. Whether the LC is irrevocable

(we shall see what this means when dealing with types of LCs)

4. Whether the LC and proforma invoice match and no discrepancies exist.

Step IV - Notification:  The advising bank notifies the beneficiary that the LC is ready and in order.

Post-shipment

Step V - Shipment:  The exporter completes the customs formalities and ships the goods to the importer.  The documents pertaining to the shipment, viz. invoice, certificate of origin, packing list, transportation documents, etc. are prepared and/or collected from the appropriate authorities.  The exporter must ensure that due care is taken in the preparation of documents as an LC payment is based on, one, presenting all required documents and two, correctness of the same.

Step VI - Document Check: The exporter hands over the documents to his bank, viz. the advising bank, who will check the same and see whether they are complete and confirm to the terms on the LC.  If everything is in order, the documents are sent by the advising bank to the issuing bank.  The exporter may enjoy a line of credit with his bank and based on the invoice value of the goods be given an advance amount.  This process is called discounting of documents and the payment received is in the form of a loan or overdraft.  The payment is not final till the issuing bank transfers the sum to the advising bank.

Step VII - Document Dispatch:  The documents will be forwarded by the advising bank to the issuing bank.  On receiving the same the latter will check them for correctness and compliance.  They will either through a line of credit or ensuring that a balance was available before the issuance of the LC make arrangements for remittance of money.

Step VIII - Clearance:  The importer collects the documents from the issuing bank after arranging for the payment.  He can now customs clear the goods.

Step IX - Payment:  The issuing bank will remit the sum invoiced to the advising bank.  The latter in turn credits the amount into the exporter's bank account after adjusting its fees, any advance given and interest on the same.

Step X - Notification:  The exporter's bank will notify the exporter that monies have been credited in his account.  The process is thus complete.

The ten steps that we have seen are a very simple form where only four parties are involved, viz. the exporter, importer, the advising bank and the issuing bank.  This is where no confirming and corresponding bank plays a role. 

Kinds of Letters of Credit

Irrevocable Letter of Credit

Most LCs cannot be cancelled by the issuing bank for any reason without the express permission of the beneficiary.  For certain reasons at times it may make commercial sense to enter into an agreement where the LC can be changed by the importer or the issuing bank without the exporter's permission.  The former is an irrevocable letter of credit while the latter is a revocable one.

LCs issued under the Universal Customs Practice for Documentary Credit (UCP 500) are assumed to be irrevocable unless otherwise specified.  We shall be dealing with UCP 500 at a later stage.

Confirmed Letter of Credit

An exporting company may at times may not be comfortable doing business with an unknown foreign bank.  He may not know the bank's creditworthiness, or may feel that the risks of relying on a foreign bank may be too high or may just be plain averse to taking a risk by supplying to someone new.  In such a case the exporter may resort to a confirmed letter of credit.

A Confirmed Letter of Credit is one in which the beneficiary gets from a bank, called the confirming bank, an additional level of security.  Should either the importer or the issuing bank default in payment, the confirming bank will pay.  This is provided that the documents submitted conform to the terms on the LC.  The confirming bank could be the advising bank.

The advantage of having a confirmed letter of credit is that the creditworthiness of the issuing bank is substituted by the confirming bank is substituted by the confirming bank.  When the advising bank is the confirming bank, it may issue a credit to the exporter immediately on presenting the documents.  This will make funds available to the exporter earlier by at least a week.

However, a confirmed LC does have one disadvantage.  When the confirming bank gives a guarantee, which is what an LC is all about, that it will pay in case of default, it will obviously charge a fee.  This fee could range from 0.5 to 1.5 percent, high considering that margins are often small and very rarely do banks default.

There are times when the need for a third or fourth bank to get involved in the process comes into play.  Sometimes banks enter into agreements in which they act as correspondent banks to each other.  A Correspondent Bank is a foreign bank with which a domestic bank has a preferred business relationship.  The purpose of these agreements is for each bank to have a representation in a foreign market.  Correspondent banks route their business through each other resulting in better communications and quicker transfer of funds.

Electronic Letters of Credit

Today in the Internet Age almost all correspondence takes place electronically.  Electronic Documents along with Electronic Signatures are recognized as legal in almost every country.  Paper Documents are very fast disappearing.  Electronic transfer of transportation and commercial documents has since the mid nineties become an accepted practice.  Today it is a norm.  A great deal of money transfers have taken place through the Society for Worldwide Interbank Financial Telecommunications (SWIFT).  In 1999, SWIFT along with Imperial Bank created the Electronic LC.  However, due to the introduction of the Trade Card Electronic LCs are not so much in use today.

Stand-by Letter of Credit

There may be times when an exporter and importer enter into an agreement for a regular supply of goods.  The exporter would not like to enter into an open account system for either or both of the following reasons:

One, the exporter still fears that the importer may default on payment, and;

Two, he may need credit until such time as he receives the remittance from the importer or his bank.

This problem can be averted by what is called a Stand-by Letter of Credit.

A Stand-by Letter of Credit is an LC that covers a number of shipments affected over a period of time.  It is similar to a traditional LC but with the following exceptions:

One, it has a much longer validity period which, could range from a month to over a year

Two, it applies to more than one shipment, avoiding the need for a separate LC for each shipment affected.

The mechanism of its working are that once the exporter and importer enter into a contract for supply of goods under a stand-by LC, supplies are made on an open account basis.  In case the importer does not meet his payment obligations, the exporter will invoke the guarantee made on the LC.  This is a good instrument for handling business with a distributor.

Stand-by LCs are regulated by the ICC and these rules are published in an ICC publication International Stand-by Practices ISP 98.  The rules, eighty-nine in all, listed out in ISP 98 govern the language, documentation and practices of stand-by LCs.

Applicability, Amendments and Discrepancies

The Letter of Credit as an instrument in international trade has been in use now for over a century.  Its use has resulted in a great deal of growth in trade between countries.  Although the open account system and other methods, that we will be discussing, have replaced them, LCs are still a preferred instrument of choice.

 

An LC is a means of making sure that the exporter gets his payment.  It is an ideal instrument when the exporter is new to international business, is risk averse or has doubts about the credit-worthiness of the importer.  The disadvantages of LCs are the costs and cumbersome procedures associated with them.  In a competitive environment, importers are insisting on an open account system and there are several suppliers from various countries willing to oblige.

 

The LC as an instrument is complicated and is also document oriented.  Therefore, it is fairly frequent that the LC and documents do not match or a mistake has been made in preparing one or more of these documents.  What happens in case of such a discrepancy?  It is important as discrepancies are a frequent occurrence, they can be minor without actually affecting the essence of the contract between exporter and importer (at time it could be as tiny as an English word spelt differently, e.g., colour/color).  Unfortunately, monies cannot be released in case of discrepancies.

Before we look at remedies let us look at some types of discrepancies that could take place.  It should be noted that their occurrences are very frequent.  Discrepancies occur when shipping dates cannot be adhered to; changes occur in suppliers' costs like insurance, shipping charges, etc., changes in number of packages, part numbers or type of packing.  A discrepancy could be as minor as a spelling mistake or as major as a change in invoice amount.

It is the role of the advising bank to check the correctness of the documents.  In case of discrepancy, the advising bank may request for an amendment to the LC from the issuing bank.  The word amendment is defined earlier.  Both parties, the beneficiary and the importer, through the issuing bank, must agree to the amendment/s.  Amendments while having a fee attached to them are also cumbersome, could at times mean involving government authorities or the importer may reluctantly agree to them after a discount on the invoice value.

Considering the potential problems that could be forced by the exporter in case of discrepancy, it is imperative that great care be taken to adhere to the terms of the LC.  Equal care should be taken to the preparation of the proforma invoice, as the issuing bank uses this document on the basis of which the LC is issued.  Sometimes an issuing bank may refuse to transfer money even for a small typographical error.

UCP 500, URR 525 and SWIFT

The ICC, through its various publications, monitors and regulated various aspects of international trade.  Two publications of the ICC, UCP 500 and URR 525 deal with LCs and documentary credits.

The UCP 500 is the Universal Customs Practice which, among other things deals with documentary credit.  It details the responsibilities of the applicant and the beneficiary.  It makes an attempt to address most of the areas in which there could possibly be misunderstandings between the issuing bank, the advising bank, the applicant and the beneficiary.  LCs issued subject to UCP 500 have tremendous advantages.  This is because over the years jurisprudence has accumulated that has now almost universal usage.

International traders are advised to use banks that are a part of the SWIFT network, which most banks are.  The Society for Worldwide Interbank Financial Telecommunication (SWIFT) is, like SITA is for airlines, an international corporation supporting an Electronic Data Interchange (EDI) network.  It was created by banks worldwide to obtain a secure and reliable means of transferring financial information internationally.  Among other things, it facilitates communication of LCs and transfer of funds, electronically.  Documents transferred through SWIFT's network are treated as original documents.

An LC issued through SWIFT's network invariably follows UCP 500 guidelines,  In fact, unless otherwise stated, they do so.  Most banks are part of the SWIFT network so most LCs are issued under UCP 500.

The EDI system developed by SWIFT is extremely well developed.  Besides facilitating exchange of documents such as LCs, banks that are members of the SWIFT system can exchange secure messages with each other.  Due to numerous safeguards within the SWIFT network banks are able to rely on the data transmitted and received.  The SWIFT network also has a number of other services, such as, inter-bank transfer, something everyone takes for granted these days.  Thanks to SWIFT's network and various other EDI networks the use of paper has almost disappeared.

URR 525 is another publication of the ICC.  Its full title reads as Uniform Rules for Bank-to-Bank Reimbursements under Documentary Credits.  Outlined in the rules here are the responsibilities of banks involved in international transactions conducted under the UCP 500.  It applies when payments are made to the exporter directly by the advising bank or by the corresponding bank of the issuing bank.  The bank that makes the payment is then reimbursed by the issuing bank.

As this practice has turned out to be a very common means of expediting the process of money transfers under LCs, the ICC felt the need to draft uniform rules in this matter.  The rules apply to banks not to exporters.  However, exporters are advised to refer to them before requesting payment from the advising bank or the corresponding bank of the issuing bank.

 

 

 

 

Other Methods of Payment

Documentary Collection is a process by which an exporter asks a bank to safeguard its interest in a foreign country by holding on to a document pertaining to a shipment or more specifically to the title of goods till such time as the importer satisfies certain requirements that ensure that the exporter gets paid.  Before we look at the mechanisms of the working of documentary collection and its various types, we need to look at certain definitions.

Bill of Exchange: An instrument in which the importer promises to pay the exporter the sum owed within a certain period of time.  Also, known as a draft, it legally binds an importer to pay within the period.  A BoE should not be confused with a Bank Draft which is a cheque issued by a banker for payment for any purpose.

Remitting Bank: In a documentary collection transaction, the bank that interacts with the exporter and the presenting bank (next description) in the importing country.  It is the remitting bank that receives documents from the exporter and sends them to the presenting bank.

Presenting Bank:  In a documentary collection, the bank that interacts with the importer on behalf of the exporter.  It is the presenting bank that receives the documents from the exporter or from the remitting bank and will hold them till the payment is secured either by a money transfer or signing of a draft.

Drawee:  The importer who signs the draft.

Protest:  A legal document which the presenting bank will file if the drawee defaults on payments in spite of having signed a draft.  By filing a protest the presenting bank notifies other parties that the drawee is not honouring its depts.

Instruction Letter:  A document sent by the exporter to the presenting bank in which it spells out its instructions regarding how the bank should handle the documents and how to handle an importer who does not accept the draft sent.

There are various kinds of drafts like sight draft, time draft, date draft, etc.  We have seen in an earlier session how a shipper safeguards his interests by routing documents through his bank.  In case of an air shipment (this includes a multimodal shipment if the last leg is by air) the air waybill should be consigned to a bank.  The delivering carrier (could be a forwarder) will only release the goods on receipt of a bank release order from the bank the air waybill is consigned to.  In case of an ocean shipment the original documents are routed through a bank and the shipping line will deliver only when presented with the original bill of lading.  This safeguards the exporter in the following ways:

• The bank release order or original BL will be handed over to the importer either on making payment or signing of the draft.  This allows the exporter, should the importer not take delivery of the goods, have the goods shipped back to the origin, costing it only the shipping amount and saving the value of the goods.  Alternatively, it could find another customer for its goods.
• A documentary collection could be set up by the exporter through its own bank.  The exporter's bank then acts as the remitting bank, collecting the documents from the exporter and sending them to the presenting bank in the importing country along with an instruction letter.  We shall now look at the various instruments of documentary collection.

Sight Draft:  A draft or a bill of exchange, as we have seen is an instrument that legally binds an importer to pay within a certain period of time.  When the exporter's instructions to the presenting bank says that documents have to be delivered to the drawee only after it has collected payment, it is a sight draft transaction.  Also called Documents Against Payment (D/P) meaning that the draft is payable immediately, i.e. at sight.  Hence the terminology sight draft.  The title of the goods is retained by the exporter till the payment is made and original documents or a bank release order is made and given to the importer by the presenting bank.

Time Draft:  In a competitive situation it is very difficult to do business without offering some kind of credit terms to a buyer.  Where the exporter still wishes to offer some credit to the importer but still wishes to secure his payment he can go for a time draft or date draft transaction.  A time draft is a promissory note (another word for draft or bill of exchange) that the importer signs saying it will pay within a certain number of days, say 90, 120 or 180.  These are usually in multiples of 30 days.

By putting his signature on the draft, the importer commits that it will pay for the goods supplied within the specified period.  The exporter will instruct the presenting bank, through his instruction letter, that the documents for release of the goods be handed over only after signing of the draft.  This system is also called Documents against Acceptance (D/A).

Date Draft:   In a time draft the credit period starts at the time the buyer (drawee) endorses (signs) the draft.  A date draft is another type of draft where credit period starts from the date of shipment.  The main difference between time a date drafts is that in a time drafts the credit period starts from the date of endorsement while in a date draft the same starts from the date of shipment.

What constitutes shipment date?  It is the date on which the contract of carriage is executed, i.e. the date of issuance of the bill of lading or the waybill.  The big advantage that a date draft has over a time draft is that the exporter has control over the date at which the shipment is affected but no control over the date on which the importer will endorse the draft.

Acceptance, Applicability and Precautions

One of the advantages that documentary credit has over LCs is the procedures are not as cumbersome.  If proper precautions are taken by the exporter he should not face any major problem.

Protest:  The draft being a legal document in the importing country, the importer's commercial debt towards the exporter becomes official and legally enforceable.  Collection becomes easier if the importer decides not to honour his commitments.  A default here is not an international issue but a domestic one.  In case of a default, the presenting bank will file a protest wherein all parties to the transaction are informed about the default.  This can have disastrous consequences for the importer.  Among the consequences could be difficulty in getting credit in the future and in some countries defaulters lists are published in the local press tarnishing the reputation of the importer.

Instruction Letter:  An exporter, once he completes the formalities at the origin, will hand over to the remitting bank various documents pertaining to the shipment.  These include an invoice, packing list, the BL or waybill, certificates of origin, etc.  It is always advisable to include an instruction letter.  In an instruction letter, the exporter, through the remitting bank, tells the presenting bank what it expects to be accomplished.

The Instruction Letter tells the presenting bank the procedures it should follow in its dealings with the importer.  It tells whether the terms are sight draft, i.e. documents against payment (D/P) or against acceptance (D/A) through a time or date draft.  In case of a date draft, the bank must notify the importer as soon as it receives the documents, but as the draft is already signed, the importer has no incentive to delay taking delivery.  In case of a time draft, the date takes effect only when it is signed by the importer.

URC 522:  The guidelines for documentary collection are listed out in an ICC publication called Uniform Rules for Collections (URC 522).  When preparing the instruction letter it is always advisable to mention that the collection is subject to the URC 522.  The instruction letter is the only document that the presenting bank will follow.  It will not refer to any other document that accompanies the shipment document.

The rules outline the responsibilities of the remitting bank and the presenting bank.  It also lays down the limits of these responsibilities.  Although the URC 522 is an international standard for documentary collection, it has not reached the universal nature that ICP 500 has.  This is the reason why the instruction letter should mention URC 522 in it.

Trade and Banker's Acceptance:  Under URC 522, the responsibilities of the presenting bank end when it notifies the importer and releases the documents after the importer endorses the draft (D/A) or makes arrangements for payment (D/P).  This process is called trade (or trader's) acceptance.  Here the importer has control over when to endorse the draft and whether or not to sign it at all.

Trade acceptance could pose problems for the exporter as the importer could delay or even refuse to endorse the draft.  When this happens, the title of the goods are still with the exporter, who may have to arrange for warehousing till such time as the draft is signed, or he gets an alternative buyer, or ships the goods back to the origin.  The costs and risks involved can only be imagined.

These problems can be circumvented by requesting banker's acceptance instead of trade acceptance.  Here, the exporter asks the presenting bank to accept the draft on behalf of the importer.  Under Banker's Acceptance the onus of payment is on the presenting bank.  An Aval is a promise that , should the importer default, the bank will make the payment.  Aval and Banker's Acceptance, though synonymous, are used differently often.

Applicability:  Documentary collections, as we have seen, are less cumbersome and expensive than LCs and provide a good amount of safety.  Due to these reasons it has become a good way to conduct international sales.  The exporter retains the title of the goods till the importer accepts the draft (D/A) or makes payment (D/P).  Exporter's risk is further reduced in case of banker's acceptance or aval.

Documentary collections, though, do pose more risks to the exporter than LCs.  The reason for this is that payment is dependent on the primary transaction, i.e. the contract of sale.  An importer could delay or refuse to sign the draft.  He may cite poor quality merchandise or wait for goods to be resold before he endorses the draft.  An LC, however, is not dependent on the primary transaction.  It is dependent on documents and payment is ensured if the documents are in order.

A documentary collection, therefore, should be used if the exporter has a fair amount of trust and confidence in his buyer, but for various reasons, like getting finance for instance, an open account transaction is out of the question.  If an importer refuses to conduct business on an LC, the exporter could use banker's acceptance as a method if he is uncertain of the buyer's creditworthiness.

International Forfaiting:  We have learnt in an earlier lesson what international factoring is all about.  Factoring as a means of finance is very popular in a system where the factoring house collects the monies from the buyer and in turn finances the exporter.  Sometimes, a buyer, may want to purchase capital goods on a very long term basis, i.e. years instead of months  This means of financing credit on such long term basis is called forfaiting.

International Forfaiting is a means of finance in which an exporter collects from his buyer a series of drafts with fairly long-term due dates.  The exporter then sells the receivables to a Forfaiting Firm who buys them (i.e. finances the exporter) without recourse, i.e. the latter is responsible to collect the dues from the importer.  Usually the drafts are given by the importer, which have been given an aval by the importer's bank.  This is an arrangement that helps the importer buy goods at no risk and at fairly moderate cost to the exporter.

Cards in International Trade

Credit Cards as a means of finance for consumer purchases has been in existence for decades.  The debit or charge card is a later development.  Using a similar principal, a number of banks have started offering plastic money to their corporate accounts for making domestic and international purchases.  Purchasing, procurement or trade cards, as they are called are slowly gaining universal acceptance.  The exporter gets paid immediately while enjoys a fair amount of credit.  We shall use the nomenclature Procurement Card.

There is a history to the origin of the procurement card.  Several companies, especially with banks remote places, make myriad cash purchases.  These could range from office supplies, maintenance parts, or daily canteen supplies or transportation bills.  A company which has a centralized purchasing or accounts department would need to have a cheque sent to its headquarters or keep huge cash imprests.  Procurement cards given to departments to make certain purchases help address the problem.  While the supplier needn't wait for his money, the bank bills the head office directly.  The finance departments at the head office can check the account on a daily basis online.  Payments are made monthly.

There is a card which came into existence in 1994, created by the World Trade Centres' Associations.  This is an electronic system of payment which, combines the advantage of an LC with the other procurement cards in that:

• no payment is made till the documentation is in order and without any discrepancies.
• if the documents are in order the buyer has to make payment
• the supplier receives his payment immediately

Besides being quick, Procurement Cards are also very inexpensive.  Documents are transferred and payments made through the SWIFT network.  In most cases the transfer of money is automatic.

How to choose the right Incoterm and Method of Payment

Terms of Trade and Terms of Payment are two points that an exporter an importer must agree upon.  The Terms of Trade decides which costs the exporter will pay, which the importer will pay and the point at which the responsibility shifts from the former to the latter.  This is determined by the Incoterm chosen.  The terms of sale under which the transaction is performed specifies the point at which the exporter gets paid.  However, one issue still exists for the importer and exporter to consider.  It is the currency under which the transaction is undertaken.

However, there are some points that need to be looked at before we come to the point. What we have dealt with so far has been more from an exporter's than an importer's perspective. With international purchases of raw materials and components increasing, importers need also to be guided. The following are tips that an importer will find useful in international purchases:

1.       List out your needs and find out who can fulfill them

2.       Choose a good customs expert, a CHA or a Customs Consultant.  You may save huge amounts in duty and storage charges if the right advise is given.

3.       Manage your documents.  Ensure that you have the right papers before the consignment reaches its destination.  Improper documentation could lead to delays in clearance and unnecessary storage charges.

4.       Know your rights.  Even if the documentation is not complete goods could be moved from airport or CFS to a bonded area where the storage charges are much less.

5.       Use a bank that will give a good exchange rate.  With the right bankers you could save huge amounts in your foreign exchange remittances.  Also, if you have an open account system with your suppliers, make remittances when the rates are low.

6.       Get as many quotes as possible, with different possible INCOTERMS..  Look for hidden costs.  Most freight forwarders, when they do not know a figure, put a term at actuals.  It is advisable to know what actuals are.

Currency of Payment

When an importer places an order for merchandise, he has three choices of currencies in which the transaction can take place, the exporter's currency, the importer's currency and a third country's currency.  While we shall look into the basics here, students are advised to study the mechanisms of how things work in the International Currency Market.  Before we look at the pros and cons of using any of these currencies, let us look at a few definitions:

Hard Currency:  A currency that can be converted into another currency with no difficulty whatsoever.  E.g., US Dollar, Euro, UK Pound.

Convertible Currency:  A currency that can be converted into another currency.

Soft Currency:  A convertible currency that can not readily be converted into another currency.

[Hard and Soft Currencies are both convertible currencies with varying degrees of convertibility]

Inconvertible Currency:  A currency that can not be converted into another currency.

Currency:  The monetary unit used by a country, e.g. USA - Dollar and cent, UK - Pound and penny (pence), India - Rupee and paisa.

Exchange Rate:  The amount paid to purchase one unit of another currency.  Most currencies have rates which fluctuate according to market forces, whereas some currencies have rates which are fixed to another currency, always a hard one.  The former are called Floating Currencies and the latter are called Pegged Currencies.

Pros and Cons of Different Alternatives

When choosing the currency of transaction two factors are taken into consideration:

One, thr risk of currency fluctuation.  We have in an earlier lesson seen what Currency Risk is.  Depending on whether the exchange rate goes up or comes down could result in a Foreign Exchange Gain or Loss.

Two, the convertibility of the currency.  It is always advisable to do international business in a convertible currency, preferably a hard currency.

Let us now look at the pros and cons of the three alternatives.  Exporters and importers in India very rarely do business in Indian Rupees.  Most Indian exporters quote and invoice mainly in Dollars, Euro or Yen.  The US Dollar being used for exports to and imports from most countries, with the Euro for trade to and from the EC countries and the Japanese Yen for Japan.

In the first instance, the exporter and importer agree to transact business in the exporters currency.  For example, an exporter located in Japan supplies goods to an importer in Sri Lanka.  The invoice is made in Japanese Yen.  Here there is no exchange rate fluctuation risk for the exporter.  It is the importer who bears the risks and finds out how to deal with it.  Resolving convertibility problems is also the importer's responsibility.

In the second instance, the importer's currency is used for quotation and transaction.  For example, a garment exporter from India supplies clothes to a department store in Germany.  The invoice is made in Euro.  There is no exchange rate fluctuation for the importer.  The risks are all borne by the exporter, and it is he who will determine how to handle these risks.  Exchanging the importer's currency to the local currency is also his responsibility.

The final instance is doing business in a currency that is neither the importer's or the exporter's.  For example, a pharmaceutical exporter from India supplies medicines to an importer in Nigeria.  The invoice is made in US Dollars, a hard currency.  The reason for this is that the Nigerian currency is inconvertible and the Indian Rupee does not have universal acceptance.  Both parties have to manage their fluctuation risks.

Types of Exchange Rates

International Traders are doing business where foreign exchange transactions are involved need to manage risks related to exchange rate fluctuations.  For this they need to have a good understanding of the functioning of the foreign exchange mechanism.  This is a vast topic not a part of this course.  We shall provide some broad guidelines here.

When a trader purchases foreign exchange to pay for his imports or converts the export proceeds into domestic currency units, he may go in for one of the following rates: Spot Rate, Forward Rate and Currency Futures or Options

A Spot Exchange Rate is the rate for immediate delivery of the foreign currency, i.e. within a maximum of forty eight hours.  This is the rate paid by a foreign traveler when he purchases foreign exchange.  Or, the rate used for conversion when a foreign tourist makes purchases.  There is always a difference between the buying and selling rate.  Forward Exchange Rate is the rate for delivery on a particular day.  Currency Options is a method used to speculate on the value of the currency.  Traders are advised to hire a person experts who are well versed in foreign exchange transactions.  This could be a consultant or an employee.

Like other risks, exchange rate risks may be retained or managed by the traders.  The managing of exchange transaction risks is called Hedging.  People involved in international trade are advised to study hedging procedures and techniques.

Risk Management and Insurance

Managing risks in International Logistics and Transactions is perhaps one of the most complex issues that logisticians and other professionals dealing with them encounter. The insurance industry, and companies therein, use their own jargon, words or terms - known or unknown - which are used only by them. For example, an average, a loss incurred by a cargo owner on an ocean voyage, has a totally different meaning when it's otherwise used. There are myriad such terms and words which we'll come across as we  o along; e.g. jettison, barratry and Inchmaree clause. What's more is the fact that centuries old traditions and concepts still exist. Many of them have not changed since they were first used and this compounds the difficulty. Further, there are British and American methods of interpretation that we shall see.

However, the topic is of immense importance to logistics practitioners and users. Whether one move goods across continents or over short distances, whatever the mode, perils exist and risks with them that that everyone involved ought to be aware of and understand. How does one manage these risks? Under what circumstances does one absorb them and under what circumstances does one transfer them? We will in this unit look at the perils associated with different modes of transportation . Before that we will look at the particularities of International Insurance and at some of the peculiar jargon being used. We will look at the covers statutorily offered by carriers, handlers and warehousing companies and how these can be enhanced. What happens when there is a loss or damage? We will look at the procedures needed to be followed to make claims; also who can claim and who they claim with.

Are the perils of transportation, handling and storage the only ones involved? What happens when the consignee refuses to take delivery of their cargo; or, if delivery has been taken but, merchandise not paid for? We will look at covers offered when the importer defaults on payment.

Understanding the Complexities of International Insurance

 Making certain that the type of coverage selected is right is one of the greatest concerns in international insurance. Are both exporter and importer in agreement on the type of coverage to be taken? Often, one learns the hard way only after the event. Only after a loss has taken place cover does one discover that the insurance cover was inadequate. In the same way, one should note, that it does not make sense to over insure. Compensation will always be limited to the value of goods.

International Insurance - particularities vis-à-vis Domestic Insurance

International movement of goods, in many ways, is different from domestic movements. So, the way insurers them also is different. What are the differences between domestic and internal insurance policies? Here are some of the factors that make them different:

·         In international insurance, the number of coverage operations are more. There exist a minimum of six different standard insurance policies. Also, within each of these there exist several variations depending on specific clauses that may or may not be included or excluded. We will be dealing with these in detail.

·         Risks are either misunderstood and often ignored or overestimated. Till quite recently international shippers were located in or very close to ports. Mechanized land transport came into existence long after shipping. So, traders not only had a good understanding of the perils of long voyages but also interacted a great deal with ship owners. Today, thanks to great road and rail infrastructure and very fast movement by land, most manufacturing and distribution centres are inland. Of course, policy changes too had much to do with it. 3PL service providers and container services, where goods are picked up at the shippers' door and delivered at the consignee's designated place, has meant that exporter and importer are hardly involved in international movement of goods. It therefore becomes difficult for them to comprehend or appreciate the damage that can be caused by ordinary normal movements, let alone bad storms.

·         Lack of understanding of INCOTERMs, especially CIF and CIP is another issue. Although INCOTERMS 2020 has, to some extent, plugged this loophole, exporters often go in for only the basic cover. This may often be inadequate.

·         Carriers do offer coverage, but this is limited. If the value of the goods is less than the cover provided by the carrier, insurance is an absolute waste. In many cases, carriers are exempt from any liability.

Every party involved in international trade - service provider and purchaser - should be aware of the policies available, the amount of cover offered by carriers and the unique vocabulary in the field of insurance. This will help them arrive at best decisions. They also need to know how to make claims.

Unique Jargon used by the Insurance Industry

Depending on the risks they cover and the perils faced, insurers use very precise terminology - jargon - words that are unique to insurance business, or words found in the dictionary but having a different meaning here. Participants need to understand the meaning of these terms before embarking on the study of the subject - not just them, but every professional connected with logistics also. Let's look at some of these terms.

An Average is a loss incurred on an ocean voyage by the owner of the cargo. It applies to ocean transport only. There are two types of averages - general and particular.

A General Average refers to what is general in nature. In other words, it applies to all the owners of the cargo on board, nor just one. It occurs when there is a fire on board the ship, the vessel is grounded or capsizes. Also, when to save the ship, crew or remainder of the cargo, the captain decides to dump some of the cargo over board, it is considered a general average. Obviously, if this wasn't done, all the owners would have suffered losses. Their cargo is served by this action and, therefore they are indebted to the owners whose cargo is jettisoned. This will be looked at in detail.

A Particular Average is a partial loss which the cargo owner incurs. It could happen from any of the following reasons: cargo becomes wet from sea water; and, damage due to rough seas. Here the costs fall exclusively on the owner of the cargo and the insurer.

Barratry is the act of willful misconduct or disobedience by the captain or crew of the ship when the act results in damage to the ship or cargo.

Perils are events that cause losses.

A Hazard is a situation that increases the probability of damage due to a peril. This could be due to the nature of the cargo; improper  packing, securing or stowing. Poorly trained crew also could be a hazard.

Jettison: When some cargo has to be thrown over-board in order to save the rest of the cargo, the crew and the ship, the act is called jettison. It also applies to dumping fuel from an aircraft.

A Risk is the probability of a loss. Risks are of various types - speculative, pure, objective and subjective among others.

A Speculative Risk is one that can generate, not just a loss, but a gain as well. E.g. fluctuations in exchange rates.

A Pure Risk is the chance of only a loss incurring. Insurers only cover pure risks.

Objective Risk: When the chance of a loss can be accurately calculated due to plenty of empirical data available, it's termed as an objective risk. There is plenty of data available on issues like the number of ships that have sunk or the number of piracies that have taken place. A mathematical calculation is made on the probability.  

Subjective Risk is the loss perceived by an individual or organization. The perception may be wrong or right. Individuals may over- or underestimate the risks. Only when studies are made and research conducted does a subjective risk become objective and the matter thus settled.   

Perils of International Transportation

Goods face numerous perils and hazards in transit, whatever the mode of transportation. One of the main reasons for this is multiple handling  with multiple carriers involved in pre-, main & post-carriage operations. The more the segments in a trip, the more the number of hazards. Therefore, international shipments face more hazards than domestic shipments. As goods are often transferred from one mode to another, and one carrier to another, the goods gets exposed to risks. These perils have implications on insurance coverage. Further, they have a bearing on how goods are packed. Packaging will be dealt with in detail at a later stage.

We shall look at the perils faced by different modes of transportation. Some are applicable to all modes, e.g. theft and pilferage, others specifically to one mode. Today international shipments are faced with the danger of theft and pilferage. This is common not just to carriers but to trading community and all other logistics players as well. During pre- & post-carriage, the risks are more. It is very difficult to pinpoint the total value of these thefts as data is hard to obtain. While containerization has substantially reduced theft, it hasn't altogether eliminated it. Much of this happens through well-organized syndicates.

Perils Faced by Ocean Shipments

For a land-based trader, who is more familiar with movement by truck or train, it is difficult to envisage the perils of ocean transportation. But, ocean shipments, even containerized ones, are subject to a large number of risks. The reasons for these are as follows:

Cargo movements: When at sea, waves and wind cause ships to sway and the cargo is subject to movement. This could damage cargo, containers and the entire, especially if the cargo hasn't been fastened properly. Bad weather could make things worse.

Over-board losses: Cargo may be lost over-board due to storms and other reasons.

Container losses: Containers could fall from the vessel.

Other reasons for loss of cargo include jettison, fire, sinking or capsizing of vessel, stranding, general average, piracy, collision with another vessel or some structure like a bridge, contamination, cargo causing harm to other cargo - e.g. infested groundnuts harming wheat, strikes, stowaways, arrest, bankruptcy, inadequate equipment, and more.

Insurable Interest

Before we get into different types of covers offered, we need to look at and understand the term Insurable Interest. When goods are transported, handled or stored, there are several parties involved in various processes and steps in getting the cargo moved from origin to destination. All of them are interested in their safe arrival. Let us look at who these parties are:

·         the owner of the goods (exporter or importer)

·         forwarders

·         transporters

·         bankers

If the goods don't reach the destination safely or get lost/damaged in transit, a claim has to be made. So, who is eligible to claim? If the goods are insured, which party shall the insurance company compensate? What one needs to know and understand very clearly is that the insurance company will only compensate a party that has insurable interest in the safe arrival of goods. The insurance contract is legally binding only if they have an interest in the subject matter and, of course, the goods are insurable. No insurance company will accept the proposal form if these conditions are not met. So, what is insurable interest or rather. who has it? A party who would experience a financial loss due to damage or loss of cargo is one who has insurable interest.

Depending on the INCOTERM used, insurance may be purchased by either the importer or exporter, or goods may not be insured at all. Of course, if not insured no insurance company comes into the picture. Insurable interest is, almost always with the owner of the goods.

Risk Management

Companies can manage their risks in three possible ways: one, retain the risk; two, transfer the risk; and three, take a mixed approach. Let's elaborate.

Risk retention: Here the company decides not to insure the goods, i.e. it decides that it is more cost-effective not to spend on an insurance premium. The following circumstances are ideal for risk retention:

·         very large number of movements

·         negligible exposure, i.e. goods are of low value - one should note that the carriers' liability would cover the loss

In addition to the two above reasons, it may so happen that the parties underestimate the risks and don't insure. Over insurance makes no sense as the maximum amount that will be paid will be the invoice value of the goods.

Risk transfer is for just the opposite reasons why risks are retained and a mixed approach is where some consignments are insured and some are not. While a company may follow one of these three strategies, whatever their justification, they should have a firm policy on the maximum amount of exposure they are willing to bear.

Marine Insurance Policies

Although the term marine insurance is used, to applies to all modes of transportation. Besides covering the loss of goods, marine insurance companies also offer covers for vessels and aircraft owners. These policies only matter to the cargo owner if the entire ship or aircraft is chartered.

There are two main types of marine cargo insurance policies - open policy and special cargo policy. An open policy covers all shipments made by the company within a specified time-frame, generally one year. A special or individual policy covers only a particular shipment. The advantage of an open policy is that one needn't purchase insurance each time a shipment is affected. One should note that, whoever purchases insurance, it must be purchased prior to the shipment leaving the port/airport of origin.

Once the insurance premium is paid, a certificate of insurance issued by the insurance company, needs to be obtained. In case of an open insurance policy, the insurance company gives blank policy forms where the details can be filled up, as needed. Marine cargo policies can be purchased directly or through agents. Most freight forwarders also act as insurance agents. Carriers, in certain cases, insure the cargo on behalf of the shipper.

There are two major groups of marine insurance policies. One group are termed as Insurance Marine Clauses A, B & C. These use British language and law. They are named after the Institute of London Underwriters also called the International Underwriting Association of London. The second group is based on US law and named according to the coverage offered, viz. All Risks, With Average & Free of Particular Average. The chart gives an idea of what is covered under various policies.

Insurance companies will not cover for five specific risks:

·         improper packing

·         inherent vice, goods that have some natural properties which could, under certain circumstances, causes damage; e.g. steel rusts, wood warps or splits, etc.

·         ordinary leakage

·         unseaworthy vessel being used

·         nuclear war

A very detailed study of insurance is out of the scope of this course.

Filing an Insurance Claim

Whenever damage or loss is noticed, it is imperative on the party concerned  the claim process needs to start. The first step in the process, and also the most important, is notification. Both the insurer and carrier have immediately to be notified, in writing, about the nature of apparent damage.

The insured has to then hire the services of a registered surveyor. A Surveyor is an independent company or individual who investigates the damage and submits an estimate of the damage to the insurance company.

Once the surveyor's report is submitted, the claim may be filed. The insurance company will give a checklist of documents to be submitted. These will then be scrutinized and the claim settled.

Carrier's Limit to Liability

We have already stated that carriers also cover shipments against damage or loss. They have, depending on the mode of transport, certain upper limits to this liability. For air shipments, the liability can be increased by paying a valuation charge. This is clearly specified in the original transport document. If the value of the goods is equal to or less than the carrier's limit to liability, insuring the cargo is an absolute waste. Insurance does not mean that the carrier has escaped its cost of the damage. The amount due from the carrier will be collected by it from the insurance company. Also, before settling a claim, they insurer will check whether a parallel claim is being filed with the carrier.

Commercial Credit Insurance

Besides damage/loss caused due to the perils of transportation, there are other risks which an exporter and importer faces. One of them is when the exporter does not get paid for the goods supplied or the buyer refuses to take delivery of the ordered shipment. Commercial credit insurers offer cover for these losses. They cover the following types of transactions:

·         a sale to a foreign customer on open account

·         a sale to a foreign customer on credit terms

·         where bankers need a cover to provide finance

Commercial credit insurance covers such contingencies

Risks and Liabilities of a Freight Forwarder

We have, in previous modules, seen what the role of a freight forwarder is, let us look at one important aspect of their being, the risks and liabilities they face. We have already seen that they are an essential and integral part of the global supply chain, whatever the mode of transport. As airfreight is the core competence of most participants, the outlook will mainly be with reference to air carriage but this is applicable to all modes of transportation. Just to recollect, using a slightly different perspective from what we've used, a freight forwarder is a multi-function agent/operator who undertakes to handle the movement of goods from point-to-point on behalf of the cargo owner. WTO estimates global trade to be worth over USD 20 trillion today, close to 90% by sea, but a great deal moves by air and other modes of transportation, including MTO, as well. These numbers are staggering. While most of the cargo is delivered without a problem, there are incidents, rare but not significant, when cargo is lost, damaged, abandoned (extremely rare, but with severe consequences whenever it happens) and even fraud.

It's a very well known adage that a chain is as strong as its weakest link. So, which is the weakest link in the supply-chain? Before we answer this question, let us look at what the legal status of a freight forwarder. It, being almost always an entity without assets, outsources most of its services. While carriers, ports, airports, etc., even agencies like the customs broker (CHA in India) and MTO, have laws governing them, the freight forwarder or third-party logistics service provider isn't so fortunate. So, if legal redress is needed, whether for the service provider or purchaser, which laws would they come under? The contract of carriage or consignment note, is an agreement between the shipper and carrier. So, as per the law, only the carrier can be sued for breach, if one occurs during carriage. Yet, it is the forwarder who invariably has to bear the blame.

Unfortunately, even when a loss takes place when cargo isn't in their custody, the freight forwarder is invariably affected because carriers, customers and regulatory bodies either look to them to sort it out or hold them liable. Unfortunately, the forwarder is the most vulnerable because, while carriers and authorities get paid on time, they aren't. So, the customer hold their payment till the problem is sorted out.

Often though, the freight forwarder could be at fault but, these are rare instances. So, both the forwarder themselves and the customer, need to understand the Risks and Liabilities of a Freight Forwarder. Remember, the freight forwarder is a third-party logistics service provider. So, its liability is an extremely complex issue. There can be no general principals as each case is usually different and unique. The liability is intrinsically related to relationship between them and their principals, the former being an agent. They serve as conduits for global movement of goods between exporters and importers on one hand and the transportation and regulatory entities on the other. By accepting to service a customer, (under the Indian Contracts Act a contract may be oral) they are exposed to several unique risks and liabilities. By undertaking to handle a shipment for services which could include transporting goods from point-to-point, their risks and liabilities may include, but aren't limited to the following:

·         Total Loss of Cargo which happen due to various reasons. Among them, damage or theft, while the cargo is or isn't in the custody of the freight forwarder.

·         Loss of money which, due to market practices of extending credit for long periods, may happen if the customer doesn't make payment even when there are no service issues.

·         Damage to cargo which could happen for myriads of reasons. Cargo may not be correctly or properly packed, handling may be improper, &c.

·         Rerouting of cargo could be a major source of unnecessary expense. This may happen due to various reasons. Due to a miscommunication over the phone, a shipment could land in Dulles instead of Dallas. Another reason why this could happen is cross-labelling. Incorrect documentation is a third possible reason.

·         Abandonment of cargo happens very often. The consignee may not take delivery of a shipment and abandon it due to lack of funds, cancellation of order, etc. When this happens, the shipper may hold the forwarder's payment, although it isn't their fault.

·         Non-collection of documents often happens. A house air waybill may have been issued and, for a shipment involving an LC or documentary collection, a delivery order may have been issued without a bank release order. In case of a sea shipment, where a house bill of lading is involved, if delivery has been affected without production of the consignee's original of the BL. Here the liability could be huge.

·         Incorrect release of cargo, e.g. if, in case of a negotiable BL (AWBs can never be negotiable), if the cargo was released to a party without the production of the consignee's original BL or without proper endorsement.

·         Delays due to improper documentation happens when cargo may be delayed at some point – the origin, in transit or at the destination – due to incorrect documents being submitted by the forwarder to the carrier, or incorrect declarations being filed with customs. In cases like this, or any other incorrect documents on the part of the forwarder, obviously they are liable.

Besides the points made above, a freight forwarder may also be liable as a contractual carrier under the following circumstances:

·         They have negotiated and quoted for the entire carriage to the shipper or consignee.

·         They have issued their transportation document.

In many jurisdictions it is possible for the forwarder to be exempted from all liability if it could be proved that they exercised due diligence and took all possible steps in respect of the following:

·         receiving and storing of the goods

·         selecting the most suitable carriers

·         delivering the goods to the consignee

·         plus, all other matters en-route

Let us look at an example. A consignee may have abandoned the goods because the cost of delivery turns out to be more than the value of the goods. If negligence on the part of the forwarder is the reason, obviously they are liable. How could this happen? One example could be, that the consignee was not notified, or notified late, resulting in late clearance. Due to this, demurrage or detention charges were levied.

It could also happen that the costs increased because proper documents were not handed over to the forwarder by the consignee or shipper, leading to a delay in clearance. In such a case, the forwarder is not liable. For charges collect air shipments, if the consignee doesn't take delivery within a stipulated period, charges are reversed to prepaid and, if the shipper doesn't pay, debited to the IATA agent. For sea shipments, if the booking of cargo is done through the forwarder, they will be billed for abandonment.

We've seen that the forwarder's role is very important. Customers rely on them, due to their experience and expertise, to handle their cargo. They pick up the cargo from the seller; in certain cases arrange for proper packing of goods; handle and prepare the required documents; get whatever clearances that are required at the origin, destination and in transit; and deliver the goods at the right place, in the same condition that they were picked up in. They have to ensure that their customer's interests are best served by using the most suitable resources and routing.

When one looks at the scope of responsibility of a freight forwarder, it's vast. Unfortunately, they work with very thin margins and get the last priority when it comes to payment. Considering the risks involved and their vulnerability, it is essential that they get themselves properly protected and covered for these risks. An unintentional error may lead to a problem involving some cost. If the customer claims that the forwarder is negligent, they are liable. In such a case, the onus of proving non-negligence is on the forwarder. So what covers do they need to take? The following list will give one an idea:

·         Marine liability cover for overseas trades

·         Full liability protection to cover all forwarding operations

·         Third party liabilities

·         Regulatory breaches

·         Errors & Omissions and Legal Liability – all freight forwarders may be exposed to contractual liability for a loss, irrespective of who is responsible

·         Survey and mitigation costs

·         General Average and Salvage Charges including cargo disposal as in some General Average situations freight forwarders also could be roped in

·         A comprehensive Liability Cover and Risk management

·         Insurance cover packages may be available in the market to cover the liabilities mentioned above. Forwarders should check with their insurance agent for the same. This will be dealt with in detail in the module on insurance.

The freight forwarding business is considered to be one with almost no entry barriers. Considering the number of single person outfits in the sector who operate from a tiny office or no office at all, the perception isn't false. However, if you the student and reader feel that it's easy  think again. The life of a forwarder isn't all that easy.

Liability of the Freight Forwarder in case of Abandoned Cargo

A very important issue that needs to be addressed is ~ what is the liability of the freight forwarder in case the cargo has been abandoned? The answer to this question varies depending on whether a house or master air/sea waybill/bill of lading was issued. These documents have already been discussed in previous modules. To decide on this, one needs to first look at the relationship between the carrier and either the shipper or forwarder. One needs to start at the very beginning of the process and see in what capacity the freight forwarder has made this booking with the carrier. Here are some possible ways in which this could have been done:

·         The forwarder could be acting as an agent of the shipper and made the booking with the carrier in this capacity. This fact was clearly known to the carrier. In this case will have no liability, or a very limited one. To cover one's liability, in such a case, the forwarder may purchase an insurance policy from an insurance company or a risk management provider like a TT Club.

·         Often the booking is made in their own name and the fact that the forwarder was acting on behalf of the shipper wasn't mentioned. In such cases, the agent would have some answering to do.

As we have stated, what kind of transport document, viz. house or master, was issued and how also plays a vital part here. Let's look at various possible scenarios:

1.      House AWB/BL issued to the shipper, consigned direct to the consignee, who hasn't cleared the shipment: Every HAWB/BL must have a corresponding master document, which will show the forwarder as shipper and the overseas agent as consignee. The document that the carrier has doesn't show the original shipper or the final consignee. When cargo is abandoned, the carrier with pursue the entity listed as the shipper on their consignment note. The forwarder here has acted as a principal, not an agent. The airline/shipping line will be well within their rights to place the claim on the forwarder.

2.      The forwarder has issued an AWB to the shipper directly and consigned directly to the consignee, with no consol and break-bulk agent involved. The consignee hasn't cleared the shipment: This document doesn't have the agent's name in the shipper box. They act here as agents to both the shipper and carrier. The AWB, as we've seen, is a contract between the shipper and carrier. So, there's no liability for the agent. Associations and federations like the Air Cargo Agents' Associations (ACCAI) and the Federation of Freight Forwarders' Associations of India (FFFAI), SOPs and Standard Terms of Contract (STCs) are made for the use of their members. Such STCs are generally localized and should sufficiently cover their liabilities. It is advised that freight forwarders have at least the following: 

·         A comprehensive Liability Cover and Risk management

·         A properly incorporated STC in order to manage the risks and limit exposure to cover themselves sufficiently before embarking on the business of freight forwarding.

Currency of Payment

When an importer places an order for merchandise he has three choices of currencies in which the transaction can take place, the exporter's currency, the importer's currency and a third country's currency.  While we shall look into the basics here, students are advised to study the mechanisms of how things work in the International Currency Market.  Before we look at the pros and cons of using any of these currencies, let us look at a few definitions:

·                     Hard Currency:  A currency that can be converted into another currency with no difficulty whatsoever.  E.g., US Dollar, Euro, UK Pound.

·                     Convertible Currency:  A currency that can be converted into another currency.

·                     Soft Currency:  A convertible currency that can not readily be converted into another currency.

            [Hard and Soft Currencies are both convertible currencies with varying degrees of convertibility]

·                     Inconvertible Currency:  A currency that cannot be converted into another currency.

·                     Currency:  The monetary unit used by a country, e.g. USA - Dollar and cent, UK - Pound and penny (pence), India - Rupee and paisa.

·                     Exchange Rate:  The amount paid to purchase one unit of another currency.  Most currencies have rates which fluctuate according to market forces, whereas some currencies have rates which are fixed to another currency, always a hard one.  The former are called Floating Currencies and the latter are called Pegged Currencies.

 

Pros and Cons of Different  Alternatives

When choosing the currency of transaction two factors are taken into consideration:

·                     One, the risk of currency fluctuation.  We have in an earlier lesson seen what Currency Risk is.  Depending on whether the exchange rate goes up or comes down could result in a Foreign Exchange Gain or Loss.

·                     Two, the convertibility of the currency.  It is always advisable to do international business in a convertible currency, preferably a hard currency.

Let us now look at the pros and cons of the three alternatives.  Exporters and importers in India very rarely do business in Indian Rupees.  Most Indian exporters quote and invoice mainly in Dollars, Euro or Yen.  The US Dollar being used for exports to and imports from most countries, with the Euro for trade to and from the EC countries and the Japanese Yen for Japan.

In the first instance, the exporter and importer agree to transact business in the exporters currency.  For example, an exporter located in Japan supplies goods to an importer in Sri Lanka.  The invoice is made in Japanese Yen.  Here there is no exchange rate fluctuation risk for the exporter.  It is the importer who bears the risks and finds out how to deal with it.  Resolving convertibility problems is also the importer's responsibility.

In the second instance, the importer's currency is used for quotation and transaction.  For example, a garment exporter from India supplies clothes to a department store in Germany.  The invoice is made in Euro.  There is no exchange rate fluctuation for the importer.  The risks are all borne by the exporter, and it is he who will determine how to handle these risks.  Exchanging the importer's currency to the local currency is also his responsibility.

The final instance is doing business in a currency that is neither the importer's or the exporter's.  For example, a pharmaceutical exporter from India supplies medicines to an importer in Nigeria.  The invoice is made in US Dollars, a hard currency.  The reason for this is that the Nigerian currency is inconvertible and the Indian Rupee does not have universal acceptance.  Both parties have to manage their fluctuation risks.

Types of Exchange Rates

International Traders are doing business where foreign exchange transactions are involved need to manage risks related to exchange rate fluctuations.  For this they need to have a good understanding of the functioning of the foreign exchange mechanism.  This is a vast topic not a part of this course.  We shall provide some broad guidelines here.

When a trader purchases foreign exchange to pay for his imports or converts the export proceeds into domestic currency units, he may go in for one of the following rates: Spot Rate, Forward Rate and Currency Futures or Options

A Spot Exchange Rate is the rate for immediate delivery of the foreign currency, i.e. within a maximum of forty-eight hours.  This is the rate paid by a foreign traveller when he purchases foreign exchange.  Or, the rate used for conversion when a foreign tourist makes purchases.  There is always a difference between the buying and selling rate.  Forward Exchange Rate is the rate for delivery on a particular day.  Currency Options is a method used to speculate on the value of the currency.  Traders are advised to hire a person experts who are well versed in foreign exchange transactions.  This could be a consultant or an employee.

Like other risks, exchange rate risks may be retained or managed by the traders.  The managing of exchange transaction risks is called Hedging.  People involved in international trade are advised to study hedging procedures and techniques.