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Copyright © International Chamber of Commerce (ICC). All rights reserved. ( Source of the document: ICC Digital Library )
by Guillermo C. Jimenez
Export and import commercial transactions commonly involve the use of a number of standard documents and forms, in particular:
> Purchase order — prepared by the importer, this is often the key contractual document, it records the transaction’s key commercial terms;
> Pro forma invoice — prepared by the exporter, it also records the transaction’s key commercial terms and may be used as a confirmation of the importer’s purchase order (or in other cases as a binding offer);
> Commercial invoice — this is the exporter’s bill for the goods sold;
> Bill of lading — this crucial document has three functions:
> Documentary credit (also known as letter of credit) — an advance assurance of payment to the exporter provided the exporter complies with documentary conditions;
> Certificate of inspection — a document which attests to the quality of the goods shipped;
> Certificate of origin — a document which designates the country of origin of the goods (which may be crucial for calculation of import duties);
> Consular invoice — a document certifying the details of an export contract, provided by a consular representative of the importing country residing in the exporting country;
> Packing list — a detailed list of the contents of each shipping unit;
> Insurance certificate (or policy) — proof of insurance coverage.
International traders should be familiar with the correct usage and potential pitfalls involved with each of these documents.
This chapter provides an outline of the sequence of events in an international trade transaction and illustrates the use of each of these key documents in that sequence.
International commercial transactions are commonly based on an exchange of commercial forms between buyers. In international transactions, the sale contract requires the parties to enter into a number of subsidiary agreements with bankers, transport companies and insurers.
The documentary requirements in international transactions can be crucial, particularly in the case of the so-called “documentary sale”, the classic export transaction that requires the seller to submit shipping documents to a bank for payment under a documentary credit.
In this chapter we review the sequence of events in two international trade transactions:
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The simple transaction provides an easy overview of the basic structure of international sales transactions.
The more complex transaction with documentary credits is very useful to understand (even if one does not anticipate using documentary credits) because it involves all the main export documents and sub-contracts. Once you understand a documentary credit, simple export transactions become easy to grasp.
Figure 2.1
A Documentary Affair: Export-import transactions require the parties to carefully manage a number of standard documents.
As we discussed earlier in Chapter 1, one of the main factors that makes export transactions complex is risk. When exporters perceive a high risk of non-payment they insist on payment security devices such as the documentary credit, which render the transaction more complicated.
However, in many other cases the parties do not perceive a high degree of non-payment risk. For example, when selling to large, well-established corporations in a stable industry the risk of non-payment is low. In such cases, exporters are willing to accept simpler payment methods, such as “open account” (meaning the exporter delivers the goods and then waits the agreed credit period to invoice the importer).
Another factor of complexity is the choice of shipping term (under Incoterms® 2010 rules). Several Incoterms® rules require the parties to split their respective duties of transport and customs clearance (as well as the risk of loss).
However, two Incoterms® rules are “simpler” in that they place all transport duties (and risks) entirely on one or the other side. Thus, the Ex Works (EXW) Incoterms® rule places all transport responsibility on the importer, while the Delivered Duty Paid (DDP) Incoterms® rule places all transport responsibility on the seller. The DDP Incoterms® rule makes life easy for the importer because all transport and customs responsibilities, as well as payment of customs duties, are for the exporter. Usage of the DDP Incoterms® rule with an open account payment term indicates the presence of a so-called “buyers’ market” — a highly-competitive market in which sellers are obliged to offer convenient terms for buyers.
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Figure 2.2
Export Transactions: The Sequence of Events
Commonly, the exporter markets goods at trade shows or through circulation of catalogues and or through a website. Thereafter, he receives an inquiry from an importer, requesting a price quote for a certain amount of goods of a specified quality. The importer’s inquiry may arrive as a form document referred to as an RFQ (Request for Quote) or RFP (Request for Proposal). See Figure 2.3: Request For Quote (RFQ).
[Page24:]Note that is quite common for traders to include language in their price catalogues (whether printed or online) to the effect that the prices are not binding upon the exporter until confirmed. Both parties will commonly include language in their initial documents to prevent pre-contractual liability in the event one of them decides not to go through with a transaction.
At some point, the parties will move to a contractual phase by exchanging a legally-binding offer and acceptance. Either party may make the offer. When the offer is formally accepted, a contract is formed.
Three common methods of forming the export contract are as follows:
> Purchase order as offer
In transactions involving large commercial buyers, the purchase order (rather than the pro forma invoice) is usually the main contract form and constitutes the first legally-binding offer. In such cases, the seller’s confirmation of the purchase order will constitute the acceptance (and may come in a form document referred to as a “confirmation” or as a pro forma invoice). See Figure 2.4: Purchase Order.
> Pro forma invoice as offer
The exporter may wish to provide a complete contractual offer along with the price quote. One technique is for the exporter to send a pro forma invoice as the first document that formally specifies the key terms of sale, including the price, delivery and payment terms. In this case, the pro forma invoice serves as the first legally-binding offer and the importer may formally accept it by sending in a purchase order or other confirmation. See Figure 2.5: Pro Forma Invoice.
> Use of standard contracts or model contracts
An alternative method is for either the exporter or importer to make an offer via a standard contract form, such as the “Specific Conditions” form of the ICC Model International Sale Contract. The Specific Conditions form is very similar to a Pro Forma Invoice or Purchase Order in that it records all of the necessary commercial terms of a sale contract (e.g. price, description of goods, delivery terms, payment terms, etc.) See Figure 2.6: ICC Model International Sale Contract. The ICC Model International Sale Contract comes in two parts and, if the parties use the first part (Specific Conditions),[Page25:]it is assumed they wish to use the complementary “General Conditions” as well (these are a complete set of legal terms). See Figure 2.7: ICC Model General Conditions of Sale. The contract is formed when both parties have signed the Specific Conditions form.
In this example, we are assuming a DDP contract. DDP contracts make the transaction easier for the importer at the cost of requiring more work by the exporter. With the DDP term, the exporter has to arrange for carriage all the way to the importer’s premises (and must also take care of all customs formalities and payment of import duties).
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The exporter commonly prepares his shipment with the assistance of a freight forwarder, who books space for the cargo and may also assist with customs formalities. When the goods are delivered to the carrier (this is called “shipping” the goods), the exporter receives in exchange a signed transport document (usually a “bill of lading” or “waybill”). This important document acts as a receipt indicating that the goods were received in apparent good order and quantity and also stipulates the contractual rights of the holder of the bill of lading against the carrier. See Figure 2.8: Bill of Lading. In this simple sale, a waybill is used because it is easier to manage than a traditional bill of lading (with waybills there is no requirement to transmit the original document, a copy is sufficient).
In order to fulfil its delivery obligations, the exporter must arrange for the goods to be delivered in good condition to the importer’s premises (or other designated point).
Since we have assumed an open account payment, the exporter invoices the importer and then awaits payment after the specified credit period. Open account terms are commonly designated by shorthand contractual terms such as “net 60”, which means that payment is due within 60 days of invoicing. The importer may make the payment via an electronic funds transfer, sometimes known as a “wire transfer” or “SWIFT” payment. SWIFT (Society for World Interbank Funds Transfers) is the global banking network that provides secure interbank connections for funds transfers and confidential communications.
In this second example we look at a more complex transaction involving a documentary credit. Documentary credits tend to be used when the exporter does not know the importer or when the exporter needs to raise finance on the guarantee offered by the documentary credit. Although we will cover documentary credits in detail in Chapter 12, for our purposes here let us note that a documentary credit provides the exporter with an advance guarantee of payment, but this guarantee is conditional upon the exporter submitting the precise documents stipulated in the documentary credit.
This transaction is more complex because the documentary credit process contains a greater number of steps and requires the careful use of a number of export documents.
We assume here that export marketing and contract formation proceeded as in the above example.
When the exporter does not know the importer or is unable to obtain sufficient credit information about the importer, the exporter may wish to insist on payment by documentary credit (DC), a payment mode which provides important assurances to the exporter: the exporter is assured that funds for payment are available at a trusted bank, and the exporter knows that the importer cannot receive the goods unless payment is effected. Documentary credits are also known as “letters of credit” (LCs).
When the parties have agreed to payment by documentary credit, the importer is obliged to take the first steps, by opening or issuing a documentary credit in advance of shipment. Ideally, the sale contract will give the importer a deadline for opening the credit. Otherwise, a reasonable period will be presumed. The buyer opens the credit by filling out a documentary credit application form.
In the classic example of the documentary sale which we are setting forth here, the exporter quotes a CIF Incoterms® 2010 price, which means that the price includes freight to destination plus insurance.[Page27:]
The ICC Incoterms® rules define transport cost and risk obligations of the parties and are dealt with in detail in Chapter 4. CIF stands for “cost, insurance and freight” and was developed in the context of the maritime shipment of general cargo.
Under the CIF Incoterms® 2010 rule the exporter is responsible for export customs formalities, such as obtaining an export licence. Import formalities and duties, conversely, are for the importer’s account. An experienced export trader understands that there are often disputes about unloading or discharging costs under CIF, so he may choose to specify in the contract of sale that all unloading charges are for the importer. When the goods are delivered to the carrier, the exporter, as shipper, receives from the carrier the bill of lading.
In a CIF contract, the exporter must normally provide the importer with a “negotiable” bill of lading (to be distinguished from a “waybill”, which is not negotiable). A negotiable bill of lading allows the goods to be sold while in transit and is a key document in the documentary credit process. See Figure 2.8: Bill of Lading.
Under the CIF Incoterms® 2010 rule, the exporter must respect the Incoterms® requirement to obtain insurance coverage for 110% of the value of the goods (the extra 10% is meant to cover the minimum profit anticipated by the importer; it is possible to request greater coverage). See Figure 2.9: Insurance Certificate.
In banking terminology, the importer is referred to as the “applicant” or “account party”. The exporter is referred to as the “beneficiary”. The documentary credit contains the terms and conditions under which the bank will pay. Generally, this includes a list of documents which the beneficiary (exporter) must furnish, such as the commercial invoice, inspection certificate, bill of lading, etc.
Let us assume in this example that the beneficiary has stipulated that the credit be confirmed. By this, the exporter requires the importer to obtain from another bank (usually one located in the exporter’s country) a confirmation of the credit, which means that the confirming bank adds its own irrevocable undertaking to pay under the[Page28:]terms and conditions of the credit. This may be considered advantageous by the exporter who prefers to work with a relatively close and reliable paymaster, such as his own bank. Let us assume that the confirming bank agrees to confirm the credit.
Note: not all credits are confirmed; confirmation is an additional bank service performed for a fee, and therefore makes sense whenever the exporter does not wish to take the risk that the issuing bank may become unable to pay under the credit. Of course, the exporter may simply be more comfortable dealing with a known bank, and that is also a sufficient reason for requesting a confirmed credit.
The confirming bank will notify the exporter that a confirmed credit is available through its services. This notice will specify the amount of the credit and the precise documents required for payment. The exporter should carefully review this notice upon receipt to ensure that it will be feasible to comply with the documentary conditions, and also to verify that the credit conforms to any conditions spelled out in the sale contract. See Figure 2.10: Advice of Confirmed Documentary Credit.
The exporter prepares the shipment and instructs the freight forwarder to obtain the necessary transport document. After shipment of the goods, the exporter goes to the confirming bank and presents the various documents required under the credit. In addition to the bill of lading, the exporter will likely be required to present the following documents under the conditions of the documentary credit (note that the number and type of documents should be agreed to by both parties in the contract of sale):
The “commercial invoice” is the bill of sale from exporter to importer. Although it is prepared by the exporter itself, it is of vital importance that accuracy be perfect when the commercial invoice is one of the documents presented under a documentary credit. Even small errors in a commercial invoice will generally be counted as discrepancies. See Figure 2.11: Commercial Invoice.
The “certificate of origin” certifies the country in which the goods originated or in which the preponderance of manufacturing or value was added. Not all countries require a certificate of origin. In many cases, the exporter’s own certification on company letterhead will suffice. See Figure 2.12: Certificate of Origin.
Certificates of “pre-shipment inspection” are not mandatory in international trade, but they are quite common in large-value shipments, especially between unfamiliar parties.[Page29:]
Inspection certificates are commonly required under a documentary credit and are a powerful security and anti-fraud device for buyers. See Figure 2.13: Certificate of Inspection.
“Consular invoices” contain detailed descriptions of the goods shipped as certified by a consul of the receiving country residing in the exporter’s country. See Figure 2.14: Consular Invoice.
An export “packing list” itemizes the material in each individual package and indicates the type of shipping package, such a box, crate, drum or carton. Commercial and legal stationers and freight forwarders often carry packing list forms. See Figure 2.15: Packing List.
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The confirming bank takes up the documents, examines them and, if it finds them conforming to the conditions of the credit, gives or promises to give value to the exporter under the credit. There are different ways the exporter can get paid, depending on the type of credit. It can be paid immediately (“sight” credit), or at a later time (“deferred payment” credit) or a draft payable in the future can be discounted for a partial, immediate payment (“acceptance” or “negotiation” credit). Documentary credits are explored in detail in Chapter 12.
The confirming bank will transmit the documents to the issuing bank which, if it finds they are conforming, will in due time reimburse the confirming bank for the funds it has paid out under the credit, and will then turn the documents over to the importer and debit its account for the amount of the credit. The importer will use the transport documents to obtain delivery of the goods from the carrier. This is assuming that everything works out as planned. However, surveys show that shipping documents frequently contain errors when they are first presented to the bank for payment. Correction and/or waiver of these “discrepancies” may take time and, in some cases, even delay or prevent payment.
If no discrepancies are noted by the banks, the issuing bank will debit the importer’s account and release the documents to the importer. The bill of lading is especially important for the importer, because this is what allows the importer to receive delivery. When a traditional bill of lading is used as part of a documentary credit-based transaction, the importer needs to provide the carrier with an original, signed bill of lading in order to receive the goods. If the carrier inadvertently releases goods to a party who does not have a bill of lading, the carrier will be liable for misdelivery. Thus, the use of a negotiable bill of lading provides the exporter with the assurance that the importer cannot obtain the goods without authorizing payment under the credit.
Test Your Knowledge: Phases of an Export Transaction
True/False
Answers: 1. F 2. F 3. T 4. T 5. T