IF YOU CAN’T DODGE A IF YOU CAN’T DODGE A RISK, HEDGE ITRISK, HEDGE IT

Mitigating Risks in International Mitigating Risks in International

Payment and CollectionPayment and Collection September 19, 2007September 19, 2007

National Association of Credit ManagersNational Association of Credit ManagersGateway Regional ConferenceGateway Regional Conference

Presented By:Presented By:Jennifer SchwesigJennifer Schwesig

Armstrong Teasdale, LLPArmstrong Teasdale, LLP

INTRODUCTIONINTRODUCTION

• Laws applicable to bankruptcy, insolvency, Laws applicable to bankruptcy, insolvency, security interests, and creditor and debtor security interests, and creditor and debtor rights vary drastically from country to rights vary drastically from country to countrycountry

• Problems involving collections are more Problems involving collections are more readily avoided before credit is extendedreadily avoided before credit is extended

KEY ISSUES IN INTERNATIONAL KEY ISSUES IN INTERNATIONAL TRADE FINANCINGTRADE FINANCING

Arranging for and receiving paymentArranging for and receiving payment Foreign exchange risks and controlsForeign exchange risks and controls CollectionsCollections

MINIMIZING INTERNATIONAL MINIMIZING INTERNATIONAL CREDIT RISKSCREDIT RISKS

Risk of non-payment and collection Risk of non-payment and collection increases in international transactionsincreases in international transactions

May be difficult to check overseas buyer for May be difficult to check overseas buyer for creditworthinesscreditworthiness

Goal is to minimize or eliminate the risk of Goal is to minimize or eliminate the risk of non-payment or inability to receive non-payment or inability to receive paymentspayments

Determining the payment method, Determining the payment method, financing and other key terms is importantfinancing and other key terms is important

MINIMIZING INTERNATIONAL MINIMIZING INTERNATIONAL CREDIT RISKSCREDIT RISKS

• Credit Risk Reduction MethodsCredit Risk Reduction Methods:: Credit ChecksCredit Checks Payment TypesPayment Types Export Credit Guarantees and InsuranceExport Credit Guarantees and Insurance Proper Documentation/AgreementsProper Documentation/Agreements

MINIMIZING CREDIT RISKSMINIMIZING CREDIT RISKS• Credit ChecksCredit Checks

Know the exact entity or individual you are dealing Know the exact entity or individual you are dealing withwith

Check buyer’s credit history (if possible)Check buyer’s credit history (if possible) Reliable up-to-date information may be difficult to Reliable up-to-date information may be difficult to

findfind Suggestions:Suggestions:

Department of Commerce International Company Department of Commerce International Company Profile (ICP) Profile (ICP)

Local U.S. embassies (commercial divisions)Local U.S. embassies (commercial divisions) Private credit reporting servicesPrivate credit reporting services

MINIMIZING CREDIT RISKSMINIMIZING CREDIT RISKS The type of payment works to increase or The type of payment works to increase or

decrease credit risksdecrease credit risks Types of paymentsTypes of payments

• Open AccountOpen Account• Advance paymentAdvance payment• Documentary SalesDocumentary Sales• Letters of CreditLetters of Credit• Bills of Exchange (Draft)Bills of Exchange (Draft)• Trade & Bank AcceptancesTrade & Bank Acceptances• Conditional Sales ArrangementsConditional Sales Arrangements

MINIMIZING CREDIT RISKSMINIMIZING CREDIT RISKS Open AccountOpen Account

• Least secure methodLeast secure method• Seller sends goods with invoice for paymentSeller sends goods with invoice for payment• Advantages Advantages

reduction in transaction costs reduction in transaction costs works well with high volume shippingworks well with high volume shipping

• DisadvantagesDisadvantages Perform significant credit checks on buyer (credit risks)Perform significant credit checks on buyer (credit risks) Seller loses control of goods when dispatched (shipping Seller loses control of goods when dispatched (shipping

terms imp.)terms imp.) Buyer may refuse to accept deliveryBuyer may refuse to accept delivery Seller must wait for payment until after the buyer has Seller must wait for payment until after the buyer has

received goodsreceived goods No risk to buyerNo risk to buyer

• Supplement rights with title retention clauseSupplement rights with title retention clause

MINIMIZING CREDIT RISKSMINIMIZING CREDIT RISKS Best Practices for Open AccountBest Practices for Open Account

• SellerSeller No open account when buyer is new or cannot No open account when buyer is new or cannot

determine risk and reliability of buyerdetermine risk and reliability of buyer Goods are delivered before 1Goods are delivered before 1stst payment payment Make sure to supply goods or services consistent with Make sure to supply goods or services consistent with

a good contract dealing with disputes and non-a good contract dealing with disputes and non-paymentpayment

Insist on an electronic transfer (cleared funds) Insist on an electronic transfer (cleared funds) instead of a bank draft or checkinstead of a bank draft or check

Define credit termsDefine credit terms• BuyerBuyer

Inspect goods before making a paymentInspect goods before making a payment Make payment within agreed credit termsMake payment within agreed credit terms

MINIMIZING CREDIT RISKSMINIMIZING CREDIT RISKS Advance PaymentAdvance Payment

• Time of payment: before shipmentTime of payment: before shipment• Goods available to buyers: after paymentGoods available to buyers: after payment• Risk to exporter: noneRisk to exporter: none• Risk to importer: relies on exporter to ship Risk to importer: relies on exporter to ship

goods as orderedgoods as ordered Best Practices for Advance PaymentBest Practices for Advance Payment

• SellerSeller Provide clear payment instructions (SWIFT)Provide clear payment instructions (SWIFT) Avoid accepting bank drafts or company checksAvoid accepting bank drafts or company checks

• BuyerBuyer Avoid this arrangement, use letter of credit insteadAvoid this arrangement, use letter of credit instead

MINIMIZING CREDIT RISKSMINIMIZING CREDIT RISKS Documentary Sales Documentary Sales

• 2 types2 types documents against paymentsdocuments against payments documents against acceptancedocuments against acceptance

• Helps avoid some risks in open account transactionHelps avoid some risks in open account transaction• Seller uses carrier to withhold delivery of goods until Seller uses carrier to withhold delivery of goods until

buyer pays or signs a negotiable instrument to paybuyer pays or signs a negotiable instrument to pay• TransactionTransaction

Seller ships goods and forwards draft & bill of lading (BOL)Seller ships goods and forwards draft & bill of lading (BOL) Correspondent of seller’s bank notifies buyer of receipt of Correspondent of seller’s bank notifies buyer of receipt of

goodsgoods Buyer pays depending on sight draft or time draftBuyer pays depending on sight draft or time draft Correspondent delivers BOL to buyer for buyer to claim Correspondent delivers BOL to buyer for buyer to claim

goodsgoods• The BOL allows for title transfer only after payment is The BOL allows for title transfer only after payment is

receivedreceived

MINIMIZING CREDIT RISKSMINIMIZING CREDIT RISKS Documents Against PaymentsDocuments Against Payments

• Time of payment: on presentation of draftTime of payment: on presentation of draft• Goods available to buyer: after paymentGoods available to buyer: after payment• Risk to exporter: If draft unpaid, must dispose of goodsRisk to exporter: If draft unpaid, must dispose of goods• Risk to importer: relies on exporter to ship goods as Risk to importer: relies on exporter to ship goods as

describeddescribed Documents Against AcceptanceDocuments Against Acceptance

• Time of payment: on maturity of draftTime of payment: on maturity of draft• Goods available to buyer: before paymentGoods available to buyer: before payment• Risk to exporter: relies on buyers to pay draftsRisk to exporter: relies on buyers to pay drafts• Risk to importer: relies on exporter to ship goods as Risk to importer: relies on exporter to ship goods as

described in documentsdescribed in documents

MINIMIZING CREDIT RISKSMINIMIZING CREDIT RISKS Bills of Exchange (Draft)Bills of Exchange (Draft)

• Unconditional order directing buyer to pay a fixed sum Unconditional order directing buyer to pay a fixed sum on a determined date (like check, except gives title to on a determined date (like check, except gives title to goods)goods)

• Usually used in conjunction with documentary saleUsually used in conjunction with documentary sale• By accepting the draft, the buyer acknowledges the By accepting the draft, the buyer acknowledges the

obligation to payobligation to pay• Common payment terms 30-90 days after sightCommon payment terms 30-90 days after sight• Seller presents draft and any documents to bank in Seller presents draft and any documents to bank in

order to obtain endorsement, use of overseas bank order to obtain endorsement, use of overseas bank correspondent and collection facilities.correspondent and collection facilities.

• Common documents with draft = BOL, commercial Common documents with draft = BOL, commercial invoice, packing list, insurance etc. invoice, packing list, insurance etc.

MINIMIZING CREDIT RISKSMINIMIZING CREDIT RISKS Best Practices Documentary & Bills of Best Practices Documentary & Bills of

ExchangeExchange• SellerSeller

Make sure satisfied with buyer and country risksMake sure satisfied with buyer and country risks Make sure goods and services supplied in accordance with Make sure goods and services supplied in accordance with

contract termscontract terms Make sure collection instructions clear and identical to Make sure collection instructions clear and identical to

terms agreed upon in the contractterms agreed upon in the contract• BuyerBuyer

When asked to pay or accept bill of exchange, make sure When asked to pay or accept bill of exchange, make sure consistent with contractconsistent with contract

Make sure satisfied with goods or services before Make sure satisfied with goods or services before instructing bank to pay or accept bill of exchangeinstructing bank to pay or accept bill of exchange

Make sure correct documents received to obtain goodsMake sure correct documents received to obtain goods

MINIMIZING CREDIT RISKSMINIMIZING CREDIT RISKS Letters of CreditLetters of Credit

• Most widely used method of international paymentMost widely used method of international payment• Different types (documentary/commercial, standby etc.)Different types (documentary/commercial, standby etc.)• Instrument whereby a bank furnishes credit in place of Instrument whereby a bank furnishes credit in place of

the buyer’s creditthe buyer’s credit• Autonomous document separate from the contractAutonomous document separate from the contract• ProcedureProcedure

Underlying contract provides payment to seller via LOCUnderlying contract provides payment to seller via LOC Buyer arranges for bank to open LOC for the benefit of the Buyer arranges for bank to open LOC for the benefit of the

sellerseller LOC has precise instructions which provide payment LOC has precise instructions which provide payment

against the delivery of a full set of documentsagainst the delivery of a full set of documents Payment made upon delivery of documentsPayment made upon delivery of documents

MINIMIZING CREDIT RISKSMINIMIZING CREDIT RISKS Documentary LOC (Commercial LOC)Documentary LOC (Commercial LOC)

• Bank makes payment on presentment of documents detailed Bank makes payment on presentment of documents detailed in LOCin LOC

• Normally BOL, Insurance, draft & certificate of originNormally BOL, Insurance, draft & certificate of origin

Standby LOCStandby LOC (used in lieu of bank guarantee) (used in lieu of bank guarantee) Payment made in the event buyer fails in obligation to payPayment made in the event buyer fails in obligation to pay Seller provides documents evidencing defaultSeller provides documents evidencing default Cost =1-3% of the transactionCost =1-3% of the transaction

FormsForms• Revocable v. Irrevocable Revocable v. Irrevocable

Revocable not enforceable, don’t useRevocable not enforceable, don’t use• Confirmed v. UnconfirmedConfirmed v. Unconfirmed

Confirmed if unfamiliar with overseas bankConfirmed if unfamiliar with overseas bank• Back-to-BackBack-to-Back

Issued upon the security of an existing LOCIssued upon the security of an existing LOC

MINIMIZING CREDIT RISKSMINIMIZING CREDIT RISKS Best Practices LOCBest Practices LOC

• SellerSeller Make sure local bank as authenticated the LOCMake sure local bank as authenticated the LOC Examine the LOC carefully for consistency with sales Examine the LOC carefully for consistency with sales

contractcontract Make sure to present all documents namedMake sure to present all documents named

• BuyerBuyer Check credit for LOCCheck credit for LOC Consistency with contractConsistency with contract All necessary documentsAll necessary documents Insist on terms to protect interests such as late Insist on terms to protect interests such as late

payment dates etc.payment dates etc.

MINIMIZING CREDIT RISKSMINIMIZING CREDIT RISKS• Other Payment MechanismsOther Payment Mechanisms

Title RetentionTitle Retention Best if goods easily identifiable and not incorporated into a Best if goods easily identifiable and not incorporated into a

finished productfinished product Seller retains ownership of goods until purchase price is Seller retains ownership of goods until purchase price is

paid in fullpaid in full Pay attention to INCOTERMSPay attention to INCOTERMS

Conditional SalesConditional Sales If buyer defaults seller may rescind contractIf buyer defaults seller may rescind contract

Security InterestSecurity Interest Seller is granted a security interest in goods (more common Seller is granted a security interest in goods (more common

when sale is financed, but local laws vary)when sale is financed, but local laws vary) Promissory NotePromissory Note

Buyer’s obligation documented by promissory noteBuyer’s obligation documented by promissory note

Still may be difficult to physically reclaim goodsStill may be difficult to physically reclaim goods

MINIMIZING CREDIT RISKSMINIMIZING CREDIT RISKS Trade and Bank AcceptancesTrade and Bank Acceptances

• Promise by drawee of the draft to pay instrument when Promise by drawee of the draft to pay instrument when it maturesit matures

• Provides short-term fixed rate financingProvides short-term fixed rate financing• Trade acceptanceTrade acceptance

Bank as draweeBank as drawee Before acceptance drawee has no obligationsBefore acceptance drawee has no obligations Holder can only enforce the draft is the draft is dishonoredHolder can only enforce the draft is the draft is dishonored Once acceptance occurs, drawee primarily liable to holderOnce acceptance occurs, drawee primarily liable to holder

• Bank AcceptanceBank Acceptance Non-interest bearing draft drawn by company on bankNon-interest bearing draft drawn by company on bank Acceptance occurs by stamp approval with signature of Acceptance occurs by stamp approval with signature of

bankbank If bank honors acceptance, buyer must put funds in bank If bank honors acceptance, buyer must put funds in bank

before payment is duebefore payment is due

MINIMIZING CREDIT RISKSMINIMIZING CREDIT RISKS Conditional Sales Arrangements Conditional Sales Arrangements

(Contractual)(Contractual)• Seller retains ownership of goods until Seller retains ownership of goods until

purchase price is paid in fullpurchase price is paid in full• If buyer defaults seller may rescind contractIf buyer defaults seller may rescind contract• Seller often granted a security interest in Seller often granted a security interest in

goodsgoods• Buyer’s obligation documented by promissory Buyer’s obligation documented by promissory

notenote• Useful where buyer is end user and goods sold Useful where buyer is end user and goods sold

are easily identifiable & nonperishableare easily identifiable & nonperishable• Still may be difficult to physically reclaim Still may be difficult to physically reclaim

goodsgoods

MINIMIZING CREDIT RISKSMINIMIZING CREDIT RISKS Export Credit InsuranceExport Credit Insurance

• Involves insuring exporters againstInvolves insuring exporters against Commercial risksCommercial risks

• Non-acceptance of goods by buyerNon-acceptance of goods by buyer• Failure of buyer to pay debtFailure of buyer to pay debt• Failure of banks to honor documentary creditsFailure of banks to honor documentary credits

Political risksPolitical risks• War, riots etc.War, riots etc.• Change of government policy or political partyChange of government policy or political party• Blockage of foreign exchange (i.e. exchange Blockage of foreign exchange (i.e. exchange

controls)controls)• Currency devaluation (i.e. Argentina)Currency devaluation (i.e. Argentina)

MINIMIZING CREDIT RISKSMINIMIZING CREDIT RISKS Export Credit GuaranteesExport Credit Guarantees

• Issued by financial institution (banks) or Issued by financial institution (banks) or government agency (EXIM Bank in U.S.)government agency (EXIM Bank in U.S.)

• Assistance for companies without Assistance for companies without sufficient track records to obtain credit sufficient track records to obtain credit from banks for exportsfrom banks for exports

• Instruments to safeguard export-Instruments to safeguard export-financing banks from losses that may financing banks from losses that may occur from providing funds to exportersoccur from providing funds to exporters

AGREEMENTS/DOCUMENTATIONAGREEMENTS/DOCUMENTATION

INCOTERMS (2000) ICCINCOTERMS (2000) ICC• Standard trade definitions most commonly used in Standard trade definitions most commonly used in

international sales contracts.international sales contracts. Uniform Customs and Practice forUniform Customs and Practice for Documentary Documentary

CreditsCredits• UCP500 is the standard practices guideline for letters of creditUCP500 is the standard practices guideline for letters of credit• Standards to be followed by banks in examining LOCsStandards to be followed by banks in examining LOCs• Applies only to LOCs referencing UCP textApplies only to LOCs referencing UCP text

eUCPeUCP• In November 2002, ICC published a new guide called eUCP to In November 2002, ICC published a new guide called eUCP to

supplement UCP500 for electronic transactionssupplement UCP500 for electronic transactions International Standby Practices (ISP98)International Standby Practices (ISP98)

• Governs standby LOCs in place of UCP which focuses more on Governs standby LOCs in place of UCP which focuses more on commercial letters of creditcommercial letters of credit

AGREEMENTS/DOCUMENTATIONAGREEMENTS/DOCUMENTATION• Important to document transaction Important to document transaction

whether it is in the form of a simple whether it is in the form of a simple purchase order or formal contract purchase order or formal contract (attention to both sales and purchase (attention to both sales and purchase forms)forms)

• Signed and notarized by both partiesSigned and notarized by both parties• Key clauses that can affect payments:Key clauses that can affect payments:

TitleTitle Payment (currency)Payment (currency) Choice of LawChoice of Law Choice of ForumChoice of Forum Assignability of accountAssignability of account

AGREEMENTS/DOCUMENATIONAGREEMENTS/DOCUMENATION TitleTitle

Passage (Where do you want title to pass & is that consistent with the Passage (Where do you want title to pass & is that consistent with the INCOTERM used?)INCOTERM used?)

Retention (include specific language in contract)Retention (include specific language in contract) Assignment of AccountsAssignment of Accounts

Allow for assignment by seller and look for purchaser prohibitionsAllow for assignment by seller and look for purchaser prohibitions PaymentPayment

Note currency of contract to avoid exchange risksNote currency of contract to avoid exchange risks Be specific in description of payment terms ($ recommended)Be specific in description of payment terms ($ recommended)

Choice of LawChoice of Law (Provision that specifies applicable law is (Provision that specifies applicable law is essential)essential)

Avoid uncertainty as to applicable lawsAvoid uncertainty as to applicable laws Usually enforceable if reasonable nexusUsually enforceable if reasonable nexus Certain issues still decided by local lawCertain issues still decided by local law

Choice of ForumChoice of Forum Litigation or binding arbitration?Litigation or binding arbitration? Designate arbitration body and applicable rules which differ from Designate arbitration body and applicable rules which differ from

internal rules (ICC, AAA etc.)internal rules (ICC, AAA etc.)

FOREIGN EXCHANGE RISKSFOREIGN EXCHANGE RISKS

In addition to forms and types of In addition to forms and types of payments, collection efforts are also payments, collection efforts are also significantly affected by:significantly affected by:• Foreign Exchange RisksForeign Exchange Risks• Foreign Exchange ControlsForeign Exchange Controls

FOREIGN EXCHANGE RISKSFOREIGN EXCHANGE RISKS General Foreign Exchange RiskGeneral Foreign Exchange Risk

• Risk of loss on account of change in Risk of loss on account of change in Forex rates during a particular period of Forex rates during a particular period of timetime

• Liability to make a future payment in Liability to make a future payment in foreign currencyforeign currency

• Asset denominated in foreign currencyAsset denominated in foreign currency Overseas subsidiariesOverseas subsidiaries

• Debt payable in foreign currency Debt payable in foreign currency Risk for both creditor and debtorRisk for both creditor and debtor

FOREIGN EXCHANGE RISKSFOREIGN EXCHANGE RISKS Corporate Forex RisksCorporate Forex Risks

• Transaction ExposureTransaction Exposure Input material of component denominated in foreign Input material of component denominated in foreign

currency, manufactured domestically or finished product is currency, manufactured domestically or finished product is for exportfor export

• Operational ExposureOperational Exposure Effect of exchange rate on revenue and expenditures and Effect of exchange rate on revenue and expenditures and

income statement income statement Profits earned outside U.S. and converted to $Profits earned outside U.S. and converted to $

• Translation ExposureTranslation Exposure Multinationals risk associated with foreign assets & Multinationals risk associated with foreign assets &

liabilitiesliabilities Consolidated statements in common representative Consolidated statements in common representative

currencycurrency Forex value of assets and liabilities must be translated into Forex value of assets and liabilities must be translated into

reporting currencyreporting currency

FOREIGN EXCHANGE RISKSFOREIGN EXCHANGE RISKS

Hedging Foreign Exchange Risks Hedging Foreign Exchange Risks Should the risk be hedged?Should the risk be hedged?

Size of the risk/transactionSize of the risk/transaction Amount of time involvedAmount of time involved Amount of moneyAmount of money Stability of foreign currency involvedStability of foreign currency involved Presence of exchange controlsPresence of exchange controls

FOREIGN EXCHANGE RISKSFOREIGN EXCHANGE RISKS Basic Hedging TechniquesBasic Hedging Techniques

• Payment and sales in U.S. $ or home Payment and sales in U.S. $ or home country currency, risk is transferred to country currency, risk is transferred to other partyother party

• Internal hedge Internal hedge Purchase amount of foreign currency Purchase amount of foreign currency

needed for transaction at the time the needed for transaction at the time the transaction is consummatedtransaction is consummated

• Acquire asset denominated in foreign Acquire asset denominated in foreign currency that equals liabilitycurrency that equals liability

FOREIGN EXCHANGE RISKSFOREIGN EXCHANGE RISKS Basic Hedging Techniques (cont)Basic Hedging Techniques (cont)

• Forward Exchange ContractsForward Exchange Contracts Agreement between 2 parties that obligates them to Agreement between 2 parties that obligates them to

exchange at a specified future date (settlement date) exchange at a specified future date (settlement date) at an agreed upon priceat an agreed upon price

Different than futures contracts which have standard Different than futures contracts which have standard contract sizes, time periods, settlement procedures contract sizes, time periods, settlement procedures and are traded on regulated exchanges throughout and are traded on regulated exchanges throughout the world. the world.

Forward exchange clause within a contractForward exchange clause within a contract Examples:Examples:

• Date is determined (end of month, specific date etc.)Date is determined (end of month, specific date etc.)• Rate is fixed (watch out for transfer pricing with related Rate is fixed (watch out for transfer pricing with related

partiesparties• If rate fluctuates parties will renegotiate pricesIf rate fluctuates parties will renegotiate prices

FOREIGN EXCHANGE FOREIGN EXCHANGE CONTROLSCONTROLS

Risk regarding access to foreign currencyRisk regarding access to foreign currency Government controls the availability or use of foreign Government controls the availability or use of foreign

currency for capital transfers & payment for current currency for capital transfers & payment for current transactionstransactions

Forms:Forms:• Laws, regulations & other measures by stateLaws, regulations & other measures by state• typically through the central banktypically through the central bank• Restricts availability or use of forex (directly or indirectly)Restricts availability or use of forex (directly or indirectly)• Domestic interest rates high to attract foreign capital and vice Domestic interest rates high to attract foreign capital and vice

versaversa Result:Result:

• May have restrictions on access to forexMay have restrictions on access to forex• Inability to pay in dollarsInability to pay in dollars• May lose dollar denominated contracts (Argentina)May lose dollar denominated contracts (Argentina)

DEALING WITH DEFAULTDEALING WITH DEFAULT

Collecting payments overseas Collecting payments overseas can be difficult and expensivecan be difficult and expensiveNegotiate with the customer first Negotiate with the customer first Consider formal collection actions Consider formal collection actions

when:when: Other remedies have been exhaustedOther remedies have been exhausted The amount involved enough to warrant The amount involved enough to warrant

collection effortscollection efforts

DEALING WITH DEFAULTDEALING WITH DEFAULT

Common Collection Actions:Common Collection Actions: Legal proceedings (vary throughout the Legal proceedings (vary throughout the

world)world)Arbitration (preferable from an Arbitration (preferable from an

international collection standpoint)international collection standpoint)File ClaimFile Claim

Jennifer Schwesig

Armstrong Teasdale, LLP

One Metropolitan Square

211 N. Broadway, Suite 2600

St. Louis, MO 63102

(314) 259-4710

jschwesig@armstrongteasdale.com

www.armstrongteasdale.com