Documentary Collection (Documentary Draft) in International Trade

The documentary collection or documentary draft is one of the most common methods of making payments in international trade. To facilitate the transaction, two banks are usually involved, one in the exporter’s country and one in the buyer’s country. The banks may be independent banks or branches of the same bank.

A draft can be drawn (documents payable) in the currency of the country of payment or in a foreign currency. This method of payment falls between the open account, which favors the buyer, and the letter of credit, which protects the exporter. Bank fees are less expensive, usually a specific sum for each service, as opposed to a percentage of the transaction amount, which is used for letters of credit.

A typical documentary collection procedure includes the following steps (see also Figure 11.2):

• After the exporter (drawer) and overseas customer (drawee) agree on the terms of sale, the exporter arranges for shipment and prepares the necessary documents such as in­voice, bill of lading, certificate of origin, and draft.
• The exporter forwards the documents to its bank (remitting bank) with instructions.
• The remitting bank then forwards the documents to its overseas correspondent bank (collecting bank) in the importer’s country, with the exporter’s instruction letter that authorizes release of documents against payment (D/P) or acceptance (D/A) or other terms.
• The collecting bank contacts the importer to effect or accept payment. If the instruc­tion is documents against payment (D/P), the importer pays the collecting bank in ex­change for the documents. The collecting bank then sends the proceeds to the remitting bank for payment to the seller. If the instructions are documents against acceptance (D/A), the collecting bank releases documents to the overseas customer only upon for­mal acceptance of the draft. Once the draft is accepted, the collecting bank releases the documents to the buyer. On or before maturity, the collecting bank then presents the accepted draft for payment. When the buyer pays, the collecting bank remits the funds in accordance with instructions.

The basic instructions for collection of shipping documents (in addition to those pertain­ing to release of documents and remittance of funds) include the following:

• Procedures as to how nonpayment or nonacceptance is to be communicated to the remitting bank
• Instructions as to who pays the bank’s collection charges
• Listing of documents enclosed
• Name of a party to be contacted in case a problem arises.

The banking practice relating to documentary draft is standardized by the Uniform Rules for Collections (International Chamber of Commerce [ICC], 1995). The uniform rules apply only when the parties to the contract agree to be governed by those standards. The rules set out the rights and duties of banks and users of documentary collections (Reynolds, 2003).

1. Documents Against Payment

In a typical document against payment (D/P) transaction, the exporter draws a draft on the foreign buyer (drawee) through a foreign bank (collecting bank) that receives the col­lection documents from the exporter’s remitting bank (Johnson and Bade, 2010; Wells and Dullat, 1991). In this instance, a sight draft is presented with other documents specified by the buyer or the buyer’s country, and the collecting bank provides these documents to the buyer upon payment. This means that the buyer does not receive the documents and thus does not obtain possession of the goods until payment is made to the collecting bank. This method is widely used in foreign trade and often designated as “sight draft, documents against payment” (S/D, D/P).

The original order bill of lading giving title to the goods is made out to the order of the shipper and is endorsed by the latter either in blank or on the order of the collecting bank (Maggiori, 1992). This ensures that the seller retains title and control of the shipment until it reaches its destination and payment is made to the collecting bank. When the collecting bank is paid, it endorses the bill of lading and other documents to the buyer. The original bill of lading must be properly endorsed by the buyer and surrendered to the carrier before buyer procures possession of the shipment.

Order bills of lading are not available with air shipments. If the importer’s name is on the air waybill (not a negotiable document) as consignee, often nothing more is needed to hand over the merchandise to the buyer (importer) than the latter’s identification, and the im­porter can obtain the goods without payment. This problem can be resolved by designating a third party, such as a custom broker or, with prior permission, a collecting bank as consignee on the air waybill. The importer’s name should be mentioned as the party to be notified for identification of shipment.

In using S/D, D/P, there remains the potential risk of nonpayment by importer. The buy­er’s ability or willingness to pay may change between the time the goods are shipped and the time the draft is presented for payment (Johnson and Bade, 2010; McMahon et al., 1994). It could also be that the policy of the importing country may change (e.g., exchange controls), making it difficult for the importer to make payments. In the event of nonpayment by the buyer, the exporter has the choice of having the merchandise shipped back or selling it to another buyer in the importing country.

2. Documents Against Acceptance

In this method, the exporter allows the overseas customer a certain period of time to effect payment for the shipment. The buyer receives the documents, and thus the title, to the goods in exchange for acceptance of the draft to pay at some determinable future date. A time draft is used to establish the time of payment; that is, that the payment is due within a certain time after the buyer accepts the draft. A date draft, which specifies the date of payment, is sometimes used. When a time draft is used, the customer can potentially delay payment by delaying acceptance of the draft. An exporter can prevent such delays by either using a date draft or tying the payment date to the date on the bill of lading (e.g., thirty days from the date of the bill of lading) or draft. The collecting bank holds the draft to present for payment on the maturity date.

This method offers less security than an S/D, D/P because documents that certify owner­ship of merchandise are transferred to an overseas customer prior to payment. Even when the customer is willing and able to pay, payment can be prolonged if the customer delays acceptance of the time draft. This method is quite similar to open-account sales in which the exporter extends a trade credit to an overseas customer in exchange for payment at some determinable future date. One major difference between the two methods is that in the case of documents against acceptance (for which a time or date draft is used), the draft is a ne­gotiable instrument (unlike an account receivable in an open account) that can be sold and easily converted into cash by the exporter before maturity.

A draft drawn on and accepted by a bank is called a banker’s acceptance. Once accepted, the draft becomes a primary obligation of the accepting bank to pay at maturity. If the draft is accepted by nonbank entities such as importers, it is known as a trade acceptance. The greater the creditworthiness of the party accepting the draft, the greater the marketability of the banker’s or trade acceptance. They are important tools that can be negotiated or discounted to companies engaged in trade finance and which can serve the financing needs of exporters.

Example: A U.S. company, ABC, agreed to sell a ton of oranges to a food com­pany in Singapore (XYZ) for $100,000. A draft drawn by ABC is accepted by XYZ’s bank to pay on an agreed-upon future date. ABC has two options:

1. It may hold the acceptance until maturity and then collect. The exporter would receive the face amount less the bank’s acceptance commission of 1.2 percent per annum ($ acceptance of $100,000 for three months)

2. ABC may decide to discount (i.e., sell at a reduced price) and receive the money at once. In this case, ABC will receive the face amount of the accep­tance less the acceptance fee and the discount rate.

3. Direct Collection

Exporters can bypass the remitting bank and send documents directly to the foreign collect­ing bank for payment or acceptance. This reduces bank charges and speeds the collection process. In this case, the collecting bank acts as the exporter’s agent for follow-up and collec­tion without the involvement of the remitting bank.

4. Liability and Responsibility of the Banks

The Uniform Rules for Collections (ICC, 1995) distinguish two types of collection arrange­ments: clean collections and documentary collections. In the case of clean collections, a draft is presented to the overseas buyer for the purpose of obtaining payment or acceptance without being accompanied by shipping documents. Documentary collections, which are the subject of this chapter, however, involve the presentation of shipping (commercial) and financial documents (draft or promissory note) by the collecting bank to the buyer. In certain cases in which a collection is payable against shipping documents without a draft (invoice is used in lieu of a draft), it is termed cash against documents.

In documentary collections, banks act as agents for collection and assume no responsi­bility for the consequences arising out of delay or for loss in transit of any messages, letters, or documents (ICC, 1995). They do not question documents submitted for collection and are not responsible for their form and/or content or for the authenticity of any signatures for acceptance. However, they have to act in good faith and exercise reasonable care in execution of the collection order. The bank’s major responsibilities include the following:

• Verification of documents received: The banks check whether the documents appear to be as listed in the collection order and advise the party in the event of missing documents.
• Compliance with instructions in the collection order: The exporter instructs the remit­ting bank on payment whether the documents shall be handed to a representative in case of need and what to do in the event of nonpayment or nonacceptance of the draft. These instructions are then sent along with other documents by the re­mitting bank to the collecting bank. The latter is permitted to act only upon these instructions.

In case the buyer refuses to pay, accept the draft, or pay the accepted draft at maturity, exporters often instruct the collecting bank to (1) protest (i.e., present the dishonored draft again); (2) warehouse the merchandise; or (3) send the merchandise back to the exporter. The collecting bank may be requested to contact the exporter’s agent for clearance of the merchandise. All charges for carrying out these instructions are borne by the exporter. If the collecting bank releases the documents to the overseas customer contrary to instructions, the bank is liable to the seller; it has to pay the seller and collect from the buyer (International Perspective 11.1).

The use of documentary collections offers certain advantages. It reduces transaction costs for both parties, helps maintain suitable levels of control for exporters, and speeds up the flow of transactions. The major risk with this method, however, is that the buyer may be unable or unwilling to pay or accept the draft on presentation. It is thus important to check credit references, consider taking out credit insurance, or secure collateral to cover the transaction.

Source: Seyoum Belay (2014), Export-import theory, practices, and procedures, Routledge; 3rd edition.