An export contract is an agreement between a seller and an overseas customer for the performance, financing, and other aspects of an export transaction. An export transaction is not just limited to the sale of final products in overseas markets but extends to supply contracts for manufacture or production of the product within a given time period. Parties should have a well-drafted and clear contract that properly defines their responsibilities and provides for any possible contingencies. This is critical in minimizing potential conflicts and allowing for a successful conclusion of the transaction (see International Perspective 8.1).
Although many export contracts are concluded between the seller and an overseas buyer (the main contract), the buyer may also enter into a contract with an independent consultant for technical assistance and with a lender for financing in the case of complex projects. The exporter as prime contractor may enter into joint venture agreements with other firms, such as subcontractors or suppliers, to bid on and perform on a project. Parties could also establish a partnership, corporation, or consortium in order to bid on and undertake different aspects of the transaction while assuming joint responsibility for the overall project. Such collaboration is common when one firm lacks the financial or technical resources to perform the contract.
It is relevant to state briefly how these joint venture arrangements differ from one another. Members may form a partnership for the purpose of undertaking the export contract. Each of the members remains responsible for the entire transaction even though the parties may be carrying out different portions of the export transaction. Parties could also establish anew corporation to act as exporters or prime contractors. In the case of a consortium, each partner of the venture has a separate contract with the customer for performance of a portion of the work and thus is not responsible to the other members.
1. Scope of Work Including Services
The goods to be sold should be clearly spelled out in the contract. There is also a need to include the scope of work to be performed by the exporter, such as installation, training, and other services. The scope of work to be performed is usually contained in the technical specification, which should be incorporated into the main contract (by listing it with the other documents intended to form the contract). It is also important to specify whether the agreed price covers certain services, such as packaging, special handling, or insurance. Any contribution by the overseas customer should be explicitly stated along with the consequences of the failure to perform those services necessary to enable the exporter to complete the transaction on time. Such contributions could include provision of office space and other support services, such as secretarial and translation, government licenses, permits, and personnel necessary for the performance of the contract.
2. Price and Delivery Terms
The total price can be stated at the time of the contract, with a price escalation clause that provides for increases in the price if certain events occur. Such provisions are commonly used with goods that are to be manufactured by the exporter over a certain period of time and when inflation is expected to affect material and labor costs. Such a clause also extends to increases in costs arising from delays caused by the overseas customer. It is important to draft the contract with a clear understanding between the parties as to whether such a clause applies when there is an excusable delay. In many contracts, the price escalation clause is in force in cases of excusable delay in performance by the exporter.
The contract should also specify the currency in which payment is to be made. Foreign exchange fluctuations could adversely affect a firm’s profit. In addition, government exchange controls in the buyer’s country may totally or partially prevent the exporter from receiving payment for goods and services. Thus, it is important to provide the necessary protection against such contingencies. The following contract provisions would be helpful to the exporter.
2.1. Shifting the Risk to the Overseas Customer
An exporter may shift the risk by providing in the contract that payment is to be made in the exporter’s country and currency. This ensures protection against currency fluctuations and exchange controls.
2.2. Payment in Importer’s Currency
Even though the seller will generally prefer payment in U.S. dollars, such a requirement may be difficult to comply with if U.S. dollars are not readily available in the buyer’s country. The exporter may have to accept payment in the importer’s currency. In such a situation, the exporter could fix the exchange rate in the invoice and thus be compensated in the event of devaluation. Suppose Smith, Inc., of California, exports computers to Colombia; the price could be stated as follows: “300 million Colombian pesos at the exchange rate of $1 = 1,000 pesos. The importer will compensate the exporter for any devaluations in the peso from the rate designated in the contract.”
Another method of protection against fluctuations in the importer’s currency is to add a risk premium to the price at the time of the contract. Yet another method is to establish an escrow account in a third country in an acceptable (more stable) currency from which payments would be made under the contract.
The contract should clearly indicate the delivery term (e.g., FOB, New York, or CIF, London), since there are different implications in terms of risk of loss, insurance, ownership, and tax liability. The seller would ideally prefer to be paid cash in advance (before delivery of goods or transfer of title) in its own currency or by using a confirmed irrevocable letter of credit. The buyer often desires payment in its own currency on open account or consignment. Hence, the provision to be included in the contract has to accommodate the competing interests of both parties.
3. Delivery, Delay, and Penalties
The most common type of clause included in export contracts is one that provides for a fixed or approximate delivery date and that stipulates the circumstances under which the seller will be excused for delay in performance and even for complete inability to perform. Most contracts state that either party has the right to cancel the contract for any delay or default in performance if it is caused by conditions beyond its control, including but not limited to acts of God and government restrictions, and that neither of the parties shall be liable for damages (force majeure clause). The force majeure clause may also cover a number of specified events, including the inability of the exporter to obtain the necessary labor, material, information, or other support from the buyer to effect delivery. It should also include certain warranty obligations, such as delays in manufacture of replacement components. It is important to state that the force majeure (excusable delay) clause will apply even though any of the causes existed at the time of bidding, were present prior to signing the contract, or occurred after the seller’s performance of its obligations was delayed for other causes. Some force majeure clauses provide for the temporary suspension of the contract until the causes for the nonperformance are removed; others state that the agreement will be terminated at the option of either of the parties if performance remains impossible for some stated period.
Contracts often provide for damages if the delay is caused by one of the parties. In the event that the delay is caused by the exporter (i.e., unexcused delay), some contracts specify that the importer will be entitled to recover liquidated damages (even in the absence of actual damages), whereas others provide that payment would be limited to damages actually incurred by the buyer (see International Perspective 8.3).
The converse of the seller’s obligation to deliver is the buyer’s obligation to accept delivery as stipulated in the contract. If delay in delivery is caused by the buyer, most contracts provide that the seller will be entitled to direct damages incurred during the delay, such as warehousing costs, salaries and wages for personnel kept idle, or loss of profit. Some contracts even provide for payment of indirect (consequential) damages, such as loss of productivity or loss of future profits due to delays caused by the buyer. Both parties can possibly eliminate or reduce potential risks of excusable delay by inserting (1) a best-efforts clause, without expressly providing for consequences in the event of delay, or (2) an overall limitation-of- liability clause. In cases in which the contract does not expressly impose the previous obligation on the customer, the customer remains responsible for delays caused personally or by someone for whom the customer is responsible. In most legal systems, a party has an implied duty to cooperate in the performance of the work by the other party or not to interfere with the performance of the other party.
4. Quality, Performance, and Liability Limitations
Most contracts state that the seller warrants to the buyer that the goods manufactured by the seller will be free from defects in material, workmanship, and title and will be of the kind and quality described in the contract. It is not uncommon to find deficiencies in performance, even when the exporter provides a product with state-of-the-art design, material, and workmanship. Therefore, it is advisable to use certain approaches to limit risk exposure:
- Specify in the contract the performance standards that are to be met, and provide warranties for those that can be objectively tested, such as machine efficiency, for a specified period, usually a year.
- Stipulate the kinds of damages that may be suffered by the buyer for which the seller is not responsible, such as loss of profit for machine downtime, extra costs of acquiring substitute services, as well as other damages that are incidental or consequential.
- Limit the liability, especially in exports of machinery and equipment, to a specific amount expressed either in reference to the total contract price or as a certain sum of money. This limit should cover all liability or liabilities arising from product quality or performance.
- Carefully evaluate the cost implications of an extended warranty or an evergreen warranty provision before agreeing to include it in the contract. An evergreen warranty is automatically renewed each time a failure protected under the warranty provision is corrected.
5. Taxes and Duties
In the United States, Canada, and other developed countries, an exporter will not be subject to any taxes (i.e., when products are exported to these countries) if business is not performed through an agent, a branch, or a subsidiary. However, when the price includes a breakdown for installation and other services to be performed in the importing country, such income could be taxable as earnings from services. In some cases, it may be advisable to reserve the right to perform these services through a local affiliate to restrict exposure to foreign taxes. It is thus important to consider the tax and customs duty implications of one’s pricing and other export decisions relating to shipment of components or assembly of (final) products. It is also helpful to evaluate the impact of tax treaties with importing countries.
6. Guarantees and Bonds
It is quite common for overseas importers to require some form of guarantee or bond against the exporter’s default. Public agencies in many countries are often prohibited from entering into major contracts without some form of bank guarantee or bond. Guarantees are more commonly used than bonds in most international contracts. These are separate contracts and independent of the export agreement.
Bid guarantees or bonds are often provided at the first stage of the contract from all bidders (potential exporters) to provide security to the overseas customer. Then, performance guarantees or bonds are provided by the successful bidder(s) to protect the overseas customer against damages resulting from failure of the seller to comply with the export contract.
Finally, payment guarantees or bonds are provided so that the importer can secure a refund of the advance payment in case of the exporter’s default.
In the case of a bank guarantee, a standby letter of credit is issued by a bank, under which payment is made to the importer on demand upon failure of the exporter to perform its obligation under the export contract. Most importers favor a contract provision that allows them to obtain payment from the bank by simply submitting a letter that the exporter has defaulted and demanding payment. However, it may be advisable to stipulate in the standby credit that the amount of the credit becomes payable to the importer only upon the finding by a court or arbitration tribunal that the supplier of goods or services is in default of the contract.
A bank guarantee (standby credit) and a bond are similar in that both instruments are a form of security provided by a third party (a bank in the case of a guarantee, a surety company in the case of a bond) to the importer against the exporter’s default. Both instruments are issued only if the exporter has a good credit standing, and both specify the amount payable in the event of default, the period within which such claims can be made, and the fee charged for such services.
In export trade, there is a tendency to make standby credits payable on the submission of a letter by the importer that simply alleges default by the exporter and demands payment. This is not usually the case with bonds, which are payable only when the importer has shown that the exporter is in default under the export contract. Bonds also usually require that the importer have met its obligations under the contract before realizing any benefits from the bond. In short, the surety company will conduct an investigation on the conduct of the parties before making a decision about payment. Second, the bank in the case of a standby letter of credit does not have the option of performing the contract (e.g., completing delivery of goods not made by exporter, paying losses incurred by exporter), as does a surety company. The bank guarantor is required to pay the full amount of the standby credit without regard to the actual damages suffered. Under a bond, the surety is obliged to make good on only the actual damages suffered by the overseas buyer. In both cases, the exporter has to reimburse the bank or the surety company for any payments made under the guarantee or bond, respectively. In view of the widespread use of guarantees (standby credits) in international trade and the possibility of abuse, many countries provide an insurance program for their exporters that protects them against wrongful drawing on the credit. In 1978, the International Chamber of Commerce adopted the Uniform Rules for Contract Guarantees, which deals with guarantees, bonds, and other undertakings given on behalf of the seller and applies only if the guarantee or bond explicitly states the intentions of the parties to be governed by these rules. In view of the limited acceptance of the Uniform Rules for Contract Guarantees, the ICC adopted, in 1992, the Uniform Rules for Demand Guarantees, which attempt to standardize existing guarantee practice. As in the case of contract guarantees, the parties have to state their intention to be subject to these rules.
7. Applicable Law and Dispute Settlement
The fundamental principle of international contract law is that of freedom of contract. This means that the parties are at liberty to agree between themselves what rules should govern their contract. Most contracts state the applicable law to be that of the exporter’s country.
This indicates the strong bargaining position of exporters and their clear preference to be governed by laws about which they are well informed. It may be possible to arrange a split jurisdiction, whereby the portion of the contract to be performed in the customer’s country will be interpreted under the importer’s laws and the portion to be performed in the exporter’s country will be governed by the laws of that country.
In cases where there is no express or implied choice of law, it may be the role of the courts to decide what law should govern the contract based on the terms and nature of the contract. The factors to be considered often include the place of negotiation of the contract, the place of performance, location of the subject matter, place of business, and other pertinent matters.
For several reasons, a large and growing number of parties to export contracts provide for arbitration to settle disputes arising under their contracts. Despite the wide use of arbitration clauses, the superiority of arbitration over judicial dispute resolution is not clear-cut, and parties considering arbitration should also be aware of the disadvantages in this choice, such as lack of mandatory enforcement mechanisms and difficulty obtaining recognition and enforcement of the award, which requires a separate action of law. It is also stated in some contracts that the parties agree to abide by the award and that the award is binding and final and enforceable in a court of competent jurisdiction.
Source: Seyoum Belay (2014), Export-import theory, practices, and procedures, Routledge; 3rd edition.