02 August 2021 • 21 min read
3 Ways To Ensure Payment From Your Foreign Buyer
Learn how to ensure your foreign buyer pays you in full & on time. Along with the pros & cons of the most common international payment terms. And what to do if the buyer refuses to pay.
Exporting comes with as many risks as it does rewards. One of the biggest risks is getting paid. It isn’t uncommon for an importer to delay or even refuse payment because a) they don’t have the funds, b) they have gone bankrupt, c) they are in a dispute with the exporter, d) there is a sudden drop in demand for the product in their country, e) they are unable to sell the goods, and so on. What makes the risk of non-payment for an exporter that much greater is the physical distance between them and their foreign buyer and the differences in the legal structures of their countries.
Keeping these risks in mind, this blog aims to arm you, the reader, with the information you need to make sure you get paid in full and on time. Read on to know about:
- Common export payment methods
- How to ensure you get paid
- What to do if buyer refuses to pay
Export payment terms
While there’s no foolproof way to make your buyer pay up, you can minimise the risk of non-payment by picking the right payment method. There are numerous ways to get paid. The one that’s right for you depends on:
- How well you know the buyer
- Whether this is your first time exporting to this buyer
- Transaction volume and value
- The amount of risk involved
- The payment terms demanded by the buyer (because they will surely have a say in the matter)
Let’s take a look at the six most common export payment terms:
- Payment in Advance / Cash in Advance: This is the least risky method for exporters because they get paid before they transfer ownership of the goods/services to the buyer. Payment can be full or partial, and is usually via bank transfer or credit card. An exporter might opt for this method if the buyer is new, has a shaky credit history or is based in a high-risk country (where trade is impacted by government controls on international fund transfers, war, natural disasters, etc). For an importer, however, this is a high-risk option because they cannot check the quality of the goods or ensure on-time shipment. So, if the exporter insists on payment in advance, they risk losing out to a competitor offering more attractive payment terms.
- Open Account: Here, the buyer receives the goods before payment is due, making it a high-risk option for exporters. The buyer agrees on a payment due date – 30, 60 or 90 days from the date of invoice or delivery. An exporter should go with this option only if they have implicit trust in the buyer, their ability to pay and the potential they hold for more business. However, an open account can help you get new buyers in a competitive market. One way of offsetting the risk of non-payment is by using export credit insurance or factoring (more on this later).
- Consignment: A variation of open account, consignment means the exporter gets paid only after the goods have been sold to the end customer. Because it is the riskiest of the six options listed here, the exporter is advised to partner with a reputed foreign distributor/third-party logistics provider and get the necessary insurance cover to minimise non-payment risk.
- Documentary Collection: This is a method where banks act as intermediaries. The exporter hands over the required documents (invoices, shipping documents, etc) to their bank (the remitting bank), which sends the documents along with instructions for payment to the importer’s bank (the collecting bank). These are then passed on to the importer, who makes the payment in exchange for the documents via the banking system. Documentary collection works in two ways – a) the importer makes the payment at sight, which is called “Cash Against Document” or “Document Against Payment”, or b) the importer makes the payment on a specified later date, which is called “Cash Against Acceptance” or “Document Against Acceptance”. This payment term works well for both the exporter (who retains physical control of the goods till payment) and importer (who pays for the goods only after they are shipped).
- Letter of Credit: A letter of credit (L/C) is a written commitment by a bank (the issuing bank) on behalf of the importer to pay the exporter an agreed upon sum, provided the exporter submits the documents and complies with the timelines set out in the contract. Under an L/C, payment is routed from the issuing bank to the exporter’s bank (the negotiating bank). It is considered one of the safest modes of payment. It ensures the exporter receives their payment in full and on time. Furthermore, buyer verification is built into the process as the issuing bank will open an L/C account only after doing a credit adequacy test of the buyer. As for the importer, they will receive the goods they agreed to buy. An L/C can, however, be costly because the banks will charge a fee. This can be split by the two parties. In some importing countries, a letter of credit is mandatory for high-value transactions. An L/C transaction can be made more secure by picking the right type of L/C from the following:
- Irrevocable L/C – Can’t be changed/cancelled without the consent of the exporter and importer. Safe for exporters.
- Confirmed L/C – Payment guarantee is backed by a second bank. So, if the issuing bank defaults on payment, the confirming bank will cover it. Safe for exporters.
- Revocable L/C – The issuing bank can cancel/amend the L/C at any time without seeking the exporter’s consent or giving them prior notice. Unsafe for exporters.
- Sight L/C – The exporter gets paid immediately (within days) after submission of the right documents. Recommended for exporters.
- Deferred Payment L/C – The exporter gets paid only after an agreed upon time has passed after submission of documents. Not the best bet for exporters.
- Red Clause L/C – Contains a clause (traditionally printed in red) under which an exporter can avail of an advance before shipment of goods.
- Green Clause L/C – An extension of the red clause L/C, it offers exporters an advance to pay for raw material, processing, packing, warehousing and insurance charges. Advance is granted only after the goods have been warehoused at the port.
- Standby L/C – This guarantees that the bank will pay the exporter “if something fails to happen” (such as the importer refusing to pay). It acts as a back-up plan rather than a standard L/C.
- Escrow Account: Under this method, a neutral third party receives payment from the importer, holds it until the export transaction is complete and then releases payment to the exporter. It is beneficial to both buyer and seller. An escrow account is usually used in moderate-value transactions or in dealings with a new buyer. Escrow services are now used widely in payment in advance transactions. Just be sure to verify the escrow service provider you plan to hire.
Three ways to ensure payment from your foreign buyer
Even if you pick the right payment method after careful scrutiny, there is still a chance you might not get paid. Here’s what you can do to secure your payment:
- Avoid discrepant L/C: A letter of credit is one of the surest ways to get paid and highly suited for high-volume, high-value, high-risk exports. But every once in a while, an exporter might fail to meet one or more of the stipulated conditions. They might miss the shipment date or enter incorrect information on a document, for example. This leads to a “discrepancy” and the L/C becomes “discrepant”. When this happens, payment is no longer guaranteed. A discrepant L/C is usually not a deal-breaker and not all that uncommon. But it causes delays and invites additional costs, including extra bank fees. To avoid a discrepant L/C or if you are stuck with one, here’s what you, as an exporter, must do:
- Comply with agreed upon timelines
- Ensure documents are correctly filled and submitted
- If you discover an error, fix it immediately and have your bank send the amended document to the issuing bank
- Negotiate with the importer for a favourable outcome. Remember, the banks are not negotiators but merely intermediaries. And a discrepant LC is as much an importer’s problem (they risk hefty demurrage/storage charges at the port of destination) as it is an exporter’s headache
- Get export credit insurance: An export credit insurance (ECI) plan provides coverage of up to 95% of your invoice value and covers non-payment as a result of:
- Commercial risks – Buyer bankruptcy/insolvency, payment default, slow payment
- Political risks – War, terrorism, riots
- Other risks – Changes in import-export regulations, expropriation (when the government takes away privately owned property for public use), currency inconvertibility (the inability to convert and transfer funds out of a country)
Both private insurance companies and government institutions – such as the Exim Bank in the US and the ECGC (Export Credit Guarantee Corporation of India) in India – offer ECI plans. The ECGC offers a variety of short, medium and long-term plans with 80%-90% coverage. The Small Exporter’s Policy (SEP), for example, is targeted at exporters with a turnover of Rs 5 crore or less while the Micro Exporter Policy(MEP) provides 90% coverage to exporters with a turnover of less than Rs 100 lakh. However, ECGC plans don’t cover a) losses arising from quality disputes, b) exchange losses due to exchange rate fluctuations, c) buyer’s failure to obtain import authorisation, d) risk inherent in the nature of goods being exported.
- Try export factoring: When an exporter sells their invoices to a financier (factor) at a discount, it is called export factoring or invoice factoring. How does it work? After the invoice sale, the factor pays the exporter 80%-90% of the invoice amount. On receiving payment from the importer, the factor passes on the balance amount to the exporter after deducting the factoring fee and interest. Factoring is a fast-growing business in the import-export community and an alternative to export credit insurance. It not only lowers non-payment risk, it also eases the exporter’s cash flow and allows them to attract new buyers by offering open account terms. Factoring fees can vary depending on the buyer’s financial standing, the type of goods, the political and economic stability of the market and even on the type of factoring service offered. When it comes to exports, the most common factoring services on offer are:
- Recourse factoring – The exporter must buy back the invoice if the factor fails to collect payment from the importer. Hence, risk of non-payment lies with the exporter and not the factor.
- Non-recourse factoring – The factor takes on the risk of non-payment. But this doesn’t mean the exporter is free of all risk. It means the exporter is free of only those risks specifically stated in the factoring contract. This service costs more than recourse factoring.
- Limited factoring – The factor buys a portion of the exporter’s total invoices and remits payment collected against those invoices. The factor makes the selection on the basis of certain criteria (such as cost considerations, processing capacity, etc).
A financial tool similar to factoring and beneficial to exporters seeking to secure their payments is forfaiting, where the exporter sells their claim to trade receivables to a third party (forfaiter) for an immediate cash advance. What differentiates forfaiting from factoring is that it a) offers a cash advance that is 100% of the value of the receivables, b) is an export finance tool specific to international trade, c) deals with medium-to-long-term receivables (due in months or even years), d) involves letters of credit, and e) has the forfaiter assuming all risk of non-payment.
What to do if your foreign buyer refuses to pay
- Negotiate directly with the importer to come to an amicable solution
- Reach out to the embassy/consulate or any other diplomatic presence of the importer’s country in your country
- Take the help of the concerned export promotion council in your country
- Claim payment from the ECGC if you have an export credit insurance plan with them
- Hire an international debt collection agency. Collection agencies work mostly through negotiation and rarely legal action, which means you have a chance of solving your payment problem without permanently ruining your relationship with the buyer
- If all else fails, go in for arbitration, where a neutral third party resolves the dispute between you and your buyer. Arbitration is fast, cheap, private and a better alternative to legal action through the court system, where cases can crawl and your reputation could suffer. However, it requires the consent of both the exporter and importer. An arbitration clause can be included in your contract. Arbitration cases in international trade are handled by institutions such as the International Chamber of Commerce and the
IndianCouncil of Arbitration.
Picking the right payment term for your export might seem difficult but with a little due diligence, your chances of getting paid are that much higher. Remember to not only consider the risk factor but to pay attention to your buyer’s interests as well. The idea is to strike a balance.
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