The Worldly Wise Letter of Credit
If you're in the export business, don't ever let your customer dictate what goes onto your letter of credit
Not even a war will necessarily invalidate a letter of credit. That's what Richard Koehler learned a while back.
He'd agreed in a letter of credit -- a bank document that guarantees the payment of a customer's drafts up to a specified amount for a certain period -- to ship a fleet of fire trucks to Taiwan on December 5, 1991. Then, a couple of months shy of the ship date, the Gulf War broke out, and the Department of Defense began expropriating vessels that would have been suitable for his cargo, playing havoc with the ship date on the letter of credit.
If Koehler's export company, IKR Corp., hadn't met the ship date, the letter of credit would have been worthless, leaving the $1-million Houston company stuck with $650,000 worth of trucks. With Koehler over a barrel, the customer could have rewritten the terms of the sale made official by the letter of credit and negotiated a discount or strung out payment. But Koehler, a seasoned international-trade expert, found a way to ship his trucks on time.
Letter-of-credit snafus like Koehler's will become more common as growing companies sell and ship more goods overseas -- and as armed forces enforce the peace accord in Bosnia. Even under less rarified circumstances, profits from major international deals have been wiped out by minor discrepancies such as typos on a letter of credit. Inexperienced CEOs, grateful to learn that a customer has agreed to pay by letter of credit, think of the document as a bank check, not as a statement of the final terms of sale. How the customer fills in the blanks determines how promptly a supplier gets paid -- if at all.
But suppliers have more leverage than they might think. "Suppliers must tell customers that they want to participate in the drafting of the letter of credit," urges Koehler. "If they tell a customer to 'take care of the details,' they are effectively surrendering control of the sale to the customer." The customer can then tweak the terms of sale in ways the supplier never imagined. A customer could stipulate that payment would occur when goods were safely in its warehouse rather than when the ship leaves port. But the ship could wreck and sink the cargo, or a foreign customs inspector might not release the goods until he is bribed, or the goods may not pass an inspection, and the supplier would have to pay to ship the goods back to the United States.
Nor is there much incentive for a supplier's bank to help edit such damning language from the letter of credit at an early stage, since it can later earn fees by correcting such mistakes. Koehler has the customer fax him a preliminary copy of the letter of credit, issued by a bank that has reviewed and agreed to the deal. He then double-checks the document for discrepancies and faxes his corrections directly to his customer -- before either his or the customer's bank is any further involved and any amendment fees are levied. To further insulate himself from such costs, Koehler stipulates that the customer pick up all letter-of-credit charges and fees.
Koehler, who now gives seminars on negotiating letters of credit, also skirts amendment fees by using language that's as flexible as possible. He recalls one novice supplier who had written in the exact weight of a cheese that was being shipped. When the cheese arrived a few pounds lighter because of evaporation, the letter of credit was invalidated. To get it amended cost the cheese supplier about $300 in bank fees, erasing his entire profit margin on the deal.
On the following page Koehler reveals how to avoid the dangers lurking in a letter of credit so that it's as "close to cash as you can get."
Richard Koehler gets picky about his letter of credit:
Credit number of: Copy the internal bank-reference number on all accompanying documents! When we haven't done that, we've had issuing banks reject letters of credit.
Advising bank: You need to specify the "advising bank." Interfirst Bank is IKR's own bank. If we had to work with Banque Nationale de Paris (the "issuing bank" that is setting up this letter of credit for the buyer) as the advising bank, it wouldn't be working on our behalf to resolve discrepancies, and its fees might be higher than our own bank's.
Beneficiary: We learned the hard way that if we're to be paid promptly, our address must match exactly what's printed on our invoices and stationery. [In the sample] they've added "USA," which is not on our stationery. If we hadn't gotten this corrected on the draft of the letter of credit, we would have been hit with a fee to have it corrected later by our bank.
Expiry date: The expiry date is the date the letter of credit is no longer valid. When we ship by sea, we always ask for an expiry date that's one month after the anticipated ship date, so we have plenty of time to gather the documents for presentation. Customers will try to give us only two weeks after the ship date, because it costs them money to keep the letter of credit open for longer.
At-sight clause: This means that when all the documents called for by the letter of credit are presented to the advising bank, it will take about five days for the issuing bank to pay it off. A customer might try to write in payment terms of 30, 60, or 90 days here. Getting paid "at sight" is about as close to cash as you can get.
Accompanying documents: A "clean airway bill" (or ocean bill of lading) means that the vital information on the airway bill is identical to the information on the letter of credit. If yellow is misspelled yelow on the letter of credit, then it must be misspelled on the airway bill as well. Even if this said "airway bill," it would still have to be clean for the letter of credit to be honored. If a discrepancy was found, it could become a spitting contest.
Covering: The details of every item being shipped are best left only on packing lists, invoices, and purchase orders. If the letter of credit listed every nut and bolt we were shipping, so would the accompanying documents. That would create hundreds of opportunities for discrepancies that could hold up payment.
Shipment from: You want to look at the ship date as soon as you receive a draft letter of credit to make sure you can live with it on your production schedule. Watch out for anxious customers who might try to put in an early date to see if you can speed up your production schedule for them.
Transshipments: Prohibiting transshipments -- loading goods from one aircraft or vessel onto another -- reduces the buyer's risk of damage and loss. But your customers may allow transshipping if it saves on shipping costs.
Partial shipments: If we indicate that we want to do partial shipments, we might speed up cash flow by shipping the first purchase orders early and receiving payment for them.
Method of reimbursement: If I hadn't negotiated for payment of the letter of credit to be made through a U.S. bank (Philadelphia International), it could have taken an entire month for the bank in Singapore to receive and review the documentation before wiring the money to IKR.