Payment terms in International trade : a legal-financial evaluation of letter of credit usage

Abstract

International trade is conducted for the purpose of providing a nation with commodities it Jacks in exchange for those it produces in abundance. There are several factors that affect the creditworthiness of the parties involved in international trade. Various payment terms are used in international trade. Some are cheaper and riskier than others. Others command a higher price but reduce the risk of non-payment. Therefore payment terms offer different levels of risk and protection for both the buyer and the seller. Of great importance in international trade is the letter of credit. To overcome the difficulties and risks involved in international trade, the buyer and the seller make arrangements to have intermediaries (banks) involved in the two countries to facilitate the settlement. There are various types of letters of credit. The buyer and the seller choose that type of letter of credit which best suits their circumstances. Letters of credit are considered to be a very secure method of payment. They offer a number of advantages, which advantages must be weighed against the costs incurred when undergoing this type of transaction. In order to reduce the problems of conflicting laws since different countries are involved, the International Chamber of Commerce issued Uniform Customs and Practice (UCP), which is a set of private rules for trade. This set of rules has undergone periodical revisions to keep pace with the changing usage and the fast-paced nature of international trade, with the latest version referred to as UCP600. One of the most important principles behind every letter of credit is that these deal in documents and not in goods. Therefore the terms and conditions included in the letter of credit need to be fulfilled by the documents presented. The supplier must therefore understand the conditional nature of letter of credit and the fact that payment is not made unless the terms and conditions of the letter of credit are met. For this reason letters of credit are considered to be a secure method of payment. Once a trading relationship is established between the seller and the buyer, they may opt for flexible payment terms so as to reduce the costs incurred. However, this option is not always advisable, since the conditions of any of the two parties may change, without the other party getting to know about it on time. Companies must choose prudently the payment terms, especially if they are going to ease their credit arrangements. They must therefore assess each situation individually. This does not mean that assessment will totally eliminate risk. It is for this reason that letters of credit are advisable, since they offer a good level of protection for both the buyer and the seller.