Do you know how to use an outward documentary collection and are you sure about the cash against documents procedure?
I’ve been talking about payment conditions in the last couple of weeks, and documentary collections are one of those procedures which are often used by older exporters, but also often misunderstood. It’s the kind of payment term that you probably would only agree in specific markets (it’s popular in North Africa and Israel), but need to understand how it works if you were to take over a client who has that agreed term.
Table of Contents
Effectively, a documentary collection or a cash against documents procedure is where the purchase price is paid by the importer against documents that the exporter has sent to a bank which he has appointed. The payment might be immediate (cash against documents or CAD, also known as documents against payment or d/p) or might be on the importer accepting to pay at a later time (documents against acceptance or d/a).
The payment documentation could be a bank draft/bill of exchange (usually), and trading documents would be things like invoices, bill of lading, a packing list, a certificate of origin.
The bill of exchange represents a formal demand for payment (& is therefore an essential document) and the bill of lading is the document which signifies the right of ownership of the goods.
The bank acts solely as a trustee: Under a collection order, the exporter hands over the export documents to his bank (remitting bank) with the instruction to forward these documents to the importer’s collecting bank only once the importer has paid or has accepted a Bill of Exchange.
With a documentary collection, there’s no guarantee for the exporter that the buyer will actually pay for the goods or even accept the goods. Compared to a letter of credit, that makes it a more risky payment term.
On the other hand, the importer also has no guarantee that the goods will be correct and according to the purchase order, because the exporter’s bank who is holding the documentation just hands over the paperwork (without even checking if it has the correct information).
The importer pays up against the documentation without having any rights to actually look at the goods first. Of course, there are a couple of methods to get around this but in general, that would be the basic agreement. For that reason, the exporter should be sure to use one of the “C” group of INCOTERMs to allow him to retain ownership and control over the goods and the transport documents until he is paid (or has the necessary acceptance).
The exporter doesn’t hand over the rights to the goods until he’s been paid in the case of cash against documents (or documents against payment), sometimes known as CAD (or d/p). Or secondly, until the importer has formally accepted to pay against the documents at a specified time in the future.
As with a letter of credit, this is a little bit difficult to regulate in national law and the International Chamber of Commerce, or ICC, has a set of documentary collection rules. Although because this method of documentary collection can also be used in domestic trade sometimes, then it’s easier to regulate on a national level than a letter of credit.
When should you use an outward documentary collection?
Firstly, the “outward” part here means that the collection process is covering an export trade.
- as this doesn’t offer the same level of security for either side as a letter of credit then documentary collections are best to select when both partners have known each other for some time and accept that the other party is reliable.
- Both partners have to be sure that the other is willing and able to fulfil their obligations under this agreement. However, you should always be aware that the situation of a partner or the economic situation in the country, of course changes over time. So a partner who you regarded as financially stable and able to pay five years ago might now have different management and a completely different financial situation.
- The third important criteria is to ensure that the importing country is stable or fairly stable, at least politically and economically.
See also my post on general considerations when deciding on the most appropriate payment terms.
Further limitations on documentary collections
In countries with extremely strict foreign exchange controls then this payment method may not be allowed – the government may insist on letter of credit payment terms as that makes the control of hard currency easier.
Egypt recently introduced this kind of controls, meaning that with a few exceptions, all shipments have to be paid for with an L/C. (Exceptions include most pharmaceuticals and basic food stuffs such as tea or infant formula).
What are the risks involved with a cash against documents procedure?
For the exporter any form of cash against documents doesn’t offer a payment guarantee so you have to be sure that your importer is both able and willing to pay.
For the importer, it means that he pays or agrees to pay on the basis of documents – not something he will want to do if he doesn’t trust the exporter.
And in this case, the importer still would have the regular comeback under contract law if he finds out at a later point in time that the goods don’t actually conform to the purchasing agreement. As long as he hasn’t yet paid so in the case of documents against acceptance, for example, then he’s always going to be in a stronger position versus the exporter if the goods are then in his hands and he can prove that they are not conforming to the documentation.
One way to ensure that the contractual obligations of the exporter as regards quantity and quality of the products are actually met prior to the export taking place would be for the buyer to insist on having an independent inspection by an organisation such as SGS prior to shipment. This would help in the case of cash against documents where it’s an at sight payment.
How does the process look and what must the bank do?
In a cash against documents procedure, the exporter ships the goods and sends the agreed documents including the bill of lading to his bank. The bill of lading is important to include as this confers ownership on whoever holds the documentation.
The bank presents the documentation against payment or promise of payment to the importer.
The bank has no liability for whether the importer will accept or even pay and also isn’t obligated to inform the exporter if the buyer is in any kind of financial difficulty.
Two main types of documentary collections
What is Cash against documents (CAD)?
The buyer has to pay as soon as the documents are presented to him by the remitting (or correspondence bank. The bank has no right to hand documents over to the buyer before payment has been received. So, in most cases, that realistically means that payment is made on the next working day after documents have arrived.
There are situations though, where it can be agreed that the bank will present the documents to be paid when the ship arrives (bit unclear as how will the bank know this?) or on a specified date. This is obviously a much better situation for the importer for his cash flow than if the documents arrive weeks before the container.
In some countries, it’s a legal obligation for the legal import and customs clearance to occur before the payment can be made due to currency controls.
In such cases, if you have a cash against documents payment term then the importer might deposit the value of the goods in local currency to be held by the bank in order to obtain the access to the documents prior to actually making the payment. This can only occur if the exporter explicitly allows his bank to hand over the documents in this way.
It could be problematic if the local currency is extremely volatile, and there are major changes between the documents being handed out and the deposit paid and the actual date of payment. The importer has the obligation to take over the difference should that occur.
The bank doesn’t have the right to make decisions themselves. For example, they can’t allow an importer to take samples of the shipment to check the quality without the permission of the exporter.
What are the risks of handing over documents provisionally in this way?
- The buyer could take possession of the unpaid goods
- the importer could sell the goods on to someone further down the supply chain.
- The importer could use the goods as collateral to raise a loan at a different bank from the remitting or correspondence bank.
Consequently, this payment term is usually only used in established partnerships.
It’s also important to remember that this is really not practical if the transport time is really short. So for example, within Europe, the transit time is just a couple of days meaning that the goods arrive before the documents in most cases and making this kind of payment term irrelevant.
What is Documents against acceptance?
This is a payment term where the exporter effectively offers the importer a credit that should cover the period until the goods are resold and the importer receives his money. That means that rather than the importer using his own capital to cover his stock period and his payment terms with his clients, it is the capital of the exporter which is tied up in this agreement.
How does this form of outward documentary collection work?
The buyer accepts to pay against a draft which either has a fixed date that it’s due, or more usually a number of days after acceptance eg 30, 60 or 90 days after acceptance.
If necessary, an exporter can take this acceptance and can forfait against it to improve cash flow if required.
There’s also the option that the bank could add an aval which is a kind of guarantee or confirmation to increase the exporter’s security.
What should the order to the bank include?
- What happens if the importer doesn’t pay on time?
- What happens if the buyer doesn’t accept to pay against the documents?
- who can protest (legal step to be taken as proof that documents were NOT accepted)?
- Who is an emergency contact and which specific rights does this emergency contact have? This could be an agent locally or a lawyer who organises for example what happens to the goods if the buyer doesn’t pay or accept to pay.
- What information about the financial situation of the importer should the bank transfer to the exporter?
- And where should the money be transferred?
The bank is later obliged to check that they have all of the necessary documentation. However, they don’t have to check whether the documentation is correct, just that they have the right documents and in the right quantity. If the importer doesn’t accept to pay against the documents, then all the follow on costs which are associated with the goods will be charged to the exporter. For example, if the shipment needs to be repatriated or sent on to a further third country.
It’s therefore important, to give the bank as specific a set instructions as possible about the shipment process, the payment process and also all of the documents in order to avoid misunderstandings.
When can an exporter access his money?
Usually, the money is available directly after either payment or acceptance so it’s up to the seller if he wants to transfer the money immediately to his home jurisdiction or wait. However, in some countries if they have really strict foreign exchange controls (see the example mentioned above where the documents are handed out against a deposit in local currency) there could be delays if the forex transfer permission takes a long time.
The exporter can reduce the exchange risk here by agreeing with the customer that they will cover any losses due to exchange rate fluctuations.
What are the advantages of outward documentary collection?payment terms?
- typically the costs are much cheaper than a letter of credit (& often shared between both partners).
- Additionally, the preparation of the documentation is far less complex than for a letter of credit as the bank isn’t checking for each comma or spelling mistake. They are simply checking that the documents are available, and not that they are correct in content.
- payment can be received faster than with a letter of credit as there is less administrative processing
- Also, working with this payment term doesn’t affect the credit worthiness of the buyer as his credit line isn’t directly affected.
If in doubt ask a specialist
Whilst using a documentary collection can be a good option if you have an established relationship with your import partner, you still need to ensure that you take all the right steps as otherwise you might not get paid – or worse still be left with the costs of disposing of the goods on the other side of the world. It therefore pays to make sure that you ask a specialist prior to finalising any kind of agreement – you can save a lot of costs and headaches in that way!
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