When trying to evaluate the creditworthiness of overseas clients located thousands of miles away, exporters often throw up their hands in frustration. This is particularly so when different languages are involved.
Barriers become even more severe when foreign importers fail to pay for shipments. That’s because taking legal action in a distant land can be prohibitively expensive and practically impossible.
Usually the exporter’s bank is responsible for contacting either the importer’s bank or the importing company directly in an attempt to collect on the exporter’s commercial invoice. However, a home-country financial institution normally can’t force payment from an importer located in another jurisdiction. When the importer fails to pay, all the exporter can do is to launch an official objection through his or her bank.
Below are five practical tips on how exporters can prevent or mitigate losses that result when an importing company either refuses or is unable to pay for delivered cargo.
1. Export Credit Insurance
Export credit insurance is a specific form of property and casualty coverage that reimburses policyholders in the event that foreign buyers fail to pay for shipped products. Some financial institutions require that exporters insure their cargoes with export credit insurance. Otherwise, these exporting companies won’t qualify for business development loans.
Export Development Canada (EDC) had a dominant 64% share of the Canadian credit-insurance market in 2006. Private companies that underwrite trade credit insurance in Canada include Euler Hermes (17%), Coface (9.9%) and Atradius (1.3%).
A government Crown Corporation, EDC is Canada’s official export credit agency and largest provider of trade credit insurance. EDC offers the following competitive advantages to Canadian exporters.
- Full financial backing of the Canadian government (Standard & Poor’s credit rating of AAA)
- Lower premium rates for even smaller exporters (enabled by EDC’s reduced financial capital costs and limited need for reinsurance)
- Exemption from federal government taxation
- Absence of private sector pressures like paying dividends and earning minimum profit levels
- Ability to partition large and risky transactions between corporate and government of Canada accounts.
EDC underwrites the following types of export credit insurance:
- Accounts receivable insurance
- Single-buyer insurance
- Performance security insurance
- Contract frustration insurance
- Political risk insurance.
2. In Case of Need Representatives
An exporter can also appoint one or more persons who represent the shipper’s interests in the importing country. These ‘In Case of Need Representatives’ are usually specifically mentioned on the exporter’s Documentary Collection form under Remarks. With a local presence, ‘In Case of Need Representatives’ help resolve conflicts between the importer and the exporter. These representatives can be ambassadors, business partners and even friends or relatives of the export company owner. However, a bank doesn’t qualify.
3. Third-Party Collections by Confirming House
For a price, an exporter can delegate the financial responsibility for collecting outstanding payments for a shipment to a confirming house. A confirming house is a financial intermediary that accepts both the exported goods and related shipping documents.
On receipt of a shipment's documentary collection, the confirming house pays the exporter and takes title and full financial responsibility for the delivered goods. The confirming house then works directly with the importing company to arrange transportation of the goods to their final destination.
By hiring a confirming house, an exporter can effectively bypass risks associated with the importer not paying. As compensation for assuming these risks, a confirming house normally charges about 10% for these services.
4. Irrevocable Letters of Credit
Arguably more time-intensive, an irrevocable letter of credit represents a more traditional financial tool that helps to mitigate the risk of importer non-payment. A letter of credit is a guarantee from the importer’s bank that the exporter will be paid, provided that the exporting company has fully complied with the letter of credit’s terms and conditions. The importer specifies the letter of credit’s terms and conditions, such as shipment date, quality and packing standards.
It is the exporter’s responsibility to establish whether the letter of credit is revocable or irrevocable. An irrevocable letter of credit maintains the importer’s guarantee to pay unless all four parties (importer, importer’s bank, exporter and exporter’s bank) agree to cancel the letter of credit.
An even safer financial tool is the confirmed irrevocable letter of credit, in which the importer agrees to pay the exporter’s bank instead of using the importing bank.
5. Importer Pre-payment, Partial Payment and Installment Payment
Pre-payment may well represent the ultimate in the importer showing trust in the exporter’s ability to deliver. To prepay a shipment, the importing company sends the full payment amount before the exporter ships the requested goods.
Partial payments are another method that requires a high-level of trust on the part of the importing company. Where partial payments are involved, no product is shipped until the exporter receives the full amount owed.
Under the installment payment method, the exporter releases the product shipment after receiving the first payment. This means that the outstanding amounts are payable in further installments.
Pre-Payment Removes Any Risk of Importer Default
Export credit insurance does show flexibility in meeting the needs of importing customers. Trade insurance also mitigates risk and can speed the flow of funds to exporters on an ongoing basis. However, by definition pre-payment is the most cost-effective and low-risk way for exporters to guarantee that they receive payment for their product shipments.
Sources for this Article
This article presents independent insights and comments based on a review of Dr. Harmeet Singh Kohli’s analysis titled International Trade – A Simple View to a Complex Process (Global Training Center, Inc) and Insuring Canada’s exports by Maciej Kotowski (CD Howe Institute).
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