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Payment for paperless trade: Are the viable alternatives to the documentary credit?

Law and Policy in International Business, Fall 2001 by Laryea, Emmanuel T

I. INTRODUCTION

The ever-increasing move to paperless trade calls for an evaluation of various aspects of international trade, of which payment is particularly important.1 There are four traditional methods of payment in interna tional sales: (1) cash in advance or prepayment; (2) payment on account or open account; (3) documentary collection; and (4) documentary credits.2 Trade parties adopt the most suitable method for their purpose, but the documentary credit is,3 for reasons to be outlined later, the most frequently used method.4 Thus, the documentary credit has been described as "the life blood of international

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commerce."5 Although the documentary credit is sometimes used in domestic trade, its qualities come into sharp focus in international transactions. Consequently, the discussions in this article focus on its use in international transactions.

While international factoring is becoming an increasingly important method of payment,7 and new electronic forms of payment are emerging,8 the traditional methods of payment, and the documentary credit in particular, continue to dominate. In its over one-hundred fifty years of use,9 the documentary credit mechanism has required the presentation of paper documents to complete the transaction.10 As a result, digitization of trade documentation raises questions as to the best mode of payment. These questions need serious consideration.

This article assesses whether there are viable alternatives to the documentary credit for paperless trade or whether the documentary credit can be effectively dematerialized to adapt to paperless trade. Such an assessment entails addressing four main issues: (1) the reason

documentary credits are the preferred method of payment; (2) the relevance of the documentary credit in paperless trade; (3) viable alternatives to the documentary credit; and (4) the operability of electronic documentary credits.

Part II discusses the reasons for the popularity of documentary credits, highlighting that credits satisfy three crucial interests of trade parties that the other methods of payment do not-security, liquidity, and proximity. This section reviews all four major methods of payment because the popularity of the documentary credit is best understood when compared with these other methods of payment. Part III discusses the continuing relevance of the documentary credit in paperless trade. It assesses whether the needs served by credits continue to be relevant to paperless trade. This part concludes that, although electronic documentation may change the nature of the needs, they remain relevant. Part IV explores the possibility of satisfying traders' interests by alternative payment methods and concludes that there are currently no alternative methods that meet the needs of traders as well as or better than the documentary credit. Part V discusses the adaptation of the documentary credit to paperless trade, and Part VI concludes the article.

II. REASONS FOR THE DOCUMENTARY CREDIT'S POPULARITY

The documentary credit is the most popular payment method because it secures the interests of all parties involved in the transaction, provides liquidity to importers and exporters, and affords the parties a local entity to sue in the event of a dispute. With respect to these qualities, credits are unparalleled by the other methods of payment. To explain the preference for documentary credits in international sales, this section briefly reviews the four traditional methods of payment and highlights the major disadvantages of the three non-documentary credit payment methods.

A. Cash in Advance or Prepayment

Cash in advance, or prepayment, simply refers to the arrangement where a buyer, pursuant to a contract of sale, transfers funds into an account accessible to the seller in advance of the manufacture, procurement or shipment of the goods that are the subject matter of the contract. While a precise definition of the prepayment method is difficult to pinpoint,ll each variation of the definitions contain one key characteristic-the availability of funds before fulfillment of the contractual obligation.12 Still, actual prepayment is not the only means by which a buyer could make funds available to the seller in advance of shipment. For example, prepayment may be effected by "packing" credits or "red clause" credits, which, unlike the cash in advance method, includes a contract requirement of bank credit.13

Though safe for the exporter, the prepayment method is risky for the importer. The importer cannot be sure that the goods, or the correct quantity of goods, will be delivered. Moreover, in the event of the exporter's insolvency, the importer may not be entitled to the goods even though it may have effectively paid for them.

Another reason the prepayment method is not popular with importers is that the importer locks up capital overseas for the duration of the transaction by paying the exporter before it receives the goods. The importer extending the credit to the exporter may not be in the financial position, or willing, to lock up working capital for a considerable period.14 Not surprisingly, prepayment is not a popular method of payment. Today, it is used mainly among associated companies.

Payment for paperless trade: Are the viable alternatives to the documentary credit?

Law and Policy in International Business, Fall 2001 by Laryea, Emmanuel T

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