Operating a business will always involve some level of risk. When operating a business venture on an international scale, the risks typically become higher in number and more complex in nature.
Conducting proper due diligence is always a good first layer of protection against some of those risks, but is often not enough on its own. International businesses need to focus on mitigating some of the more prevalent risks inherent in conducting business abroad.
Protecting your paycheck internationally is a whole different ballgame
In my experience, one of the highest risks encountered by international entrepreneurs is the risk of non-payment.
What if I ship my product over to the buyer but never get paid? In a domestic scenario, for instance, where both companies are located in Ontario, Canada, the process would be fairly straightforward.
Typically, the unpaid seller will send a formal demand letter asking for the monies owed. If the payment still isn’t made, you would then start a lawsuit in the Ontario Superior Court to attempt to obtain a judgment in your favour, which would allow you to legally collect the monies owed to you by seizing the assets of the buyer.
But what happens if the seller is a Canadian business and the buyer is halfway across the world in China, for example? How do international businesses protect against the risk of non-payment when the transaction and/or the parties are located in different areas around the globe?
Always start with an ironclad contract
In a previous blog, I highlighted the importance of both an arbitration clause and a governing law clause in an international contract as a means to protect your business abroad.
To recap, if a dispute arises between a Canadian seller and a buyer in China, the courts will look to the contract to determine the right course of action. The contract is king.
The governing law clause will dictate which laws will apply to the matter, whether they are Canadian, Chinese, or from another third party altogether.
The arbitration clause will outline the agreed upon process for dispute resolution between the parties. Although these clauses provide certainty in terms of process and help avoid costly disputes, the specific risk of non-payment highlighted in the example above can be mitigated even further. This is done through a widely used instrument of international payment called the Letter of Credit.
The LOC could be the best tool in your arsenal
The Letter of Credit, also commonly known as the LOC, is considered to be one of the most secure instruments to reduce the risk of non-payment in international transactions, and is widely used by international businesses in their daily operations.
As an example, in the scenario above where a Canadian seller of widgets is shipping goods to a buyer in China, the Chinese buyer would request the LOC from their bank, and that bank then undertakes to pay the Canadian seller upon presentation of certain documents to the bank.
The LOC is like an insurance policy for the seller, in the sense that it guarantees payment to the seller when the proper documents are presented.
The seller is guaranteed payment one way or another, regardless of other events like bankruptcy or civil strife in the buyer’s country that could otherwise make it difficult to transfer payment from buyer to seller.
If the buyer is unable to make the payment, the bank will cover the outstanding amount.
Get your documents in order
It is important to keep in mind that the issuing bank will only release the funds to the seller when it presents certain documents, including:
- a certificate of origin;
- an inspection certificate;
- a bill of lading;
- an insurance certificate;
- a commercial invoice;
- and a packing list
As long as the seller provides the necessary documents and they are compliant, the bank releases the funds to the seller. Therefore, the LOC is one of the best tools for exporters or sellers to use to reduce the risk of non-payment in international transactions.
The seller is assured to receive payment for the goods shipped provided they meet the conditions listed in the LOC in terms of presenting the required documentation to the bank, thus mitigating one of the biggest risks to exporters in global trade. Don’t trade without it!
Have you ever been faced with issues of non-payment? How did you resolve the issue and move forward?
Very Interesting article. Thank you, Catherine.
The Bill of Lading is implying a sea shipment, but we may also need to ask for LOC in case of shipment on road.
For instance which document shall be required in the LOC for deliveries from Germany to Russia?
Can we use in this case an FCR (Forwarders Certificate of Receipt)?
Are banks familiar with this document? Would they accept it?
Yes, banks will accept a FCR or in case of airfreight an AWB (airway bill)
Great question Francesco, and thanks for your answer Gerhard!