D/P, D/A and Their Use in International Sales Transactions
by David Greenberg
The following article originally appeared in the December 2011 issue of ABC-Amega's free client newsletter, "Credit-to-Cash Advisor". Most sellers are very familiar with Open Account (O/A) and Letter of Credit (L/C) transactions. In the international arena, open account sales are regarded as having the most risk; letter of credit transactions as having the least.
Between these two poles, however, are two lesser-known transaction types: Documents Against Payment (D/P) and Documents Against Acceptance (D/A). These represent risk levels lower than an O/A, but greater than an L/C. Both rely on an instrument widely used in international trade called a bill of exchange or draft. Bill of Exchange / Draft A bill of exchange, or draft, is a negotiable instrument that is both drawn up by and made payable to the exporter/seller. Although written by the seller, it has the equivalent effect of a check written by the buyer. It is generally a three-party instrument consisting of a:
- Drawer -- the party issuing the bill of exchange; usually the exporter/seller.
- Drawee -- the recipient of the bill of exchange for payment or acceptance; usually the buyer.
- Payee -- the party to whom the bill is payable; usually the seller's bank.
Bills of exchange are either payable at sight (sight drafts) where the bank pays the full amount upon presentation, or payable at some future date (time or term drafts). Here's how they work with Documents Against Payment (D/P) and Documents Against Acceptance (D/A) transactions. (Click to view a PDF process map of the D/A and D/P process.) D/P -- Documents Against Payment The D/P transaction utilizes a sight draft. Payment is on demand. After the goods are shipped, the exporter sends the sight draft to the clearing bank, along with documents necessary for the importer/buyer to obtain the goods from customs. The buyer has to settle the payment with the bank before the documents are released and he can take delivery of the goods. If the buyer fails or refuses to pay, the exporter has the right to recover the goods and resell them. On the surface, D/P transactions seem fairly safe from the seller's perspective. However, in practice there are risks involved.
- The buyer can refuse to honor payment on any grounds.
- When the goods are shipped long distances, say from Hong Kong to the United States, it is usually impractical and too expensive for the seller to ship them back home. Thus, the seller is forced to sell the goods in the original country of destination at what is usually a heavy discount.
- In cases of shipments by air freight, it is possible that the buyer will actually receive the goods before going to the bank and paying for them.
D/A -- Documents Against Acceptance The D/A transaction utilizes a term or time draft. In this case, the documents required to take possession of the goods are released by the clearing bank only after the buyer accepts a time draft drawn upon him. In essence, this is a deferred payment or credit arrangement. The buyer's assent is referred to as a trade acceptance. D/A terms are usually after sight, for instance "at 90 days sight", or after a specific date, such as "at 150 days bill of lading date." As with open account terms, there are some inherent risks in selling on D/A:
- As with a D/P, the importer can refuse to accept the goods for any reason, even if they are in good condition.
- The buyer can default on the payment of a trade acceptance. Unless it has been guaranteed by the clearing bank, the seller will need to institute collection procedures and/or legal action.
Advantages for the Seller in D/P and D/A Transactions Despite the risks listed above, utilizing D/P and D/A transactions does have a number of advantages for the seller.
- The bill of exchange facilitates the granting of trade credit to a buyer.
- It can provide the seller access to financing.
- The bill of exchange is formal, documentary evidence, acceptable in most courts, confirming that the demand for payment (or acceptance) has been made to the buyer.
Recourses for Dishonored Bills of Exchange It is possible for the seller to dispute an unpaid/unaccepted (called dishonored) bill of exchange, sue the buyer, and potentially receive payment. The seller disputes a dishonored bill of exchange via a formal, usually two-step, process. Step #1 Noting: A bill of exchange is noted in order to obtain official evidence that it has been dishonored. A Notary Public presents the bill/draft to the drawee (buyer) for acceptance or payment and notes on the bill the reason given for dishonor. Noting is often followed by a formal protest. Step #2 Protesting: The Notary Public produces a formal deed of protest bearing his seal. This document provides formal evidence of the presentation of the bill to the drawee and the reason for the dishonor. The protest is accepted by most courts in the world as evidence that the bill has been dishonored. Should the buyer fraudulently obtain possession of the documents, or the goods, without paying or accepting the bill of exchange, it is possible to seek satisfaction from the clearing bank or the customs warehouse. ABC-Amega made and won such a claim for a fireworks manufacturer in the People's Republic of China. (Note: the names of the parties have been changed.) Click next below to read the case study...
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