Letters of Credit - Sight Drafts, Time Drafts

Reading this article will make you a semi expert on the subject. For more information you can see my book Letters of Credit and Documentary Collections which can be found on line. Also see my other articles on Letters of Credit on Associated Content. This information is based on my 30 years of experience in international business operations.

The bill of exchange is commonly called a draft or bill. In the previous articles, it was noted that it is necessary to have a draft when doing a letter of credit collection or a documentary collection such as documents against payment method (D/P). Drafts are available from your bank or the advising bank. It is necessary for your office to fill in the draft correctly. The draft is a key document that the bank will use to remit the correct amount to our company. The banks will only pay the amount in the draft and does not go by the Invoice amount.

Drafts are like bills in that there is a small risk that payment will be dishonored. This is why a sight draft is the best method as the title of the goods being shipped will not be transferred until payment is made. If the buyer does not pay, then the exporter must return the goods at his expense. This is the only risk.

A sight draft must be used by the exporter if he feels any risk of nonpayment. For ocean bills of lading or ocean shipments, the bank will not turn over the documents for release until payment is made. Air shipments or air waybills of lading, however, do not need to be presented in order for the buyer to claim the goods. So for air shipments, there is some more risk.

In addition to a sight draft there is a time draft which is payable sometime in the future. A time draft is extending credit terms to the buyer. You will need to know what documents your customer will require for the transaction. Then your bank will also send an official letter to the customer's bank advising what documents are being sent with the draft. This letter advises what documents are enclosed for the collection, and it spells out the type of collection and any terms or conditions. If it is a documents against acceptance with payment due thirty or sixty days after the bill of lading date, the letter also advises the payment due date. The letter is advising the payment instructions and any additional instructions, such as the customers bank is to advise receipt of the documents. It also states that the collection is subject to the Uniform Rules for Collection of Commercial Paper, International Chamber of Commerce Publication No. 522.

Of course there is a fee from your bank for doing this collection. It is normal for bank charges to be paid by your company for charges at your remitting bank. The customer pays for bank charges on his side at the collecting bank. There will also be a wire transfer fee of about $20 when the payment is made.

Once you have some experience with a customer and how to make drafts and documents, this can all go very smoothly and is much easier than doing a letter of credit. As stated the best method to use for collections is documents against payment. This uses a sight draft or payable at sight by the collecting bank. One other point is that each country may have different requirements for the documents that are sent. One must be careful that all the necessary documents are sent; otherwise, payment may be delayed.

A clean draft is when no shipping documents are attached to the draft sent to the remitting bank. The documents are sent together with the goods directly to the buyers. Using a clean draft is very risky if one does not know the buyer or customer. This clean draft is usually used to pay for services and not goods.

Names of parties when using drafts are:

Drawer: This is the party who issues the draft or the seller.

Drawee: This is the party who owes the money to the seller. This is the buyer or customer.

Remitting Bank: This is the seller's bank that is remitting the documents to the presenting bank or collecting bank, which is the buyer's bank.

Collecting or Presenting Bank: This is the customer's or buyer's bank.

So in conclusion, if you know the customer well and they do not have any credit problems, it is best to use the D/P system with a sight draft. Of course when using Net 30 Day payment terms or doing a direct sale to a trusted customer, sight drafts are not necessary. Letters of credit all require a sight draft or time draft to be made out as part of the required documents.

Coming next is an article on Letter of Credit Assignment of Proceeds.

References: Uniform Rules for Collection of Commercial Paper, International Chamber of Commerce Publication No. 522, www.unzco.com/basicguide/figure12.html, www.aesdirect.gov, www.sba.gov, www.ffiec.gov