If you have ever drafted a bill of exchange, and do not feel comfortable with the risks associated with it, you may find the documentary bill a step forward in assuring that you receive your due payment.
A documentary bill is a bill of exchange with the bill of lading as collateral.
Essentially, the seller draws a bill of exchange on the buyer and attaches it to the bill of lading. Only upon acceptance of the bill of exchange, payment, or arrangement of payment does the buyer receive the bill of lading and is transferred ownership of the goods.
The documentary bill maintains the same advantages as per a standard bill of exchange: the seller can realise cash immediately by selling the bill of exchange at a discount to a bank; the buyer is given credit until the maturity date of the bill of exchange.
Difference with bills of exchange: the collateral
A documentary bill incorporates a big difference with respect to a bill of exchange: the presence of a collateral.
In case the buyer defaults on its payment to the seller, the latter can recourse to the goods sold. The buyer has to return the bill of lading to the seller, who then reacquires ownership of the goods and can sell them to another buyer.
If the buyer does not return the bill of lading to the seller, he is liable towards this latter, for example, he might have to sell the goods himself to repay the seller.
The advantage of the documentary bill is that the seller maintains the benefits of a bill of lading but has an additional guarantee in the form of the goods sold as collateral in case the buyer does not pay.
Disadvantages of the documentary bill
However, there are two main disadvantages with this form of guarantee, which makes the documentary bill still abundant with risk.
The first is that the seller, having received back the ownership of the goods originally sold to the defaulting buyer, must find another buyer for the goods in order to monetize his credit. If the goods are already parked in the buyer’s country, or any country where the seller is not familiar with, finding a second buyer in reasonable time may be hard.
The second disadvantage relates to what kind of default the seller is dealing with. If the buyer defaults on its payment because he is in financial distress, but is acting in good faith, he may be willing to return the bill of lading in due time to eliminate a liability. But, if the buyer is acting in bad faith, he may be unwilling to return the bill of lading, and the seller will be left with the sole option of suing the buyer in a foreign country, which is the main issue in all international transactions.
Role of banks in the documentary bill
To help mitigating such risk, it is common practice to use banks to transfer the documents and to arrange for payment.
The seller’s bank (the remitting bank) will arrange for a bank in the buyer’s country (the collecting bank) to deliver documents against acceptance of bill of exchange (D/A), payment (D/P), or another form of payment arrangement that binds the buyer to the bank.
In this case, the seller receives immediate payment (D/P) or can count on the collecting bank that, acting as the seller’s agent in the buyer’s country, can pursue the buyer though his domestic legal system, therefore limiting the risk of a total default, i.e. non-payment and non-return of the documents.
As you can see, by implementing this scheme, the documentary bill becomes way more protective of the seller than a simple bill of exchange; yet, it becomes also more complicated and expensive.
Uniform Rules for Collection (URC)
In order harmonize the rules of collection and payment worldwide, the ICC (International Chamber of Commerce) has published standardized rules of collection, called Uniform Rules for Collection (URC).
These rules came into force in 1996 and help deal with the problems such as those that we have previously discussed, further assuring the seller of his due payment.
One last important comment: as per the Incoterms, also the URC must be specifically incorporated in the sale contract in order to be applicable (we discussed this requirement about Incoterms in our article What are trade terms and Incoterms?).
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