IF YOU CAN’T DODGE A RISK, HEDGE IT Mitigating Risks in International Payment and Collection

1. IF YOU CAN’T DODGE A RISK, HEDGE ITMitigating Risks in International Payment and Collection September 19, 2007 National Association of Credit Managers Gateway Regional Conference Presented By: Jennifer Schwesig Armstrong Teasdale, LLP

2. INTRODUCTION • Laws applicable to bankruptcy, insolvency, security interests, and creditor and debtor rights vary drastically from country to country • Problems involving collections are more readily avoided before credit is extended

3. KEY ISSUES IN INTERNATIONAL TRADE FINANCING • Arranging for and receiving payment • Foreign exchange risks and controls • Collections

4. MINIMIZING INTERNATIONAL CREDIT RISKS • Risk of non-payment and collection increases in international transactions • May be difficult to check overseas buyer for creditworthiness • Goal is to minimize or eliminate the risk of non-payment or inability to receive payments • Determining the payment method, financing and other key terms is important

5. MINIMIZING INTERNATIONAL CREDIT RISKS • Credit Risk Reduction Methods: • Credit Checks • Payment Types • Export Credit Guarantees and Insurance • Proper Documentation/Agreements

6. MINIMIZING CREDIT RISKS • Credit Checks • Know the exact entity or individual you are dealing with • Check buyer’s credit history (if possible) • Reliable up-to-date information may be difficult to find • Suggestions: • Department of Commerce International Company Profile (ICP) • Local U.S. embassies (commercial divisions) • Private credit reporting services

7. MINIMIZING CREDIT RISKS • The type of payment works to increase or decrease credit risks • Types of payments • Open Account • Advance payment • Documentary Sales • Letters of Credit • Bills of Exchange (Draft) • Trade & Bank Acceptances • Conditional Sales Arrangements

8. MINIMIZING CREDIT RISKS • Open Account • Least secure method • Seller sends goods with invoice for payment • Advantages • reduction in transaction costs • works well with high volume shipping • Disadvantages • Perform significant credit checks on buyer (credit risks) • Seller loses control of goods when dispatched (shipping terms imp.) • Buyer may refuse to accept delivery • Seller must wait for payment until after the buyer has received goods • No risk to buyer • Supplement rights with title retention clause

9. MINIMIZING CREDIT RISKS • Best Practices for Open Account • Seller • No open account when buyer is new or cannot determine risk and reliability of buyer • Goods are delivered before 1st payment • Make sure to supply goods or services consistent with a good contract dealing with disputes and non-payment • Insist on an electronic transfer (cleared funds) instead of a bank draft or check • Define credit terms • Buyer • Inspect goods before making a payment • Make payment within agreed credit terms

10. MINIMIZING CREDIT RISKS • Advance Payment • Time of payment: before shipment • Goods available to buyers: after payment • Risk to exporter: none • Risk to importer: relies on exporter to ship goods as ordered • Best Practices for Advance Payment • Seller • Provide clear payment instructions (SWIFT) • Avoid accepting bank drafts or company checks • Buyer • Avoid this arrangement, use letter of credit instead

11. MINIMIZING CREDIT RISKS • Documentary Sales • 2 types • documents against payments • documents against acceptance • Helps avoid some risks in open account transaction • Seller uses carrier to withhold delivery of goods until buyer pays or signs a negotiable instrument to pay • Transaction • Seller ships goods and forwards draft & bill of lading (BOL) • Correspondent of seller’s bank notifies buyer of receipt of goods • Buyer pays depending on sight draft or time draft • Correspondent delivers BOL to buyer for buyer to claim goods • The BOL allows for title transfer only after payment is received

12. MINIMIZING CREDIT RISKS • Documents Against Payments • Time of payment: on presentation of draft • Goods available to buyer: after payment • Risk to exporter: If draft unpaid, must dispose of goods • Risk to importer: relies on exporter to ship goods as described • Documents Against Acceptance • Time of payment: on maturity of draft • Goods available to buyer: before payment • Risk to exporter: relies on buyers to pay drafts • Risk to importer: relies on exporter to ship goods as described in documents

13. MINIMIZING CREDIT RISKS • Bills of Exchange (Draft) • Unconditional order directing buyer to pay a fixed sum on a determined date (like check, except gives title to goods) • Usually used in conjunction with documentary sale • By accepting the draft, the buyer acknowledges the obligation to pay • Common payment terms 30-90 days after sight • Seller presents draft and any documents to bank in order to obtain endorsement, use of overseas bank correspondent and collection facilities. • Common documents with draft = BOL, commercial invoice, packing list, insurance etc.

14. MINIMIZING CREDIT RISKS • Best Practices Documentary & Bills of Exchange • Seller • Make sure satisfied with buyer and country risks • Make sure goods and services supplied in accordance with contract terms • Make sure collection instructions clear and identical to terms agreed upon in the contract • Buyer • When asked to pay or accept bill of exchange, make sure consistent with contract • Make sure satisfied with goods or services before instructing bank to pay or accept bill of exchange • Make sure correct documents received to obtain goods

15. MINIMIZING CREDIT RISKS • Letters of Credit • Most widely used method of international payment • Different types (documentary/commercial, standby etc.) • Instrument whereby a bank furnishes credit in place of the buyer’s credit • Autonomous document separate from the contract • Procedure • Underlying contract provides payment to seller via LOC • Buyer arranges for bank to open LOC for the benefit of the seller • LOC has precise instructions which provide payment against the delivery of a full set of documents • Payment made upon delivery of documents

16. MINIMIZING CREDIT RISKS • Documentary LOC (Commercial LOC) • Bank makes payment on presentment of documents detailed in LOC • Normally BOL, Insurance, draft & certificate of origin • Standby LOC (used in lieu of bank guarantee) • Payment made in the event buyer fails in obligation to pay • Seller provides documents evidencing default • Cost =1-3% of the transaction • Forms • Revocable v. Irrevocable • Revocable not enforceable, don’t use • Confirmed v. Unconfirmed • Confirmed if unfamiliar with overseas bank • Back-to-Back • Issued upon the security of an existing LOC

17. MINIMIZING CREDIT RISKS • Best Practices LOC • Seller • Make sure local bank as authenticated the LOC • Examine the LOC carefully for consistency with sales contract • Make sure to present all documents named • Buyer • Check credit for LOC • Consistency with contract • All necessary documents • Insist on terms to protect interests such as late payment dates etc.

18. MINIMIZING CREDIT RISKS • Other Payment Mechanisms • Title Retention • Best if goods easily identifiable and not incorporated into a finished product • Seller retains ownership of goods until purchase price is paid in full • Pay attention to INCOTERMS • Conditional Sales • If buyer defaults seller may rescind contract • Security Interest • Seller is granted a security interest in goods (more common when sale is financed, but local laws vary) • Promissory Note • Buyer’s obligation documented by promissory note • Still may be difficult to physically reclaim goods

19. MINIMIZING CREDIT RISKS • Trade and Bank Acceptances • Promise by drawee of the draft to pay instrument when it matures • Provides short-term fixed rate financing • Trade acceptance • Bank as drawee • Before acceptance drawee has no obligations • Holder can only enforce the draft is the draft is dishonored • Once acceptance occurs, drawee primarily liable to holder • Bank Acceptance • Non-interest bearing draft drawn by company on bank • Acceptance occurs by stamp approval with signature of bank • If bank honors acceptance, buyer must put funds in bank before payment is due

20. MINIMIZING CREDIT RISKS • Conditional Sales Arrangements (Contractual) • Seller retains ownership of goods until purchase price is paid in full • If buyer defaults seller may rescind contract • Seller often granted a security interest in goods • Buyer’s obligation documented by promissory note • Useful where buyer is end user and goods sold are easily identifiable & nonperishable • Still may be difficult to physically reclaim goods

21. MINIMIZING CREDIT RISKS • Export Credit Insurance • Involves insuring exporters against • Commercial risks • Non-acceptance of goods by buyer • Failure of buyer to pay debt • Failure of banks to honor documentary credits • Political risks • War, riots etc. • Change of government policy or political party • Blockage of foreign exchange (i.e. exchange controls) • Currency devaluation (i.e. Argentina)

22. MINIMIZING CREDIT RISKS • Export Credit Guarantees • Issued by financial institution (banks) or government agency (EXIM Bank in U.S.) • Assistance for companies without sufficient track records to obtain credit from banks for exports • Instruments to safeguard export-financing banks from losses that may occur from providing funds to exporters

23. AGREEMENTS/DOCUMENTATION • INCOTERMS (2000) ICC • Standard trade definitions most commonly used in international sales contracts. • Uniform Customs and Practice forDocumentary Credits • UCP500 is the standard practices guideline for letters of credit • Standards to be followed by banks in examining LOCs • Applies only to LOCs referencing UCP text • eUCP • In November 2002, ICC published a new guide called eUCP to supplement UCP500 for electronic transactions • International Standby Practices (ISP98) • Governs standby LOCs in place of UCP which focuses more on commercial letters of credit

24. AGREEMENTS/DOCUMENTATION • Important to document transaction whether it is in the form of a simple purchase order or formal contract (attention to both sales and purchase forms) • Signed and notarized by both parties • Key clauses that can affect payments: • Title • Payment (currency) • Choice of Law • Choice of Forum • Assignability of account

25. AGREEMENTS/DOCUMENATION • Title • Passage (Where do you want title to pass & is that consistent with the INCOTERM used?) • Retention (include specific language in contract) • Assignment of Accounts • Allow for assignment by seller and look for purchaser prohibitions • Payment • Note currency of contract to avoid exchange risks • Be specific in description of payment terms ($ recommended) • Choice of Law (Provision that specifies applicable law is essential) • Avoid uncertainty as to applicable laws • Usually enforceable if reasonable nexus • Certain issues still decided by local law • Choice of Forum • Litigation or binding arbitration? • Designate arbitration body and applicable rules which differ from internal rules (ICC, AAA etc.)

26. FOREIGN EXCHANGE RISKS • In addition to forms and types of payments, collection efforts are also significantly affected by: • Foreign Exchange Risks • Foreign Exchange Controls

27. FOREIGN EXCHANGE RISKS • General Foreign Exchange Risk • Risk of loss on account of change in Forex rates during a particular period of time • Liability to make a future payment in foreign currency • Asset denominated in foreign currency • Overseas subsidiaries • Debt payable in foreign currency • Risk for both creditor and debtor

28. FOREIGN EXCHANGE RISKS • Corporate Forex Risks • Transaction Exposure • Input material of component denominated in foreign currency, manufactured domestically or finished product is for export • Operational Exposure • Effect of exchange rate on revenue and expenditures and income statement • Profits earned outside U.S. and converted to $ • Translation Exposure • Multinationals risk associated with foreign assets & liabilities • Consolidated statements in common representative currency • Forex value of assets and liabilities must be translated into reporting currency

29. FOREIGN EXCHANGE RISKS • Hedging Foreign Exchange Risks Should the risk be hedged? • Size of the risk/transaction • Amount of time involved • Amount of money • Stability of foreign currency involved • Presence of exchange controls

30. FOREIGN EXCHANGE RISKS • Basic Hedging Techniques • Payment and sales in U.S. $ or home country currency, risk is transferred to other party • Internal hedge • Purchase amount of foreign currency needed for transaction at the time the transaction is consummated • Acquire asset denominated in foreign currency that equals liability

31. FOREIGN EXCHANGE RISKS • Basic Hedging Techniques (cont) • Forward Exchange Contracts • Agreement between 2 parties that obligates them to exchange at a specified future date (settlement date) at an agreed upon price • Different than futures contracts which have standard contract sizes, time periods, settlement procedures and are traded on regulated exchanges throughout the world. • Forward exchange clause within a contract • Examples: • Date is determined (end of month, specific date etc.) • Rate is fixed (watch out for transfer pricing with related parties • If rate fluctuates parties will renegotiate prices

32. FOREIGN EXCHANGE CONTROLS • Risk regarding access to foreign currency • Government controls the availability or use of foreign currency for capital transfers & payment for current transactions • Forms: • Laws, regulations & other measures by state • typically through the central bank • Restricts availability or use of forex (directly or indirectly) • Domestic interest rates high to attract foreign capital and vice versa • Result: • May have restrictions on access to forex • Inability to pay in dollars • May lose dollar denominated contracts (Argentina)

33. DEALING WITH DEFAULT • Collecting payments overseas can be difficult and expensive • Negotiate with the customer first • Consider formal collection actions when: • Other remedies have been exhausted • The amount involved enough to warrant collection efforts

34. DEALING WITH DEFAULT • Common Collection Actions: • Legal proceedings (vary throughout the world) • Arbitration (preferable from an international collection standpoint) • File Claim

35. Jennifer Schwesig Armstrong Teasdale, LLP One Metropolitan Square 211 N. Broadway, Suite 2600 St. Louis, MO 63102 (314) 259-4710 jschwesig@armstrongteasdale.com www.armstrongteasdale.com