A seller/exporter who wishes to succeed in today’s global market must offer favourable terms of payment in addition to other sales terms to accommodate the needs of the buyer/importer.
There are various methods of payment in international trade. This variety reveals a common cause of concern to buyers and sellers: the need to find a form of payment that provides some level of security at low cost.
This article addresses, among other things, the benefits and risks involved in the adoption of escrow services in making payments in international trade.
Methods of Payments in International Trade
The primary methods of payment in international transactions include, but are not limited to:
b. Letters of Credit (LC);
c. Documentary Collections (D/Cs);
d. Open account.
In cash-in-advance transactions, the seller is assured of the credit worthiness of the buyer and can eliminate the risk of non-payment of the purchase price since payment is received before the goods are shipped.
Wire transfers and credit cards are the most commonly used cash-in-advance options available to exporters. With the advancement of the internet, escrow services are becoming a mutually-beneficial cash-in-advance option open to exporters and importers.
What is an Escrow Service?
Escrow in international trade is a service that allows both seller and buyer to protect their individual interests in a transaction by placing the funds in the hands of a trusted third party until a specified set of conditions are met.
This is how it works. The escrow service accepts funds from the buyer. When payment is verified, the service notifies the seller that payment has been made. The seller is then instructed to ship the goods to the buyer, and the escrow service uses tracking information to ensure that goods are delivered.
The buyer has an agreed-upon time frame within which he may inspect and accept the goods and notify the escrow service of its decision. If the buyer accepts the goods, the funds are released by the escrow service to the seller.
The fee of the escrow service can either be paid in full by one party or split between the seller and the buyer.
Escrow services can offer a mutually beneficial cash-in-advance method for both parties.
Consider this scenario – Ajayi is a large scale cassava farmer from Saki in Oyo State. His reputation reaches a Chinese Company which makes alcohol from cassava roots. The company contacts him and places an order. As the exporter, Ajayi requires payment in full and up-front but the company is reluctant to send the money until it receives the goods.
In this case, by placing the funds in the hands of an escrow service that holds and disburses it according to their instructions, both parties can be satisfied, the payment issue is resolved, and the deal closes.
Escrow service can be provided more cheaply than a letter of credit transaction and it ensures that the seller does not bear the same risk as an open account transaction. In an open account transaction, goods are shipped and delivered before payment is made.
While open account is the most advantageous option available to a buyer, it is one of the highest risk options for a seller as the buyer could default in its payment obligation after the shipment of the goods. Escrow service eliminates such high-profile risk. Escrow service is also a less cumbersome transaction than other methods of payment.
When Escrow Services is Preferable
Escrow service appears to be the most beneficial option available to both the seller and buyer in the following instances;
1. Where the credit worthiness of the buyer is doubtful, unsatisfactory and unverifiable.
2. Where the buyer is a new customer and/or has a less established history of operation.
3. Where the seller’s product is unique, not available elsewhere, or in popular demand.
4. Where the political and commercial risks of the buyer’s home country are very high.
In any case, escrow service is preferable in high-risk transactions where the credit worthiness of the buyer is not assured or where there is need to avoid the risk of non-payment for the goods.
Risks of Escrow Services
Although there are valid reasons to justify the adoption of escrow services in certain transactions, sellers should be aware of the risks involved in the use of escrow services.
First, escrow services are third party contractors. Thus, their trustworthiness must be assessed the same way the trustworthiness of a bank is assessed in a letter of credit transaction.
In a letter of credit transaction, the parties agree that a letter of credit issued by an international bank is acceptable, presumably because both know and can assess that bank’s trustworthiness. The same is true of an escrow service.
If an escrow service is to hold funds and release them when appropriate, the assurance that it will do so must be assessed by the parties. In addition, just like any other transaction, escrow agreements have been found to be subject to fraud.
The International Crime Complaints Centre has cautioned traders that fraudsters are setting up phony escrow sites which mirror true escrow services and accept funds under false pretences.
Thus, traders should conduct due diligence into any escrow service to prevent fraud. The identity of an escrow service may be verified with the International Crime Complaints Centre, escrow-fraud.com, among others.
Also, an escrow service owes no payment obligation to a seller until the buyer has inspected the goods. This means that the escrow service will not release the funds to the seller until the buyer has authorised it.
However, in a letter of credit transaction, once the documents demonstrating that the goods have been shipped are presented to the bank, the bank is obliged to pay the seller.
The buyer cannot stop the bank from paying so long as the documents have complied with the terms of the letter of credit except in limited circumstances.
Apart from the risks to be considered, other terms of the escrow agreement should be negotiated.
For instance, the escrow agreement should stipulate in clear terms the obligations of the escrow service, the buyer and the seller. These obligations may include the steps to be taken by the escrow service to ensure that the goods have been shipped or the steps to be taken to verify the bank account details of the buyer and the seller, among other things.
Provisions should also be made for the event, the occurrence of which will trigger payment to the seller or refund of payment to the buyer. A dispute resolution clause should also be provided for.
Any sale is a gift until payment is received. And, because getting paid in full and on time is the ultimate goal for the seller in each sale, an appropriate payment method must be chosen carefully to minimize the payment risk while also accommodating the needs of the buyer.
There is no method of payment that is one-size-fits-all in every international transaction. Some transactions may warrant the use of escrow services, while others may not. It is however important for sellers and buyers to understand the risks involved before deciding to adopt escrow services.
Zacheaus Olamide Akanni is a Litigation and Maritime & Admiralty Law enthusiast. He holds a Bachelor of Laws (LL.B) Degree from the University of Ibadan, Ibadan, Oyo State. Zacheaus is an aspirant to the Nigerian Bar, being a First Class Graduate of the Nigerian Law School.