Myths

Myths About International Business

Joseph Zodl

(excerpted from remarks to Export Operations Seminar

Washington, DC March 26, 2001)

Myths? Here they are:

1) A letter of credit is a guarantee that the seller will be paid.

2) Under NAFTA, all goods shipped from the U.S. to Canada or Mexico, or our import shipments from Canada or Mexico, are now duty-free.

3) A NAFTA Certificate of Origin is required for all shipments to Canada or Mexico.

4) "FOB" and such are freight terms best left to the transportation department to figure out.

Let's take a look at these and get to the facts:

1) A letter of credit is a guarantee that the seller will be paid.

Definitely not! A letter of credit is a statement, backed by a bank, that payment will be made providing that all the terms and conditions in the letter of credit are met. If there is a discrepancy, payment is refused by the bank unless the buyer decides to waive the discrepancy. If he decides not to, then payment will not be forthcoming.

There are essentially three ways in which a letter of credit discrepancy comes about:

A) a violation of Publication 600, which constitute the rules for a letter of credit. For example, a bill of lading must show the name of the carrier (Article 20).

(In some cases, an l/c can overrule Publication 600. For example, Publication 600 states that the beneficiary (seller) has 21 days after date of shipment to present documents (Article 14). However, the letter of credit can grant a longer or shorter time if the applicant (buyer) so desires.).

(Publication 600, in effect as of July 1, 2007, is published by the International Chamber of Commerce and can be obtained from most banks with international departments.)

B) a contradiction--one of the documents contradicts another. Therefore, one (or both) of the documents must be incorrect. For example, a packing list may state "1,000 units in 100 master cartons" but the bill of lading states "99 master cartons" were shipped.

C) a specific document discrepancy with the terms and conditions of the letter of credit. For example, a letter of credit states that shipment must be made by the 15th of the month. But the bill of lading shows that the goods were not shipped until the 16th.

In any of these cases, the bank will decline to pay unless the buyer decides to waive the discrepancy.

In some instances, the documents controlling the shipment are returned to the seller and the shipment can be brought back or redirected to another buyer. In some instances, especially air shipments, the buyer can claim the goods anyway and so the seller is back to open account.

It is not unheard of for a dishonest buyer to open a letter of credit with a built-in discrepancy. Here's one example: a letter of credit calls for an air shipment to be consigned to the buyer at his destination airport. Shipment must leave "before the 15th but after the 16th of the month." No matter what date is on the airwaybill, there will be a discrepancy because the dating is an impossible condition. With the goods consigned direct, the buyer will possibly have possession of the goods before the documents are presented to the bank by the seller.

The letter of credit must be in the hands of the seller and carefully examined before shipment. Letters of credit are discussed at length in chapter 7 of Export-Import.

2) Under NAFTA, all goods shipped from the U.S. to Canada or Mexico, or our import shipments from Canada or Mexico, are now duty-free.

Some U.S. importers are opening themselves up for penalties by stating that an imported product qualifies for duty-free treatment under NAFTA when the facts are only that the product was manufactured in another NAFTA country.

Canada, Mexico, and the United States are Most Favored Nations (MFN) to each other. The term is changing to Normal Trade Relations (NTR). The U.S. also has NTR status with Japan, France, Germany, and most other trading partners.

Under NTR status, many goods are duty free regardless of NAFTA and many are dutiable.

For example, golf balls entering the United States are duty free if they have a country of origin that is any NTR country. Golf clubs are dutiable at 4.4% under NTR but are duty-free if they qualify under NAFTA.

If a product has a country of origin within NAFTA, it qualifies under NTR for each of the other NAFTA countries. It will only be considered "originating" within the meaning of NAFTA and hence qualifying for special treatment if it meets one of the NAFTA criterion.

3) A NAFTA Certificate of Origin is required for all shipments to Canada or Mexico.

No, only shipments which qualify under NAFTA may be issued a NAFTA Certificate of Origin by the seller. Some exporters are risking very large fines by issuing NAFTA CofO's on all exports to Canada and Mexico. There are six preference criteria, and the goods must meet one of them to qualify.

If a seller has Japanese cameras in his warehouse and exports it to Canada, obviously that doesn't qualify. But what if he sells NAFTA-originating cameras with a Japanese lens attached? At what point does it become a NAFTA product?

The preference criteria must be checked carefully for all goods before the CofO is issued.

The fines and penalties I mentioned reach to 75% of the value of the shipment, with a maximum of $100,000. Note that this is per shipment. Plus, the goods will be assessed duty plus interest.

NAFTA is discussed in chapter 8 of Export-Import.

4) "FOB" and such are freight terms best left to the transportation department to figure out.

On the contrary, whether the buyer or the seller will pay the freight is only part of the story. "FOB" or "Free on Board" is a term of sale, not a freight term.

The 13 terms of sale that have been established also determine other major points of a sales contract: who will arrange export and import clearance, who is at risk of loss or damage during transportation, and so on."

These are not determined by the transportation department, although that department responds to them. Terms of sale are determined by the marketing department of the seller negotiating with the marketing department of the buyer. If either party neglects them in the negotiation, that party usually loses money.

In my corporate responsibilities, I have been involved in the strategic management of transportation and logistics as well as strategic marketing. Terms of sale are marketing terms established by the seller's marketing group in negotiation with the buyer's purchasing group. It should be reflected on the buyer's purchase order and copied to the seller's sales order so that the order flows through smoothly the way seller and buyer agreed. The transportation and logistics groups respond to the term of sale; they do not negotiate it.

The worldwide standard is Incoterms, of which the 2000 edition is the current version. All together, there are thirteen possible terms of sale or letter of credit is a guarantee that the seller will be paid. Most companies will only use a few in the normal course of business. "FOB" is very popular, although it is different from the meaning of "FOB" for domestic shipments. "CFR" (formerly C&F or C+F), and "CIF" are widely used.

"FCA" and "CPT" are examples of terms of sale not as widely used as they might be. They are relatively recent in their creation and have not displaced the earlier terms as broadly as they probably will in the years to come as more sellers and buyers become aware of their uses.