The Benefits of International Trade - Research Paper Example

Introduction International trade is one of the most important elements of economic activity that take place across the globe. Over the period of time, the improvement in technology has made it possible for the firms to trade across the border at relatively cheaper cost and gains the benefits of international trade. However, despite such facilitation there are certain risks which are involved in the conduct of international trade including the legal disputes between the parties as well as other risks peculiar to the circumstances. There are also different ways which can be used to finance the international trade to minimize the risks involved. Since cross border trading involve the risk of default by either party to the transaction, it is therefore always preferable that a more secure and appropriate way shall be taken to conduct the transactions at international level. Letter of Credit is one of the most important instruments to conduct the transactions and is considered as the lifeblood of international commerce as per Kerr L.J, Harbottle (Mercantile) Ltd v National Westminster Bank Ltd [1978] Q.B 146 pg 155. Letter of credit is used a guarantee by a third party to ensure that the payments against the goods exported will be paid off to the seller in due course. This paper will therefore attempt to evaluate the significance of the letter of credit and its legal significance of the doctrine of strict compliance and autonomy. International Trade International trade is critical for the overall commerce that takes place between the different countries of the world. The basis of the international trade is deeply rooted into the doctrine of comparative advantage wherein one country trade with other based on the cost of producing each commodity. However, there are certain rules and regulations that govern the economic transactions that take place as a result of international trade. The rules and regulations basically are promulgated in order to ensure that the risks are adequately covered and each party is suitably protected against any kind of fraud or adverse outcome. International Chamber of Commerce (ICC) is the authority which has the necessary powers to issue guidelines and rules that mostly govern the international trade transactions that take place across the border. UCP Guidelines are the comprehensive set of guidelines issued by the ICC which basically covers the most important aspects of conducting the trade between two parties to the contract across the borders. UCP or Uniform Customs and Practices for Documentary Credit as well as Inco terms are two most important documents that cover the international trade. Risks involved in international trade International trade is different from the domestic trade in the sense that it carries different and unique risks that are peculiar to this type of trade only. Some of the important sources of risks include: Political Risk Political risk is often difficult to assess and evaluate however, the losses due to the political events can be huge. Political risk is different from the other risks because political risk can be hard to negotiate with and as such the different options such as rescheduling as well as negotiated settlements can be difficult. Political risks can include the risks such as imposition of embargo against the exporter’s country, placement of trade barriers, war etc. Currency Risk Currency risk can emerge due to changes in the relative rate of domestic currency against the currency of trade. Since international trade mostly takes place in foreign currency i.e. US $ therefore the relative changes of USD against the home currency can be adverse for the exporter. This is because of the fact that the adverse changes in foreign exchange rates can reduce the payoff to the exporter. Transport Risk From the perspective of the international trade, transport risk is probably one of the critical risks because transporting through any means of transport can be risky owing to various factors including late delivery, delays in shipments, accidents etc. Though in-transit insurance can serve as a hedge against this type of risk however, it still is critical from international trade perspective. Legal Risk Legal Risk can arise due to the differences in the regulations of two countries and as such international exporters and importers may face extra risks. The conflict in legal system as well as the applied regulations may create situation where they may favor one party to the transaction. Financial Risk All above risks ultimately result into the financial risk which includes the likelihood of incurring financial losses due to conducting transactions at international level. Main Sources of Finance in International Trade There are various sources of financing the international transactions however; they differ according to the circumstances and benefits that they may offer to either party in the transaction. Some of the important sources of finance are: Advance Payment Open account is probably one of the simplest methods of financing the international trade. In this mode of financing importer basically pays the exporter in advance before affecting the shipment of the goods and as such importer assumes all the risks for getting the goods. Open Account Under this arrangement, importer is basically trusted with affecting the payment after receiving the goods shipped by the exporter. This also means that the exporter assumes almost all the risk in this transaction. Documentary Credit Documentary credit or Letter of Credit is probably the most common mode of financing in the international trade. A letter o Credit or LC is a written undertaking by the banks on the behalf of its customer promising to affect the payment against the goods shipped by the exporter upto the stated value of the credit on the LC.12 It is important to note that the banks and financial institutions often allocate limits against which LCs are issued in favor of the customers to affect the payment in international trade. There are various types of LCs however revocable LCs are not considered as good because they are not good in securing payment.3 LC is therefore a sort of promise by the bank that in case of the non-payment by the importer, payment will be made to the exporter by the borrower under the circumstances. The relationship between the issuing bank of the LC and the beneficiary who is going to receive the proceeds of LC is therefore governed by the law of contract.4 Laws Relating to the Letter of Credits According to legal rulings, letter of credit is considered as “the life blood of international commerce”5and as such the importance of Letters of Credit in International trade6 is widely recognized in different cases at International as well as national level. A letter of credit is legally binding agreement and is considered as a contract7 for the purpose of law. A letter of credit is also termed as of Sui Generis contractual nature.8 The obligor therefore has to pay the stipulated amount under the credit when the bill against such credit matures.9 As discussed above that there are two sets of rules that govern the international trade including UCP 600 and Inco terms. Both the sets of regulations are issued by the International Chamber of Commerce which is binding on the member countries. However, UCP laws need to be incorporated in the member countries too otherwise they may not be binding on the member States. It is also critical to note that the rights and obligations of both the parties are not affected even if UCPs are not incorporate as English Courts mostly take into account the mercantile customs and practices though UCP is not in force in England. As discussed in Royal Bank of Scotland Plc v Cassa di Risparmio delle Provincie Lombard10, UCP are not the statutory code and as such any deviations from the accepted principles under UCP must have the express consent of both the parties. This case therefore vividly portrays the role of UCP in governing the transactions that take place through Letter of Credits. UCP rules itself express under Article- I of UCP 500 that these rules, though are binding on each of the party to the transaction including Banks however, it is not necessary that the parties cannot deviate from the rules if they expressively desire so to deviate from the accepted UCP principles under any circumstances. Though such deviation may strip parties from any rights or increase the risk. Doctrine of Strict Compliance There are three most important principles under the law that governs the documentary credit. They are: 1. Documentary nature of instruments 2. The doctrine of strict compliance11 3. Principle of Autonomy12 Above three principles indicate that the beneficiary is entitled to receive full payment provided he provides complying documents and make a demand for payment.13 The doctrine of strict compliance requires that the banks shall examine the documents with utmost care and accept only those documents that are strictly in accordance with the terms and conditions as stipulated in the credit.14 Thus the doctrine of strict compliance give the banks a right to refuse those documents which are not drawn in strict compliance with the terms and conditions outlined in the credit and as such, in order to affect the payment or release of goods, it is binding on both the parties i.e. exporter and importer, to change the information presented in the documents according to what is stated in the terms of credit.15 It is also critical to note that the doctrine of strict compliance is given the due weightage in letters of credit owing to the agency law. It therefore requires that the issuer of the documentary credit must act within the mandate given to him and secondly the bank shall only obtain those documents which are perfectly marketable and can be used under the circumstances wherein goods are lost or destroyed. 16 In cases such as expiry of the credit before the presentation of the documents, courts often rule in favor of the banks because banks, under the doctrine of strict compliance, are not required to obtain the documents which does not match with the terms and conditions stipulated in the credit.17 Conclusion There are different ways to finance the international trade however, letter of credit or documentary credit is one of the most important and commonly used methods of financing and executing the transactions at the international level. Letter of credit is basically a written commitment from the issuer- mostly a bank- that in case the importer of the goods fails to pay the exporter, bank will affect the payment in favor of the exporter. In this way, the risk involved in the international trade is reduced and both the parties to the transaction are protected. This also because of the fact that the governing of letter of credit is done under the Uniform Customs and Practices issued by the International Chamber of Commerce which are supposed to be followed by the member States and as such they govern most of the transactions. It is however, also important to note that the UCPs are not binding unless incorporate into the country and in UK they are not in force. Under the doctrine of strict compliance, banks are only required to obtain the documents that are only in conformity with the terms and conditions stipulated in the credit and as such banks are not entitled to obtain the documents and affect the payments against the documents which are faulty and do not comply with the terms and conditions. This doctrine therefore protects the banks from affecting the payments against the faulty documents and protects itself against any adverse situation. Read More