Chapter Summary

A. FINANCING FOREIGN TRADE

This chapter examines both the mechanism of financing foreign trade and the sources of
foreign trade financing. To understand international trade, one has to be familiar with the
documents, trade terms, and financing arrangements used in international sales.
International Trade Documents
The most important documents used in international trade are: (a) bills of lading, (b) bills of
exchange and promissory notes, and letters of credit.
B. BILLS OF LADING
The form and function of the bill of lading was discussed in Chapter 10.
C. BILLS OF EXCHANGE
bill of exchange is a written, dated, and signed instrument that contains an unconditional
order from the drawer that directs the drawee to pay a definite sum of money to a payee on
demand or at a specified future date. !t is an important tool in international trade because it is
a negotiable instrument, that is, an instrument that can be transferred free of most claims or
defenses that the drawer might ha"e. #egotiability ma$es a bill of exchange more readily
salable, and therefore a useful financial tool for raising money.
The Law Governing Bills of Exchange
There are three principal laws that go"ern most bills%of%exchange transactions in the world
today. These are: (1) the &nglish Bills of Exchange Act ('&) of 1(() which is in force in the
*nited +ingdom and in "irtually all of 'ritain,s former colonies- ()) the Uniform Commercial
Code (*CC) which has been adopted in most of the *nited .tates- and (/) the 10/0 Uniform
Law on Bills of Exchange and Promissory Notes (*1') which has been adopted by most
&uropean countries. The first two of these are remar$ably similar % the merican *CC was
based on the &nglish '& % but the third, the *1', is substantially different from the nglo%
merican rules.
Types of Bills of Exchange
The form that bills of exchange must ta$e depends on the go"erning law. The nglo%
merican laws re2uire only that a bill be in writing and be payable to order or to bearer. The
*1' adds to this the re2uirements that a bill: (a) contain the term 3bill of exchange3 in the
body and language of the chec$, (b) state the place where the bill is drawn, (c) state the place
where payment is to be made, and (d) be dated.
'ills ta$e se"eral particular forms. These include 3time bills,3 which are payable at a definite
future time- 3sight bills3, which are payable on presentment or at a stated time after
presentment- 3trade acceptance,3 where the the drawer and the payee are the same person- and
3chec$s,3 where the drawee is a ban$.
D. PROMISSORY NOTES
promissory note is a promise made by a ma$er to pay a determinate sum of money to a
payee. !t is not a bill of exchange because there is no third party drawee. !t is, howe"er,
go"erned by the same rules.
#otes are used in a "ariety of credit transactions and are commonly gi"en the name of the
transaction in"ol"ed. 3Collateral notes3 are secured by personal property- 3mortgage notes3
are secured by real property- 3installment notes3 are payable in installments- and 3certificates
of deposit3 are promises by a ban$ to repay money recei"ed.
E. NEGOTIABILITY OF BILLS AND NOTES
'ills of exchange and promissory notes may be either negotiable or nonnegotiable. 4owe"er,
for trade to run smoothly, especially international trade, these instruments need to be
negotiable. 5or a bill or note to be negotiable, it must (a) be in the proper form (as described
abo"e), and (b) contain a promise by the ma$er or drawer to ma$e payment. To meet the
promissory re2uirements, a bill or note must (1) state an unconditional promise or order to
pay, ()) state a definite sum of money or a monetary unit of account- (/) be payable on
demand or at a definite time, and (6) be signed by the ma$er or drawer.
Unconditional Promise or rder to Pay
5or a bill or note to be negotiable, it must contain an affirmati"e promise to pay made either
as promise by a ma$er or as an order by a drawer to a drawee. The promise may not be
implied. !t also may not be conditioned upon the performance of some other obligation.
4owe"er, mere reference to some other agreement (such as the fact that the ma$er,s
performance is secured by a mortgage) does not ma$e a bill or note nonnegotiable.
Definite !um of "oney or "onetary Unit of #ccount
The *1' specifies that the sum paid must be 3money3 (i.e., the currency of any go"ernment).
The common law allows for the sum paid to be money or a monetary unit of account (that is,
a money of account established by an intergo"ernmental institution or by agreement between
two or more states).
The sum must be 3certain,3 3determinate,3 or 3definite.3 !n other words, the amount to be paid
has to be ascertainable from the bill or note itself without reference to an outside source.
Paya$le on Demand or at a Definite Time
The time when a bill or note is payable has to be ascertainable from its face.
!igned $y the "a%er or Drawer
'ills of exchange must be signed by the drawer, and promissory notes by their ma$er.
signature is 3any symbol executed or adopted by a party with present intention to authenticate
a writing.3
F. THE NEGOTIATION AND TRANSFER OF BILLS AND NOTES
7nce a negotiable instrument circulates beyond the original parties, the laws go"erning
negotiation apply.
#ssignment
n assignment is the transfer of rights under a contract. 8hen an assignment is made, the
assignee ac2uires only those rights that the assignor possessed. dditionally, all ob9ections to
honoring the assigned obligations that could be raised against the assignor can be raised
against the assignee.
&egotiation
The negotiation of a bill or note is its transfer in such a way that the recipient becomes a
holder. *nli$e an assignee (who only ac2uires the rights of the assignor), a holder can ac2uire
more rights from the transferor than the transferor possessed. The rights which a holder
ac2uires depends on the manner in which the instrument was negotiated, and the go"erning
law.
'ills and notes which are 3order paper3 name the payee or endorsee who is to be paid. 7rder
paper is negotiated by deli"ery and endorsement. 'ills and notes which are 3bearer paper3 do
not designate a person to be paid (they are instead made out to 3bearer,3 or to 3cash,3 or are
endorsed without naming an endorsee). 'earer paper is negotiated by deli"ery alone.
8hen endorsements are added to a bill or note, they may be one of four $inds: (1) special
endorsements, ()) blan$ endorsements, (/) 2ualified endorsements, and (6) restricti"e
endorsements. .pecial endorsements name an endorsee to be paid- blan$ endorsements do
not. 2ualified endorsement states that the endorser does not guarantee that the instrument
will be accepted or paid. :estricti"e endorsements limit the rights of subse2uent holders in
some way, such as conditioning payment on the occurrence of a specified e"ent, or ma$ing
the endorsee a collection agent, or ma$ing the instrument payable only to a particular person-
or re2uiring the endorsee to pay the proceeds to the endorser or to some third party.
'orged Endorsements
5orged endorsements are treated differently by each of the principal laws regulating bills and
notes. The *1' ma$es a forged endorsement fully effecti"e, and both the person ta$ing an
instrument with such an endorsement, as well as all subse2uent holders, are entitled to
payment. The nglo%merican rules ma$e the person best able to pre"ent the forgery from
happening liable for payment. ;enerally, this is the endorsee, who is re2uired to $now who
the endorser is. There are two exceptions, howe"er. The drawer, ma$er, or endorser who
transfers an instrument to either an impostor or fictitious payee is liable for payment because
they were in a better position than the subse2uent endorsee to pre"ent the forgery.
Limitations on the Excuses that Drawers and "a%ers (an Use to #void Paying ff a
Bill or &ote
8hen a bill or note is properly negotiated, drawers and ma$ers must pay the person
presenting the instrument for payment. The excuses that drawers and ma$ers can use for not
paying nonnegotiable instruments are se"erally limited when an instrument is negotiable. The
most extensi"e limitations are those contained in the *1'. nyone who ac2uires a bill or note
by negotiation is a holder who is entitled to payment from the ma$er or drawer. There are
only three excuses a"ailable to these parties: (1) that the possessor is not a holder because he
did not ac2uire title through an uninterrupted series of endorsements, ()) that the holder
ac2uired the instrument in bad faith, and (/) that the holder ac2uired the instrument through
gross negligence.
The nglo%merican rules impose, by contrast to the *1', "ery few limitations on the
excuses that ma$ers and drawers can use to get out of their obligation to pay off a bill or note.
To a"oid these excuses, a possessor must first be a holder, that is, someone who ac2uired the
bill or note through an uninterrupted series of endorsements. person who is not a holder is
not entitled to the instrument and must gi"e it up.
8hen the possessor of a bill or note is an ordinary holder, a ma$er or drawer can draw upon a
lengthy list of excuses for not paying, including: breach of contract, failure of consideration,
incapacity, duress, fraud, forgery, material alteration, illegality and discharge in ban$ruptcy.
The list is narrowed (to the last six items), howe"er, if the holder can pro"e that he is entitled
to the additional status of a holder in due course (4<C). n 4<C is a holder who ac2uires an
instrument for "alue, in good faith, and without notice that it is o"erdue, that it has been
dishonored, or that the ma$er, drawer, or a prior endorser has a "alid excuse for not paying it
off.
Lia$ilities of "a%ers) Drawers) Drawees) Endorsers) and #ccommodation Parties
There are two $inds of liability that are imposed on ma$ers, drawers, and endorsers of bills
and notes: 3signature3 liability and 3warranty3 liability. person who signs an instrument has
a contractual obligation to ma$e payment. 5or ma$ers and drawees, this
obligation is 3primary,3 that is, they must ma$e payment on presentment of the instrument.
5or drawers and endorsers, the liability is 3secondary3- in other words, they only ha"e to pay
if the ma$er or drawee fails to do so.
The *1' does not impose warranty liability on endorsers, which is a form of liability uni2ue
to the nglo%merican laws. The warranties found in the '& and the *CC are: good title,
the signatures are genuine, the instrument has not been materially altered, no $nown defenses,
and no $nowledge of insol"ency proceedings that would affect the rights of the endorsee.
The *ole of Ban%s in (ollecting and Paying &egotia$le Instruments
'an$s may perform at least four functions in connection with the negotiation of bills and
notes: (1) as the issuer of their own instruments (e.g., certified chec$s), ()) as a drawee or
acceptor (thereby assuming primary liability for payment), (/) as an agent for a holder or
transferee (to ma$e collection), and (6) as an endorsee (who pays the endorser and then
presents the instrument for payment in their own right).
G. LETTERS OF CREDIT
letter of credit is an instrument issued by a ban$, or other person, at the re2uest of a person
called an account party. This instrument is a conditional agreement between the issuer and the
account party that is intended to benefit a third party. The issuer is obliged to pay a bill of
exchange drawn by the account party, up to a certain sum of money, within a stated time
period and upon presentation by the beneficiary of documents designated by the account
party.
The function of the letter of credit in international sales transactions is to substitute the credit
of a recogni=ed international ban$ for that of the buyer. !n such an underta$ing, the buyer is
the account party, the buyer,s ban$ is the issuing ban$, and the beneficiary is the seller.
Governing Law
The go"erning law for letter of credit transactions, e"en in most domestic transactions, is the
!nternational Chamber of Commerce,s Uniform Customs and Practices for Documentary
Credits (*C>). 8hile it is neither a treaty nor a legislati"e enactment, most ban$s incorporate
the *C> in the terms of the credits they issue.
#pplying for a Letter of (redit
The terms of a letter of credit are specified by the account party in an 3application3 which, if
accepted by the issuer, becomes the agreement go"erning the relationship not only of the
account party and issuer, but also the relationship between the issuer and the
beneficiary. 8hile a letter of credit does not ha"e to be in any particular form, it does need to
be (a) in writing, (b) signed by the issuer, and (c) complete and precise.
Documentary 'ormalities
1etters of credit must also clearly indicate if they irre"ocable. .hould there be any doubt,
credits will be interpreted as being re"ocable. They must additionally indicate when and how
they are to be paid. 5inally, they must also name the ban$ which is authori=ed to pay the
credit, to accept bills of exchange drawn in accordance with the letter, or to negotiate the
credit.
#dvising and (onfirming Letters of (redit
7nce a ban$ issues a letter of credit, it will commonly deli"er the instrument to a
correspondent ban$ located in the beneficiary,s country, which will in turn deli"er the credit
to the beneficiary. This ban$ assumes no liability for paying the letter of credit. n issuing
ban$ may also re2uest another ban$ to confirm an irre"ocable letter of credit. confirmation
is an independent promise by a second ban$ that it will pay, accept, or negotiate a credit, as
appropriate, when the documents specified in the credit are presented to it and the other terms
and conditions of the credit ha"e been complied with.
The $ligations of Ban%s
n issuing ban$ or any ban$ that is re2uired to pay, accept, or negotiate a letter of credit is
obliged to do so solely on the basis of the documents presented by the beneficiary. s long as
the documents appear regular on their face, the ban$ must pay. ban$ is not to concern itself
with matters 3off the document,3 such as the condition of the goods in"ol"ed in the
underlying transaction, or e"en their existence.
!n determining whether the documents are in order, a ban$ is entitled to apply the so%called
3rule of strict compliance.3 !n other words, a ban$ may re9ect documents that do not exactly
comply with the terms specified in the letter of credit. s a practical matter, in cases where
only a minor discrepancy exists, ban$s will commonly obtain a written wai"er from the
account party. !f there is a ma9or discrepancy or if the seller is unable to perform as originally
agreed, ban$s will commonly arrange for the account party to ma$e an amendment.
'ecause ban$s are re2uired only to ta$e into consideration the documents presented by the
beneficiary, they are allowed to pay on a letter of credit e"en if they are aware that the
beneficiary has perpetrated a fraud on the account party. !n fact, most courts ha"e held that a
ban$ must pay in such a case, and is liable if it fails to do so.
*ights and *esponsi$ilities of the #ccount Party
The account party,s rights and obligations are based on two contracts: (1) the underlying
contract with the beneficiary, and ()) the contract with the issuing ban$ relating to the letter of
credit. !ts rights under the first contract are determined by ordinary contract law. !ts rights
under the second are limited by international practice.
The main limitation on an account party,s rights under the contract with the issuing ban$ is the
doctrine of pri"ity. That is, because the account party is only in pri"ity with the issuing ban$,
it can only loo$ to the issuing ban$ for performance. The account party has no rights "is%?%"is
any other ban$.
*ights and *esponsi$ilities of Beneficiaries
The right of a beneficiary to collect on a letter of credit is based, not on contract, but on
commercial practice. &ssentially, to collect on the credit, a beneficiary must comply with its
terms and conditions of the credit and present to the issuer (or the issuer,s agent) the
documents designated in the credit.
H. FINANCING FOREIGN OPERATIONS
The money needed to finance a multinational enterprise can be raised from a "ariety of
sources, including the company,s own internal funds. !nternal funds are not always enough,
howe"er, and companies in such cases turn to the world,s capital mar$ets and to go"ernmental
and intergo"ernmental in"estment and de"elopment programs.
Private !ources of (apital
>ri"ate sources of capital funding were discussed in Chapter (.
Governmental !ources of (apital
;o"ernmental sources of capital can be found in both the host and the home country. @ost
host countries ha"e de"elopment ban$s that pro"ide low%interest%rate long%term loans to
foreign in"estors. @ost de"eloped countries ha"e a "ariety of agencies that finance imports
and exports. &xamples of *nited .tates agencies include: the gency for !nternational
<e"elopment (!<), the 7"erseas >ri"ate !n"estment Corporation (7>!C), and the &xport%
!mport 'an$.
*egional and International Development #gencies
'oth regional intergo"ernmental agencies as well as international agencies underwrite
multinational in"estments. :egional de"elopment ban$s exist for frica, sia, &urope,
merica, and the !slamic countries.
The world,s de"elopment ban$ is the !nternational 'an$ for :econstruction and <e"elopment
(!':<), commonly called the 8orld 'an$. The 8orld 'an$ has two subsidiary agencies: (1)
the !nternational <e"elopment ssociation (!<) and ()) the !nternational 5inance
Corporation (!5C). 'oth the 8orld 'an$ and the !< pro"ide funds directly to go"ernments,
while the !5C pro"ides funds to pri"ate companies.
Words and Phrases
d"ising 'an$
gency &ndorsement
ssignment
'earer >aper
'ill of &xchange
'ill of 1ading
'ills of &xchange ct
Certificate of <eposit
Chec$
Conditional &ndorsement
Confirming 'an$
<ebt 5unding
<ocuments gainst cceptance
<ocuments gainst >ayment
&ndorsement
&ndorsement for Collection
&ndorsement >rohibiting 5urther &ndorsements
&2uity 5unding
5ictitious >ayee :ule
4older
4older in 'ad 5aith
4older in <ue Course
!mpostor :ule
1etter of Credit
@onetary *nit of ccount
#egotiation
7rder >aper
>resentment
>romissory #ote
>rotest
Aualified &ndorsement
:estricti"e &ndorsement
:ule of .trict Compliance
.ight 'ill
.tandby 1etter of Credit
Time 'ill
Trade cceptance
Practice Questions
True+'alse
1. T 5 Trade documents are used in international trade because buyers and sellers are
separated both in distance and by the differing financial practices of their home
countries.
). T 5 bill of exchange is a two%party instrument. That is, it contains a promise from
a ma$er to pay a payee.
/. T 5 @a$ers and drawees of negotiable instruments (bills of exchange and
promissory notes) ha"e 3primary3 liability (that is, they must ma$e payment on
presentment of the instrument).
6. T 5 confirmed letter of credit allows for the bills of exchange designated in the
letter of credit to be negotiable at any ban$.
B. T 5 n ad"ising ban$ is a ban$ that independently promises that it will pay, accept,
or negotiate a letter of credit when the documents specified in the credit are
presented to it and the other terms and conditions of the credit ha"e been
complied with.

"ultiple (hoice
C. ccording to the Uniform Law on Bills of Exchange and Promissory Notes
(*1') of 10/0, a bill of exchange must:
a. contain the term 3bill of exchange3 in the body of the instrument.
b. contain the term 3bill of exchange3 in the language of the instrument.
c. state the place where the instrument was drawn.
d. ll of the abo"e.
e. 'oth a. and b. abo"e.

D. promissory note which is secured by personal property is $nown as aEan:
a. certificate of deposit.
b. collateral note.
c. installment note.
d. mortgage note.
e. #one of the abo"e.

(. *nder which of the following laws is the drawer of a bill of exchange, after
paying a forged instrument, allowed to reco"er from the endorsee who too$ the
instrument from the forgerF
a. Convention on International Bills of Exchange and International Promissory
Notes (C!'#) of 10((.
b. English Bills of Exchange Act ('&) of 1(().
c. Uniform Law on Bills of Exchange and Promissory Notes (*1') of 10/0.
d. United tates Uniform Commercial Code (*CC).
e. 'oth b. and c.

0. *nder which of the following laws does the transferor of a negotiable
instrument ha"e 3warranty liability3F
a. Convention on International Bills of Exchange and International Promissory
Notes (C!'#) of 10((.
b. English Bills of Exchange Act ('&) of 1(().
c. Uniform Law on Bills of Exchange and Promissory Notes (*1') of 10/0.
d. United tates Uniform Commercial Code (*CC).
e. 'oth a. and d.

10. letter of credit obtained by a seller naming the buyer as the beneficiary is
called:
a. clean.
b. confirmed.
c. re"ol"ing.
d. standby.
e. #one of the abo"e.

Essay
11. .eller has a confirmed letter of credit it recei"ed from 'uyer for the sale to 'uyer of 1,000
bales of ;rade cotton. The letter of credit re2uired .eller to deli"er a carrier,s bill of lading
and a certificate of inspection to the confirming ban$ before the ban$ was allowed to pay on
the credit. The cotton that .eller shipped was defecti"e and .eller had to bribe the carrier in
order to obtain a clean bill of lading and the inspection ser"ice in order to get a satisfactory
certificate. 'ecause .eller has a long%time relationship with the confirming ban$, .eller told
the ban$ about the bribes. The confirming ban$, which was depending on .eller to recei"e the
money from the sale of the cotton to pay off a debt the .eller owed to the ban$, paid on the
letter of credit anyway. (ctually, it too$ the credit as payment in full on the debt .eller owed
it.) The confirming ban$ then forwarded the credit to the issuing ban$ as$ing for
reimbursement. The issuing ban$, which had been tipped off about what had happened by an
employee of the carrier, refused to pay. The confirming ban$ then sued the issuing ban$,
demanding reimbursement. 8hat should the court,s decision beF &xplain.