This is a guest post from Renaud Anjoran. Renaud runs a product quality inspection business in Shenzhen and he also writes the truly excellent and perinially helpful Quality Inspection Tips. My firm has worked with Renaud on a number of China product matters and we have consistently found him to be highly knowledgeable about China product sourcing. This post arose from a long email “conversation” between co-blogger Steve Dickinson and Renaud, which ended as so many of those do: with me suggesting that it be turned into a blog post.
So here’s the blog post, written by Renaud Anjoran.
Most transactions with Chinese suppliers are done through bank transfers. This payment method was described in a previous China Law Blog post, China Manufacturing Payment Terms. Limit Your Risks.
Many importers/foreign manufacturers are not familiar with Letters of Credit (LC) as an alternative to bank transfers. Letters of Credit were designed to protect both product buyers and product supplier in international trade. In practice, they are usually more favorable to the buyer.
How a letter of credit protects the buyer
An importer that pays by LC does not have to wire a deposit before production and it usually has the option to cancel the payment in the following cases:
- If a supplier does not ship at the right time. Typically if this happens, the LC simply expires, but the buyer still has the choice to pay if it wants the goods.
- If a supplier does not honor the product specification or if there are too many defects. One of the conditions of the LC should be that the LC will not be paid on unless and until the product buyer has signed off on product quality or a specified third party QC agency has issued its certificate of inspection.
- If the seller fails to provide any document listed as required in the LC or the documents do not fully conform to the LC’s requirements.
Why letters of credit can be cancelled by the buyer in most cases
Even something as small as a typo in the LC, or the fact that a quantity is written in dozens rather than in pieces in the invoice is usually enough to cause a discrepancy in the LC, which in turn allows the buyer to cancel payment.
In practice, a small minority of LCs are “clean,” i.e., without any discrepancy. In all other cases, the buyer has the option to refuse payment and cancel the transaction, even if the goods are already on a boat (in which case the buyer will not get the documents to get the products out of custom).
CLB Note: We are aware of a Seattle buyer company that refused goods that had already arrived in Seattle because the street address (which was irrelevant) of one of the parties in the letter of credit was off by a single letter.
Tips for negotiating payment by letter of credit
For the reasons mentioned above, Chinese suppliers typically refuse to accept Letters of Credit. Here is how you can increase your chances of finding a Chinese company that accepts this payment method:
- When sourcing your product, try to identify as many potential suppliers as possible. This will at least increase your chances of finding one that will accept an LC.
- In your first conversation with your potential suppliers, mention that you always pay by LC on your first order. Try to get the supplier to accept this payment method in writing
- Sell your project to your potential suppliers. Good manufacturers are inundated with customer inquiries, so you need to make yourself stand out. Explain why they should work with you. Call the Chinese company’s sales manager if necessary
- Send your potential Chinese manufacturer a draft of the LC before opening it. You will usually need the commercial invoice, the packing list, the certificate of origin and/or GSM form A, the bill of lading, and an inspection certificate. Try to avoid putting “soft terms” into your Letter of Credit that will make it even more difficult for suppliers to collect payment.
- If possible, use a major international bank. This will tend to reassure your suppliers.
- Unfortunately, bank fees are much higher for an LC than they are for a bank wire, so an LC only makes sense for transactions of at least USD$30,000.
- Chinese exporters are good at guessing whether a project is likely to become a source of long-term business. When they see what they think will be a a one-shot deal, they generally insist on getting a deposit and will not agree to an LC payment arrangement.
In summary, Letter of Credit are a payment tool that makes it unnecessary to transfer a 30% (or more) deposit to your Chinese manufacturer. They are usually more favorable to the buyer’s side, and for that reason, many Chinese companies refuse to accept them. But some Chinese product suppliers have been paid via Letters of Credit from some of their foreign customers for years, and sometimes Chinese manufacturers will accept your Letter of Credit if they really want your orders.
What do you think?