Document against payment

What Is Document against Payment?

Document against payment (D/P) is a method of payment used in international trade where an exporter instructs their bank to release shipping documents to an importer only upon receipt of payment. This arrangement falls under the broader category of International Trade Finance, specifically a type of documentary collection. In a D/P transaction, the importer must pay the specified amount, usually at sight, before gaining possession of the documents needed to clear the goods through customs and take delivery. This method provides a level of security for the exporter, as they retain control over the goods until payment is made¹⁸, ¹⁹.

History and Origin

The practice of using banks as intermediaries to facilitate international payments has a long history, evolving from early forms of trade finance like bills of exchange. The origins of trade finance date back thousands of years to Mesopotamia, with early examples of instruments akin to bills of exchange found on Babylonian clay tablets around 3000 BC. Extensive use of trade finance for importing and exporting goods, particularly with distant lands, became more prevalent during the Roman era, significantly aiding the expansion of the Roman Empire and merchant operations¹⁷.

The formalized system of documentary collections, including documents against payment, developed as international commerce became more complex and standardized practices were needed to mitigate risks. The International Chamber of Commerce (ICC) plays a crucial role in standardizing these practices. The latest revision of the rules governing documentary collections, known as the Uniform Rules for Collections (URC 522), came into effect on January 1, 1996¹⁶. These rules outline the procedures banks should follow for both documents against acceptance (D/A) and document against payment (D/P) transactions, helping to resolve operational problems faced by practitioners¹⁵.

Key Takeaways

Document against payment (D/P) requires an importer to pay for goods before receiving the necessary shipping documents.
It offers the exporter a degree of security by ensuring payment before the importer gains control of the goods.
D/P transactions are governed by the Uniform Rules for Collections (URC 522) established by the International Chamber of Commerce (ICC).
While offering more security than an open account transaction, D/P provides less payment assurance than a letter of credit.
Key parties involved include the exporter, importer, the exporter's bank (remitting bank), and the importer's bank (collecting bank).

Interpreting the Document against Payment

In a document against payment arrangement, the interpretation is straightforward: the release of critical shipping documents is conditional upon the importer making the payment. This means the importer cannot take possession of the goods until the payment obligation, typically a sight draft, is fulfilled. For the exporter, this offers a significant degree of control, as they maintain ownership of the goods, via the documents, until funds are received. It acts as a middle ground in terms of payment risk between the high risk of an open account and the higher security of a letter of credit¹⁴.

Hypothetical Example

Consider a scenario where a bicycle manufacturer, "Pedal Power Inc." (the exporter) in Vietnam, sells a shipment of bicycles to "City Cyclers Ltd." (the importer) in the United States. They agree to use document against payment terms.

Pedal Power Inc. ships the bicycles and receives a bill of lading and other commercial invoice documentation from the carrier.
Pedal Power Inc. then presents these documents, along with a collection instruction, to its bank, the remitting bank, with instructions to release them to City Cyclers Ltd. only upon payment.
The remitting bank forwards the documents to City Cyclers Ltd.'s bank, the collecting bank, in the United States.
The collecting bank notifies City Cyclers Ltd. that the documents have arrived and payment is due.
City Cyclers Ltd. inspects the documents (not the goods) and, if they are in order, makes the payment to the collecting bank.
Upon receiving the payment, the collecting bank releases the bill of lading and other shipping documents to City Cyclers Ltd.
With the bill of lading, City Cyclers Ltd. can now claim the bicycles from the shipping company at the port of destination.

In this example, Pedal Power Inc. ensures it receives payment before City Cyclers Ltd. can take physical control of the bicycles, reducing its immediate payment risk.

Practical Applications

Document against payment is commonly applied in international trade transactions where there is an established level of trust between the exporter and the importer, but the exporter still desires more assurance than an open account. It is often chosen for its balance between security and cost-effectiveness compared to more complex methods like a letter of credit ¹³.

This payment method is particularly suitable for:

Transactions where the exporter has a long-standing business relationship with the importer and is confident in their ability and willingness to pay.
Situations where the goods are standardized and easily resold, reducing the risk for the exporter if the importer refuses to pay.
Cross-border sales involving goods with relatively short transit times, as delays in payment could result in higher storage costs at the destination port.

Banks act as facilitators, handling the flow of documents and funds, thereby streamlining the process for both parties¹². The framework for these transactions is provided by the Uniform Rules for Collections (URC 522), which are followed by a significant majority of the world's banks¹¹.

Limitations and Criticisms

While document against payment offers advantages over an open account transaction, it is not without limitations. A primary criticism is that the bank facilitating the collection acts merely as a conduit for documents and funds, offering no payment guarantee to the exporter. Unlike a letter of credit, if the importer refuses or is unable to pay upon presentation of the documents, the remitting bank and collecting bank are not obligated to make the payment¹⁰.

This exposes the exporter to several potential payment risks:

Refusal of Payment: The importer might refuse to pay if, for example, they face financial difficulties, a change in market demand, or a dispute over the goods. In such cases, the goods remain at the destination port, and the exporter faces the costs and complications of either finding an alternative buyer in the destination country, arranging for return shipment, or abandoning the goods⁹. This can lead to significant financial losses, especially for custom-made or perishable goods⁸.
Document Discrepancies: Although banks in a documentary collection typically do not verify the authenticity or accuracy of the underlying goods, minor discrepancies in the shipping documents can provide the importer with a reason to delay or refuse payment⁷.
Country Risk: Political or economic instability in the importer's country could lead to issues like foreign exchange controls, preventing the importer from making payment even if willing⁶.

Therefore, document against payment requires a degree of trust in the importer's financial standing and a stable political environment in their country⁵.

Document against Payment vs. Documents against Acceptance

Document against payment (D/P) and documents against acceptance (D/A) are both forms of documentary collection but differ fundamentally in the timing of payment relative to the release of shipping documents.

In a Document against Payment (D/P) transaction, the importer must make immediate payment (at sight) to the collecting bank before they can receive the documents needed to take possession of the goods. This provides the exporter with higher security as they retain control of the goods until payment is received⁴.

Conversely, in a Documents against Acceptance (D/A) transaction, the importer receives the shipping documents from the collecting bank in exchange for accepting a time draft or bill of exchange. By accepting the draft, the importer legally commits to paying the exporter on a specified future date, typically 30, 60, or 90 days after sight or a fixed date. This effectively grants the importer a period of trade credit, allowing them to take possession of and potentially sell the goods before payment is due. The risk to the exporter is higher with D/A compared to D/P, as they release control of the goods without immediate payment³.

The key distinction lies in the timing: D/P is a "pay first, get documents later" method, while D/A is an "accept to pay later, get documents now" method.

FAQs

What types of documents are typically involved in a document against payment transaction?

A typical document against payment transaction involves several shipping documents essential for the importer to take delivery of the goods. These commonly include the bill of lading, which serves as a title to the goods, a commercial invoice detailing the sale, a packing list, and sometimes an insurance certificate or certificate of origin.

Is document against payment risk-free for the exporter?

No, document against payment is not risk-free for the exporter. While it reduces the risk of non-payment compared to an open account, the exporter still faces the risk that the importer may refuse to pay after the goods have arrived at the destination. If this happens, the exporter must decide whether to find an alternative buyer, ship the goods back, or abandon them, incurring potential losses².

How does document against payment differ from a letter of credit?

Document against payment (D/P) relies on the importer's willingness and ability to pay, with the banks acting solely as intermediaries for document and fund exchange. A letter of credit, by contrast, is a binding undertaking by a bank (the issuing bank) to pay the exporter, provided that the exporter presents compliant documents. This means the bank assumes the payment risk, offering a much higher level of security to the exporter than D/P¹.