Padhy Leather:

Minimizing Commercial Risk Through a letter of credit

Course Number: OMIS 6310 X

Course Name:, Managing International Trade In Supply Chains

Instructor: Prof. Tony Bejjani

Assignment due date: 13th March, 2023

Submitted By

Sara Alsharef (219674340)

Apeksha Arora (215274574)

Afsaneh Khandan (219290394)

Ashish Kumar (219984384)

Ahmed Sikdar (213427703)

Padhy Leather | Team 6 1

Table of Content

Executive Summary……………………………………………………………………………………………………………………3

Introduction……………………………………………………………………………………………………………………………….4

Concerns for Importers & Exporters……………………………………………………………………………………………5

Mohanty’s business decision problem………………………………………………………………………………………..6

Payment options in International Business…………………………………………………………………………………6

Risks in International Trade………………………………………………………………………………………………………..9

Risks for exporters having clients in Developed Countries…………………………………………………………11

Payment method for mitigating Commercial Risk…………………………………………………………………….12

Mechanics of Documentary Letter of Credit (DLC)……………………………………………………………………13

Recommendation…………………………………………………………………………………………………………………….15

Conclusion……………………………………………………………………………………………………………………………….16

References……………………………………………………………………………………………………………………………….17

Padhy Leather | Team 6 2

Executive Summary

The Padhy Leather case is a prime example of the situations usually faced by the entrepreneurs, especially

the new entrants to the market. The business development manager Puja Mohanty’s key role with the

company is to negotiate the trade contract with the foreign suppliers and of machines & raw materials.

In addition, a part of her responsibilities is to minimize the risk of international trade which includes

concerns regarding non-payment and default risk. The case discusses how the seminar regarding exports

from India turns out to be a great source of vital knowledge related to international trade risks, methods

of payment and mitigation strategies. The key questions discuss the dilemmas of importers and exporters

in international trade which includes commercial risk, carriage risk, currency risk, country risk and

compliance risk. The next step discusses the problem of the business development manager in detail. Her

priority remains at developing new business clients but minimizing the risk at the same moment. Her

major concern is that not all the new clients agree to 100% payment before shipment of the products and

as a result, the company is losing potential customers. Moving ahead, focus shifts to the modes of

payment and what are the merits and demerits for importers & exporters.

The different modes include Clean Payment and various Letter of Credit (LC) options. We have also

discussed the various risks attached to international trade and how they are different from domestic

trade. The description also includes the mitigation plan that the company could follow in future to avoid

any risks. The analysis discusses the major risks specific to exporters dealing with new clients in developed

countries. This scenario is specific to M/S Padhy Leather Ltd. One of the common concerns with such

clients is nonpayment and payment default. We have also elaborated the useful mitigation plans in such

cases including the background check for the client, opening LC and taking up credit insurance to keep the

risk factor under control. Towards the end of the analysis, we have touched on the Documentary Letter

of Credit, its benefits to the company and how it safeguards the interest of exporters and works as a credit

enhancement tool for the importers. Finally, we have a recommendation for the company as to how they

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can approach the situation and the way in which Documentary Letter of Credit (DLC) would best suit the

situation of the company and help develop long lasting relationships with new overseas clients.

Introduction

The global market presents unique challenges and opportunities for small-scale businesses, particularly in

the context of international trade. This case study highlights the complexities of international trade and

the impact of market competition on small-scale businesses. This case study focuses on Padhy Leather

Ltd, a start-up in New Town, India that specializes in exporting leather garments. The company's business

development manager, Puja Mohanty, faces the challenge of expanding the company's export operations

while minimizing commercial risks associated with exporting to new and untested clients. Mohanty's main

concern is how to manage the risk of non-payment (commercial risk), which has led her to stipulate 100%

advance payment for almost all export orders. While this strategy provides some security, it also results

in the failure to firm up many contracts. Mohanty needs to find a way to minimize the risk of non-payment

while still being able to conduct business with new and untested clients.

This is a critical business decision because if Mohanty cannot find a way to reduce commercial risk, the

company's growth and profitability will be severely limited. One payment method that can help minimize

the commercial risk of non-payment is the use of a documentary letter of credit (DLC). This assignment

will describe the concept and mechanics of a DLC and its applications in international business. It will also

explain how a DLC works as a credit enhancement device for importers and a credit risk mitigating tool

for exporters. In addition, this case study will explore various payment methods in international trade,

identify risks, and explain how to manage them. To manage the risks associated with international trade,

businesses like Padhy Leather Ltd can benefit from conducting thorough market research, partnering with

reputable freight forwarders, and connecting with local organizations or trade associations.

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1. Describe the dilemmas or concerns of buyers/importers and sellers/exporters in international trade

Buyers/importers and sellers/exporters both face various dilemmas and concerns in international trade.

Some of these concerns include:

1. Commercial (Non-payment) risk: Sellers/exporters are concerned that they will not receive

payment for their goods, while buyers/importers are concerned that they will not receive the

goods they paid for. This risk can be minimized by using secure payment methods, such as a letter

of credit.

2. Carriage (transport) risk: This is the risk of damage or loss of goods during transportation. Both

importers and exporters are concerned about this risk, as it can result in financial loss. Buyers and

importers need to ensure that products are transported and delivered safely and efficiently, while

sellers and exporters need to ensure that products are packaged and labeled appropriately to

comply with regulations and minimize damage during transit.

3. Currency risk: Exporters may be concerned about the fluctuation of exchange rates, as it can

affect the value of their goods. Importers may also be concerned about currency risk, as they may

need to convert their currency into the exporter's currency to pay for goods.

4. Country (political and economic) risk: This risk is associated with the political and economic

stability of the countries involved in the transaction. Both importers and exporters may be

concerned about this risk, as it can affect the ability to conduct business and receive payment.

5. Compliance risk: This is the risk of non-compliance with regulations or laws in the importing or

exporting country. Both importers and exporters may be concerned about this risk, as it can result

in legal and financial penalties. Buyers and importers are concerned about compliance with local

regulations and import/export laws, while sellers and exporters need to ensure that their

products meet the standards and regulations of the importing country.

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2. Explain Mohanty’s business decision problem

Mohanty's business decision problem is how to minimize the commercial risks associated with exporting

leather garments to new and untested clients while still expanding the business and improving

profitability. The problem arises because Padhy Leather Ltd, is a startup that specializes in exporting

leather garments, and it needs to develop new markets and clients to grow and succeed. Mohanty has

been stipulating 100% advance payment for almost all export orders, which has been a major obstacle in

firming up many contracts because many new clients are unable to provide such upfront payments. This

approach has limited the company's ability to expand its customer base and increase its profitability.

Mohanty needs to find a way to minimize the risk of non-payment while still being able to conduct

business with new and untested clients. This is a critical business decision because if Mohanty cannot find

a way to reduce commercial risk, the company's growth and profitability will be severely limited. One

solution to Mohanty's problem is to use a letter of credit, which serves as a written commitment from a

bank on behalf of the importer to guarantee payment to the exporter for goods or services, provided that

the exporter complies with the terms and conditions specified in the letter of credit. This approach would

provide security and protection for both the importer and exporter, allowing Padhy Leather Ltd to expand

its customer base and improve profitability.

3. Explain the various payment options available in international business, and their relative merits and

demerits for exporters and importers

There are 3 methods of payments for international trade:

1. Clean Payments: This is when all shipping and commercial documents are dispatched directly

from exporter to importer with the bank playing a limited role of remitting the fund as needed.

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 a. Advance payments/Remittance: When the importer pays the full payment in advance to

the exporter. Such transfer work completely in the favor of the exporter and the importer

bears all risks if exporter fails to comply.

b. Cash on Delivery: The exporter ships the good to the importer’s address without taking

any advance payments. The payment is settled by the importer only once they receive

the goods. This method is highly favorable toward the importer and the exporter bears

all risks of non-payment or refusal of goods.

c. Open Account Sale: Used primarily when a long-term relationship between importer and

exporter exists. Open account simply means that the exporter sends the goods whenever

requested by the importer without taking any payments. The importer’s responsibility is

to settle all invoices with the exporter at the agreed upon future date. This type of trade

usually happens in a buyer’s market. In such a relationship, the exporter assumes most of

the risks and the importer assumes the least risk.

d. Consignment Sale: When finding a buyer is hard, an exported can choose consignment

sale as an option. In consignment sale, the goods are exported to an overseas selling agent

without any payment received from the selling agent. The selling agent tries to sell the

goods at the local market and only when the selling agent receives payment, they pay the

exporter. There is a great risk for the exporter when using a consignment sale and the

importer or selling agent assumes zero risks.

2. Bills for collection or Documentary Collection: Exporters and importers used the banking system

to move funds and documents. Exporter would ship the goods, however, all financial, commercial

and transport documents were sent through banks for collection.

a. Documents against payment: The exporter sends all necessary documents to the

collecting bank, who then releases the documents to the importer only once the importer

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 makes the payment for the goods. Hence no documents are released until payment is

made. This gives the exporter better control over the goods.

b. Documents against acceptance: The collecting bank releases the documents to the

importer only once the importer accepts the terms of payment. While no payments is

required to release the document the importer agrees to pay the exporter at a later date.

This method does not provide much control to the exporter, however, it allows the

exporter to take legal action if the importer defaults on the payment.

3. Documentary Credit or Letter of Credit: A letter of credit provides a guarantee from the

importer’s bank that if the importer fails to make the payment, the bank will pay the exporter.

The payment would only be made if the exporter fulfills their duties as per the agreement with

the importer. Using a letter of credit helps lower the risk of the exporter, since it is taking a risk

against the bank not the importer.

a. Sight and Term Letter of Credit: A sight LC is when the importer makes the payment at

the time of receiving the documents from the exporter. A term LC also known as a usance

LC is when the importer receives the goods and documents but the payment to the

beneficiary will be made at an agreed upon future date.

b. Confirmed Letter of Credit: Using a confirmed letter of credit reduces the risk of non-

payment since it is a document which is confirmed by a second bank, usually in the

exporter’s country. This means that there is a payment guarantee from two banks. The

exporter’s bank will require proof of documentation form the exporter. Once received

they will provide a confirmed letter of credit to the buyer’s bank, who will then make the

payment to the beneficiary.

c. Transferable Credit: It is a letter of credit that is “transferable” during the issuing process.

The exporter in this case acts as an intermediary who obtained the goods from other

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 suppliers. The exporter can request the bank to transfer the funds of the LC in full or part

to one or more beneficiaries. No further transfers can be made by the second beneficiary.

d. Back-to-back credit: This is usually used when the exporter acts as an intermediary

between the importer and the suppliers. The exporter uses the letter of credit received

from the importer to get a second letter of credit which is used to purchase more goods

from the suppliers.

e. Standby Letter of Credit or Guarantee Credit: To prevent a payment default, the

beneficiary (exporter) of the standby Letter of Credit (LC) could file a claim and receive

their funds if they have met all the conditions of the LC. This is similar to a bank guarantee

and is used as a substitute in countries where bank guarantees are not allowed.

4. Explain the various risks in international trade. Identify risks that are common in domestic trade and

risks that are unique to international trade. Explain the methods for managing these risks

There is no trade without risks and the same is true when trading internationally. Various risk factors exist

which makes trading with one country more difficult than another. Common risks which are found in any

trade, both international and domestic include:

1. Carriage (Transport) Risk is the risk involved during transport of goods. Items can be damaged or lost

during transit.

- Mitigate risk:

o By using proper packaging and storage

o Choosing the appropriate transport method and route

o Getting insurance for the transportation of goods

o Using correct Incoterms will help better understand and assume responsibilities.

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Commercial (Contract and Credit) Risk is when the buyer of a good, fails to make the payment on time or

rejects to accept the goods. For example, if a buyer goes bankrupt, they will be unable to pay for the goods

they received.

- Mitigate risk:

o Advance payment from buyer

o Requesting a credit report from the buyer to understand the history of the buyer’s purchases

and payments.

o Letter of Credit issued by the importer’s bank.

o Confirmed Letter of Credit from another bank at the exporter’s country. This helps localize

the risk.

o Getting a credit risk insurance

Certain risks are only found when trading internationally. These include:

1. Currency Risk is the fluctuations on currency impacting trade especially when a trade transaction (i.e.

payment) is being settled at a later date. Adverse fluctuations can cause the buyer to purchase the product

at a higher value, contrarily the seller may receive a lesser value for the goods sold.

- Mitigate risk:

o Use hedging techniques, for example, purchase or sell options, futures contracts, or forward

exchange contracts.

o Get insurance on exchange rate fluctuation risk.

2. Country Risk which may also be called sovereign risk, is when the government of a nation fails to meet

its payment commitments. Even when buyers are willing to make the payment, certain economic and

political situations can prevent or make trade difficult. An extreme example would be when a country is

at war, it can be difficult to transport good and payments into or out of the country.

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 - Mitigate risk:

o Conduct prior research before supplying to economically unstable countries.

o Do business only with countries that are deemed safer and low risk for international trade by

World Trade Organization or country risk rating from Export Credit Guarantee Corporation

(ECGC)

o Get insurance from political or economic risks/export credit risk insurance.

o Use confirmed LC by bank in exporter’s country.

5. Identify the most crucial risk when an exporter deals with new clients from developed countries

For companies trying to grow and enter new markets, exporting products and services may be a profitable

investment. It does, however, come with some risks, especially when working with new clientele from

developed countries. Exporters should be cautious of potential risks even if buyers from industrialized

nations are sometimes seen as more dependable and financially secure (Baltensperger & Herger, 2009).

When working with new clients from wealthy nations, the danger of non-payment or payment default is

one of the most important concerns. These customers might originate from nations with established legal

and financial systems, yet they might still be unable to pay for the goods or services that have been

provided. Many circumstances, such as financial hardships, economic downturns, or even fraud, may

contribute to this danger. For exporters, particularly small and medium-sized businesses (SMEs) that

might not have the financial reserves to withstand the loss, non-payment can have major repercussions.

Additionally, it may harm the exporter's reputation and hinder their ability to win new business. As a

result, it is crucial to take action to reduce this risk. Thorough background checks on new clients are one

approach to reduce the risk of non-payment. This entails examining their creditworthiness, financial

security, track record, and reputation in the concerned business. For information on possible clients,

exporters might also contact their local chambers of commerce or professional organizations. Requesting

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payment guarantees or letters of credit is an additional strategy to reduce the risk of non-payment. These

are financial tools that guarantee payment to the exporter even if the buyer doesn't make their payments

on time. While letters of credit are normally granted by the buyer's bank and guarantee payment to the

exporter after certain requirements are completed, payment guarantees may be issued by a bank or other

financial institution. Dealing with trustworthy intermediaries like banks or suppliers of trade credit

insurance can also aid in reducing the risk of non-payment. In order to assure prompt payment, banks

might offer financing and payment processing services.

Trade credit insurance companies can offer protection against non-payment or other credit risks. In

contracts with clients, it is also critical to clearly define payment terms, including due dates and penalties

for late payments (Rienstra & Turvey, 2013). Exporters should seek legal counsel as needed to make sure

they are properly protected, and contracts should be legally binding and enforceable in the applicable

jurisdictions. In conclusion, even if exporting to developed-country customers can seem less risky than

exporting to customers in developing country customers, there are still some risks involved that need to

be addressed. One major risk that exporters, especially SMEs, must be aware of is non-payment or

payment default. As a result, it is crucial to take action to reduce this risk, such as thoroughly investigating

prospective customers, getting payment guarantees or letters of credit, working with trustworthy

intermediates, and putting explicit payment terms in contracts. By adopting these steps, exporters can

reduce the possibility of non-payment and make sure their business endeavors are long-term, financially

successful, and sustainable.

6. Explain the best payment method for mitigating commercial (default) risk. How should Mohanty

manage the commercial risk her company is facing?

A confirmed letter of credit is typically the best payment option for reducing commercial (default) risk. A

confirmed Letter of Credit (LC) is a legal promise that, upon fulfilment of specified requirements, a buyer

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will pay a seller for goods or services. In this instance, a second bank's confirmation of the LC gives an

additional degree of security and lowers the possibility of non-payment. Mohanty should think about

taking the following actions to address the business risk her organization is facing:

1. Do extensive research on possible clients: Before working with a new client, Mohanty should

make sure they have a good credit history and a strong reputation in the field.

2. Employ a confirmed LC for significant transactions: Mohanty ought to think about using a

confirmed LC as the mode of payment for significant transactions. This will guarantee that, after

the LC's terms are fulfilled, the buyer's bank will pay for the products or services.

3. Take into account trade credit insurance: Mohanty would also want to think about acquiring trade

credit insurance, which can shield her business from losses brought on by client non-payment.

4. Track client payment patterns. If a customer's payment is overdue or late, it's critical to track their

payment histories and take fast action. This can aid in the early detection of potential issues and

enable Mohanty to take appropriate action.

5. Diversify customer base: To lessen the reliance on any one client or market, Mohanty's business

must spread its clientele. This can reduce the negative effects of one customer's non-payment on

the company as a whole.

Mohanty can limit the business risk her company is exposed to and reduce the possibility that consumers

won't pay by following these procedures.

7. Explain the concept and mechanics of a DLC and its applications in international business. How does

a DLC work as a credit enhancement device for importers and a credit risk mitigating tool for exporters?

As Alavi puts it, Letters of Credit have been the backbone of international business in some form or other

since the dawn of civilization where one could not guarantee the security of precious items such as gold

in travel between countries that gave them the ability to trade in the destination. In time, LCs evolved

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from a simple promise of payment document into the modern-day tool that nowadays international trade

revolves around, especially with the introduction of credit arrangements in the 19th century which

enables two businesses to have a safe international transaction. The seller sells their products to a

company which they do not have much information about with ease of mind and the buyer gets to pay

the invoice in a due date of 30, 60 or 90 days based on their arrangement with their bank. Every

Documentary Letter of Credit has at least three participants but in its most common form it involves four.

The process starts with two businesses in two different countries to agree on a contract of sale. By this

contract, exporter agrees to provide goods the importer commits to pay the price of goods upon delivery

via Documentary Letter of Credits. Also, information regarding the details of the Credit will be also

mentioned in the underlying contract. The Buyer (or Account Party) then requests its bank (issuing bank)

to issue a credit in favor of the seller (Beneficiary) based on a sales contract which gets submitted to the

bank. With this, the bank essentially agrees to pay the seller if they can provide a set predetermined set

of documents proving the delivery of goods. Usually, the issuing bank is not present in the countries of

both buyer and the seller which means the seller might get their bank involved (advising bank) which acts

as an agent for them. The responsibility of this bank is only to let the seller know the credits have been

issued in their favor and they have no other obligations (Alavi, 2016). Enon Chong identifies four different

uses for the Letter for Credits:

1. DLCs reduce risk both for selling and purchasing businesses by providing assurance of payment

for exporter and guaranteeing delivery of goods for importer.

2. It provides finance for importer and injects cash flow into their company while providing exporter

with the chance to raise money before being paid by issuing bank.

3. Documentary Credits are used as security for other obligations.

4. DLCs are conditional payment method and provide the possibility for seller to receive payment

from importer even if the issuing bank denies their request (Enonchong, 2011)

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But as Mann explains, these do not fully explain the widespread use of DLCs. The payment-assurance

narrative can be a partial reason, but it can’t be the most important as it “rests on a line of reasoning that

is largely untrue at one important and critical point: the seller's possession of an absolute right to

payment.” What usually happens is that the sellers do not have the right set of documents showing the

delivery of the goods and the buyer waives this obligation. Essentially, the importer vouches to the issuing

bank that they have received the goods, when it is under no obligation to do so, in order for the exporter

to get paid. If this is the case, why doesn’t the seller just ship the product to the buyer and wait to get

paid? This would certainly be cheaper for both parties, as it doesn’t involve LC fees. This is where a second

narrative gets put forward by Mann: the main use of DLCs is the confirmation of information where the

ability of both parties to gather information about each other is limited. It can be extremely hard for a

small business to confirm the credibility of another small business which is located in another country.

This is where DLCs come in handy. The issuing bank has much more a credible persona on the international

stage and is very unlikely to default on a payment so instead of small business relying on an unknown

business to pay their debts, the issuing bank essentially lends its name and fame to the importer and the

exporter is assured that there is significantly less risk involved in the transaction. Also, the importer gets

the benefit of financing the purchase and paying their debt in a month or two (Mann, 2000)

Recommendation

We have considered all the different aspects attached to exporting commodities out of India and what all

potential risk factors could threaten the flow of business out of the country. M/S Padhy Leather Ltd. have

found themselves in a similar situation wherein the clients connecting the company business have reached

a saturation. Major concern found out was that the new clients are not willing to pay 100% payment

before receiving the products and the reliance factor towards those new customers was meager from the

business development manager. After considering various factors, we consider that the Documentary

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Letter of Credit (DLC) would be the best solution for M/S Padhy Leather given their overall experience in

the field. The company has to deliver as per the contract terms by shipping goods to the client and then

present all the documents listed in DLC. At this juncture, the company need not worry about getting

money from the clients. Instead, they will get it directly from the issuing bank under the Letter of Credit.

Conclusion

To sum up the whole case analysis, we conclude that the companies which are entering into the exports

business, should understand the possible modes of payment that they can use according to their situation.

At times the exporters find good and reliable clients but at other times they fear losing the money due to

non-payment or default by the customer. And hence, selecting the right mode of payment for the right

reasons becomes very crucial. It is also important to highlight here the relevance of INCOTERMS. The

exporter can actually decide the terms of delivery by choosing the right INCOTERMS before shipping the

goods out of their warehouse. It is crucial for the exporter to decide at what exact moment the risk needs

to be transferred to the buyer. For instance, there is physical damage to the goods at a certain point of

shipment, who is going to bear the cost of the damage. In such cases, having the goods insured at the

right time could save tons of money for the exporter. Therefore, both the exporter and importer must be

aware of the modes of payment, potential risks associated with it and various mitigation plans that could

save the day for the people involved with the transactions.

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References

Alavi. (2016). DOCUMENTARY LETTERS OF CREDIT, LEGAL NATURE AND SOURCES OF LAW. Journal of Legal

Studies (Arad.), 17(31), 106–121. https://doi.org/10.1515/jles-2016-0012

Baltensperger, E., & Herger, N. (2009). Exporting against Risk? Theory and Evidence from Public Export

Insurance Schemes in OECD Countries. Open Economies Review, 20(4), 545–563.

https://doi.org/10.1007/s11079-007-9076-y

Enonchong. N. The Independence Principle of Letters of Credits and Demand Guarantees, Oxford

University Press, (2011). 9

Ronald J. Mann. (2000). The Role of Letters of Credit in Payment Transactions. Michigan Law Review,

98(8), 2494–2536. https://doi.org/10.2307/1290352

Rienstra-Munnicha , P., & Turvey, C. (2013, December). An analysis of welfare effects of export credit

insurance and guarantees on the exporting and importing countries. GALE ACADEMIC ONEFILE.

Retrieved March 11, 2023, from https://www.gale.com/intl/ebooks

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