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Combating late payments by means of the commercial practice

In recent years we have witnessed the adoption and amendment of European Community legislation[1] on combating late payment in commercial transactions, as a proof that it is an important and difficult issue to solve. In fact, SME are the most sensitive ones to late payment, being affected their competitiveness and profitability.
However, the laws don’t define properly some concepts such as when it is considered that a service has been rendered, or when merchandise has been received. These concepts and the correct definition are quite relevant, since based on when they happen, it is established the verification period, and the most important payment term. In this article we are focusing on merchandise, leaving the service for another moment.
The uncertainty opens the door to circumvent good business practice. Current trade transactions can be very complex, with the involvement of several factors, such as transportation, customs, verification periods… which difficult to establish the moment of reception of the goods, and therefore the actual date of payment. There can be many cases where doubts may arise. For example, when is it considered the reception in a sale of goods sent from Germany to Portugal? What if the goods are coming from China and it takes a month to reach the destination? It may seem as a small matter, but defining when that moment occurs will affect when the payment is made, or when the right to claim arises, if applicable.
Proposal: watch the commercial conditions under which the transaction is agreed.
In international trade it is widespread the use of Incoterms[2] as a basic tool to establish the conditions under which the purchase and sale of goods are developed. Broadly speaking, the different rules that constitute the Incoterms (11 in the current version of 2010), clearly indicate what rights and responsibilities the buyer and the seller have in each of the phases in the process of selling and transporting goods. Each of the rules specify who responsible is for transports, export documentation, if any, or who bears the procurement of insurance, among other things.
Therefore, this is a generally accepted instrument in transactions between companies, which can be used to clearly determine the moment of reception of goods. How? The approach is simple, and starts from the idea that when the responsibility of the shipping is transferred from the seller to the buyer, it is also understood that the buyer has received the goods. I mean, once the seller, according to the Incoterm that guides the operation, made the full delivery of the goods, they pass to the buyer, and it starts the countdown of the payment deadline and the verification deadline, if any. This is without prejudice, of course, that the seller has complied with other legal and contractual obligations.

Example 1: sale of goods by a seller located in Istanbul (Turkey) to a buyer located in Frankfurt (Germany). The contract terms establish that the delivery method is EXW-factory. This means that the delivery of the goods shall be completed when those are available to the buyer at the seller’s own premises. Therefore, if transportation between origin and destination is made in four days, and taking into account the proposal exposed above, the reception by the buyer shall be considered made, not when receiving the goods in Frankfurt on the fourth day, but at the time they were already available in Istanbul. That is the moment to consider to define the payment date, without paying much attention to what the invoice says. The four days of this example may seem irrelevant, but think how the issue becomes important when there are involved more complex and protracted displacements.
Example 2: an Italian seller sells to a buyer located in Los Angeles (USA) goods coming from China. Contractually it is established that the buyer has 30 days to verify the goods, and additional 30 days for making payment. That is, payment has to be made in 60 days from reception of the goods. The delivery of goods is managed in accordance with the Incoterm FOB-Shanghai, which means that the seller has done his part and transferred the responsibility of the shipment when the goods are delivered on board the vessel nominated by the buyer. The expedition to destination takes 20 days (assuming that it is carried out immediately to shipment). The usual practice would say that the payment is due 60 days after the buyer receives the goods in Los Angeles. But if we use trading conditions to determine the reception by the buyer, we will establish that this occurred when the merchandise is shipped in Shanghai. That means that the 20 days of transport are not added to the agreed time, but discounted. In fact, the verification period starts with the shipment, and if that verification is made when the goods arrive at their destination, the buyer will have only 10 days to do this, apart from the 30 additional days to make the payment. Chart 1 allows us to visualize the flow of the operation in this example.

FOB Shanghai

[1] Directive 2011/7/EU of the European Parliament and of the Council of 16 February 2011 on combating late payment in commercial transactions.

[2] Incoterms is a trademark of the International Chamber of Commerce (www.iccwbo.org).



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