Mitigating Techniques for Commercial Risk/Documentary Draft Collection
|Unit 3.5- Mitigating Techniques for Commercial Risk
Introduction | Commercial Banks | Loans | Letter of Credit | Draft Collection | Accounts Receivable | Governments | Factoring | Forfaiting | Banker's Acceptances | Credit Insurance | Summary | Resources | Activities | Assessment
Documentary Draft Collection
This type of document is archaic--if you haven’t seen it before, it may not make much sense. A documentary draft or bill of exchange is very similar to a letter of credit in that it is an agreement between a buyer and seller. (A simple check is the most familiar type of draft to most people.) Documentary drafts are still widely used, however, in many countries whose commercial law is based upon the Napoleonic Code. They were primarily used in domestic commerce as a way of facilitating transactions between individuals and companies who had faith in one another. The use of documentary drafts in global commerce began as a result of trade between companies in countries whose commercial law was based upon the Napoleonic Code, and they were also used in the United States. Using a draft is a multi-step process:
- 1. A seller writes out a draft in his/her own favor (to his/her own account).
- 2. When the buyer accepts the draft (signed it to accept payment), the draft then becomes a trade acceptance. A trade acceptance is a form of commercial paper that is both endorsable and liquid.
- 3. In many countries, failure to satisfy a trade acceptance can lead to an immediate seizure of the personal assets of the acceptor.
- 4. In order for the documentary draft to work, a third party acts as a guarantor of the draft.
The third party will guarantee payment of the draft upon presentation of the proper documents. While some companies would act as guarantors as a favor to special customers or clients, banks became involved as the third party. In certain letter of credit transactions, documentary drafts are also used as a backup to create additional assurance that a buyer will pay his/her obligations to a seller via a third party, in most instances a bank.