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ESCROW & LETTER OF CREDIT COMPARED 10 replies,10655 views

#1
I have been seeing a large number of questions on the merits of "escrow" as a method of payment, and also its comparisons with LC as another method of settlement. This article aims to briefly compare both the methods. But first the disclaimer: I have never used escrow; my information is only from what I have read on the net about escrow. Hence, this comparison is based only on that premise, and limited by such understanding.

Comparisons:
1. The seller has to pay for shipment, even if the sale is on a FOB basis.

Implications:

(a) Sellers money is stuck till the buyer accepts the goods. Strain on exporters cash flow. [In LC transactions, no payment of freight is called for on FOB shipments. In fact, the seller gets paid full value immediately on negotiation of documents.]

(b) If the transaction goes into dispute, not only the cost of goods, but the freight charge too gets stuck for a long time. [Dispute is a remote possibility if documents are approved by the bank. For confirmed LCs, once negotiated the payment is final and irreversible. ]

2. Buyer must deposit funds with the escrow before shipment is made.

Implications:
(a) Possible cash flow problem for the buyer. [In contrast, under an LC he pays the bank only after documents have been approved by his bank. Never in advance.]

(b) LC or no LC, under DA terms buyer could even pay after taking shipment and sale of goods. No such facility under escrow mode of payment.

3. The buyer gets time to accept or reject the goods.

Implications:
(a) Advantage for the buyer. Bad for the seller, as he does not get paid immediately on delivery, even if the sale is on a CAD/COD (Cash on delivery) basis. [If a non-LC ** bills is sent through a bank, buyer receives funds immediately after buyer pays the bank. Under LC (** or DA terms) he gets paid even earlier, at the time of negotiation/acceptance.]

(b) Seller loses use of funds. Time when he will get his funds is not determined at the time of shipment. Depends on the escrow companys schedule and rules. At the same time, seller pays interest to bank for his working capital.

(c) Pays higher premium on export credit for his non-LC bills.

4. Sellers receive their money if and when the buyer accepts the merchandise.

Implications:
(a) For the seller, not any better from if the bills had been sent on DA basis through a bank. Actually, it is more risky, since the payment is subject to whims and fancies of the buyer, and there is no protection of an accepted usance draft. The accepted draft could have been used by the seller to proceed legally against the buyers refusal to pay on due date.

(b) No good for the buyer either even if he refuses the goods, since his money would be stuck with the escrow company till the dispute is resolved. When, how long&who can say?

5. Each form of payment takes a different length of time to process, and has different limits. For example, Escrow.com says that money order and check payments have a limit of $2000, and are subject to a 10 day banking hold. And...

6. Each of the payment options has a different transaction fee payable to the escrow company.

Implications:
(a) Where is the clarity in procedure, transparency and certainty!

7. Upon delivery of the shipment, the seller must accept or reject the returned merchandise within a fixed number of days or the inspection period will automatically expire.

Implications:
(a) If it happens to take more time to resolve a dispute, either party may be at risk of losing control over the goods.

(b) The rules of the game are not set by any internationally accepted procedure or body, or by the buyer or seller. !

(8) The entire operation in an escrow service depends on the integrity of the escrow company concerned. One would have to do some research to find out if one should trust that company with one's money, and whether - at the end of the day - the will still be there, and deliver.

I could add at least ten more points of comparison, but let me conclude by saying that LCs operate under a set of internationally accepted and approved rules, are time tested, and generally accepted by courts around the world. The rules have been approved and signed for by more than 160 countries, are backed by the local and international chambers of commerce and their governments, have a transparent grievance redressal and dispute resolution system, are supported by innumerable case laws that are also endorsed by the judicial systems of various countries. Finally, there are experts and professional (inside banks and outside) on LCs if help is required by a buyer or a seller.

It would be interesting to calculate the cost of funds, losses on exchange rates, loss of interest, the total of the explicit, implied and hidden cost, the uncertainty factors on account of possible delays and the time lag built into the system of escrow in processing at each stage and the facts above  in comparison with LCs used in international settlement.

Given a choice, I'd always, every time, choose reputed international banks (that are invariably governed by their respective countrys' Central Banks) over a privately owned escrow company. In my opinion, an escrow system settlement of international trade is not a win-win situation for the buyer or the seller as is the case in an LC transaction; actually (if I had to choose) not much of a choice - everything considered, if compared with Letters of Credit.
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#2
Re: ESCROW & LETTER OF CREDIT COMPARED

Replying To [Catalyst]:


First thanks for your article.  Second I would say is that a person that would be using escrow is a personal buyer or small company that does not have the resources of a much larger company.  Even I would not do a $100,000.00 USD + deal thru escrow.  But for the individuals that are doing deals of $25,000.00USD or less I consider it a good method.  In fact and its been my experience that major banks will not even open a documentary credit less than $100,000.00USD so it leaves a void for safe payment terms for these small buyers.  The company whose service I know also has a binding arbitration of disputes that will go no longer than 28 days.  This arbitration is not done by the escrow company itself and is not the benefactor of the arbitration.  Deals can be ammended if ratified by both barties without additional costs unlike an L/C.  This company will only provide the service if the seller shipis via a trackable shiping process.   What escrow does offer that a regular L/C does not is a time for the buyer to inspect the goods first.   Thus if a buyer were buying 10 items to resell that cost 5000.00 they could forgo the cost associated with a pre-shipment inspection.  Something that any buyer on a larger scale would not do. 

Best regards,

Ranger 

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#3
Re: Re: ESCROW & LETTER OF CREDIT COMPARED
Replying to [Ranger]:Yes, I totally agree with Mr Ranger!
[em17]
#4
ESCROW & LETTER OF CREDIT COMPARED
Replying to [Ranger]:

In India, Africa, South America, South East Asia, and in many other countries in these parts of the world, U$100,000 is not an amount to be scoffed at by the commercial banks. Having been there for well over 25 years, I have seen a v. large number of LCs opened by banks in India and overseas (including those from the US, the UK, and some of the former European nations) for amounts far below US$100,000 (or equivalent).

The article was to make the readers aware of the plus and minuses of escrow (as a method of settlement of international trade) as compared to an LC. If the article has been able to do that, my purpose in writing the article would have been achieved!

#5
Re: ESCROW & LETTER OF CREDIT COMPARED
Quoting from [Catalyst]:


Replying to [Ranger]:


In India, Africa, South America, South East Asia, and in many other countries in these parts of the world, U$100,000 is not an amount to be scoffed at by the commercial banks. Having been there for well over 25 years, I have seen a v. large number of LCs opened by banks in India and overseas (including those from the US, the UK, and some of the former European nations) for amounts far below US$100,000 (or equivalent).


The article was to make the readers aware of the plus and minuses of escrow (as a method of settlement of international trade) as compared to an LC. If the article has been able to do that, my purpose in writing the article would have been achieved!



Once again Mr. Bose that has been achieved.[em19]  I have been researching what it does cost to open Documentary credits in several countries with several large banking institutions in each of the countries and have found that the costs to open these credits are actually very close in their opening fee's but in regards to other fee's such as ammending the original documentary credit and even an insertion of a red clause can be very low to a very substantial fee.  Even in the fee of the confirming bank seems to be based on the country where the original documentary credit was opened.  This fluctuation however with regards to the confirming banks may be based on the overall credit liquidity of the origination banks due greatly in part to the default of housing loans and the debt carried by even the most remote banking institutions who thought that getting into the U.S. housing loans was very safe.   Actually I would love to see a sub-category of Payment and Finance with regards to economic investment.

Best regards,

Ranger

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#6
ESCROW & LETTER OF CREDIT COMPARED
Replying to [Ranger]:

To parties in these parts of the world I suggest that it is a better option for them to get inserted a clause in the LC to the effect "all charges within XXX (the country of the applicant) would be on account of the applicant". This is because USD 100 is a lot of money if converted to a local currency. And LC charges can keep mounting for every possible reason. The amount may be relatively "small" by US standards. It is not so outside the US, especially when it keeps adding up.

The scale of bank charges have nothing to do with the events you mentioned. They are based mostly on local cost of living and price indices.

#7
Re: ESCROW & LETTER OF CREDIT COMPARED
Accepting escrow is a very good way of showing your business is genuine.  Rejecting escrow, and touting non bank payment terms (i.e.e Western Union/Money Gram) is a sure sign that your business is fake and fraudulent.  Businesses who reject escrow are to be dealt with extreme caution.  Personally I will not do business with anyone who rejects escrow.  There are far too many scams on Alibaba not to demand escrow.
#8
Reply #

Thank you for your great article on ESCROW. Definitely it has both merits and demerits. Nevertheless, we can think of other soft way of monitoring or controlling behavior or both Buyer/supplier. As many of Asian developing countries are bound to use LC and if you see majority of Alibaba member except China are Asian SMEs.

and ESCROW is to (stuck) invest money in advance (for about a month or more). I worked with some Chinese companies they usually says 15-20 days lead time in order to get the order. Later they add 1-2 months additional time, Probably ESCROW is somewhat a good soultion, still stucked money for longtime.

What do you think ? if Alibaba or other B2B implement option like Reputation ranking (Gold membership refining based on their performance). This is a segmentation (from current Liquidity or critical mass) of potentially Loyal (trustable) Buyer and supplier, Where both buyer and supplier has to be member, (Supplier already paid for Gold membership) now buyer (may be paid or not upto e-marketplace's business model).  Buyer can search supplier /product with high earned Gold karats to low, then send RFQ (Request for quotation) and supplier whoever send request and participate for Reverse auction will get +ve remark (+little Gold Karats adds up).  Now negotiation will be much easier for Buyer just check the Reverse auction  (NSS + DSS). Choose one supplier with given deliver date + product details + price and payment terms or payment date). If accepted by buyer and goes for order placement meaning agreement for exact payment terms+ payment date. Any delay for payment he will buyer will be punished with -ve Gold Karats or decrease Karats earned. Similarly if delivery not done within offered date by supplier will also earn -ve Gold karats. This is share to only Gold Karats based member within the current B2B e-marketplace,about companies loyalty background and to make people (member) know them to avoid opportunistic behavior /loyalty gap/ Negotiation support/ decision support for potential partner. will update more features once i get some feedback from you.

I wish to get your feedback on it. Thanking you!!

 

#9
Reply #
helpful article
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#10
Reply #
I would disagree with some of the comments made. Firstly, an L/C has to be backed by cash otherwise the bank treats this as a monthly rollover advance which in these days of tight banking, is near to impossible to achieve. Irrespective of whether the transaction is escrow or L/C- clear funds are whats needed. I'm not saying that this is the case for 100% of transactions however nowadays, it is the case of 98% of cases. Escrow run through a reputable escrow or legal firm is a lot less costly with the same buyer protections.The same documentation has to be submitted to the escrow firm/attorney however there is not the restrictive noose and fees implemented by banks. With banks charging flat %'s on $$ amounts, banks are pricing themselves out of the L/C market
#11
pagamento
nao consigo achar opçao pagar com boleto bancario ??

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