Procedures of forfaiting

Procedure The exporter receives 15%-20% of the sales price as a down payment in cash and obtains the agreed form of trade receivables for the due balance to the time of shipment of the goods.

These receivables usually include interest at a fixed rate, mutually agreed between the foreign buyer and the exporter, for the duration of the repayment period. This takes the form of a series of semi-annual maturities (e.g. 5 year repayment terms - 10 semi-annual promissory notes or bill of exchange).

The series of maturities is then sold on a without recourse basis subject to satisfactory documentation to a forfaiter who deducts interest in the form of a discount at an agreed fixed rate for the complete credit period. The forfaiter may hold the trade receivables until maturity, or may sell them to another forfaiter.

The ultimate holder presents each trade receivable for payment at its respective maturity to the bank at which they are payable. The discount rate used in the purchase can either be fixed at the time of delivery of the receivables for the discount (in which case the interest rate risk is borne by the exporter) or up to 12-18 months in advance, and longer in exceptional cases, thus enabling the exporter to build this cost into their sale price. 

• Trade receivable purchase agreement that gives evidence of the purchase of the particular form of debt instrument (e.g. promissory note) by the Forfaiter from the exporter
• Bills of exchange / promissory notes / book receivables / deferred payments under an L/C Guarantee
• Confirmation and authentication of signatures
• Copies of exchange control approvals (where necessary)

Both the promissory note and bill of exchange is widely used in forfaiting transactions. Under a forfaiting agreement, a promissory note or bill of exchange / draft is issued for each installment of the supplier's credit, thus documenting the existence of a claim of the exporter on the importer that is totally abstract, that is, it is unconditional, irrevocable, and divorced from the underlying trade transactions.

The widely used guarantee (of the guaranteeing bank) is incorporated into a separated document, as the legal significance of the expression "aval" is not recognized in all countries.

In some cases, importers may prefer to open a letter of credit to cover their debts under a supplier's credit. It is possible to discount the deferred payment draft arising under these letters of credit. For forfaiting purposes an irrevocable letter of credit is issued by the importer's bank in the import's country. The letter of credit does not have to be transferable, or confirmed by the advising bank in the export's country but it must be subject to the uniform customs and practices of documentary credits UCPDC of the International Chamber of Commerce, Paris.

Such a letter of guarantee should essentially incorporate that the guarantee is irrevocable and unconditional, fully transferable, abstract and divisible. Abstract implies that the guarantee must be independent of the performance of the underlying commercial transaction. Also the individual repayments and respective maturities covered by the guarantee must be stated.

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