What is an Avalised Bill of Exchange?
Bills of Exchange are widely used throughout the world for settlement of debts, however in their normal form they do not guarantee payment by the drawee (debtor).
To obtain such a guarantee of payment it is necessary to have the bill guaranteed by a bank, normally the drawees (debtor’s) account holding branch.
This is accomplished by the bank writing the words “pour aval” on the reverse of the accepted bill and signing it with authorised signatories of the bank which can be authenticated. The bill is now avalised.
What is the process for an overseas debt?
The drawer (creditor) will send the completed bill of exchange to his / her bank together with any other relevant documentation. If goods are involved in the transaction, they may or may not have been shipped at this point.
The bank will send the documents to the drawees (debtors’) bank on a ‘collection’ basis with an instruction to release the documents only after the bill has been accepted by the debtor and avalised by the bank.
The drawees (debtors) bank sends the bill to the drawee requesting him to accept the bill and authorise them to avalise it. The drawee will accept the bill by stamping it with his company stamp and signing it.
The bank will then add its guarantee and record a liability against the debtor that will remain in place until the bill matures and is paid.
Cost of Avalising a Bill of Exchange
The bank adding it’s aval will make a charge (payable by their customer, the debtor) similar to their guarantee commission. We cannot be specific as to the level of this charge, however as a guide a UK bank may base its guarantee charging on a ‘standard’ rate of around 2 – 3% p.a, charged on a quarterly or monthly basis (or part thereof).
Avalised Bills v Documentary Letter of Credit
Once obtained, the level of security offered by an avalised bill of exchange is similar to that of a letter of credit, in that the importer’s bank is providing a guarantee of payment. In the case of an aval, it must be remembered that the guarantee covers the ‘tenor’ or term of the bill following acceptance by the debtor and aval by the bank. In most cases the guarantee will not be provided until after the goods have been shipped and associated shipping documernts have been remitted through the banking system on ‘collection’ (although the exporter will retain ‘constructive control’ over the goods if the documents include a full set of original bills of lading)
Documentary letters of credit are issued by the importer’s bank prior to shipment (and normally prior to manufacture / sourcing of the goods or provision of services), thus providing a guarantee at an earlier stage, albeit subject to presentation of documents which comply with the letter of credit.
The cost of a letter of credit is likely to be far higher than that of an avalised bill of exchange due to the longer ‘risk’ period that the bank is exposed to as well as the increased processing (advising, amending L/Cs and checking documents).
An exporter is likely to pay no more than a standard ‘term’ collection (documents against acceptance), however the importer will pay the bank’s ‘avalising’ / guarantee commission as outlined above in addition to the standard ‘collection’ charges.
Using Avalised Bills to Finance Exports
As with ‘term’ letters of credit, it may be possible to use avalised bills of exchange as a means of finance.
Assuming the bank avalising the bill is of good standing, is located in a relatively politically / economically stable country, and is acceptable to the exporter’s bank (or an alternative financier in the exporter’s country), the avalised bill may be ‘discounted’, providing the exporter with 100% non-recourse funds (less a financing cost) at any time up to maturity of the bill.
It is recommended that exporter’s speak with their bank (or other financier) prior to agreeing the avalisation, to establish if they are prepared to offer such a facility and the associated financing costs.
The financier will normally require the following information:
- Term of the bill of exchange (eg: 60 days sight, 90 days from date of bill etc)
- Avalising bank name and location
- Transaction details, ie: buyer, goods end user (if appropriate)
- It is vital that the aval is obtained before the creditor loses control of the goods. This is achieved by either delaying shipment of the goods until the avalised bill has been received, or ensuring the documents of title to the goods – a full set of original Bills of Lading – remain under their control until receipt of the avalised bill. This can be achieved by sending the documents via the banks on a ‘collection’ basis as stated above.
- Avalisation can only apply to term bills of exchange that mature at a future date.
- Once the bill has been avalised it cannot be cancelled without the drawer’s (creditor’s) authority, and is in effect an unconditional guarantee. This is a benefit to the creditor but may be less acceptable to the debtor.
- The aval is only as good as the standing of the bank giving it. The financial strength of the bank and country in which the aval is arranged should be checked with your bankers.
- We recommend the drawer (creditor) obtain agreement of the drawee to arrange for their bankers to avalise the bill prior to presenting it for acceptance.
This is not a comprehensive description of avalised bills but merely a guide to their general method of operation and is provided without engagement or responsibility on the part of MJ Hayward Associates Ltd.