Sight Drafts versus Term Drafts
The sight draft is most commonly used in international trade. In a sight draft, the payment is on demand or on presentation of the negotiation documents to the paying bank or the importer. In practice, the bank may pay within three (3) working days (not instantly) after the receipt and review of the negotiation documents and if they are in order, that is, the documents comply exactly to the letter of credit (L/C) stipulations.
In certain countries where the business relationships between the exporter and the bank is well established, the bank may pay the exporter a few hours after the receipt of the negotiation documents that are in order.
In the sample L/C it was stipulated "available by your draft(s) drawn at sight", as such the payment is by sight draft(s).
The term draft--(time draft or usance draft)---is used in a deferred payment arrangement. The payment is on the maturity date determinable in accordance with the stipulations of the letter of credit (L/C). The maturity date can be at a stated period after sight or after date:
§ after sight ---
§ after date ---
In other words, in a term draft the exporter extends the credit to the importer.
If a term draft is accepted by the accepting bank (in the case of draft drawn on the confirming bank or the issuing bank or other bank stipulated in the letter of credit), such draft becomes what is known as banker's acceptance. The exporter may hold the banker's acceptance pending payment by the bank on the maturity date or discounts it with the bank, thus provides the exporter with immediate funds.
If a term draft is accepted by the importer (in the case of draft drawn on the importer) when it is presented to him/her by the collecting (presenting) bank, such draft becomes what is known as trade acceptance. In practice, the collecting bank usually holds the trade acceptance pending payment by the importer on the maturity date and advises the remitting bank of the date of acceptance. The drawee may default on the payment of a trade acceptance. Nevertheless, the trade acceptance has a better chance of being paid by the importer compared to a sales invoice.
The usual way the drawee accepts a draft is by writing or stamping the word "ACCEPTED" on the face of the draft, plus the drawee's authorized signature and the date accepted.
Unless the importer's integrity is irrefutable, using a term draft is risky, especially when the draft is drawn on the importer where the remitting bank and the collecting bank are merely acting as agents without guarantee of payment.
In certain countries, the importer may have access to the customs warehouse or docks and examine the goods before accepting them. The risk is that the importer may intentionally reject the goods even when they are in good order and condition, without paying or accepting the draft. The importer may reject the goods, for example, if the local market prices of the goods have dropped. Unless the goods are shipped back or rerouted to other buyers, the goods may incur warehousing charges and be subject to foreclosure after a period of time and auctioned off by the customs. The importer, not surprisingly, could be one of the bidders at the auction and obtain the abandoned goods at a fraction of the import cost. A remedy to counter such rejection is to send the draft and documents immediately to the remitting bank, so that the remitting bank may relay them to the collecting bank and the collecting bank presents them to the importer for payment or acceptance before the goods arrive at the destination.
The importer, however, has the right to reject goods that deviate from the contracted specifications and quality. The importer can instruct the collecting bank not to pay the draft.