The Practicalities of Customs Bonded Warehouses
As more customs bonded warehouses spring up around the globe, exporters are in a good position to benefit from this counterparty performance and credit risk management tool.
Licensed by a country’s local customs authority for temporary storage or processing of goods on which no duties are paid until the goods are cleared for internal consumption, customs bonded warehouses provide services such as deep freeze or bulk liquid storage, commodity processing and coordination with onward transportation. (A summary of the cargo flows is set out in Figure 1 and the theory of how the process should work is outlined below.)
Summary of customs bonded warehouse theory
Two parties enter into an international sales contract that requires delivery of goods on a cost insurance and freight (CIF) or cost and freight (CFR) basis. The parties agree that the buyer will pay for the goods before their arrival at the port of discharge, and that the seller will keep the original bills of lading until receipt of payment.
Due to various reasons – for instance, a short distance between the ports of loading and discharge – the buyer fails to make the payment on time but assures the seller that it will be made in a matter of days. The seller faces a dilemma: to unload the goods and accept uninsured credit risk on the buyer or postpone unloading operations until receipt of payment but run the risk of vessel demurrage.
There is an alternative if the port of discharge has an independent customs bonded warehouse. A legitimate holder of the bills of lading – usually the seller or his financing bank – may instruct the carrier to unload the goods in the bonded warehouse and hold them in custody until receipt of payment. This way the seller may retain control over the goods while avoiding demurrage expenses. Should the buyer default on the sales contract, the seller may resell the goods to other customers in the same market or re-export them without paying customs duties in the country of transit (which includes a considerable value-added tax in many jurisdictions).
When the seller enquired why the goods had been released to the buyer, the latter’s forwarding agent replied that only the buyer had a stevedoring agreement (docker labour agreement) with the port, and the buyer was also indicated as the notify party in the bills of lading. Further investigation bore no fruit, as the parties engaged in the handling of the goods at the port of discharge accused each other of miscommunication on the goods’ actual status, though agreeing that the goods had been misdelivered to the buyer. Taking into account that the goods were paid for, the seller decided not to pursue that case any further. As the seller’s bank was aware of all developments, the whole story did not help the professional reputation of all parties involved.
The problem of misdelivery of cargo under a bill of lading is well covered, but most comments focus on emerging markets. In my opinion, developed markets are no less prone to this problem – just for other reasons. The misdelivery outlined in the above example took place in a leading European port; one that is considered a paragon of efficiency. Too often, however, efficiency is provided at the expense of safety.
Getting it right
In order to ensure against unwelcome surprises, a party contemplating the use of a customs bonded warehouse as a risk management tool should consider the following:
- National legislation on bonded warehouses may substantially differ from one state to another, so make sure there is an appropriate regulatory framework in the country of destination.
- Not all merchandise is acceptable for storage in bonded warehouses. For example, perishable goods such as crops and foodstuffs may not be deposited in a bonded warehouse in some countries, or their authorised storage may be limited in time. Make sure that the bonded warehouse is suitable for your cargo.
- The port of discharge should operate an independent, public bonded warehouse and not a private one. Entrust the cargo to an independent and impartial custodian acting in your best interests.
- Before entering into a contract of affreightment, inform the carrier that you may need to unload (but not deliver) the cargo at a bonded warehouse at the port of destination against a letter of indemnity (LOI). Make sure that the carrier agrees to follow the consignee’s instructions in this respect.
- Issue negotiable bills of lading to your order or to the order of the financing bank. Coordinate with all parties concerned that part 1/3 of the original bill of lading will be sent in a ship’s bag, and that part 2/3 of the original bill of Lading will be kept by the consignee until receipt of payment.
When the need to unload the cargo in the overseas bonded warehouse starts to loom, proceed as follows:
- Do not surrender the original bills of lading to unload the goods into the bonded warehouse. Instead, have the consignee instruct the carrier to unload the cargo against a letter of indemnity (LOI). Be proactive with all related formalities, as the carrier may require the original to start unloading operations. The more sub-charterers are involved in the sea voyage, the more time is required to complete related formalities.
- Do not attempt to manage the whole process through the carrier. Contact all parties concerned – the ship’s agent, the discharge port authority, and the customs representative – and inform them about the forthcoming operation. Notify these parties about the legitimate owner of the cargo and about circumstances requiring its unloading in the bonded warehouse. Make it crystal clear that no delivery is possible to the buyer without the cargo owner’s explicit instructions and the delivery of the original bills of lading. Ask the port authority about conditions of storage, and guarantee payment of stevedoring and storage expenses incurred by the cargo in case the buyer does not fulfill his payment obligations. Whenever appropriate, request that all parties concerned acknowledge in writing agreement with your instructions. The carrier should be informed of your activities and copied on all related correspondence.
- Considering that the bonded warehouse is not necessarily separated from the main port area, ask the port authority about the exact location of your cargo, and request the port authority to issue a bonded warehouse receipt as soon as the cargo is unloaded from the vessel. You may also consider sending an independent surveyor to inspect the physical location and condition of the cargo, as well as having the surveyor randomly inspect the cargo throughout the storage period.
- Take into account the aspects of cargo safety. How is the bonded warehouse safeguarded, and what kind of insurance is in place? If the warehouseman’s insurance is not sufficient, the easiest solution is to extend the marine insurance policy to insure the cargo at the port of discharge against all risks.
- Try to have a contingency plan in case the buyer defaults on the sales contract. Think about the next steps in advance.
- When the buyer makes the payment, have the retained bills of lading endorsed and delivered according to the buyer’s instructions.