Enforceable and binding sales contract for secured trade and financing

A written sales contract is the founding document for initiating international trade transactions in Bangladesh which is also the case with most developed and developing countries. 

Unfortunately, the applicability of sales contracts does not seem to be distinctly understood, and the importance of legal enforceability is hardly recognised. 

In fact, these agreements between exporters and importers have been reduced to the role of an information source while processing the issuance of a documentary credit. 

We use different types of contracts in maintaining our businesses in Bangladesh.

For starters, the 'Firm Contract' is a requirement for trade services by banks in Bangladesh.  The term is specifically mentioned in Bangladesh Bank Guidelines on Foreign Exchange Transactions (GFET) and Export Policy of Bangladesh. 

Though the term 'Firm Contract' may be interpreted differently, one standard interpretation is associated with the binding nature of the contract. It means, it should not be changed, amended, or cancelled unilaterally by a party.  

Guideline on Prevention of Trade-Based Money Laundering also puts forward cautionary note regarding the potential vulnerability of the contract documents. 

Then we have sales contracts that have implications for the trade payment methods used in any country. Documentary Credit has been the most dominant trade payment method in Bangladesh, especially in the case of imports. 

Although the 'Firm Contract' is legally binding for local businesses, such explicit, binding and legally enforceable contracts are not available for sales contracts, especially in the case of international trade. But  why do we need one?

Firstly, a binding sales contract is a crucial risk management tool in documentary credit operation though it is not considered very essential to many in the case of LC.  

Secondly, contract clauses/terms are essential information in the process of issuing a letter of credit. On top of that, a binding contract agreement and legal enforceability are particularly useful in case of the failure of the performance under the LC arrangement. 

Extensive use of back-to-back LC in Bangladesh also has important implications for the legal enforceability of 'sales-purchase contracts'.  

Furthermore, the popularity of documentary collections is increasing steadily, especially in exports. Between 2019 and 2020, a binding sales contract became very important to ensure the safety and security of the banks, traders, and also contributed to the 'country risk' management. 

Unfortunately, there appears to be no extraordinary concern with the sales-purchase contract on the part of traders or bankers in Bangladesh.  

Use of Cash in advance has been limited in Bangladesh, however, the volume and number of 'cash in advance' increased in recent times, especially during the Covid-19 pandemic when a sizable volume of health and essential equipment/goods were imported against cash in advance. 

The Sales-purchase contract can function as the guiding document in case of cash in advance and open account even though their use has been limited in Bangladesh (outside EPZ) to date. 

The use of the product may go up soon as Bangladesh Bank allows the conditional open account to support exporters since June 2020. A contract is particularly essential in the case of open accounts for the safety and security of the exporters. 

The growing use of open accounts would necessitate binding and legally enforceable sales contracts in the upcoming period in Bangladesh.  

And the adoption of these contracts can be beneficial to the economy as well. For instance, contract partners like the United Nations Convention on Contract for the International Sale of Goods (CISG) and the UNIDROIT Principles on International Commercial Contracts (UNIDROIT Principles) were better positioned to protect themselves during the trade interruptions. 

CISG and UNIDROIT Principles came up with better outcomes in offering protection to the traders during the pandemic. 

The applicability of the CISG has become even more relevant in the environment created by the Covid-19 pandemic, where the performance of contractual obligations and undertakings may well be deemed impossible, impractical, or unreasonably burdensome given the occurrence of unforeseen circumstances or events beyond the control of the parties.  

Bangladesh is not a signatory or ratifying country of the CISG or UNIDROIT Principles. However, the major trading partners of Bangladesh like the United States, members of the EU, China are among the signatory countries of the 'UN Vienna Convention'. They are also amongst the signatories of the 'UNIDROIT Principles'. 

However, Bangladesh is yet to sign the treaty and the principles, and the country also has not recognised national regulation to cover cross-border purchases or sales contracts. 

Bangladesh has a domestic act to handle such purchases titled Contract Act, 1872. The Contract Act, 1872, was enacted in the 19th century and re-enacted by the Parliament of Bangladesh after the country's independence. 

Over time and with the growth in the volume of trade, certain changes were made to the act. For instance, the Arbitration Act 1940 was replaced by the current Arbitration Act 2001. Arbitration Act 2001 is largely based on UNCITRAL Model Law that did not expressly mention foreign arbitral awards.

The standardisation of sales-purchase contracts is an immediate necessity to facilitate the country's international trade transactions. The status quo has many problems. 

For instance, the absence of the Arbitration Clause and Compensation Clause in the contract document is common in Bangladesh which leave local exporters vulnerable to exploitation. 

Then what can we do? 

For starters, Alternative Dispute Resolution (ADR) clauses can assure the parties that their disputes will be resolved through cost-effective and quick processes of arbitration or mediation rather than by litigation. 

Traders may also be suggested to avail the service of 'International Arbitration Centre' as a dispute settlement body. 

Bangladesh Bank may issue a 'Guideline on Model Contract' to support traders and bankers in standardising and assessing the Sales-purchase contract and thus help to minimise commercial risks, country risks, and trade-based money laundering risks in international trade.  

Issuance of back-to-back LCs against unbinding sales contracts are common in Bangladesh and are increasing in proportion and number. 

Termination of these contracts and shifting from Documents against Payment (DP) to Documents against Acceptance (DA) without consulting exporters exposed the country's weak sales-purchases contracts and vulnerabilities of a section of traders. 

Open accounts may gain popularity in the near future and must be guided by a legally enforceable contract document. 

In such a circumstance, ratifications of CISG, and UNIDROIT Principles of International Commercial Contracts are an immediate necessity. 

In the context of the Covid-19 pandemic, more than ever, businesses getting involved in international trade must come to terms with their applications and potential benefits. 

Till the ratification, exporters and importers should incorporate these in their contract documents in consultation with their counterparties.  Ministry of Commerce, Bangladesh Bank, and trade associations have roles to play in this context. 

The Contract Act 1872 is mainly an instrument to handle contracts associated with domestic trade and commercial transactions. 

CISG and UNIRDOIT principles are extensively in use in the unification of domestic regulations throughout the globe over the years. 

Such uniformity is a matter of great comfort for the traders and other stakeholders of the country when there is direct linkage and association between domestic trade and cross-border trade transactions. 

Given the growing global interconnectedness, there is a logical basis for upgrading and amending Contract Act 1872 in line with CISG & UNIRDOIT provisions. 

Unification would contribute significantly to minimising the information gap on regulatory and dispute settlement procedures amongst traders and bankers.  

Currently, the traders and bankers have a lack of awareness and information gap on the importance of a binding sales-purchase contract in the context of international trade transactions. 

Issues related to the 'applicability of a binding contract', 'implications of different contract terms/clauses', 'dispute settlement procedures', 'applicable regulations in the sales-purchase contract', and 'necessity of legal enforceability of contracts' should be disseminated through training, awareness and capacity development events for the sake of handling relevant risks. Trade finance banks and trade associations have roles to play in this regard.    

Dr Shah Md. Ahsan Habib is a Professor at the Bangladesh Institute of Bank Management.

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions and views of The Business Standard.