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Preventing Fraud in Trade Transactions

As individuals and companies grapple with the effects of the COVID-19 health crisis and global recession, fraud has abounded. In terms of international trade, this has manifested as a sharp increase in cybercrime, money laundering, impersonation, and trade finance fraud, including the trade of counterfeit medical equipment. In the following brief, MPG reviews a few practical methods for trade parties to safeguard their businesses against disreputable partners.

Escrow Accounts

As sales of Personal Protective Equipment (PPE) have risen in 2020 as a consequence of the COVID-19 outbreak, so have COVID-19-related scams and fraudulent transactions. Supply chain disruptions and acute shortages of medical equipment at the beginning of the pandemic resulted in a proliferation of trade in counterfeit PPE goods, beleaguering efforts to fight the contagion. To counteract this problem, escrow accounts are one mutually protective tool which may be used to reduce the importer’s risk of receiving a shipment of goods that fail to meet specifications, and negate the seller’s risk of non-payment.

An escrow account is an account where funds are held in trust whilst two or more parties complete a transaction. In this scenario, lawyers act as escrow agents or trustees, holding clients’ funds in a non-interest-bearing bank account, in which the client deposits funds to be held in escrow, invested and disbursed by the escrow agent as instructed by the client. The establishment of an account held by a third-party guarantor ensures that the conflicting interests of the parties to a transaction, whether it involves the purchase of goods or the provision of services, are simultaneously protected. 

To avoid the perpetration of fraud against unwitting consumers, an escrow agent would hold their funds until the goods are delivered to them in compliance with the terms of the sales contract, to which the escrow agreement is ancillary. Similar to letters of credit for cross-border transactions, which substitute the credit of the importer with that of the issuing bank, escrow accounts ensure that the exporter receives payment when the underlying goods have been shipped, received, or inspected. Escrow agreements can include as many contingencies as necessary, providing multi-layered protection.

Figure 1. Escrow Accounts and How They Work.

Due Diligence

Financial institutions have their own mechanisms to prevent fraudulent transactions, such as Know Your Customer (KYC), Customer Due Diligence (CDD), Anti-Money Laundering (AML) and Financial Crime Compliance (FCC) checks. However, in trade finance arrangements, their professional due diligence is limited to checking the documentary compliance of transactions prior to processing payments. When an import transaction is covered by documentary credit, banks will pay the exporter provided that the documents submitted are in compliance with the terms of the credit, regardless of the quality and even the quantity of the goods that are shipped. Conversely, an escrow agreement may indicate additional prerequisites, such as the appointment of a third-party inspector to examine the shipment and issue a certificate of conformity prior to the escrow agent releasing the funds. 

Parties to an arrangement must be especially cautious when financial institutions are not involved in a trade transaction, and a lawyer should be retained to conduct due diligence in order to assess the trustworthiness of other agents and intermediaries. For instance, in order to mitigate transactional risks, MPG conducts extensive client due diligence, entailing a series of investigations, such as legal and audit compliance, creditworthiness analysis, checks of Central Credit Registers, AML and FCC checks. 

MPG recommends that parties to trade operations utilize multiple safeguards in order to prevent frauds and establish successful long-term business relationships. Furthermore, risks should be identified and addressed before a transaction takes place, as it is undoubtedly easier to resolve issues before money changes hands. To ensure that goods and services procured through trade meet the importer’s specifications, a lawyer well-versed in trade finance should be retained to draft escrow agreements tailored to the nature of the transaction, and due diligence should always be carried out before selling or purchasing goods. 

For inquiries about risk prevention in trade, or any other aspect of trade finance, please contact us at info@mahanakornpartners.com

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