What Is a Trust Receipt?
A trust receipt is a notice of the release of merchandise to a buyer from a bank, with the bank retaining the ownership title of the released assets. In an arrangement involving a trust receipt, the bank remains the owner of the merchandise, but the buyer is allowed to hold the merchandise in trust for the bank, for manufacturing or sales purposes.
- A trust receipt is a notice of the release of merchandise to a buyer from a bank, but the bank retains title to these goods.
- Typically companies involved in these arrangements are equipment dealers, automotive dealers, or companies involved in expensive durable goods.
- The bank remains the owner of the merchandise, but the buyer is allowed to hold the merchandise in trust for the bank, for manufacturing or sales purposes.
- This arrangement often falls under a letter of credit financing. The trust receipt serves as a promissory note to the bank that the loan amount will be repaid upon sale of the goods.
How Trust Receipts Work
A trust receipt is a financial document attended to by a bank and a business that has received delivery of goods but cannot pay for the purchase until after the inventory is sold. In most cases, the company's cash flow and working capital may be tied up in other projects and business operations.
In the normal course of running a trade business, companies purchase goods for their inventories from vendors or wholesalers to resell to consumers or to manufacture goods. These goods may either be purchased locally or imported from other companies. When these companies receive the merchandise, they are also billed by the seller or exporter for the goods purchased. In the event that the firm does not have the required cash on hand to settle the bill, it may obtain financing from a bank via a trust receipt.
The trust receipt serves as a promissory note to the bank that the loan amount will be repaid upon sale of the goods. The bank pays the exporter on its end or issues the seller (or seller’s bank) a letter of credit guaranteeing payment for the merchandise. The lender, however, retains the title to the merchandise as security. The customer or borrower is required to keep the goods separate from its other inventory and, in effect, holds and sells the goods as a trustee for the bank.
Although the bank has a security interest in the goods under the standard terms of a trust receipt, the customer takes possession of the goods and may do what they want with them as long as they do not violate the terms of their contract with the bank. If the customer decides to terminate the bank’s security interest and tie it to the inventory, they may tender the amount advanced on the goods, gaining total ownership of the goods.
Example of a Trust Receipt
Under a typical trust receipt transaction, the business has little to none of its own assets invested in the particular goods financed. The bank bears the majority of the credit risk prevalent in the transaction. The business keeps any profits made from the resale of the goods but also bears the business risk.
If the goods get damaged, lost, or deteriorate in quality or value, the loss is solely the burden of the business and it remains liable for repaying the full loan amount to the bank. In addition, any business expense (such as manufacturing costs, freight, custom dues, storage, etc.) is the responsibility of the business, not the lending institution.
Extending short-term financing through a trust receipt requires the customer or borrower to be in good standing with the bank. The bank and the customer also have to agree to the terms of the trust receipt, including such conditions as the maturity date, interest charge, and financing amount.
Maturity dates under trust receipts are short-term and range from 30 to 180 days. At the time of maturity, the customer must repay the loan to the lender with interest stipulated under the terms of the trust receipt. The bank must be repaid at the time of maturity or after the sale of the goods, whichever comes earlier. If after the maturity date, no payment has been received by the bank or the business defaults in paying its advances, the bank could repossess and dispose of the merchandise.
What Is a Trust Receipt Transaction?
When a company does not have sufficient capital to purchase merchandise, a bank may lend the company the resources to the company, but retain ownership rights, through a trust receipt transaction. Under the terms of a trust receipt agreement, the company agrees to repay the bank once the merchandise has been sold.
What Is the Difference Between a Letter of Credit and a Trust Receipt?
Commonly used in the trade industry, a letter of credit is issued from a bank to that guarantees the payment will be fulfilled and paid to the seller by the buyer. By contrast, a trust receipt is when the bank lends merchandise or goods to a business, but retains ownership of the goods. When the goods have been sold, and payment is made to the bank, the business then becomes owner of the goods.
What Happens If a Trust Receipt Is Violated?
A trust receipt becomes violated when the borrower fails to return the goods that were lent to them, or if they fail to return the sale of proceeds for the goods as stipulated under the terms of the agreement.