Supply chain and other receivables finance structures – some issues and how these structures work
Talk by Simon Cook, Partner,
Sullivan & Worcester UK LLP
Breakfast seminar on 23 February 2016
at Pinners Hall, 105-108 Old Broad Street, London, EC2N 1EX
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What the talk will cover Introduction and overview
What is “receivables finance”?
What should a financer be considering?
Specific receivables finance structures › Supply chain (buyer led, supplier led, other?) › Forfaiting and URF › Factoring › Securitisation
Some legal issues
Conclusions
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What is a receivable and what is receivables finance? What is a receivable?
› The payment by a buyer of goods or services to the seller, until the time when it is paid
› Often cross-border › An asset of the seller › A liability of the buyer › Existing receivable
Not, for example, structured trade future flows › E.g. asset-based lending with security
One possible definition of receivables finance: An arrangement providing credit to a party using an amount payable by one party to another for goods or services
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Different perspectives: the seller and the buyer Seller:
› The faster conversion of receivables into cash reduces the seller’s working capital needs
› “Days sale outstanding” (DSO) › Off-balance sheet treatment
Buyer › The quicker the buyer must pay, the more working capital it needs for
its business › “Days payable outstanding” (DPO)
Conflict of interests: the seller wants to a achieve a shorter DSO, while the buyer wants to achieve a longer DPO
Receivables financing can provide solutions for both parties
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The business case for receivables finance
Seller’s point of view: › can you monetise receivables at an early stage › Seller can finance receivables before they exist? › Seller can offer extended credit terms to buyer
Buyer’s point of view › Buyer can have extended credit terms › Buyer can support sellers’ businesses (e.g. using supply chain finance)
Financer’s point of view › offering business solutions to buyers and sellers › trading receivables to bring in other financers
Other parties › credit insurers and other providers of credit enhancement
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Trade finance and receivables finance The generation of receivables is a key factor in any trade
arrangement
Receivables represent the culmination of most if not all trading arrangements where a product or service is sold or provided
There may be more than one sale and purchase in the time from producing a raw material to selling the finished product: each sale and purchase creates a receivable which could be the subject of financing
Either or both of the seller and the buyer might see the need to obtain financial support for a sale and purchase transaction
Opportunities for financers at each step of the trading arrangements (true supply chain finance?)
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Main forms of receivables finance Trading receivables
› Receivables that are in a form where holder can transfer them – e.g. negotiable instruments
› Assignment of receivables that cannot be transferred without a transfer document – e.g. invoices
› Securitisation – SPV issues payment obligation secured on receivables
Forfaiting
Factoring
Supply chain financing
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Considerations for financers
The quality of the receivable
The credit standing of the buyer
The type of receivable
The extent of performance risk on the seller
Logistics affecting the seller’s performance
Level of recourse to the seller
Assisting the seller or the buyer or both?
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The quality of the receivable/debtor Assessing creditworthiness: who is the obligor?
› The buyer?
› Provider of credit enhancement? For example, the provider of a guarantee, credit insurance or a letter of credit
The nature of the payment obligation › Can the buyer refuse to pay if the goods are faulty? › Does the seller have the benefit of an irrevocable payment obligation, such as a
promissory note or letter of credit?
Length of time until payment is due
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What will the debtor give/financer obtain?
Ideal is irrevocable payment undertaking (IPU) › What is its place? › What are its problems?
Reality is often just an invoice with a notice to pay
Can seller collect debt for financer? › Yes!
Insurance (more later)
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Type of receivable Negotiable instruments
› Characteristics › Transferability › Credit enhancement options
Contract receivables/invoices › Characteristics › Transferability › Credit enhancement options
LCs/deferred payment undertakings › Characteristics › Transferability › Credit enhancement options
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Seller performance risk Whether the financer is taking any performance risk on the seller is
a key element to consider
Some types of financing are not available where the receivable has not become an unconditional payment obligation
Once a receivable becomes an unconditional obligation of the buyer, then the credit risk of the buyer is the main issue to consider › What is needed to make the obligation unconditional? › Example: Documents evidencing of transportation of the goods from the seller to the
buyer required to be presented under terms of an import letter of credit Where goods are transported by sea, the financing bank could take
possession of the bills of lading and present these to the issuing bank In this scenario, the bank is able to finance from the point the goods are on
board the vessel
In many ways this is a more quantifiable risk 12
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Some key risks The receivable itself
The subject of double funding
Changes to payment instructions
Structural issues
Due diligence and its place
True sale/recharacterisation (more later)
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Effect of documentary terms/laws? Application/interference of different laws
› Governing law of the sale contract/receivable
› Governing law of the receivable purchase document
› Must they be the same? The issues and how to work around the problems
What to ask › Buyer jurisdiction
› Seller jurisdiction
Standard industry terms v what you want › Override arrangements
› Framework agreement
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True sale issue Risk is that transaction will be recharacterised as a financing secured
on the receivables › Receivables purchaser will be deemed not to own the receivables › Receivables will form part of receivables seller’s estate on insolvency › May be subject to priority claims and/or competing claims of other creditors › Bank may not have valid security if required formalities not complied with at time
transaction was entered into
Relevant to all forms of receivables financing?
Welsh Development Agency v. Export Finance Co. Ltd [1992] – leading English case
“It is necessary therefore to look at the provisions in the master agreement as a whole to decide whether in substance it amounts to an agreement for the sale of goods or only to a mortgage or charge on goods and their proceeds” (Dillon LJ)
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True sale structuring considerations Some points to consider commercially to achieve a better argument for a true sale:
› Intention: the genuine intention of the parties is to effect a sale – this is a key consideration under English law
› Act as owner: act as any owner of those receivables would AND not as a secured party trying to divest itself of any risk in the transaction receivables
› Transfer of title: ensure title is properly transferred
› Repurchase triggers: Limit when any obligation to repurchase the receivables arises
› Where are receivables to be paid: during receivables purchaser’s ownership, the receivables are only paid to it or as it determines (directly or via a collection agent)
› Non-payment: the receivables purchaser takes the risk of non-payment (although this may reasonably be mitigated with insurance or properly structured indemnities)
› Insurance: any payment insurance is obtained by the receivables purchaser or it is co-insured while it is owner of the receivables (rather than just being loss payee)
› Price risk: the receivables purchaser takes any currency risk in the receivables (but may mitigate this through separate hedging arrangements)
Fall back security may be possible or arise automatically – local due diligence into requirements for valid security interest is important
Structure the transaction to reduce recharacterisation risk (ability to do this will depend on commercial structure and/or jurisdictions in question)
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Specific Structures Buyer-led structure
Supplier-led structure
Third party structures
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Buyer-led structure The buyer/debtor is the financer’s primary client
Contractual arrangements with the buyer/debtor
Confirmed/accepted receivables
Usually uses an electronic platform
Disclosed assignment
Commercial reasoning › suppliers obtain early payment (improving DSO) with financing costs based on
creditworthiness of IG buyer › used as a wider scheme to help buyer/debtor lengthen payment terms
(improving DPO) producing cash-flow benefit
Focus on accounting treatment for supplier AND buyer/debtor
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Buyer-led structure
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Supplier (Seller)
Service Provider/ Financer
Debtor (Buyer)
Supply Contract
1. Purchase Order
2. Supplies goods/services and invoice
5. Request for financer to purchase receivable (manual
discount only)
6. Payment of discounted purchase price in exchange for assignment of receivable
8. Payment of face value of receivable on maturity date
7. Notice of assignment of
receivable
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Supplier-led structure Wider variety of structures
The supplier is the financer’s primary client
Usually contractual arrangements with supplier only
Less frequently electronic platform-based
May be confirmed or unconfirmed receivables
May be disclosed or undisclosed
Supplier as collection agent of the financer
Focus on accounting treatment for the supplier
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Supplier-led structure
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Supplier (Seller)
Financer
Debtor (Buyer) Supply Contract
Receivables Purchase A
greement
2. Supplies goods/services and invoice
4. Details of accepted invoice/receivable and
request for financer to purchase
1. Purchase Order 5. Paym
ent of discounted purchase price in exchange for assignm
ent of receivable
5a. Notice of assignment (disclosed structure or supplier default only)
6. Payment of face value of receivable on maturity date
3. Acknowledgement/acceptance of invoice (confirmed structure only)
7. On-paym
ent of face value of receivable on m
aturity date
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Third party structures Wide variety of structures
Usually buyer-led
Relationship of the buyer and often the supplier is with the third party originator
Multiple financers within the structure
Identity of financers may be disclosed or undisclosed (to buyer and/or supplier)
Third party originator as paying agent and collection agent
Specific issues?
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Third party structures – other contractual structures
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Supplier (Seller)
Financer
Debtor (Buyer)
Third Party Platform Provider
Supply Contract
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Third party structures – other contractual structures
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Supplier (Seller)
Financer
Debtor (Buyer)
Third Party Platform Provider
Supply Contract
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Some legal issues What is the structure?
› Sale v secured financing › True sale issues › Does it matter?
Best position for financer › Notice of assignment › Avoid set offs and counterclaims
Must the receivable be assignable? › The law
How to transfer the receivables
Purchase of future receivables
Foreign jurisdictions
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Use of insurance
Credit insurance
Portfolio insurance (concentration risk?)
Does the insurer cover all the risks?
The wording of the policy
Disclosure
Who takes insurance?
How to get proceeds
Rights of insurers not to pay
Insurance under CRD IV as CRM
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Documentary recourse to the seller
Different types of financing have evolved which traditionally allow different levels of recourse to the seller
Forfaiting: › The receivable is sold without recourse to the seller › The seller must first take all steps to make sure the payment obligation is
unconditional › The seller receives a discounted payment only
Factoring: › The seller receives a discounted amount up front › The seller may receive more once payment from the buyer is received › If the buyer does not pay there may be recourse to the seller for all or part of the
unpaid amount
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Forfaiting
Forfaiting the right to future payment through discounting future cashflows
Convention: trade-related receivables
Arise from credits made available by suppliers (Sellers) to their customers (Buyers)
Reasons for banks using forfaiting › fees and commission › interest income - get $10,000 for $8,000 investment › trading margin › flexibility to sell the debt to further Forfaiters › diversify risk and involvement in emerging markets/SMEs › valuable (ancillary) product for existing customer
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Discounting the debt
Forfaiter
Buyer Seller I.O.U $10,000
Goods
$8,000 $10,000
Sells
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Some characteristics of forfaiting 100% financing with no minimum/maximum amount
Minimal documentation
Fixed (usually) interest rate
Available to all types of goods and services
Underlying debt instrument (negotiable?) › Eg. bill of exchange/promissory note/payment guarantee › Ideally transferable by endorsement
Pay on demand at a fixed or determinable future time a “sum certain in money” to or to the order of specified person
May be endorsed without recourse
Importance of documentation
URF 800
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Forfaiting v Factoring/Invoice Discounting
Forfaiting Without recourse Short/medium/long
term Bills of exchange/
promissory notes Bank
guarantees/avals Full discount
Factoring/Invoice discounting With recourse Short term
Invoices/book receivables
Corporate risk
Partial discount
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Securitisation background Historically covered asset backed loans
› eg residential mortgages, car loans, credit card receivables etc
Trade receivables? › More recent › Large multinational vs SMEs
Main benefits › Alternative to traditional bank lending/unsecured corporate bonds › Lower cost of funds (linked to pool of assets not general credit rating of
originator) › Off balance sheet so possibly better leverage and returns
Typical fundamentals › Involves sale of assets to SPV at a discount by originator(s) › Traditionally funded in the capital markets and rated › Credit insurance (commonly)
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What about trade receivables? Characteristics
› Short-term “business” assets › Not income-generating assets › Not usually secured › More complex jurisdictional issues (cross border)
Typical structure › Receivables are pooled and sold to the SPV at a discount › Purchase can be by way of a specified pool of receivables on a revolving basis
› Options for funding Bond issuance Commercial paper Private placement Note issuance Bank/alternative funder debt
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How does it work (at its simplest)?
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Originator
Financer/ Investors
Debtor
SPV
Sales Contract
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General considerations Funding mismatch/liquidity
Collections/servicing › Systems › Independent › Back-up
Pool specific issues › Debtor history › Contract terms › Dilution › Concentration risk
Eligibility criteria
Early amortisation and stop events
Insurance
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Conclusions Receivable Purchase – good structuring possible
Cross border issues can be dealt with
Look at structuring from “true sale” point of view
Important to have an enforceable right to payment
A number of ways to achieve this
Remember what has gone wrong and can go wrong
Length of document is not an excuse for poor due diligence
Knowledge is key to success
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Simon Cook Partner Simon Cook is a partner in the Trade & Export Finance Group in the London office of Sullivan & Worcester UK LLP. He has experience in a wide variety of banking and finance transactions, including in particular in relation to structured trade finance, trade finance, project finance, invoice discounting facilities and borrowing-base facilities in Africa, the Middle East, Asia and the CIS. His work in the structured trade area covers a range of pre-export and prepayment financings acting for both lenders and borrowers notably in oil, telecoms, soft commodities and metals sectors with particular experience in Africa and the Middle East.
Simon has worked and travelled extensively in Africa and the Middle East, having spent over three and a half years in Dubai. He has participated in a number of structured trade finance and project finance conferences and seminars throughout Europe, the Middle East and Africa, including speaking at conferences on PPP in South Africa; on project finance and structured trade finance at Afrexim's annual structured finance conferences in Cairo, Ghana and South Africa; and at structured trade finance seminars and general finance in London, Paris, Lisbon, Geneva, South Africa, Zambia, Kenya, Uganda, Ghana and Dubai.
Sullivan & Worcester UK LLP Tower 42 25 Old Broad Street London EC2N 1HQ
T +44 (0)20 7448 1002 F +44 (0)20 7900 3472 [email protected]
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Awards & Recognition TFR “Best Law Firm in Trade Finance”
Trade & Forfaiting Review (TFR) recently named Sullivan & Worcester "Best Law Firm in Trade Finance" in its 2014 and 2015 TFR Excellence Awards
GTR “Best Law Firm 2015 Poll”
Sullivan & Worcester UK LLP was the top ranked firm in the Global Trade Review (GTR) Best Law Firm 2015 poll
The Legal 500 UK 2014 and 2015
Sullivan & Worcester UK LLP was ranked in the following category in The Legal 500 UK:
Trade Finance (Tier 1)
Chambers UK 2015
Geoffrey Wynne is ranked a Tier 1 lawyer and Simon Cook a Tier 3 lawyer in Chambers UK 2015 and 2016 Directory.
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