Supply chain and other receivables finance structures ... · › Forfaiting and URF › Factoring...

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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Sullivan & Worcester advise clients concerning their activities throughout the world, with a special emphasis on the emerging markets of Africa, Asia, the CIS countries and Latin America.

Our practice is multi-disciplinary, involving attorneys and solicitors expert in trade, banking, securitization, securities law, project finance, insurance, tax, compliance issues and dispute resolution.

In addition to trade and commodities finance, the firm intends to build up a London practice linked closely to our U.S. practice and the needs of our clients worldwide. The office will also benefit from our joint venture in Israel, ZAG-S&W, and significant client activity across Europe and Asia. We will broaden and enhance our existing practices in cross-border finance, mergers and acquisitions, tax, banking and international arbitration.

© 2013 Sullivan & Worcester Sullivan & Worcester is the collective trade name for an international legal practice. Sullivan & Worcester UK LLP is a limited liability partnership registered in England and Wales under number OC381549 and is a practice of registered and foreign lawyers and English solicitors. Sullivan & Worcester UK LLP is authorised and regulated by the Solicitors Regulation Authority (“SRA”). The term partner is used to refer to a member of Sullivan & Worcester UK LLP. A list of the names of all the partners is available for inspection at our registered office, Tower 42, 25 Old Broad Street, London, EC2N 1HQ. Please see sandw.com for Legal Notices, including further information on our professional obligations. This presentation is not designed to provide legal or other advice and you should not take, or refrain from taking, action based on its content. We are providing information to you on the basis you agree to keep it confidential. If you give us confidential information but do not instruct or retain us, we may act for another client on any matter to which that confidential information may be relevant.

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Supply chain and other receivables finance structures ... · › Forfaiting and URF › Factoring...

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