supply chain finance: structuring and documenting...
TRANSCRIPT
Supply Chain Finance: Structuring and
Documenting Approved Payables Financing
Transactions
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THURSDAY, SEPTEMBER 10, 2020
Presenting a live 90-minute webinar with interactive Q&A
Ricardo (Rick) Martinez, Partner, Hogan Lovells, New York
Terry D. Novetsky, Partner, King & Spalding, New York
Mark S. Redinger, Partner, Dickinson Wright, Toronto
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Supply Chain Finance Overview
September 10, 2020
PRESENTED BY:
Terry Novetsky, King & Spalding LLP
Partner, New York
1185 Avenue of the Americas
New York, NY 10036
I. Economics of a supply chain finance facility
• Benefits for supplier, buyer, investor
II. Structuring issues
• Competing loan obligations of supplier and buyer
• COVID: Changes to Supplier Finance Landscape
• True Sale: Objectives and Concerns
• Accounting treatment
Agenda
6
The Players/The Principles
• The Players
❖ Seller/Supplier
❖ Buyer/Customer
❖ Lender/Financial Institution
❖ Platform Provider
• Principles of Securitization for Lenders
❖ To identify discrete financial assets with a predictable source of payment
❖ Credit analysis is based on cash flow and value of assets not the Seller
“Shifting the Corporate Risk to Obligor Risk”
7
Seller-Centric ProgramsThe Players
1
5
1. Supplier (Seller) sells product to/performs services for Buyers
2. “Account” is created that is due from Buyers to Supplier in x days
3. Seller sells Accounts to Lender in a “True Sale” transaction
4. Lender pays Supplier a “fixed” discount from the face value of the invoice
5. At due date, Buyer pays to a Lender-controlled bank account and Lender
sweeps funds (or directs funds towards the purchase of new Accounts)
3
4
2
Supplier
Buyers Lender
8
Buyers and Suppliers have competing interests
Limited liquidity
High financing costs
Stability and Liquidity Challenges
Short payment terms
High liquidity
Low financing costs
Desire to hold cash and optimize working capital
Long payment terms
Supply Chain Finance provides the Seller “access” to the Buyer’s stronger financial position while
providing the Buyer with extended payment terms.
Supplier
CharacteristicsBuyer
Characteristics
9
Dynamics Seller-Centric Programs
• Organized by Supplier (payee)
• Supplier/Seller agrees to sell Accounts Receivable of specific approved Buyers
to Lender
• Buyers typically not notified (in the U.S.)
❖ Payments are made into a Supplier bank account controlled by Buyer
❖ Ability to notify Buyer is typically limited to a default remedy
10
Key Benefits of Seller-Centric Programs
• Transaction Benefits – Sole Benefit is to the Seller
❖ Off-Balance Sheet Financing
❖ Indenture/Covenant Limitations
❖ Credit Risk Shift to Buyer/Account Debtor
❖ Additional Liquidity at Favorable Pricing
❖ Platform Provider Services – Full Visibility and Management of Accounts
• Typical Purchase Price Calculation
PP = Net Invoice x Discount Rate x Discount Period/360
– Discount Rate – LIBOR + Margin (but fixed at closing)
– Discount Period Tensions:
– Cushion off of due date
– quick pay/slow pay
• True Sale Challenges
❖ Fixed Purchase Price (Sellers don’t like this)
❖ Limited Recourse – (Lenders don’t like this)
11
Buyer-Centric ProgramsThe Players
1. Suppliers sell product to a single Buyer
2. Accounts Receivable are due from Buyer to each Supplier in x days
3. Buyer arranges for Supplier to sell Accounts to Bank.
Buyer acknowledges unconditional obligation to pay
4. Bank pays Supplier a discounted amount of the face value of the invoice
5. At due date, Buyer pays Lender, as owner of the Accounts Receivable
1
5
3
4
2
Suppliers
Buyer Lender
12
• Organized by Buyer (typically highly rated)
• Agrees to arrange for Suppliers to sell Accounts Receivable to Lender
❖ Could be pool-wide program for all Suppliers
❖ Lender may apply different terms for Accounts of different Suppliers
• Buyers is aware (fully informed), and irrevocably promise to pay the Accounts
Receivable when due without dispute or setoff (no dilution risk)
• Bank looks solely to credit quality of Buyer
Dynamics of Buyer-Centric Programs
13
• Buyer Benefits
❖ Longer terms
❖ Stability of supplies
❖ Platform services
• Supplier Benefits
❖ Superior cash flow – immediate funds
❖ Liquidity terms
• Lender Benefits – Predictability
• Typical Purchase Price Calculation
PP = Net Invoice x Discount Rate x Discount Period/360
– Discount Rate – LIBOR + Margin (but fixed at closing)
– Mitigation of Discount Period Tensions:
– No (or negotiated) cushion off of due date
– High quality single ‘buyer’ – payments are exactly on time
Key Benefits of Buyer-Centric Programs
14
• Draft Programs
❖ No UCC financing statement
❖ Elimination of Dilution Risk
❖ Perfection and Priority by Possession
❖ Note of Caution – Know Your Law
• Participations
❖ Well Developed “True Participation” Law – the FDIC Rule
❖ All flows and risks must match “pro rata”
❖ Voting and limited “sacred rights” – “Elevation” remedy
❖ BAFT Form
• A Few Words on Factoring
❖ “Risk” Factoring
❖ Cross-Border Factoring for Specified Industries
Important Market Variations
15
COVID-19: Shifts in the Supplier Finance Landscape
• Post-COVID-19: The Lender’s Perspective
• Post-COVID-19: Shift in Buyer Motivations and Credit Risks
• Post-COVID-19: Shift in Supplier Motivations and Credit Risks
• Force Majeure
16
“True Sale”: A Bundle of Sticks; Not a Light Switch
17
“True Sale”: Benefits and Burdens of Ownership
• Key Factors in “True Sale” Analysis
❖ Intention of the Parties
❖ Recourse
❖ Benefit of Surplus Collections
❖ Fixed or variable purchase price
❖ Call/Put Option
❖ Control over Collection Process
18
“True Sale”: Why We Care/How We Achieve It
• Focus of (and Mitigation) of Credit Risk
• Accounting and Bank Covenants
• The Good News: We Own These Receivables
❖ Can There Be Too Much Good News?
• The Bad News: We Own These Receivables
❖ How Much Recourse is Too Much Recourse?
19
Accounting Considerations
• Three Part Test under Paragraph 9 of FAS 166 / ASC 860.20
• Legal isolation [¶ 9(a)]
– Legal true sale
• Free assignability [¶ 9(b)]
• No “effective control” [¶ 9(c)]
• Buyers should be careful of accountants viewing over-extension accounts payable being classified as short-term payables financing.
• Issues to avoid:
• A difference between the liabilities owed to the Bank and the obligations owed to the Supplier
• Mandatory Supplier participation
• Buyer involvement in negotiations between Supplier and Lender
• Excessive Buyer control
• Make-whole arrangements between Buyer/Supplier
• Rebates paid to the Buyer by the Lender
20
Supply Chain Finance Overview
September 10, 2020
Presented by:
Mark Redinger, Dickinson Wright LLP
Partner, Toronto
199 Bay Street, Suite 2200
Toronto, Ontario, M5L 1G4
Receivable Based Supply Chain Financing –Typical Documentation
• Factoring/Reverse Factoring Transactions
– Supply Chain Financing can cover the entire manufacturing process from the supply of or inventory raw material to the sale to a retailer of a product/service– at any point in the ‘supply chain’ financing can be used to transfer some risk and/or access capital.
• Transaction are usually distinguished between:
– Financing the “Supply” of goods or services OR
– Financing sales proceeds from the “Supply’ of goods/services;
• Key distinction in all documentation is determining your clients interests (and goals):
– Buyer side transaction (Reverse Factoring) the Buyer is typically acquiring inventory at a premium because it does not want to tie up cash;
– Seller side transaction (Factoring) the Seller is selling A/R at a discount because it needs cash;
– Funder/Bank – in either side they are trying to make ($) from the inefficiencies in the market without any risk in the underlying transaction.
22
Receivable Based Supply Chain Financing –Typical Documentation
• Who you are acting for, and their goals determines what you are looking for in the documents:
– Buyer side transaction (Reverse Factoring) the Buyer is typically acquiring inventory at a premium because it does not want to tie up cash;
– Seller side transaction (Factoring) the Seller is selling A/R at a discount because it needs cash;
– Funder/Bank – in either side they are trying to make ($) from the inefficiencies in the market without any risk in the underlying transaction.
23
Receivables Based Supply Chain Financing -Typical Documentation
• Paying Services Agreement (Buyer/Bank/Funder) (Reverse Factoring Transaction)
– Bilateral agreement between the Funder and the Buyer;
– Buyer agrees to confirm the amount, payment due date, invoice number and other information for each Supplier invoice;
– Buyer acknowledges that if the receivable is sold to the Bank, the obligation of the Buyer to pay the Bank is “absolute and unconditional, without any claim, abatement, deduction, reduction or setoff of any kind”
• Buyer rights against Supplier not affected, but the Funder is not exposed to the commercial transaction between the parties (i.e. if the supply is defective)
– Often highly negotiated by Buyers.
– Funder can, but is not obligated to confirm supply of goods;
– Funder’s credit risk is solely on the Buyer.
24
Receivables Based Supply Chain Financing -Typical Documentation
• Receivables Purchase Agreement (Supplier/Bank/Funder) (Factoring Transactions)
– Supplier may offer to sell, and the Bank may elect to purchase, Buyer receivables, each in its own discretion (exclusive/non-exclusive)
– The sale can be Non-Recourse/Recourse to the Supplier;
– Recourse transactions are generally not ‘true sales’ and can be considered veiled loans (beware of priorities issues with other creditors)
• Funder’s risk is to both Buyer and Supplier (it can choose in some cases)
– Non-Recourse Transactions (i.e., the Supplier does not guaranty payment by the Buyer) and are explicitly articulated as a legal true sale and not a financing – however the transaction may be subject to re-characterisation risk if not structured properly
• Funder’s risk is to Buyer solely
– PPSA/UCC Matters, to register or not to register.
25
Receivables Based Supply Chain Financing -Credit Enhancement Techniques
Funder can protect itself from non-payment by utilizing other forms of credit enhancement techniques (Parent Guaranty’s, Personal Guaranty's, Trade Finance Insurance):
• Parent Guaranty/Guarantee
– Collateral guarantees from other parties or other security from the Seller/Buyer in a transactions or their affiliates (esp. required when the Buyer/Seller is an offshore jurisdiction).
• Personal Guarantee’s from Principals
– Common where the corporate structure is entirely offshore and thinly capitalized (ex. Oil bunkering deals) but the principal is not off-shore.
26
Receivables Based Supply Chain Financing -Credit Enhancement Techniques
• Trade Finance Insurance
– Can be purchased for either side of the transaction
• For Reverse Factoring, it usually covers the Buyer’s ability to pay or the Parent/Personal Guaranty(ee);
• For Factoring Transaction, it can covers the Account Debtor’s ability to pay, in some cases you can purchase insurance on the recourse provisions of the factoring agreement, i.e. resale provisions.
– Insurance will cover non-payment in certain events, i.e. insolvency, it does not cover fraud, misdirected payments.
– Most importantly it will not cover an invoice/purchase order dispute between supplier-buyer.
– Purchased by the Supplier/Funder.
27
Receivables Based Supply Chain Financing -Credit Enhancement Techniques
• Trade Finance Insurance (cont’d)
– Claims process can be complicated with strict reporting requirements;
– If litigated, insurance litigation is often lengthy, expensive and extremely technical in nature.
– Underwriting forms are not standardized so must be scrutinized carefully.
– Beware of jurisdiction clauses that subject you to the laws of other markets, notably the UK where legislation can impact the ability of claims.
*If you do act for a funder/Bank – Trade Finance Insurance is not a substitute for transaction due diligence. *
28
Receivables Based Supply Chain Financing -Typical Documentation (Other Documents)
• Participation Agreement
– Syndication agreements to the Funder. Participants can have recourse through to the Buyer/Seller but often perform through an agent.
– Often blind to the Buyer
– Funder remains fully liable to Buyer/Supplier
• Blocked Account Agreements
– Either springing/non-springing. Prevents misdirected payments if structured properly. Tension between Funder and Buyer if not all ($) is to be sent to seller.
• Notifications
– If required – often highly contentious as Buyer/Seller does not want market to
know it is factoring its accounts/purchase orders.
29
◼ UCC-1 Filings in Washington D.C.
◼ Filings with Local Register (e.g., the R.U.G. in Mexico and PPSA in Canada)
◼ Notice to Account Debtors
◼ Process Agent
◼ Local Law Addendums
Issues Pertaining to International Supply Chain Finance Transactions
31
International Supply Chain Finance
Buyer uploads
invoices
(automated
process)
Emerging market
suppliers
SCF platform
provider
(may be owned
by Bank or independent)
– A multilateral can provide the
bank additional credit
capacity to support clients;
suppliers from higher risk
– A multilateral can provide
risk sharing of up to 100% of
a client’s account receivable
(AR). A multilateral can also
provide liquidity and discount
AR itself
– AR is discounted by a
multilateral using market
based pricing. A multilateral
may also accept bank
proposed discount rate
Buyer
Bank
Multilateral
Financier accepts
early payment
requests
Supplier views invoices
and requests early
payment of approved
invoices
Financier pays
discounted
invoice amount
Multilateral
provides
funding or
guarantee
coverage
Buyer pays full
invoice amount on
due date
(automated
transfers
established)
1
2
3 4
5
– A SCF platform is typically
electronic and internet enabled
– A SCF platform can provide a
“real-time” clearing house
for the purchase and sale of
receivables on a discounted
basis
32
Bank Payment Obligation Fundamentals
BPO
established
Purchase order
Baseline Match Report
Confirm
BPO based
on SO
Request
BPO based
on Purchase
Order
Buyer Seller
33
Buyer Seller
Contract
Docu
me
nts
Ap
plic
atio
n Ad
vic
e
Docu
me
nts
LC Issuing
Bank
IssuanceLC Advising
Bank
Buyer Seller
Contract
BPO Obligor
Bank
Documents
BPO Recipient
Bank
Data
Data
Data
Buyer Seller
Contract
Buyer’s Bank
Documents
Seller’s Bank
Letter of
Credit
Bank
Payment
Obligation
Open
Account
Payment Payment Payment
Bank service based on paper
document processing
Bank service based on electronic
trade data exchangeBank service limited to payment
processing
Array of risk, financing and processing services to address both
cash and trade finance needs
Documents
Bank Payment Obligation Compared
34
Fraud Matters
• Fraud is prevalent in this space, often in retrospect there were tell-tale signs:
– Refusals to provide notifications or get acknowledgements from Buyers/Sellers;
– Supplier refusal to verify shipments of product;
– Related party transactions, where the supplier is controlled de-facto by the Buyer, cook up the transaction to extract money;
– Fraudulent or doctored invoices A/R transactions;
– Beware of non-recourse jurisdictions;
– Transaction doesn’t make sense – i.e. why would ‘X’ entity need to factor its accounts – use common sense.
35
◼ There Continue to be Developments in this Area
◼ Technology, Globalization and Increased Competition are Drivers for Growth
◼ There is Not a “One-Size Fits All” Approach
◼ Role of Legal Counsel Will Always Remain Central
Conclusions and Final Issues for Consideration
36