Geoffrey Wynne explains the principle of true sale and giving true trade priority in restructurings
True sale of the receivable
Factoring, in particular, has shown that the whole debt need not be transferred and there can be recourse to the seller of the receivable if the receivable is not paid. That level of recourse is subject to negotiation. English law requires an assignment of the receivable as the mechanism to transfer title. This can be achieved with or without notice to the debtor. The buyer of the receivable normally collects it. Sometimes the buyer of the receivable agrees that the seller can collect the receivable on its behalf. It was an agency arrangement giving the seller the right to collect and account to the buyer.
Trade debt and true trade
Does it matter?
Arguments were made, and continue to be made, that this principle was good as it encouraged the use of finance using trade receivables. The regulators took note of the possibility of viewing short-term payables under letters of credit as self-liquidating (because they closely followed the goods) and hence should get better capital relief.
paid to exporters and banks in respect of defaults (source: Berne Union)
Holding receivables, however evidenced, would then be good news for bank financers. Although credit risk mitigation under Capital Requirements Regulation (CRR) only benefits those banks that are on the advanced internal ratings based approaches. There are many structures that can be used to evidence receivables for their purchase.
Where does structuring lead?
In some cases, the holder of the IPU took the view that it would extend the payment terms of the receivable arguably well beyond its normal term. This was advantageous to the Abengoa company (as the buyer of goods) and its parent. The extended terms were granted by a financer (as the buyer of the receivable) rather than the seller of the goods. This caused Moodys to suggest that where this occurred and a bank financer extended the payment term, that receivable stopped being a trade receivable and became bank debt.3 If this continues to be the case then not only is there little, if any, chance of the debt being treated as trade debt and being repaid early but the issuer of the IPU increases its bank debt and cannot reflect the receivable (it is payable as it has the obligation to pay) as a debt owing to suppliers. This would affect its bank debt covenants, for example.
The way forward for receivables in a true trade context
It seems unlikely that there would be a wholesale change to insolvency laws to legislate for priority for trade debts over other unsecured claims. Clearly, creating some sort of security for true trade debt would be a solution. That could be possible where the receivable arises for the purchase of raw materials that then go into some sort of process which results in finished goods being sold. The receivable generated by that process could be assigned to the holder of the receivable for the raw material. This is a little complex and could be achieved at the moment with careful drafting, though it is not a general solution.
If there is a general feeling that trade debt should have a priority, those engaged in restructurings should take this as a principle of restructuring and implement it. That was the case in the Kazakhstan bank restructurings referred to above. It has also been adopted in other restructurings of a debtor with a large debt position, where some of its debts were bank debts but others were short-term debts owed, initially at least, to suppliers.
The regulators can help and the guidance for self-liquidating letters of credit has already helped a little.4 However, the premise that all trade debts arise under letters of credit is incorrect. This is especially true when coupling it with the idea that a bank will always be holding title to the goods being financed.
Receivables are, to a limited extent, considered in credit risk mitigation. The treatment could be improved further with some clear definitions to allow short-term trade debt where the buyer of the goods has irrevocably agreed to pay. All these terms would need to be defined and care needs to be taken to avoid abuses by the parties. Office holders in restructurings as well as arranging banks would also need to agree the principles. These principles would define what the acceptable debt would be, both as to how it is generated and who holds it. This is not impossible, as previous restructurings have shown. However, answers have varied widely and there is still no certainty that trade debt would always be paid.
Having the principles agreed could improve supply chain financings, get more trade debt insured and generally ensure better treatment is obtained for trade debt in a regulatory context.
Geoffrey Wynne is a partner and head of the trade and export finance practice at the law firm Sullivan & Worcester UK LLP
The Deutsche Bank view
Trade finance underpins around 80% of world trade volumes and at Deutsche Bank we have been supporting world trade with this ever since our 1871 foundation.
As Chair of the ICC Banking Commission, I am proud to lead rule writing, research and advocacy for trade finance – in particular emphasising the value of trade finance as a tool that provides importers and exporters with the financing and risk mitigation that allows them to transact with distant and often unfamiliar companies.
One of the ways we do this is the ICC Trade Register, which aims to support banks in making this happen with the provision of an objective, transparent view of the credit-related risks and characteristics of trade finance using a rich, data driven approach. The Register has done much to demonstrate trade finance’s favourable risk profile and continues to make the case for recognition as an investible asset class for institutional investors.
And as this article sets out, trade gets paid when it is structured correctly and the due diligence processes are followed to ensure safety and soundness are adhered to all the way along the value chain.
Daniel Schmand is the Global Head of Trade at Deutsche Bank
1 See ‘Restructuring banks, don’t start from here’ (November 2010) at www.economist.com/node/17583123
2 See http://bit.ly/2ml1mCj at www.abengoa.com
3 See Moody’s announcement on 16 December 2015 at http://bit.ly/2n4T8VR
4 See www.bis.org/publ/bcbs205.pdf
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