Opening Up Receivables Purchase

Within the ambit of trade finance is found a broad range of products and solutions that support global trade and its growth. This article discusses Receivables Purchase, a method of financing different from traditional lending, and financing linked to documentary credits.

In Receivables Purchase, the first source of repayment that a finance provider would look to is the debtor of the receivables. The debtor is usually the buyer of goods or services and the debt is normally evidenced by invoices issued by the seller of the goods or services. The receivables that the finance provider purchases are commercial debt, i.e. debt emanating from the payment obligations for purchase of goods or services. A finance provider acquires the right to be paid from such commercial debt, typically by way of assignment or transfer of the receivables.

Techniques of Receivables Purchase include Receivables Discounting, Forfaiting, Factoring and Payables Finance (see Standard Definitions for Techniques of Supply Chain Finance published by the Global Supply Chain Finance Forum). Common to each of the techniques is foremost the existence of receivables (i.e. they must be capable of being identified and validated) which ought to be assignable and which ought to be enforceable against the debtor in the debtor’s jurisdiction. The receivables are transferred into the ownership of the finance provider, upon which the seller (of the receivables) will receive an advance payment for the receivables.

Risks common to the finance provider across the techniques include default or insolvency of the buyer (debtor of the receivables), insolvency of the seller of the receivables, dilution of the receivables, double financing of the receivables, and fraud.

Benefits of Receivables Purchase

A seller may derive the following benefits:

1. Working capital optimisation, if the ‘sold’ receivables can be removed from the seller’s balance sheet resulting in reduction in Days Sales Outstanding and shorter cash conversion cycle.
2. Off balance sheet financing, if the financing is on non-recourse basis.
3. Credit protection from buyer insolvency or default.
4. Strengthening of capacity to sell on open account basis.
5. Strengthening of capacity for increased sales to a buyer without increasing the credit limits for the buyer.
6. Strengthening of capacity to offer longer credit terms to buyers.
7. Reduction of concentration risk on large buyers, by distributing the risk to a finance provider.
8. Lower cost of financing if financing terms are based on superior credit rating of the buyer.
9. Lower cost of goods sold if financing cost is lower than early payment discounts that may be offered to buyers.

It should be noted that many of the benefits are inter-related and reinforce each other, for example (1), (2) and (3) all result in working capital optimisation and (4), (5), (6) and (7) all result in increased capacity for business.

A finance provider may derive the following benefits:

1. Acquires title to the receivables and the right to be paid by the debtor of the receivables.
2. Improved visibility on the quality of the seller’s performance and collections – the finance provider is able to monitor the quality of the receivables it is financing on an ongoing and dynamic basis, instead of relying on periodic snapshots of financial indicators such as debtors ageing list.
3. Protection from insolvency of the seller where the transfer of receivables has been perfected against third parties.
4. In cases where the buyer’s credit rating is superior to the seller’s, the financing transactions may consume less capital than those where lending is based on the seller’s risk rating.
5. Possibility for optimisation of risk-weighted assets based on credit insurance cover for the receivables.

A buyer may derive the following benefits:

1. Improved stability of the supply chain with reduced risks of disruption caused by funding and liquidity issues of the seller.
2. Ability to buy more from the seller, as the seller’s capacity is increased thanks to available financing.
3. Possibility of longer credit terms from the seller, thanks to available financing to the seller.
4. In Payables Finance programs, the ability to make available approved invoices for seller to avail financing, at financing costs pre-agreed with the finance provider.

Elements that Make Receivables Purchase

In Receivables Purchase, the finance provider relies on the trade receivables as the primary source of repayment, as settlement of the financing will be the payment by the debtor of the receivables.

The party that receives the financing ‘sells’ the receivables to the finance provider, by way of transferring or assigning the receivables that it owns, to the finance provider. The finance provider is acquiring an asset, not in the form of a financial debt owed by the party financed, but in the form of a transfer of commercial debt owed by a third party to the party financed.

Purchase of the receivables is by way of an agreement signed between the seller and the finance provider, in which the seller assigns or transfers the receivables to the finance provider for a purchase price paid by the finance provider to the seller. The debtor may be made aware of the transfer of receivables by way of a notice it receives.

It is in the finance provider’s interest to determine that it has a valid title to the receivables and that it is able to enforce its rights on the debtor and against competing claims for the receivables. For this, the finance provider ought to pay attention to questions of effectiveness, perfection, and priority of the transfer of receivables.

Effectiveness

For a transfer of receivables to be effective against the transferor, the debtor, and third parties, the provisions concerning transfers in the relevant legal system need to be observed and question in this regard may include:

• Is notice of assignment to the debtor required?
• Who may serve the notice of assignment on the debtor?
• Is there a need to register the assignment/transfer?
• Is a transfer invalidated by a restriction on assignments in the underlying contract between buyer and seller?

Perfection

‘Perfection’ is the step required to make a transfer effective against third parties, and in the case of insolvency, against the transferor.

Applicable laws differ by jurisdiction and hence the requirements for perfection need to be understood by finance providers for their particular transactions. Requirements to be met for perfection might include any or a combination of creation of the assignment, notice of assignment to the debtor, formality requirements, and registration. When the transferor, transferee, and debtor are all in the same location, and local law applies to the underlying commercial transaction and the transfer of receivables, perfection of the transfer would typically be subject to the law of the same location – when the transferor and debtor are in different legal jurisdictions, conflict of laws matters need to be managed.

Effectiveness is a requirement for perfection, but an assignment may be effective between the transferor and transferee even if it has not been perfected against third parties.

Priority

Priority is determined by the order of perfection against third parties. As the requirements for perfection differ across legal systems, it is important for a finance provider to do the necessary to comply with the provisions of applicable law in order to protect its rights to be paid on the receivables.

As an example, there may be more than one assignment of the same receivables to different assignees/transferees, giving rise to competing claims by different transferees – the multiple transfers could have been made by the same transferor or subsequent transferors (who were transferees). In principle, the transferee that first achieves perfection against third parties has priority over the other transferees.

Receivables Purchase in Practice

Receivables Purchase can be for domestic receivables or for cross-border receivables. Particular attention needs to be paid to address conflict of laws issues when more than one jurisdiction’s laws are involved, with regard effectiveness, perfection and priority.

In a Receivables Purchase, there are three sets of relationships:

1. The relationship between the seller (transferor) and the finance provider (transferee)
2. The relationship between the seller (transferor) and the buyer (debtor)
3. The relationship between the transferee (finance provider) and the debtor (buyer)

The law governing the contract generating the receivable between the seller and buyer also governs the relationship between the transferee and the debtor, even if the law governing the transfer contract (agreement for Receivables Purchase) may be a different law. This is because the transferee does not obtain a better ‘title’ than the transferor in relation to the receivables. Questions on assignability of the receivables and the debtor’s obligations in regard to the receivables, are governed by the law of the underlying sales contract between seller and buyer.

In the event of the transferor’s insolvency, the relationship between the transferee and the insolvency administrator is governed by the state where the transferor is located.

Enforcement on debtors will be subject to the law of the state where the debtor is located. For these reasons, it is possible that a Receivables Purchase deal may involve a number of legal opinions to be obtained based on the laws of different relevant jurisdictions, for the finance provider to be sure that it perfects its transfer against third parties and preserves priority on the debt.

In practice, finance providers may accept certain risks, for example not serving a notice of assignment on the debtor upfront even when such notice would make the assignment binding on the debtor, preserve its priority on the debt and cut off set-off rights the debtor might have against the receivables. This may be done based on commercial considerations to accommodate a seller who does not wish to disclose to the buyer that it has sold the receivables.

Receivables Purchase performs an important role in the financing of trade, both domestic and cross-border. In global trade, the volume of open account trade is estimated to be four times that of trade settled by documentary credits and documentary collections. Finance providers and trading counterparties therefore have a very sizeable opportunity for availing finance with Receivables Purchase.

* This is an abridged version of my article, "Comparing Receivables Purchase with Documentary Credit Financing", published in Documentary Credit World, November/December 2019 issue.