Simon Cook explains the legal fundamentals
of three types of supply chain finance structures
Supply chain finance structures cover the purchase of receivables by way of assignment without recourse to the seller and usually form two categories: buyer-led transactions and supplier-led transactions, distinguished by the engagement of the financer or service provider with the debtor of the receivables.
This article sets out the framework of these structures along with their legal implications.
The main features of these are:
the buyer (the contractual debtor) is the financer's client;
there is a contractual nexus between financer and buyer;
the buyer has accepted liability to make payment to the financer on the due date (thus mitigating the performance risk on the supplier); and
the structures are often implemented over an electronic platform, but not a prerequisite.
The rationale for the parties is that:
the supplier obtains earlier payment;
the buyer gets better commercial terms and maintains a stronger relationship with its supplier; and
the financer makes its margin.
Both buyer and supplier have accounting treatment requirements, with the buyer wanting a trade payable on its books rather than a debt and the supplier wanting the receivable off its balance sheet.
In Figure 1, there are three contracts:
a sales contract between the buyer and the supplier;
a payable services agreement (PSA) between the financer and the buyer; and
a receivables purchase agreement (RPA) between the supplier and the financer.
Under the PSA, the financer acts as paying agent and this agreement sets out the terms on which the buyer uses the platform. Under the RPA, the receivable is transferred from the supplier to the financer and, in some cases, this agreement includes terms allowing the supplier to access the platform (this can be separately documented).
The process is that the purchase order is submitted following which the supplier supplies the goods and services and the invoice is sent out.
If the buyer wants to put the invoice into the structure, it uploads details of the invoice onto the platform (including at least the name of the supplier, the amount, the maturity date and a reference linking it to the right transaction) automatically notifying the supplier. The supplier decides either to retain the receivables or to offer them for sale to the financer. If offered, the financer has the choice to either buy the receivable or not. If instead there was an automatic sell down process, as soon as the buyer uploads the invoice the financer is bound to buy the asset.
Payment of the purchase price by the financer triggers assignment of the receivable to the financer and notice being issued to the buyer confirming the purchase. From then on, the buyer will only be able to discharge its obligations by payment to the financer in accordance with its instructions.
The buyer will put the financer in funds prior to the receivable's due date and then, on the due date, if the receivable was purchased by the financer, the financer retains the funds itself. If not purchased, the financer makes payment on behalf of the buyer to the supplier.
These structures are more varied but generally the supplier is the financer's main client. There are contractual arrangements in place between the supplier and the financer but the financer has no contractual relationship with the buyer. These are the main differences from a buyer-led structure:
supplier-led structures can have confirmed or unconfirmed receivables with the consequence (in the latter case) that there is still seller performance risk;
the assignment of the receivable may be disclosed or undisclosed to the buyer (no legal assignment in the latter case);
the supplier commonly acts as collection agent for the receivables;
if an issue arises with the supplier or the buyer or there is a default, then the financer would serve notice at that point on the buyer if the assignment was undisclosed; and
the accounting treatment is generally only relevant to the supplier who still requires the receivables to be off balance sheet.
In Figure 2, there are two of the same main contracts as with buyer-led structures. These are: a sales contract between the buyer and the supplier (though there may also be multiple sales contracts/buyers with different protections and different pricing); and an RPA.
The commercial processes are generally the same as for buyer-led structures. There is the potential for variation following issuance of the invoice depending on whether you have the confirmed or the unconfirmed receivable's structure and the receivables purchase process may be automatic or discretionary as with the buyer-led structures.
Third party structures
These are structures involving an electronic third party platform and their main features are:
buyers and suppliers have access to a wider group of financers;
financers can participate in transactions they might not otherwise be able to participate in because they do not have their own platform nor do they have the ability to do a whole programme for a customer;
these structures might be disclosed or undisclosed; and
the third party platform provider will provide the paying and collection agent's services.
In Figure 3 there are separate commercial arrangements between the supplier, the financer and the platform provider (these could also be done by way of a tripartite agreement) and the financer still has to sign up to the terms of the platform. In terms of how the commercial structure works, this is very similar to the structures set out in Figures 1 and 2 and, again, the financer purchase arrangements can be automatic or discretionary. Some of the differences to the previous two structures are:
the way in which the financer obtains its rights against the buyer: there is no contractual relationship but , assuming the documentation has been drafted properly, the PSA should give third party rights to the financer (separate from the financer's rights under the RPA);
the important point in these structures is to make sure the drafting works and rights flow through to the financer; and
in Figure 3, the cash flows go directly from the buyer to either the supplier or the financer rather than through the platform. If the cash flows go through the platform and the platform provider's accounts, a financer should ensure it is not taking insolvency risk on the platform provider as well as the buyer (buyer funds should be segregated and subject to a trust until payment is actually made down to the financer).
If things go wrong, if the systems fail, if the platform provider pays to the wrong party or it just does not pay at all, a financer's rights will very much depend on the terms of the documents so it is critical to understand exactly what the buyer's obligations are and how to enforce against it.
Simon Cook is a partner in Sullivan & Worcester's Trade & Export Finance Group, based in London
"The financer purchase arrangements can be automatic or discretionary"