The Government recently announced that over 30 major companies have committed to boost the support they provide for their respective supply chains by continuing to offer, or by actively evaluating the implementation of, supply chain finance.
There are obvious benefits to companies in shoring up their supply chain and to suppliers ("Suppliers") that can obtain funding on better terms (or who can only obtain funding at all) based on the credit of their customers ("Customers"). Whilst raising debt against receivables is not a new method for suppliers to raise finance (and a number of different financing structures are used in the market), Customers contemplating entering into the type of scheme outlined in the Government announcement should be mindful of potential issues in doing so. In part this is because the Government's announcement would appear (although this is not explicit) to adopt a different approach to conventional invoice financing techniques from a Customer's perspective.
Conventional Invoice Financing
Conventional invoice financing arrangements employ a number of different structures including factoring and invoice discounting. The relationship between the Customer and the Supplier's bank under conventional arrangements is generally very limited and the risks that the Customer may be exposed to as a result are usually also very limited and well understood.
The scheme outlined by the government involves a financially strong Customer notifying its Supplier's bank that it has approved an invoice from that Supplier. The bank is then able to offer finance to the Supplier at lower interest rates than would otherwise have applied (or to provide finance which would otherwise not have been available) based upon the Customer's credit strength and its confirmation that the invoice will be paid. Whilst not currently clear, the Government announcement may be seeking to effect a more informal form of invoice financing arrangement which avoids the time and cost to Suppliers which are inherent in conventional invoice financing structures (although it remains to be seen whether lenders would accept that). However, it is also not clear whether the Government intends to provide a detailed framework for this scheme or whether that will be left to Customers, Suppliers and their banks to craft.
The type of supply chain finance scheme outlined in the Government announcement raises the following issues (amongst others) that Customers should consider:
Customer Liability to Banks: Customers will need to understand what liability they may have to the Supplier's bank. For example, what are the consequences if the Customer confirms to the bank that it has approved an invoice, but due to a mistake, a dispute or the exercise of a set-off clause in the supply contract, it does not actually pay that invoice? A bank may claim that it has relied on the Customer's confirmation in order to make finance available to the Supplier and may look to the Customer if it suffers a loss on the loan to the Supplier. Customers should consider the following:
- can this risk of liability be mitigated in the invoice confirmation given to the bank? Will exclusions of liability and statements that the confirmation is subject to the terms of the underlying supply contract be effective in all scenarios? This could vary significantly depending upon the law applicable to the confirmation.
- can a Customer reduce its administrative burden by standardising the form of invoice confirmation it provides to all of its Suppliers' banks? Banks may insist on using their own form of confirmation, which would likely include an unqualified confirmation that the invoice is due and payable. The terms of banks' invoice confirmations should be considered carefully.
- if the Supplier's bank is also the Customer's bank, what effect might the supply chain finance scheme have on the existing arrangements between the Customer and the bank? For example, if there were a dispute between the Customer and the bank relating to the supply chain finance scheme, could the bank set off any disputed amount against the Customer's deposits? More fundamentally, could a disputed invoice default the Customer's debt facilities? Whilst this might be a remote risk commercially, the rights afforded to banks under account mandates and finance documents tend to be very wide-ranging and may provide a right of recourse in these circumstances. Customers should review their contractual arrangements with their banks to evaluate this risk.
- whilst only likely to be relevant in a small number of cases, Customers should ascertain whether participating in such a scheme will materially reduce the headline exposure limits that those banks have available for that Customer (on the basis that the bank is looking through the Supplier to the Customer for repayment of its loan).
- if the Supplier or its bank is based overseas, Customers should ensure that the invoice confirmation contains an appropriate governing law clause and that there are no other cross-border factors which would expose the Customer to unexpected risks. The analysis will vary between jurisdictions and the cost and time required to carry out that analysis should be factored in to the Customer's decision as to its level of participation in any supply chain finance scheme.
Interaction with the Underlying Supply Contract: Customers will need to consider how their purchase/supply contracts would interact with a supply chain finance scheme. Payment terms, set-off rights and the dispute resolution provisions of the supply contract are particularly important. There are a number of practical steps Customers may wish to take:
- Customers can avoid potential mismatches between the terms of the supply contracts and the supply chain finance scheme by involving their commercial teams in establishing and running schemes. Standardising supply contracts and (if possible) invoice confirmations will facilitate this process.
- stress-testing invoice approval processes will enable Customers to verify that confirmations will only be given in respect of invoices which are actually due and payable under the terms of the supply contract and where there is no potential dispute in relation to the relevant supply (such that there is no need to rely upon the relevant protections in the underlying supply contract).
- Customers should determine the level of resources that they can commit to establishing and administering supply chain finance schemes. This is particularly important for those Customers dealing with a large number of Suppliers and banks across different geographies.
Supply chain finance schemes can deliver efficiencies for both Customers and Suppliers and they merit serious consideration. Customers should take care in implementing such schemes to avoid assuming unintended risks and liabilities or adopting a scheme which proves to be disproportionately burdensome from an administrative or cost perspective. However, as each Customer and its supply chain is different, individual supply chain finance schemes can be structured to achieve their intended objectives in a manner which safeguards Customers across their businesses and geographic markets.