With commodity prices plummeting and liquidity scarce many lenders are concerned about their facilities to trade finance borrowers. Geoffrey Wynne and Veronika Koroleva look at how lenders can maximise recoveries.
A well-structured trade finance facility will have been documented to fit the specifics of the transaction. There will be a loan agreement and security documents, including an assignment of receivables, and security over the commodity and over a receivables collection account. The transaction documents may also deal with the role of such key parties as warehouse keepers and commodity transporters.
Good documents will provide early warnings against any inability of the borrower to repay, via coverage ratios and obligations to update the lenders regularly on raw material supplies, production and export sales.
Lenders ought to review this data carefully and ask for as much extra useful information as their documents allow.
Lenders should stay on top of other threats to repayment, such as margin calls under hedging transactions, the quality of the off-taker and duties to top up security on a breach of a coverage ratio.
Armed with information on the borrower’s condition, lenders and their lawyers should review the documents to check:
- whether an event of default or a potential default has occurred under the documents;
- what rights they will have if either occurs;
- when and how they can stop releases from the collection accounts or from the warehouses;
- the legal and practical steps they will need to take if they enforce their security – including taking advice from local counsel if the security is governed by foreign law or the borrower or any security provider incorporated overseas; and
- whether key off-take and other contracts contain any nasty surprises, such as the right of the off-taker to stop buying the commodity on the insolvency of the borrower.
Lenders should also seek advice about insolvency protection and other options open to borrowers and security providers in all relevant jurisdictions – e.g. under a stay on enforcing security. Consider next steps
Having obtained all relevant information and advice, lenders need to consider:
- whether termination and enforcement is in their long-term interests. Immediate termination and enforcement often produce low recoveries. Basing a financing on recoveries from enforcing security is seldom the best way to structure. This is especially so in jurisdictions where it is only possible to enforce a pledge over commodities by a long-delayed public auction with the purchase price payable in a soft currency for a commodity that has decayed and lost value in the meantime;
- time and cost of enforcement weighed against likely recoveries and the effect of enforcement on the borrower’s ability to continue production and export. Retaining receivables in collection accounts may further impair the borrower’s cash flows and its ability to produce income generating commodities. Enforcing a pledge over commodities in some jurisdictions may only be done by a public auction of the type described above. By contrast, allowing the borrower to continue exporting may bring in receivables to repay the facility;
- any waivers or amendments that may be necessary to allow the facility to continue;
- working out a joint approach with other lenders. If a problem is temporary, lenders may agree a standstill on enforcement, a deferral of repayments or making new funds available. If new funds are made available, take legal advice on how best to structure this to ensure your security is valid – especially if taking security from a borrower that is actually or potentially insolvent;
- taking no action. If a lender decides not to terminate, it should be careful not to waive its right to do so later. Make sure you expressly reserve your rights.
When borrowers get into difficulty there is a tendency for lenders to enforce immediately. This may well be the option to avoid.
Careful monitoring, analysis and working at a solution that keeps a business going to repay the financing may provide much better answers.