Understanding the nuances of receivables purchasing arrangements, the difference between the different types of recourse, and the trade and receivables finance products available on the market is key to anyone in the asset backed lending space. Understanding legal obligations, security, and how different products can help lenders create funding structures which are helpful and useful to businesses to help them grow.
Receivables purchasing arrangements
The open account market is a significant market opportunity, as we’ve seen a downturn in the use of LCs and guarantees.
A receivable is a legally enforceable right to receive payment from another person. There are two types of receivables: negotiable and non-negotiable receivables. This is a fundamentally important starting point for many financing structures.
Examples include bills of exchange and promissory notes, transferred by delivery or endorsement; making it very suitable for non-recourse receivables financing and their trading on secondary markets.
Non-negotiable receivables include invoices and payment orders. They often have conditions and contractual restrictions, prior consent of the debtor may be required or the assignment of them may be prohibited.
In comparison to open account, there is usually no recourse from a legal perspective.
Forfaiting is a typical non-recourse product, using prom notes, bills of exchanges and letters of credit as typical instruments.
The seller risks include delivery in accordance to contract, such as performance risk, the payment risk (if sold without recourse).
The buyer has no right to disputes payment once the note or bill is signed, meaning there is a payment recourse.
Factoring and structured transactions with contractual restrictions are typical products for limited recourse transactions. Invoices and agreements with limited agreements are typical instruments.
Typical products include factoring and structured transaction, using invoices and agreements with legal limitations.
Full recourse has risks on the seller: delivery in accordance to a contract, ie performance risk, and disputed risk depends on the instrument used.
Buyers may have the chance to dispute payments for full recourse transactions, depending on the instrument used.
Non recourse structures should not be substitutes, nor are they the same as Credit insurance or protracted default protection.
Limited recourse is not an obligation that the factor will not remove funding, they may exercise recourse, but they may not.
Traditional factoring is based in a whole turnover assignment of debt: all clients invoices best in the factor as soon as they are created.
Single invoice factoring uses a facultative assignment, where the factor is not obliged to purchase the clients debt. This is sometimes called ‘offer and acceptance’.
The key advantage to the factor of whole turnover assignment is that all debts belong to the factor whether uploaded to their system or not. The client may be required to repurchase debts such as those disputed or subject to set off.
The advantages to the factor for facultative assignment are limited.
Financing the trade cycle is often done through supply chain finance, although the trade cycle takes into account ABL / inventory finance, supplier finance, receivables finance, supply chain factoring and purchase order financing.
Supply chain financing (SCF) is a buyer centric product. Scf provides short term credit to optimise working capital for both the buyer and the seller at a lower financing cost. It’s an effective solution for companies to manage their working capital, improve p&l and reduce risk as well as strengthening relationships with suppliers.
Supply chain finance delivers a strengthened stable supply chain and enhanced supplier relationships.
A financially stable supply chain reduces the risk of supplier failure and the associates risks and costs.
Onboarding suppliers are one of the biggest challenges here.