Funding the small fry by banking on the big fish
Supply chain finance can help small businesses grow by enabling them to maintain their cash flow and raise working capital at relatively low risk to the funder. In a typical supply chain finance deal, a supplier sells its receivables (evidenced by invoices) to the funder, which means that the supplier has cash immediately at its disposal. The funder acquires ownership of the receivables so that the debt is owed to the funder. The funder therefore takes a credit risk on the buyer and not the supplier. This allows a small business supplying goods or services to use the credit worthiness of its “big” clients to gain access to finance.
From a legal perspective, there are a few key elements to consider to close the deal successfully.
True sale and purchase
The funder would need to be comfortable that the transaction will not be regarded as a loan, but as a true sale of receivables if it were to be scrutinised by the courts of the country in which the supplier operates. Specific advice will be needed on the requirements for taking ownership of the receivables and enforcing those rights under the relevant legal system.
Right to sell
The supplier must own the rights to the receivables to be sold, and these rights must not be encumbered (for example, by prior assignment of book debts or previous factoring). The sales contract must be reviewed to ensure that it does not prohibit the purchase of the receivables by the funder. The sales contract may, for example, provide that rights under the contract may not be transferred to a third party without the prior written consent of the buyer.
If the supplier is a state-owned entity, the possibility of raising the defence of sovereign immunity in a law suit against it is also a very important consideration. If such a defence is possible, funders need to be satisfied that this immunity can be waived and that the waiver will be upheld by the local courts.
Payment and tax
Exchange control hurdles may be encountered when payments by a buyer are to be transmitted to an offshore funder. A legal enquiry would also need to be conducted on the tax consequences of the purchase of the receivables and particularly whether the funder will be deemed to have a permanent establishment for tax purposes in the jurisdiction of the supplier or the buyer.
A thorough due diligence investigation with the right local service providers will be instrumental in carrying out a satisfactory assessment of the legal environment. This will ensure that the funder is well aware of the risks to mitigate when funding a small business by taking a credit risk on its creditworthy buyers.
Jessica Lewis | Attorney | Banking and Finance Law
This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE)