12 Risks to Manage when Financing Domestic Trade Receivables

In this day where new forms of factoring and receivable finance are the rage, it’s a good reminder to assess just what can go wrong when financing a company’s trade receivables. Let’s focus just on domestic now, as international adds another layer of complexity (egs. FX issues, jurisdictional issues, etc.)

Michael Clain, a lawyer with Windels Marx Lane & Mittendorf, LLP reminded me of the 8 risks lenders and investors are concerned about with trade receivables.

  1. Supplier fraud risk– the risk that the PO or invoice presented to the lender for financing may be fake or duplicative or may have been altered;
  2. Receivable title risk– the risk that the supplier may have already assigned or pledged the receivable to another financial institution;
  3. Receivable transfer risk– the risk that applicable law may not allow the lender to take good and marketable title to the receivable, free and clear of third-party claims, or that it may require the lender to take actions it was not aware it was required to take;
  4. Dispute risk– the risk that the buyer may claim that the goods or services provided by the supplier did not satisfy the requirements of the PO; this is a broad term that covers a number of different risks and possible claims against third parties, but our analysis doesn’t necessitate that level of granularity;
  5. Discount risk– the risk that the buyer won’t pay the full amount of the invoice for reasons other than the supplier’s performance in connection with the transaction at hand – the buyer may, for instance, take discounts for supplier non-performance of prior transactions, may take discounts in the ordinary course of its business (some large retailers for instance are known to return to their suppliers goods that don’t sell) or may hold back a portion of the payment as retainage (standard in the construction industry, for instance);
  6. Payment delay risk– the risk that the buyer won’t pay in a timely fashion;
  7. Payment direction risk– the risk that the buyer will make the payment to the supplier or some other party instead of the lender.
  8. Buyer credit risk– the risk that the buyer won’t pay due to financial inability.

I have added a few in the spirit of the holidays.

  1. Repudiation of the purchase contract by a public sector buyer
  2. Government Receivables – when the account debtor is the US Government, the question arise as to the effect of the failure of the secured party to comply with the Assignment of Claims Act.
  3. Healthcare Receivables can be unique as many of these receivables the obligor is some federal or state programs including Medicare and Medicaid. These payments typically have significant payment lag times and are subject to adjustment after the fact for overpayment determined at the discretion of govt programs
  4. Rendition of service risk– financing the service industry poses many unique problems versus goods sellers. Borrower may have a business structure for tax purposes or other reasons that deliberately divides its service functions among entities.

How many of these risks can be mitigated through the use of credit and political risk insurance? For sure it’s important to ask the right questions and read the fine print.

Certainly as more and more platforms come to market with receivables to finance, whether through special purpose vehicles, trust structures, synthetic notes, or even blockchain structures, investors need to bear in mind the various risks that can occur in something so simple as one business bills another business for goods or services rendered.

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