Eight Risks to manage when Buying Trade Receivables

Michael J. Clain is a lawyer with Windels Marx Lane & Mittendorf, LLP and works in their financial services practice.

One way to compare receivables financing structures is to analyze how – and how well – they handle the transaction risks that keep lenders awake at night.

Any lender who looks at supplier receivables as its principal means of repayment is concerned with 8 types of risks:

  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 nonperformance 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; and
  8. Buyer credit risk – the risk that the buyer won’t pay due to financial inability.

 

In future posts,  we will discuss how different receivables financing structures handle these risks.  Comparing them on their ability to deal with lenders’ concerns will give us a good sense of their growth prospects and limitations – and maybe in the process give us a glimpse of the future of trade financing.

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Voices (3)

  1. Manish J:

    1. Fraud Risk. ( fraud may be due to any party).
    1a. Title Risk ( is part of Fraud Risk, most financiers would get it in writing that seller has title, if it turns out it doesn’t. Seller cant cry innocent on technical grounds. Its a fraud or at the least breach of ARP contract)

    2. Title Transfer Risk ( even though most financiers would have this in writing from Seller, here its more acceptable that Seller was not aware of non-transferable title and its a risk Bank eliminates by proper legal study of the jurisdiction where original AR is created.)

    3.Dispute Risk – Commercial Disputes are usually not accepted by financiers and made clear in the Agreements, thus this risk thus boils down to breach of Agreement by Buyer/Seller with financiers.

    4. Dilution Risk ( not usually called a discount risk as discount is usually known, while dilution event is contingent although dilution % slabs may be known). This is a major risk and financier must get this documented or treat the AR as net of maximum possible dilution before purchasing it.

    5. Payment Delay Risk
    6. Payment Direction Risk
    ( Above two can be combined as Collection Risk)
    7. Obligor’s credit risk

  2. Tony Brown:

    In addition to Michael’s list, for receivables relating to cross-border trade the following risks are also relevant:
    1. Foreign exchange — currency fluctuation as well as overseas currency inconvertibility
    2. Regulations or government decrees in the importer’s country that prohibit importation of the goods or settlement of the receivable
    3. Repudiation of the purchase contract by a public sector buyer
    These and some of the risks listed by Michael can be mitigated through the use of credit and political risk insurance.

  3. renias pasipanodya:

    I would like to receive more publications on Trade financing

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