BG: Assignment of Receivables – The Achilles’ Heel of Invoice Financing
Receivables are a key tool in trade finance particularly with the use of invoice financing. By transferring the rights to a receivable such as an invoice, SMEs are able to get much needed working capital, getting paid by funders today, what is owed by their buyers in the future. Whether done on a recourse or non-recourse basis, assignments of the receivables are a central feature of invoice finance structures as they give funders critical rights against buyer-debtors. But without sufficient care on how assignments are obtained, this simple document can be the Achilles’ heel of an invoice financing program.
Risks in Invoice Financing
Invoice financing transforms a supplier-buyer relationship into a multi-faceted, funder-buyer as well as funder-supplier dynamic. The risks to be considered include:
- Receivable title risk: the risk that the supplier may have already assigned or pledged the receivable to another funder;
- Receivable transfer risk: the risk that applicable law may not allow the funder to take good title to the receivable, or otherwise subordinate the lender’s rights to third party claims;
- Dispute risk: the risk that the buyer may claim the supplier failed to deliver goods in accordance with the contract;
- Discount or dilution risk: the risk that the buyer will not pay the full amount of the invoice for reasons other than the supplier’s performance of the contract e.g., relying on set-off rights or discounting mechanisms in umbrella arrangements unknown to the funder;
- Payment delay risk: the risk that the buyer will not pay on time;
- Payment direction risk: the risk that the buyer will make the payment to the supplier or some other party instead of the funder; and
- Debtor credit risk: the risk that the buyer-debtor does not pay at all.
Assignments – why are they important.
A robust invoice financing program using assignments should narrow the risks above but only if careful attention is paid to how they are done. When assigning an invoice, a notice of the assignment serves both legal and practical functions. Legally, a notice of assignment is one of the requirements to create a legal assignment, which in turn allows the assignee-funder to enforce rights in its own name. Without notice, the assignment is treated as an equitable assignment which may provide challenges for a funder to enforce rights through an uncooperative supplier. Practically, a notice also serves to “flush out” some common excuses a buyer may deploy for non-payment relating to setting-off sums from other transactions, side arrangements on discounting or disputes relating to the invoice itself.
With no visibility on whether receivables had been previously assigned, a notice of an assignment serves as an important basic risk mitigant towards double financing. In addition, in cases of multiple assignments done by the supplier, a notice serves to give priority to a funder against subsequent funders – this can make all the difference if multiple financing of the same invoice is discovered later.
Forged/ Multiple Assignments
A notice of assignment as acknowledged by the buyer is only half the battle. In a pursuit for liquidity, unscrupulous traders may fabricate contracts, invoices and by extension assignment acknowledgements. These illegitimate acts may sometimes never come to light as a supplier may be able to recycle liquidity in time to repay its funders. But other times, forged acknowledgments or multiple financing are only discovered when the funder seeks to enforce against the buyer, who may be located in a difficult jurisdiction to get effective legal recourse. In the process, startling discoveries can be made:
- The buyer alleges the contract, invoice and acknowledgment of assignments have been forged;
- The buyer alleges that goods were never received notwithstanding invoicing and acknowledgment of the assignment of the invoice;
- The buyer is directed by the supplier to pay the supplier directly or a third party notwithstanding the assignment notice;
- The buyer convinces the supplier that the assignment has been extinguished; or
- The same invoice has been assigned to multiple funders.
The Achilles’ heel with assignments in invoice financing programs is that there is little interface between the funder and the buyer – the supplier plays a central role in routing documents to its funder. Funders have little visibility or capacity to verify every document and even where verification is done, an unscrupulous supplier may still impersonate their buyers with fictitious email accounts. The difficulty in detecting invoice fraud cannot be overstated and will continue to challenge the trade finance market. The Association of Banks in Singapore have introduced a Code of Best Practices for commodities financing which includes recommendations to get some reference of an assigned invoice into the invoice document itself and for lenders to obtain acknowledgment of assignments directly from the buyer. But without a registry for invoices, it would be difficult for funders to eradicate multiple assignments of the same receivable. Singapore is making plans to change that – so do watch this space.
Assignments as security or as outright transfer – why does it matter?
A receivable can be assigned as security for performance of a supplier’s obligation to repay a loan. Alternatively, an assigned receivable can operate as an outright transfer to a funder. The distinction is critical as understanding which party has ownership in the receivable can have important accounting (e.g., off balance sheet treatment) and legal consequences (e.g., the right to sue under the invoice). The distinction is even more acute if the supplier goes into liquidation – if deemed a security, a receivable would be treated as part of the insolvent supplier’s assets and if the supplier fails to register its assignment as a charge, then it may be void against the liquidator with the consequence that the funder is left unsecured for its debt. Receivables Purchase Agreements, in trying to have the best of both worlds to protect the funder for every loss and contingency can often inadvertently run the risk of being reclassified as a loan rather than a “true sale”.