Some of Those Annoying Technical Issues in Trade Finance

Presentation by

Sam Fowler-Holmes, Marian Boyle and Tom Glinka

Sullivan & Worcester UK LLP

On 26 January 2017

At 25 Old Broad Street, London

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Potential issues with security over goods

Proprietary vs possessory interests

What is possession?

Perfection requirements?

Stamp duty

Registration

Approvals

Notarisation, apostilling and legalisation

Fungible goods

Commingled goods

Future goods

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Proprietary security

Key properties

Security interests that form an encumbrance over the secured asset

Commonly referred to as a charge, hypothecation or even a pledge

Often taken where the financier will not have possession (either directly or indirectly) of the secured assets

Usually registrable and possible to have more than one security interest over the same goods

Important to know how priority of competing security interests is determined

Centralised register of security interests?

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Case study: Turkey (1)

The Law on Pledges over Movable Assets in Commercial Transactions (Law No. 6750) in force as of 1 January 2017

Designed to remediate problems with taking possession but does not exclude possessory pledges

Replaces and expands previous legislation and recognises ability to register pledges over a wide range of assets including:

Trade stock

Raw products

Machinery and other equipment

Pledge perfected by registration with the Pledged Movables Registry – failure to do so means pledge is unenforceable against third parties

Pledges under the new legislation expressed to be exempt of stamp duty but subject to a registration fee of TRY 200 (appx. USD 55)

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Case study: Turkey (2)

Parties can determine priority of pledges by agreement with default rule being order in which competing pledges are registered

The new law recognises pledges over:

future goods;

fungible goods; and

commingled goods

But to be seen how the Registry reconciles these with requirement for pledged assets to be specifically defined

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Case study: UAE New pledge law (Federal Law No. 20 of 2016) passed in December 2016

and due to come into force in March 2017

Implements significant change as allows for pledges to be taken over a wider range of movable assets and for perfection by registration

Pledges will need to be registered to be enforceable against third parties and priority will be determined by order of registration

Pledgee will have right to require pledged assets to be sold at ‘market value’ within 10 days of default without court judgment provided the parties agree this and subject to conditions

Further details still needed as to how the new registration system will work:

› Which authority will be responsible for maintaining the register?

› What information will be publically available?

› What will registration fees be?

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Possession (1)

Key properties

Security interest created by financier taking possession of secured assets

Must be able to demonstrate a sufficient level of control over how the secured assets are stored and released

Possession may be actual or constructive (e.g. via a collateral manager)

Usually fewer perfection formalities to be complied with

Competing security interests?

Should not be competing possessory interests

But potential for competing proprietary security interests

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Possession (2)

Constructive possession usually evidenced by way of a warehouse receipt, holding certificate or other written document issued by the collateral manager stating that goods held on behalf of or to the order of the pledgee

Collateral manager required to follow instructions of pledgee including in respect of release of pledged goods

Collateral manager will also need to show it has possession of goods

This will be a local law question but relevant factors can be:

Sole use of warehouse or lease of designated area

Segregation of pledged assets

Uninterrupted access to pledged assets

Labelling of pledged assets

Fencing

Will be determined on case-by-case basis 8

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Case study: Mozambique

Security taken over goods by way of possessory pledge

No central body so registration not possible and no centralised register of security interests granted

However, there are a number of perfection requirements that must be satisfied to have an enforceable security interest including:

Payment of stamp duty (0.3% of the secured amount);

Exchange control approval required from Central Bank of Mozambique;

Translation of documents into Portuguese; and

Notarisation and legalisation of signatures required.

Practical issues:

Subsequent increase in secured amount requires re-perfection of security

Need to set out all goods covered by the pledge in a schedule to the security document

Renewal mechanism if security for longer than 1 year

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Perfection requirements (1)

Stamp duty

Potentially significant financing cost

Possible mitigants:

Upstamping

Merging security documents

Use of alternative borrower

Several unhelpful recent developments:

Uganda – stamp duty previously charged at a nominal rate but now payable at 1% of

amount secured by pledge

Ghana – stamp office creating uncertainty regarding ability to limit amount recoverable and

to ‘upstamp’ at a later date

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Perfection requirements (2)

Other requirements include:

Registration

Translation

Notarisation, apostilling and legalisation

Exchange control approval

Failure to perfect security can have differing consequences including: Security being unenforceable

Financial penalties

Loss of priority

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Future, commingled and fungible assets (1)

Future assets

Validity of pledge over future assets differs greatly between jurisdictions: England – cannot have pledge over future assets as possession of asset is key to existence of

pledge

OHADA countries – require a new pledge letter to be issued for each new delivery of goods to be pledged

Turkey – new pledge law recognises pledges over future assets but how will this work in practice?

Fungible and commingled goods

Fungible goods are often stored in bulk and commingled with goods of other depositors Depositor has contractual right to re-delivery of same quantity and quality of goods

deposited rather than return of exact goods deposited

Requires warehouse operator / collateral manager to have appropriate processing and grading capabilities

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Future, commingled and fungible assets (2)

Netherlands – a pledge over commingled goods will give the pledgee a pro rata share in the totality of the commingled goods

Not all legal systems recognise security over commingled goods (e.g. Taiwan) – adopt an ‘identity preserved’ approach

South Africa – certain types of security interest (e.g. special notarial bond) cannot be taken over commingled goods but may be alternatives (e.g. general notarial bond)

Security interest may be lost where goods are commingled to form a new product

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Assignments - basics

Transfer of a right from one person to another

The benefit of a contract is a right (i.e. a chose in action)

The effect of an assignment › After an assignment the assignee is entitled to the benefit of the relevant right

› In general, assignee can bring proceedings against the other contracting party to enforce rights

› Assignment only transfers existing rights and does not create new rights

› The burden of a contract cannot be assigned

› The assignees rights are subject to any limitations, defences and set-offs (i.e. equities) that the original contracting party would have been able to raise against the assignor (at least until notice of assignment has been provided)

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Assignments – Applications in trade finance

Most commonly used in two situations › Security assignment

Assignment of rights under sales contracts/prepayment agreement Used within PXF or advanced payment structure to ensure proceeds of sales stay within

the security structure May include step-in rights that allow the Lender to perform the obligations of the

Borrower and deliver goods that have been appropriated from the Borrower through possessory security (e.g. pledge) and obtain payment from the end buyer

Proceeds applied in discharging debt Equity of redemption

› Receivables Purchase Legal mechanism for transfer of right to receive payment i.e. debt Used in payables finance, supplier finance, factoring etc. Debts purchased before maturity date at a discount Outright sale i.e. no equity of redemption

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Assignments – Types of assignment (1) – Legal Assignment Legal Assignment

› Meets requirements of s.136 of the Law of Property Act 1925 Absolute assignment in writing Signed under hand by the Assignor Express notice in writing given to “the debtor, trustee or other person from whom the

assignor would have been entitled to claim such debt or thing in action”

› Allows assignee to sue the debtor in its own name

› Requirement for absolute assignment does not exclude assignment by way of security

› BUT does prevent legal assignment of a partial debt – this can be significant in the context of receivables purchase

› Electronic document considered to be “in writing” under English law

› Other statutory provisions e.g. s.50 of the Marine Insurance Act 1906

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Assignments – Types of assignment (1) – Equitable Assignment Equitable Assignment

› An assignment that does not meet the requirements s.136 of the Law of Property Act e.g.: Unnotified/undisclosed assignments Assignment not in writing Assignment of partial debt e.g. assignment of 90% of a receivable (although consider

workarounds) Assignment of future rights

Assignment of contractual rights vs assignment of proceeds

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Assignments – Some key issues

Restrictions on assignment in the underlying agreement

Notice of assignment

Governing law and due diligence in the context of receivables purchase

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Assignments – Key issues (1) Restrictions on assignment Contractual restrictions on assignment

› Effect Linden Gardens Trust Ltd v Lenesta Sludge Disposal Ltd [1994] 1 A.C.85,108 National Bank of Abu Dhabi PJSC v BP Oil International Limited [2016] EWHC 2892

(Comm)

› Consent/waiver

› Declaration of Trust

Personal contracts and surety/indemnity contracts

Public policy

Small Business Enterprise and Employment Act 2015 and the Business Contract Terms (Restrictions on Assignment of Receivables) Regulations 2015

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Assignments – Key issues (1) Restrictions on assignment National Bank of Abu Dhabi PJSC v BP Oil International Limited [2016]

EWHC 2892 (Comm) › NBAD contracted to purchase 95% of a receivable due to BP from SAMIR (Moroccan oil

refining company) in the event of non-payment

› SAMIR became insolvent and did not pay – NBAD initially made payment to BP

› In the purchase letter BP: assigned and agreed to assign 95% of the receivable to NBAD warranted that it was not prohibited from disposing of the receivable by any other

agreement in manner contemplated in the purchase letter agreed to indemnify NBAD if any representation or warranty was breached

› It later transpired that there was a prohibition on assignment clause in the agreement between BP and SAMIR

› NBAD paid for the receivable but following the insolvency of SAMIR BP was not able to transfer the receivable to NBAD

› Decision turned on interpretation of assignment provisions and whether representation had been breached

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Assignments – Key issues (1) Restrictions on assignment National Bank of Abu Dhabi PJSC v BP Oil International Limited [2016]

EWHC 2892 (Comm) › Relevant assignment clauses:

“(iv) that [BP] will assign as at the date of receipt of payment from [NBAD] under paragraph 2 above, if legally possible under applicable laws and the Contract, to [NBAD], its rights, title, interest and claims against the Buyer in respect of the Discount Percent of the Receivable and the rights and benefits of the relevant transaction arising from the Contract to the extent of any payment made by [NBAD] and not paid under (i) and (ii) above, or, where, if not legally possible or effective for any reason, to take legal proceedings against the Buyer under the Contract to the extent of any payment made by [NBAD] and not paid under (i) and (ii) above….”

“(v) that by selling the Receivable hereunder it has assigned the Discount Percent of the Receivable in equity irrevocably to [NBAD] subject to the terms hereof (such assignment shall be deemed to take effect immediately following payment by [NBAD] of the Discounted Value), and that [NBAD] has beneficial ownership of any such amounts paid by the Buyer and of the debts in respect of which such amounts are paid, and accordingly [NBAD] shall have a right of recourse to [BP] to the extent of the Discount Percent of any amount received (whether in respect of principal, interest, fees or otherwise) by [BP] from the Buyer relating to the Receivable sold and purchased hereunder and not paid by it to [NBAD];

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Assignments – Key issues (1) Restrictions on assignment BP argued that, as it was recognised in Clause (iv) that assignment may not

be possible and the purchase letter also provided for other mechanisms of enforcement (such as subrogation) the warranty had not been breached

Alternatively, the clause was intended to cover only assignment of the fruits of the chose in action (i.e. the proceeds of the debt) which would not have been prevented by the restriction on assignment

This was rejected by the judge – The wording of Clause (v) was clear

BP liable for $66m

Notable that this was the finding even though the equitable assignment would have been valid between BP and NBAD

Key takeaways › Careful drafting required

› Due diligence on underlying contract

› Belt and braces approach not always the best

› Risks of using parts of documents from previous transactions or combining standard forms

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Assignments – Key issues (2) Notice of assignment Applicable to legal and equitable assignments

Priority › The rule in Dearle v Hall (1828) 3 Russ 1

Effect in respect of equities between Debtor and Assignor

Ability to give good discharge of debt

Registration?

Right to sue debtor directly › Legal assignment gives rise to a right to sue in the assignees own name › Equitable assignment, in theory there is a requirement to join the assignor in

proceedings as a procedural matter, however, in practice this is often dispensed with by the courts unless there is a dispute as to ownership of the relevant debt or there are multiple owners

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Assignments – Key issues (3) Governing law and receivables purchase due diligence In cross border receivables purchase, potentially several relevant

governing laws: › The law of receivable (i.e. the underlying contract) › The law of the assignment agreement › The law of the jurisdiction of the assignor › The law of the jurisdiction of the debtor

Rome convention

Practical approach › Due diligence › Independent Payment undertakings

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Insurance

Assignment of insurance policies/benefit of any claims

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Sharing the Insurance “Asset” Various ways a bank may “share” the benefits of an insurance asset

Not every “sharing” strategy creates a security interest

Compare assignment with: › Co-insurance › Loss payee › Contracts (Rights of Third Parties) Act 1999

Each structure has associated benefits and pitfalls

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The Considerations Who has control over how the insurance proceeds are applied?

Who can enforce (i.e. make a direct claim under) the insurance policy?

Will the bank’s interest in the policy be prejudiced by the acts/omissions of the borrower?

Is insurer’s consent to the arrangement required?

What will happen to the insurance proceeds in the event the borrower becomes insolvent?

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What Type of Assignment? Borrower assigns either the policy or the benefit of any claim under the

policy

Is an outright assignment of the entire policy appropriate?

Insurance contracts are “personal” to the insured - important for insurers to know who the insured is

Marine policy is assignable unless prohibited

Most policies contain an express prohibition on outright assignment

Prohibition cannot preclude insured from agreeing how policy recoveries should be applied

Assignment: legal or equitable?

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Legal v Equitable? Legal assignment transfers the entire interest in the policy to the bank – a

novation (substituting the assignee/bank for the borrower)

Legal assignment permits assignee to sue insurer in its own name and confer right to give good discharge

Only appropriate if combined with absolute assignment of the interest e.g. either the policy as a whole or a right to claim under it

Where assignment relates to only part of the policy (e.g. one section in a composite policy), the assignment has to be equitable

If entitlement to indemnity under policy has crystallised - the right to bring claim may be legally assigned

Assignment of rights to insurance proceeds is more often equitable because:

As a matter of common law, contingent rights under a policy cannot be assigned

Unless a claim has already arisen, right to claim payment is expectancy

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Assignment: Practicalities An assignment – whether equitable or legal – gives the banks a security

interest

Is there policy prohibition on assignment?

Whether the assignment is a legal assignment or an equitable assignment does not affect its priority/ranking against other assignments

Priority is established by giving notice to the insurer

Successive assignments take priority in the order in which notice of them is received by the insurer

Proof of actual notice

Need “further assurance” and irrevocable agreement that bank permitted to sue insurers in the borrower’s name

Insist on loss payee clause – enables insurers to rely on the bank’s discharge

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Assignment: the Drawbacks

Assignee takes “subject to the equities”

The bank as assignee can have no better rights than those of the assignor

The bank as assignee of the proceeds of an insurance claim takes the benefit of the insurance- but should consider if it has powers to compel performance of the burden

If there are any on-going obligations under the policy e.g. payment of premium, they still must be discharged

Borrower’s failure to make a fair presentation of the risk or, during the currency of the policy, its breach of policy warranty can prejudice assignee’s/bank’s interest

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Co-assurance Compared to Assignment Under a co-assurance structure, the bank is added as an additional insured to the

policy

Composite policy expressly covers each insured party for its respective interests

Do not confuse with joint insurance: only applicable if both insureds’ interests are “inseparably connected”(e.g. joint tenants of property)

Significant drawback of joint insurance- one joint insured interest can be prejudiced by the acts or omissions of another

As co-assured, a bank can pursue insurers for its share of the insurance proceeds using the bank’s own name – contrast position of equitable assignee

As co-assured, any failure to comply with statutory, common law or policy obligations by the borrower should not prejudice the bank’s interest - contrast position of equitable assignee

The insurance policy is construed as a bundle of separate contracts insuring each co-assured separately (common law “non-vitiation”)

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Co-assurance (2)

A non-vitiation clause provides that one co-assured’s interests will not be prejudiced by the acts and omissions of another

Limit to common law non-vitiation protection: express non-vitiation clause in the policy always preferable

For policies that incepted pre-August 2016, placing brokers’ independent duty of disclosure can be problematic if the broker is acting for both borrower and bank

As with assignment, bank’s interest as co-assured not affected by its co-assured borrower’s insolvency

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Disadvantages of Co-assurance Insurers may be reluctant to offer co-assurance terms

Duty of Fair Presentation applies- contrast no duty on assignee

The bank will be required to comply with the policy warranties, terms and conditions. An equitable assignee has no direct obligations, but…

Negotiating sufficiently broad “non-vitiation” clauses can be problematic

Parts of policy wording may be unsuitable for, or difficult to interpret in the context of, co-assurance

Insurers may delay claim payment if they are concerned about overlap of co-assureds’ interests (can be resolved by loss payee clause)

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Loss Payee Compared to Assignee Loss payee: simply the party designated under the policy as the

appropriate recipient of claims money. Loss payee can give valid receipt

Loss payee not a party to the policy

Loss payee – no right under the contracts to bring claims against insurers (unless Contracts (Rights of the Third Parties) Act 1999 applies)

Major disadvantages: › Payment to loss payee entirely dependent on the insured’s diligent fulfilment of pre-

contractual obligation to make fair presentation and post-contractual compliance with the policy terms, conditions and warranties

› Loss payee has no right to intervene in claims process

› Question mark over protection in the event of borrower’s insolvency (unlike assignment)

› Clause does not give loss payee any proprietary rights to the proceeds of claim – which would provide protection on insolvency

› Although usually acted upon by insurers, may be open to challenge by insolvency office holders

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Contracts (Rights of Third Parties) Act 1999 (1)

Helpful in getting around lack of privity

Act provides that a third party can enforce a term of the contract if the term confers a benefit on him (or if the contract states that a third party may enforce)

Requirement that the third party is expressly identified by name/answers to a particular description

Loss payee clause likely to fall within the terms of the Act thus giving a loss payee the right to sue

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Contracts (Rights of Third Parties) Act 1999 (2) Disadvantages:

Benefit of the Act is often excluded by the policy

Act expressly provides that all defences that would have been good as against the original party to the contract – the insured – are also good as against the third party (as with assignee)

In effect – insured’s failure to make a fair presentation/ misrepresentation or a breach of warranty would affect the loss payee as well as the insured (as with assignee)

Question mark over priority of rights if insolvency office holder intervenes (contrast with security of assignment)

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Summary/Conclusion Not all methods of “sharing” the benefits of insurance provide equal

protection

Consider: enforcement; whether benefits of insurance can be lost by insured’s acts and omissions; and how the “security” will hold up in the event of borrower’s insolvency

Co-assurance provides highest level of protection but has some practical drawbacks which need to be managed

Assignment of rights of proceeds creates security interest – thus protecting in the event of insolvency. However, no protection against the acts/omissions of the insured if, e.g., assured is in breach of duty of utmost good faith/has breached a warranty

Loss payee clause on its own has serious limitations

Different strategies to share/ring-fence insurance proceeds need to be considered for different deals – no “one size fits all” solution

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Sam Fowler-Holmes Associate

Sam Fowler-Holmes is an associate in the Trade & Export Finance team. He specialises in structured and unstructured trade finance and has advised financial institutions on a range of products including large-scale pre-export financing, supply-chain financing, funded and risk participations, and bank-to-bank lending. Sam's experience includes advising in relation to numerous jurisdictions across mainland Europe, CIS, Africa and Asia and for a range of commodities including, oil, gas, metals and cocoa.

Sullivan & Worcester UK LLP Tower 42 25 Old Broad Street London EC2N 1HQ

T +44 (0)20 7448 1006 F +44 (0)20 7900 3472 sfowlerholmes@sandw.com

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Tom Glinka Senior Associate

Tom Glinka is a senior associate in the London office. He is a banking lawyer specialising in structured trade and commodity finance, commodity ownership structures, trade instruments, receivables structures and emerging markets finance. He has extensive experience advising financial institutions and borrowers across a wide range of jurisdictions in Africa, Asia, South America, CIS and Europe. Commodities he has been involved in financing include, amongst others, oil, gold, aluminium, copper, steel and agricultural products. Tom has also undertaken a secondment with a major international bank.

Sullivan & Worcester UK LLP Tower 42 25 Old Broad Street London EC2N 1HQ

T +44 (0)20 7448 1007 F +44 (0)20 7900 3472 tglinka@sandw.com

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Marian Boyle Partner

Marian Boyle is a partner in our London office and heads the UK insurance and disputes practices working closely with the firm’s established trade and export finance team offering advice on insurance, risk management and commercial dispute resolution.

With over 20 years' experience, Ms. Boyle advises banks, insurance brokers, investment funds, government agencies and corporates on commercial insurance arrangements which support structured trade, commodity and pre-export financing as well as corporate finance, energy, property, M&A and outsourcing transactions. She also drafts and interprets insurance policies and advises on the use of insurance by credit institutions and investment firms as credit risk mitigation for capital adequacy purposes under the Capital Requirements Regulation.

Marian’s contentious experience includes advising clients in relation to disputes arising from trade credit, professional negligence and transactional disputes. These disputes are often international in nature and result in large-scale, highly complex multi-party litigation and arbitrations.

Sullivan & Worcester UK LLP Tower 42 25 Old Broad Street London EC2N 1HQ

T +44 (0)20 7448 1004 F +44 (0)20 7900 3472 mboyle@sandw.com

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Awards & Recognition TFR “Best Law Firm in Trade Finance”

Trade & Forfaiting Review (TFR) named Sullivan & Worcester "Best Law Firm in Trade Finance" in its 2014, 2015 and 2016 TFR Excellence Awards GTR “Best Law Firm 2015 Poll”

Sullivan & Worcester UK LLP was top ranked firm in the Global Trade Review (GTR) Best Law Firm 2015 poll The Legal 500 UK 2016

Sullivan & Worcester UK LLP was ranked in the following category in The Legal 500 UK:

› Trade Finance (Tier 1)

Chambers UK 2016

Chambers UK ranked Sullivan & Worcester UK LLP, along with Geoffrey Wynne and Simon Cook in the following area:

› Commodities: Trade Finance (UK-wide)

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