Irrevocable Payment Undertakings and Buyer-Led Supply Chain Finance; Mass Confusion Abounds
Many supply chain finance programs are structured on what is called a “buyer-led” or “buyer-focused” basis. In certain of these types of programs, although the bank or other financier providing the program (the “Finance Provider”) may purchase accounts receivable represented by invoices or otherwise provide funding to a number of suppliers, the true customer of the Finance Provider is a single corporate buyer of goods and services (the “Buyer”) for whom the program has been arranged (a “payables finance program”).[1] In certain other programs, a Finance Provider does not purchase the accounts receivable but instead relies only on a promise from the Buyer to make payment to the Finance Provider on supplier invoices the Finance Provider has funded (a “corporate payment undertaking program” and collectively with payables finance programs, “buyer-focused programs”). Whatever method is used, the Buyer’s active support of the program is the key to making the program marketable. Although the Buyer does not typically have any involvement in the relationship between the Finance Provider and suppliers directly, the Buyer will often have considerable control over which suppliers may be approached for participation in the program and what invoices will be made available for funding (the “Approved Invoices”).
Buyer-focused programs typically involve, at the very minimum, the Buyer entering into a written agreement with the Finance Provider containing an irrevocable and unconditional promise to pay monetary obligations represented by Approved Invoices submitted by the Buyer to the Finance Provider (or otherwise approved or accepted by the Buyer), free and clear from any withholdings, deductions, setoffs, counterclaims or similar defenses (an “irrevocable payment undertaking” or an “IPU”). Although, there are exceptions, in most programs provided by most of the larger Finance Providers in the market, these IPUs are provided directly by the Buyer to the Finance Provider. In a minority of cases they are provided to the supplier and then transferred to the Finance Provider.
The goal of the Buyer in providing IPUs is to increase the certainty of payment in the eyes of the Finance Provider and incentivize the Finance Provider to transact with the Buyer’s suppliers. In many cases, the Finance Provider would otherwise not be interested in funding the suppliers since those suppliers may be not creditworthy or simply have no “relationship” with the Finance Provider. Oftentimes suppliers are SMEs and would never be able to obtain financing at the pricing offered by the Finance Provider without the IPU from the Buyer.
While it is highly advantageous to a Finance Provider to receive an IPU from a Buyer, in many cases, the Finance Provider will still only want to transact with the supplier if the Finance Provider is protected from supplier-centric risks. Payables finance programs are typically based on a “reverse factoring” structure whereby the Finance Provider will purchase from suppliers the accounts receivable represented by the Buyer’s Approved Invoices. Purchasing accounts receivable can be quite complex around the world. For example, in many places such as the United States, Canada and Mexico, the purchase of accounts receivable requires filing specific registrations with public authorities in order for the purchase to be made effective against third parties. In other jurisdictions, service of notice on the Buyer, at the right point in time, may also be required in order for the purchase to be made effective against third parties and that notice may also need to satisfy certain form and delivery requirements. In all cases, the Finance Provider will need to worry about being exposed to creditors of the supplier with existing liens or other encumbrances. It is because of these complexities that many Finance Providers, especially Finance Providers who are marketing to SMEs and other small ticket suppliers, are going to be looking for more protection than a basic IPU.
The extra protection that a Finance Provider is looking for can come in many forms. For example, in a payables finance program, the Finance Provider might ask the Buyer for additional indemnifications for losses to the Finance Provider caused by deficiencies in its ownership interest in the accounts receivable it is purchasing from suppliers or unexpected competing claims. The far more popular approach, however, is for Finance Providers to instead turn to a form of super-IPU — an “independent” and irrevocable payment undertaking (an “IIPU”).[2] An IIPU, at least in theory, is a promise to pay that is an independent obligation of the Buyer, separate and unrelated to the validity, enforceability, performance, or even the existence of the underlying account receivable. In this way, because an IIPU is a separate property right given by the Buyer to the Finance Provider, an IIPU could act much like a letter of credit or a negotiable instrument. Unlike a simple IPU, an IIPU might be sold or transferred by its owner freely and independently from the associated account receivable. Of course, by definition, this would mean that the Buyer would be taking on the obligation to always make the IIPU holder whole, even if it results in a situation where the Buyer is required to make payment in respect of the relevant invoice twice – once to the IIPU holder and once to the supplier’s creditor with a superior claim to the Finance Provider on the account receivable evidenced by the invoice. In fact, Finance Providers offering buyer-focused programs regularly syndicate their exposures to Buyers in their programs based solely on the IIPU and without reference to the associated account receivable.
On its face, an IIPU seems like a winner all around for a Finance Provider. There are, however, some issues. Over the last couple of years, our team at Mayer Brown has reviewed, modified or helped create dozens of buyer-focused programs utilizing IPU/IIPU structures. Based on that experience we have reached a few basic conclusions:
(1) Perception and reality. The vast majority of buyer-focused programs are marketed on the basis of having IIPU features but often the payment undertaking is not drafted as clearly as one would hope so as to remove any ambiguity that the payment undertaking is not only irrevocable and unconditional but also independent. As far as we are aware, there is no case law in the United States, England or any other country which specifically addresses the validity or effect of IIPUs. While there are credible legal arguments that may underpin an analysis that a properly constructed IIPU is in fact a truly independent legal right, any court looking at the issue would be doing it for the first time. Any ambiguity in this circumstance, therefore, would be most unhelpful. If a true IIPU is intended, Finance Providers should be careful to state explicitly in their agreement with the Buyer that the IIPU is an “independent” legal right that is severable from the account receivable itself and freely tradeable without regard to the account receivable. In addition, in programs that do not rely on reverse factoring but instead are based on pure corporate payment undertakings, it should be made clear in the agreements among the Finance Provider, the Buyer and suppliers that a payment to the supplier by the Finance Provider on an Approved Invoice will result in the extinguishment of the related account receivable.
(2) There is a lot of confusion in the marketplace. Given the complexity and variety of buyer-focused products in the marketplace, confusion is inevitable. Although groups like the BAFT, IFTA and the rest of the Global Supply Chain Finance Forum have done an admirable job at standardizing the vocabulary of the supply chain finance industry and creating general market awareness, we believe that a material percentage of market participants are ignoring the distinction between IPUs and IIPUs and thereby often ignoring supplier risks that, in many buyer-focused programs, are significant.
(3) Accounting. We are not accountants. That is easy to conclude! But we have also learned from experience that very clearly drafted IIPUs (including pure corporate payment undertakings) are much harder for corporates to accept from an accounting perspective, especially under US GAAP, and therefore IPUs tend to be more prevalent than IIPUs.
At Mayer Brown we have had the privilege of working on and often helping to design some of the most innovative products in the supply chain finance industry. We have never, and will never, take a position on which products are “better” or “worse”. We believe that any well-designed product that solves a marketplace need is valuable. Our goal instead is to provide our clients with the maximum amount of information possible so that they may fully understand what the risks and benefits are of each product.
[1] Many of the terms used in this post are drawn from materials published by the Global Supply Chain Finance Forum. For further information please consult http://supplychainfinanceforum.org/
[2] For clarity in this blog post we are using the defined term IIPU, but we note that this term is not commonly used in the marketplace. As used in this blog post, an IIPU is roughly equivalent to a “corporate payment undertaking” as defined by the Global Supply Chain Finance Forum. However, as there are many buyer-focused programs in the marketplace that combine elements of both pure payables finance and pure corporate payment undertakings in the same program we have elected to use the term IIPU instead.
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