Monday, June 29, 2009

Blanket Security vs a Security Blanket

In prior posts we’ve noted that a TRE Seller must unconditionally commit to repurchase any sold receivable that is not paid by a stated date. We’ve also discussed the advantage of Louisiana law in that regard and we’ve expressed our opinion that the financial capacity of the Seller has to be seen as the “first line of defense” in protecting a Buyer against loss.

It’s not the ONLY defense, however.

TRE, as agent for its Buyers, also obtains a lien on the receivables sold by the Sellers on the exchange and on all of the money deposited for the Seller’s account in the TRE lock-box.

TRE files a UCC Financing Statement putting everyone on notice of its liens.

The TRE approach is unusual. It is ingenious in some respects but it's also important to acknowledge its limitations.

(I have to remind readers that I’m not a lawyer; so interested parties should consult their own counsel.)

In what ways is the TRE approach ingenious?

1) Many potential TRE Sellers will already have financing in place that encumbers ALL of their receivables. In order to convey clear title to a traded receivable, any prior lien has to be released. Otherwise it would be like trying to put a first mortgage on a house when there's already a first mortgage in place.

It’s much easier for the TRE Seller to convince its lender to release its lien ONLY with respect to the receivables sold on the exchange rather than to release it altogether. I suspect this middle-ground solution allows many companies to become potential TRE Sellers that would otherwise be unable to deliver good title to their receivables.

2) If a TRE Seller wants to sell any of the receivables due from one of its customers, it has to direct that ALL of the payments due from that customer go to the TRE lock-box. So it’s possible that payments might be received in the lock-box for invoices that have not been sold. Those payments would then, in theory at least, be available to cure defaults in payment for receivables that HAVE been sold.

3) A TRE Seller might register multiple customers with the exchange. The payments from all of those customers would go to the lock-box. Under the TRE security strategy, even the payments from other customers, not involved in a defaulted transaction, might be available to make good a default.

In what ways is the TRE approach limited?

1) As we’ve noted above, the typical receivables financing relationship requires a UCC filing encumbering ALL of the seller’s receivables. The TRE UCC filing on a Seller’s receivables is limited to the receivables traded on TRE.

2) If there is another party with a first lien on the Seller’s non-TRE receivables and those other receivables represent a substantial part of the Seller’s assets, that prior lien position could limit a Buyer’s ability to enforce the Seller’s commitment to repurchase.

3) If cash is deposited in the TRE lock-box for receivables that were not traded on TRE, and those receivables were actually subject to another party’s first lien, I suspect there could be a challenge to TRE’s use of those funds to cure an unrelated default.

The Receivables Exchange wants to be a very high volume trading platform. In order for it to reach high volume it has to be a workable platform for a great many Sellers.

In order for it to be workable for a great many Sellers, the common problem of prior “blanket” liens on Sellers’ receivables had to be addressed.

The solution TRE has apparently adopted is to give up some of the value of the typical blanket lien on receivables, in exchange for the potential to receive and withhold other funds of the Seller to cure potential defaults.

From a business point of view: when added to the advantage of the “True Sale” language of Louisiana law, and the unconditional commitment to repurchase; I think the approach makes a lot of sense.

It is NOT blanket security…but it IS a security blanket. It is comforting, to be sure, but only as an addition to the primary protection i.e. the actual financial capacity of the Seller to meet its repurchase commitment.

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