Tuesday, June 28, 2011

Pardon the Interruption

I intended to complete the list of posts identifying sources of incremental risk assumed in trading on the TRE platform before either attempting to quantify a risk premium or suggesting risk-mitigating changes in practice.

So, pardon the interruption, but I want to pause here for just one post to make a suggestion. It’s one that I think would help mitigate risk from two sources: the lack of a personal guarantee and the lack of a full notification procedure.

First, let me acknowledge that I understand the reasons why TRE has adopted the policies in place.

As we’ve pointed out, almost all TRE Sellers would be asked to provide personal guarantees by other funding sources. The lack of that requirement by TRE is thought to be of significant help in attracting Sellers. On the notification issue, I understand that a true full-notification policy would require a very substantial commitment of additional time and manpower AND it would substantially slow down the process of bringing auctions to market.

I do get it.

But the fact is that the combination of these two issues produces a potentially tempting opportunity for Sellers who either fall on hard times , or who are simply dishonest, to post invoices for sale that do not meet the criteria set forth in the Master Program Agreement.

The lack of a full notification criterion undoubtedly increases the risk that invoices will be improperly posted for sale. And the lack of a personal guarantee reduces the risk to the Seller of doing so.

There is, I think, a fairly straight-forward way to mitigate (if not eliminate) this risk.

The principals of TRE Sellers could be required to execute a CONTINGENT personal guarantee agreement that would have no effect EXCEPT in the event that invoices not meeting the criteria of the Master Program Agreement were posted for sale on the TRE platform.

So long as invoices, even those that might become problematic, actually meet the specified criteria, the obligations to cure defaulted payments would remain corporate only. However, if the invoices were improperly posted, which is a condition under the control of management, TRE and the Buyers could look beyond the corporate assets of the Seller to the personal assets of the owners.

Obviously, such a change in policy would meet with Seller resistance and would likely cause some potential Sellers to fall by the wayside.

However, if the principals of a Seller are not willing to guarantee their own adherence to the invoice posting requirements; essentially assuring TRE and the Buyers of their own honesty; they might be Sellers we could all do without in the long run anyway.

3 comments:

  1. Nicholas E. RadiceJuly 1, 2011 at 3:05 AM

    Great thinking, Mr. Lightner. Hopefully TRE adopts such a policy.

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  2. In my opinion, the ability to pursue Seller's in the event they violate the MSA only adds value in theory. In practice, bad people, or desperate people, will not be deterred by contingent liabilities. Further, if the real risk is fraud, and the inability to manage same through debtor contact, obtaining contingent guaranties from Seller's that are in need of theft to sustain their business, helps not at all. These people already have nothing, investing substantial legal expense to prove they violated the MSA, and then enforce the guarantee (or defend against it) will leave you and them with even less. As my kids say, JMO (just my opinion).

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  3. Dear Anonymous,

    Thanks for your thoughts.

    I do not agree with you, though.

    I think that personal guarantees DO have value and my experience has been that they tend to have greater value than liens under UCC filings.

    I believe that the ability to pursue an individual personally is a more powerful deterrent to bad behavior than the ability to pursue just business assets. It is often the case that owners of businesses have personal assets that they will try very hard to protect.

    It's also interesting how quickly the tone of conversations can change when it becomes clear that a spouse is going to have to become involved.

    It IS true, of course, that there are a lot of professional judgment debtors out there whose only interest is in trying to defraud those who advance money. Identifying those people up front and preventing them from becoming TRE Sellers in the first place clearly has to be a priority of the fraud prevention and risk management people at TRE.

    Thanks again,

    Chuck

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