Caveat Emptor # 2

In our post of June 20: “Blanket Security vs a Security Blanket” we discussed the fact that a Buyer of invoices on The Receivables Exchange obtains, via TRE, a lien on the receivables purchased and on any excess cash that might be available in the Seller’s lock-box account.

This is in contrast to the blanket lien on all of a Seller’s receivables that is often acquired as security by a factor or invoice purchaser; or, short of that, to the lien on all receivables due from one or more named Account Debtors.

The actual collateral providing security to a TRE Buyer is minimal relative to the industry norm.

The TRE Seller does provide an unconditional guaranty to repurchase a receivable sold on the Exchange if payment is not made to the Buyer by a date certain, which provides additional security to the Buyer. But that security is only as good as the Seller’s ability to perform.

So the importance of an accurate assessment of the Seller’s financial capacity actually increases in the context of a TRE transaction; because the specific collateral provided is more narrowly defined.

We’ve noted that the Exchange requires certain financial information to be provided by the Seller and that the TRE trading platform makes access to that information convenient. The Exchange itself, however, takes no responsibility for the accuracy or adequacy of the information provided and makes it clear that Buyers are responsible for their own due diligence and decisions.

As I’ve said before---that's fair enough, as long as we know the rules.

Those who have been in the business of buying receivables for any period of time will probably have had experience with transactions “gone bad”. Most would agree that more can be learned from one bad deal than from dozens of deals with which there have been no problems.

One of the things that I’ve learned is the importance of knowing whether I’ve really got a good, clear lien on an asset, and who else might pop up to make a claim on assets if things go bad for the debtor.

Not long ago an auction was posted on TRE by a first-time Seller. Besides financial statements, TRE makes available on its Seller Profile pages, a record of a UCC lien search. This tells us what claims have been recorded against the assets of the company and so has direct bearing on the strength of a Buyer’s collateral position.

In the case of this Seller, the prior UCC filings ran to 78 pages!

Now that, in itself, doesn’t mean that the position of the Buyer in the specific receivable being posted for sale is jeopardized.

It DOES mean, however, that the Buyer CANNOT know that its position is NOT jeopardized without devoting some significant time and attention to analyzing the prior filings. This is especially true because, in this case, there was no separate release of lien or subordination document provided for Buyer review.

A Buyer might have thought: “well let’s see if the financials are really strong and maybe I can take a chance making a bid even before I have the time to analyze the UCC filings”.

In this case it happened that the Seller’s most recent financials were noted as “internally prepared for use by management”. OK, that’s not really unusual, especially for interim accounting periods.

But in this case it happens that there is a single, large, intangible asset on the balance sheet that is roughly double the size of the company’s net worth. So, without that intangible asset, the net worth of the company would be negative rather than positive.

What’s my point?

I am NOT saying that this Seller shouldn’t be selling receivables on TRE.

I am NOT saying that TRE has failed in any way to provide what it has committed to provide to Buyers.

I AM saying, however, that TRE has made it clear that it is the BUYER’S responsibility to analyze the potential transaction and determine whether it has enough information to bid.

TRE has said “Caveat Emptor!”

I am willing to bet that in the period of time between the posting of the first auction by this new Seller and the time the first bid was recorded, no Buyer would have had time to analyze the 78 pages of UCC filings provided and determine whether or not the collateral provided was likely impaired by prior claims.

I am relatively sure that TRE will do all it can at this point in its life to try to work out any problems that arise with transactions on its platform.

But when TRE says, as it clearly does, that the Buyers and not TRE are responsible; it just makes sense to believe them.

The Buyer's first recourse is to the Seller, no matter who the Account Debtor might be and no matter what TRE might be willing to do to help out at this point.

So, indeed, let the Buyer beware!

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.