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Cross-Border Receivables Financing

The UN's international Convention simplifies unlocking cash flows of international trade, through securitization.

Steven Schwarcz and Eric Marcus, Kaye Scholer LLP

Securitization is assuming an increasingly international focus. In part, this is because companies that wish to raise funds from capital markets may not be located in countries with established capital markets. In order to gain access to capital market funding, these companies have to structure deals that cross their national borders.

Recognizing that a growing segment of the world's money is now locked into accounts receivable, and recognizing possibilities for economic growth from unlocking that wealth, the United Nations Mission on International Trade Law (UNCITRAL) has undertaken a project to simplify cross-border receivables financing and reduce its cost. The result has been the "Convention on the Assignment of Receivables in International Trade" (Convention).¹

The Convention was finalized by the General Assembly of the United Nations and opened for signature in December, 2001. It will become effective, among the states that ratify it, six months after it has been ratified by at least five member states.

The Convention would apply only to assignment of receivables, and specifically avoids involvement in any other part of the financing contract. It defines an assignment as including transfer of all, or part, or an undivided interest in a receivable, and also creation of a security interest in a receivable.

Furthermore, "receivable" is very broadly defined as a "contractual right to payment of a monetary sum." Receivables covered by the Convention are therefore not limited to traditional accounts receivables. They would also include chattel paper, credit card receivables, royalty payments under a license agreement, and most types of receivables used to back securitization transactions. In that context, the Convention is intended to resolve a host of troublesome legal issues. Some of the more significant of these are discussed herein.

Choice of Law Governing Perfection: In cross-border deals, it is often difficult to determine how to protect, or "perfect," a transferee's interest in transferred assets from creditors of the transferor.²

For assets physically located in a particular jurisdiction, the law of that jurisdiction or, sometimes, of the transferor's jurisdiction usually governs perfection. However, determination of applicable jurisdiction can be troublesome, because receivables are intangible and may therefore not be deemed to be physically located in any particular jurisdiction.

Under the Convention, the location of the assignor (i.e., the originator in a securitization transaction) would govern the choice of law.

Methodology for Perfection: Even when governing law has been fixed, one has to address the method by which perfection occurs under that law.

Although some countries have filing or other public notice systems for perfection, other legal systems may require notification of obligors, which is expensive and impractical.³ Often, the local perfection procedures may be unclear or unduly burdensome, in which case investors are forced to rely upon the originator's representations, warranties and covenants that assets transferred to the SPV are, and will remain, unencumbered by third parties.

The Convention therefore also addresses, although to a lesser extent, the means by which perfection occurs. It accomplishes this by proposing an optional centralized filing system.

In order to appreciate the importance of centralized filing, one must remember assignees want to have their claims against a transferred asset rank prior to any third party claims to that asset. In a securitization context, "priority" means that the SPV's and investors' claims against the transferred receivables are superior to any third party claims, whether secured or unsecured.

Priority is normally accomplished in a jurisdiction that perfects claims by being the first to file against receivables.⁴ However, if the originator is located in a jurisdiction that does not have a filing or other registration system to indicate priority, investors may have to rely on the originator's representations, warranties and covenants. This creates a much greater risk of fraud than when a public filing system is used.

Without a system for making public transfers of receivables ascertainable, securitization would be discouraged, because the SPV would not be able to determine its priority at the time of transfer.

UNCITRAL's Convention proposes an optional centralized registration system that could be used to provide notice. For states opting in, it would provide that "(a)s between assignees of the same receivable from the same assignor, priority of the right of an assignee in the assigned receivable is determined by the order in which data about assignment are registered (under a system established by the Convention), regardless of time of transfer of the receivable."⁵ Thus, the Convention's filing protocol would provide greater certainty as to priority.

Receivables Arising in the Future: If the transaction involves receivables that will be created at a future date, as in "future flows" transactions, one must ask if the local law permits transfer of an asset not then in existence. Many civil laws provide that a pledge or assignment can only be made when an asset exists.

The UNCITRAL Convention allows this. Article 8.1 specifically provides that "(a)n assignment is not ineffective...on the grounds that it is an assignment of future accounts receivable...provided that the receivables (can) be identified as receivables to which the assignment relates."

Commingling: Another risk is that cash proceeds of receivables pledged or sold to a SPV may be mixed, or "commingled," with the originator's own funds. This risk, to some extent, reflects common sense: if the originator is freely permitted to use collections, a court may find the originator's control inconsistent with the SPV's claim that it has a perfected interest in the collections.

Under the Convention, commingling risk is minimized. Article 14.1(b) provides that "(i)f payment in respect of the assigned receivable is made to the assignor, the assignee is entitled to payment of the proceeds..." Article 24.2 provides that "(i)f proceeds are received by the assignor, the right of the assignee on those proceeds has priority over the right of a competing claimant...if: (a) the assignor has received the proceeds under instructions from the assignee to hold the proceeds for the benefit of the assignee; and (b) the proceeds are held by the assignor for the benefit of the assignee separately and are reasonably identifiable from the assets of the assignor, such as in the case of a separate deposit or securities account containing only proceeds consisting of cash or securities."

Article 13.1 would also lessen the likelihood that commingling would occur, by authorizing the assignor or assignee to notify the obligor on the receivables to pay the assignee directly.

Preferential and Fraudulent Transfers: Bankruptcy, insolvency, or related laws of some countries may permitor requirea bankrupt company (or its representative, such as a trustee) to avoid transfers of assets or obligations incurred by the company prior to its bankruptcy. Some of these lawsreferred to as "preference laws," because they avoid preferential transfersare intended to ensure equality of distribution of the company's assets among all its creditors. Less frequently, transfers madeor obligations incurredby a troubled company for less than equivalent value may be deemed to be fraudulent and, therefore, voidable.

The Convention does not cover these issues directly, but it does generally specify the choice of preference law that would apply. This may allow the parties to a receivables financing to improve their understanding of their respective rights, by consulting insolvency counsel, expert in the applicable law.

Contractual Restrictions on Assignment: Another issue is whether contractual restrictions on assignment affect the financing. These restrictions (anti-assignment clauses) are sometimes contained in the contract pursuant to which collateral or receivables are originated.

For example, a lease or license contract may prohibit the lessor's (or licensor's) assignment of rights to payments received thereunder. Under U.S. law, certain restrictions on assignment of amounts receivables, such as accounts receivable, are unenforceable, but the laws of other jurisdictions differ.

The Convention allows certain assignments, notwithstanding anti-assignment clauses. However, the Convention still protects obligors that would be harmed by the assignment, by making the assignor liable for breach of the prohibition. The Convention also protects obligors by clarifying that the assignment of receivables does not increase their burden.

Thus, the Convention is a significant step toward harmonizing the legal infrastructure governing international receivables financing, thereby facilitating its growth, and growth of cross-border securitization generally.

©2002 Kaye Scholer LLP

Steven L. Schwarcz is Special Counsel and Eric Marcus is a partner in the New York office of Kaye Scholer LLP. This article is adapted from an article that originally appeared in the January issue of the firm's publication, "Securitization Update." It is intended as a general guide to recent developments in the law. It does not contain a general legal analysis or constitute an opinion of Kaye Scholer LLP, or any member of the firm, on the legal issues described. It is recommended that readers not rely on this general guide in structuring individual transactions, but that professional advice should be sought in such circumstances.

(1)The complete text of the Convention is available at UNCITRAL's Web site, www.uncitral.org.en-index.htm.

(2) The same problem applies regarding protection from the transleror's bankruptcy representative. In a securitization transaction, "perfection" means protecting the SPV's interest in the transferred receivables from claims of the originator's creditors.

(3) Besides the obvious cost involved in having to notify all the obligors in, for example, a trade receivables deal, it sometimes may also be culturally unacceptable to do so. Notification might also be seen as a signal that the company is in financial difficulties.

(4) Sometimes referred to as "first in time, first in right," this generally gives priority to the first person to file against the asset. Priority is ascertained by searching the filing records to determine whether other parties have prior filings against the relevant assets.

(5) Annex to Convention §1, art. 1. Also Art. 42 of the Convention. This rule contrasts, for example, with a rule that would determine priority by the time of transfer of receivables, which is not always ascertainable.

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