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When it comes to restructuring corporate debt, care needs to be taken that trade is prioritised and the “each lender for itself” approach is suppressed for a better collective outcome, says Geoff Wynne

n a market of low commodity prices and global trade growing at marginally less than world GDP, it is no surprise that some trade finance facilities are looking distinctly fragile. This article takes Ia closer look at involving trade finance obligations and, importantly, sets out the advantages of giving “true” trade debt priority.

Historic context The argument started way back in the 1980s, particularly with the Latin American debt crises, where short term were paid – country restructurings paid short term debts because they matured quickly and should be outside long term restructurings. There was an assumption that because it was short term, it was trade debt, but this was

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“The first question not always the case. would be paid because it was required for business There is certainly no evidence that any legal continuity. is, where does the system actually grants trade debt priority. But as Here is another clue that there could be better many know, the argument resurfaced in 2008–09 treatment for these trade receivables. A payer will rank if its after the financial crisis, particularly when looking argue that they will pay their trade receivables or receivable is at the bank restructurings in Kazakhstan.1 in an ongoing business because they want to Definitions were crafted for trade debt and its guarantee the source of supply. But as has been not paid?” priority in a number of cases. Each was different seen in a number of restructurings which are and in some cases trade debt (as defined) was paid continuing, where the paying party starts looking off in full. These restructurings went through a at the receivables that it has, and says, “Ah ha! court process. But within my receivables, there are those which Since the financial crisis pre-export finance I regard as short term supply of assets or goods (PXF) facilities have been getting caught in to me, and those are the ones that I will pay. restructurings. It happened in Russia and it is But unfortunately, , many of you were happening in Ukraine.2 So the discussion then was, generous to give me longer payment terms, and what would you give priority to? What that’s really like working capital for me, so it’s more would you recognise? like finance, and I’m not going to pay as a trade receivable, I’m going to treat that as a finance Recognising security payment and unfortunately I’m going to put you in And certain people, of whom this author was the finance restructuring club”. one,3 said that structurally, you should recognise Some people have taken it further to say security given in the trade financings. So where that “When I’m looking at the receivables, I will these were PXF or prepayment financing and they pay trade receivables that are owed to suppliers, created security, that security should be recognised. but I don’t want to pay trade receivables that are The counterargument is that you might have held by a financial institution. And I am going security, but you do not have full security. In to treat receivables that are owed to financial other words, at the time of the financial difficulty, institutions as financial debt, even though it is in you, the secured (providers of the PXF) cannot reality trade debt. If it was held by a supplier, I liquidate your security at that time to be repaid would have paid it.” In other words, the argument in full. And if you do not have full security, that a receivable held by a financial institution is the restructurers will not believe you have any a financial debt and not a trade debt affects its meaningful security and as a result, it defaults repayment priority. to what is called the ‘liquidation model’, which That seems to be defective reasoning, but assumes that the business stops at that point. once again it affects the ability to be involved in That ignores, in reality, any security going this financing if there is a danger of being treated forward because the commodity is in the ground, differently and unfairly. but if the company is in liquidation, it is not going to produce anything anymore, and therefore there Types of financing is no security. What is also interesting, if you look particularly Even though the whole purpose of the at some of the larger borrowers, some of restructuring is for the company to survive, whom are in difficulties and some of whom are organisers of restructurings sometimes do not not and might be in the future, is that they are recognise that future security. raising different forms of debt. So they are using In many ways, that had an adverse effect on structured trade products (PXF and prepayment the structure of trade finance because people ask financing), they are also involved in borrowing if structured trade finance is worth doing if they base and in reserve base lending. And in all of are going to be caught out by the obligor’s . those structures, remember, there is security, but it is security that assumes that business will continue Receivables in a restructuring in the future, in order to realise all of that security. As the volume of PXFs and true prepayments to There is an argument that revolving producers has diminished, in receivables facilities (RCFs) are not trade finance. While the finance has grown - either against receivables facility might just about be trade-related, it is or indeed purchase of receivables. in effect more like working capital. Perhaps the And many believed that structurally, what they expectation, if something happens to the obligor were going to do was to purchase trade receivables who has an RCF, is that the claims under that part – in other words, these were payments made by a of the financings would not be treated as trade. party receiving goods or services, and thus key to But does it matter? trading relationships. If the receivable could not In other financings, a bank issues letters be paid at the time, there was a suggestion that of credit (LCs), yet how do you treat the whatever happened to the paying party, that money reimbursement obligation from the issuing bank

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P69_TFR_Vol19_Iss10_Geoff Wynne.indd 70 06-Sep-16 2:39:02 PM if the bank is a confirming bank. If the bank is onto its position for a good few months against “There is an an issuing bank, what about its claims against growing anger from a number of other banks. the applicant. Are they trade? Are they trade But the result was, since the company continued argument that financings? to perform and since the bank held security over The regulators started introducing a phrase the sale contract, it was getting cash which it said revolving credit called “self-liquidating” which meant that they it was allowed to keep and not put back into the facilities are not began to think about whether LCs were in some restructure. In the end, there was a great deal way something special. of pressure on the bank, and there were also trade finance” The problem was the self-liquidating suggestions along the lines of: “if you think you’ve determination assumed that the bank that had got an assignment, we’re just going to stop that the obligation to pay out on the LC, held onto contract and we’ll find a series of other contracts the goods, represented by the documents of to sell the commodity, and one way or the other, title presented under the LC and therefore held you will be dispossessed of your security rights.” security. As many know, that is unlikely to be the That ultimately got the bank around the table to case. In reality, the LC is used for payment of discuss what to do. goods and the goods will be on sold into other If there is a restructuring, who runs the parties. The bank does not hold the documents of negotiation? Because that is quite an interesting title for very long. and challenging question. Who runs it will depend There is still a debate as to whether there is a on what view is taken on ongoing business or thing called “self-liquidating LC”, and this might liquidation model. Most of the time, the larger be a clue as to how one can get better treatment. lenders and debt providers are doing this on an If a guarantee was issued for trade purposes, unsecured basis. If they are banks, they are doing can the reimbursement obligation under the it on an RCF or equivalent or they may well be guarantee that was issued, result in some sort of bondholders – the combination of the lenders better treatment? and bondholders may well mean that they control Are any of these financings trade? Are they the creditors’ committee – they drive the structure trade related? Does it matter? In whose eyes does forward –and they want to achieve the best deal it matter? Well, that will be important, because the for themselves. That is really at the price of result of what happens if something goes wrong anybody else. may very well be determined by the view that is They will look at how the company can then taken in relation to the debt that is held. survive, they will look at whether new money is needed, and of course the general proposal Where financing goes wrong is, “let’s put new money in, but actually, we The first question is, where does the creditor rank - the creditors committee (set up to run the if its loan or receivable is not paid? restructuring) - will put the new money in. And of The obligor of that instrument at that course, it’s new money so we’re going to take super particular point is unable to pay. Is its position just security in relation to this because that way, we’ll an unsecured creditor? Or can it do better? Should put in that money, we’ll charge a lot of interest for it do better than being just plain unsecured? it and we’ll get it out first”. The first point to look at is: can the creditor When you have these negotiations, there deal with its secured position? Does it have are other parties involved. First of all, many of security? Can it keep security over the goods that it the loan arrangements are not bilateral; they are has financed, sell them, and keep the cash? syndicated loans. And as somebody said only the How long can it continue that position against other day, “I find myself quite often a minority the pressure building up, about joining with the lender in a syndicated transaction. Who my fellow parties trying to restructure. What arguments can lenders are is becoming more and more important a creditor make? Can it get better ranking in the to me”. or the reconstruction of a producer This concept of, not KYC (know your or a buyer of goods? What sort of arguments are customer) but KYL (know your lender), know there left to use? What position would one take as your fellow lenders (KYFL) is becoming a creditor that felt it was involved in the narrow increasingly important to a lender. If one is going financing of the trade business of the party that is to be involved in the restructure, one would like now in difficulty and what can be done? to know that the agent is going to handle this professionally, is going to come to the participant Stance in restructurings and talk to them, and that the syndicate are not Does one just try to exert pressure by holding on going to be held to ransom by a recalcitrant small to security and security rights and saying “try and lender, who will not vote in favour of any situation restructure around me”? that requires 100%. When this author was involved in a restructure This is an interesting point – whether in fact for a bank which had secured its structure, it held one goes back into document arrangements to

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“There is certainly make sure that it does not get held to ransom has the most uncertainty in most jurisdictions, in trying to achieve some form of restructuring and that probably includes the UK too. One loses no evidence that by an individual who says, “I just don’t want to the contractual right to discuss things and the law know. I’ll sit where I am and you can come and takes control. any legal system buy me out.” If one thinks about its own position if one actually grants trade The last group to discuss are those who is a senior creditor, i.e. unsecured, its position provide the credit support – such as insurers. against a subordinated creditor is to say, “I’m debt priority” The problem is that they quite often express not going to let you have any control at all the view to their insured as being, “Just act as if of what’s going on because I want to be able uninsured.” Which does not help when one needs to work out the best thing, and ultimately, if to make decision A or decision B. there’s a liquidation I get paid first and you are Generally speaking, one would expect that the subordinated.” insurer, the guarantor or anyone sitting behind, Perhaps there should be a reverse would accept its were best served by subordination, in other words, to say at the outset joining some form of restructuring if that looked that the true trade creditors should get the benefit like keeping the company going and achieving of a continuing business, and that consequently repayment. the unsecureds should agree that they will not The problem then is what to do with trade liquidate for the purpose of depriving those who debt? Analyse it first. Is there anything that one have security of their security. would regard as trade debt? Is there anything that, when looking at the restructuring, ought Essentials of restructuring in a trade to be dealt with? Quite often, a restructuring context is driven as much by the debtor as it is by The essential in a restructuring trade context the creditors because depending on how the is to keep the company going. There is no restructuring proceeds, there is an issue of doubt that when documenting transactions, one whether the trade gets paid, gets better treatment, should be looking at producing something that or whether it is subject effectively to the same is designed much more to keep the company , if that is what is required to proceed. going, particularly when there is a structured It is often the case that time is against any transaction, than creating a transaction that has complex form of restructuring because at various trip wires that can in fact force a company into stages, there are parties who can pull the trigger. liquidation. An interesting dynamic is if a creditor has a • Keep the company going. Documents that have debt owing to it, if it is a lender and its loan 26 events of default, when in reality the lender hit repayment date and repayment is not paid, actually wants to keep the company going, it has a right to be paid. It may well be able to should not be creating that number of defaults. accelerate at that point. If it is a participant in a • Respect the financings structure and avoid syndicated loan and the repayment is not due for liquidation. If one does this, then structured some time, it may not be able to do anything. secured trade has a better chance of getting paid ahead of the unsecured. There should Who can pull the trigger? be flexibility in the structure and in the So the question is, is there anyone who can pull documents to avoid defaults to start with, and the trigger and should they be dealt with first? then flexibility in the restructuring to avoid Should short-term receivables be paid because throwing it into default. they are clearly going to be due and payable and • Flexibility from all lenders. In practice, that somebody may take action in relation to it? does not happen and that is the problem. The liquidation model is not a useful idea There is always somebody who has a better when there is layered debt with different forms idea, somebody who is trigger happy and as a of security but it does equalise the parties. result of that, it is difficult to keep voluntary In liquidation, everyone is unsecured, so the restructurings going if the business continues restructuring is based on this and the restructurer to take a down turn or if everybody is not having control of payment flows, having control involved. of all the security. Then one should ask: “who can call default?” Some examples Can the number of loans repaid at one time be Metinvest faced the issue of how to treat its increased? Can there be some sort of standstill? PXF lenders when its 2015 eurobonds needed And what is interesting, logically, is that a standstill restructuring (see note 2). One gets the feeling is a good idea because it at least gives time to with Metinvest as one did with RUSAL that it reflect but in many ways, a standstill can be the was too big to fail and too complex, but what slippery slope to being obliged to restructure. is good news and will take structured trade The liquidation model, if put into practice, forward is that they did not dismantle the PXF

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P69_TFR_Vol19_Iss10_Geoff Wynne.indd 72 06-Sep-16 2:39:03 PM type facilities. They kept them going and they kept the security going forward. Abengoa, the Spanish renewables corporate kept insolvency at bay because its creditors agreed not to proceed with insolvency. It has recently landed a €1.17bn debt for rescue package.4 working? Would BAFT, the ICC Banking Commission or How to move forward the WTO support this, so that Can one put trade debt in a better position a growing number of bodies to improve the number of financings going take the line, “Look, in order forward? Is there any likelihood of legislation to to encourage trade, we need achieve this? to make sure that there is Legislation is unlikely because ultimately, it priority given to trade debt.” needs to cover the jurisdiction of the obligor If the market can go down and that takes one into all sorts of emerging that route, will the regulators markets where that may not be possible. In any accept that where this arrangement event, when all financial creditors agree that trade is in place or is bought into, that trade should get a better position, that control point should be treated as having priority in depends on who becomes the lender because a regulatory sense, and consequently, if a company is in financial difficulty, the debt regulatory capital relief can be given to may well be transferred to what one might call the trade debts that have been structured vulture funds and the like, whose interests are within this agreed preference. very different. Now this is a big step from where If they are buying the debt at 20, they regulators currently stand – they appear not make the profit at 30, they put that money in to understand trade and trade finance. a bank and consequently, there is a question The point here is that, if this can be as to whether there would be a better way of done, this could well make trade finance more controlling who might become a lender so that attractive in a way that it is not currently as all the interests are aligned. attractive as it could be. Anyway, if the interests are aligned, would Is it worth doing? Is this idea worth it agree to priority for true trade? What can true proceeding with and how can the market go trade be? The examples of the narrowest forms proceed with it? The guidance then becomes of true trade debt are those arising from goods important because it can be, in some ways, built and services for import or export, where there into a voluntary code, but a code that will be are independent third parties involved, and followed. perhaps they are short-term. So bear that in mind Restructuring of debt still remains References as a conceptually working definition for true problematic if one is a trade finance provider. 1. See www.tfreview.com/ trade, if one wants to deal with true trade. While one can certainly get oneself into a better node/7493 position by structure, what is more important is 2. See coverage of Metinvest Respecting structures how to put pressure among the market players at www.tfreview.com/ Now here is the revolutionary bit. Can there and among those who restructure and with node/12046 be general agreement that preference is for a the regulators to obtain better results for trade 3. The author was acting workout solution and that that workout solution, finance. for Alliance Bank in should itself contain principles that grant trade, Kazakhstan during the true trade or however it is defined, as a priority? This article is based on a Sullivan & Worcester restructurings. See www. If this cannot be legislated, what about breakfast briefing held in June 2016 in London. tfreview.com/node/5402 some guiding principles being produced by the Geoff Wynne is a partner at Sullivan & Worcester 4. See the WSJ report at industries where the trade finance business is UK LLP http://on.wsj.com/2bCzc6L

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