Bilateral Trade Finance

Such a facility typically might have been offered by a bank to its client on bilateral basis; the purpose of the facility would be to finance international export / import transactions.

Imagine cross-border transactions, where:

Since using equity typically comes with a higher price tag as compared to using debt, the buyer would seek bank financing to fund the purchase. A bank in turn, may decide that at every stage of the transaction they have a sufficient security cushion in the form of the goods being represented by a document: initially, the holding certificate, and later, the bill of lading. On the basis of such security, the bank might then agree to advance a (large) portion of the purchase price of the goods.

The form of security that bank would take typically includes a pledge of the documents (bills of lading, holding certificates), an assignment of contractual rights and receivables and a charge over a bank account. The security is intended to mitigate the risk of the bank throughout the life of the loan. In theory, at least, the bank will always be able to look to recover on the value of the goods, even if the borrower’s balance sheet is not strong enough. Also of note is that a facility of this type is meant to be repaid from the purchase price received by the trading house from the importer, ie, from the transaction itself.

We should also note that the trade finance market is undergoing a change: trade finance banks are reducing their participation or withdrawing completely. Investment firms / hedge funds have stepped in to a degree with similar products, however, required hedge fund returns are high and so many transactions are not commercially viable with hedge fund finance. As a result, the market consensus is that the so-called ‘trade finance gap’ exists, with estimates for the gap being as high as US$2.5tn in 2023.

There are number of legal matters to consider when putting a self-liquidating transaction together. The starting point is the robust templates of the facility and security documents. Here, it is often the case that the templates are overly restrictive and are not followed in practice.

Having a restrictive document but which is not implemented in practice is not a good thing for the lenders. The courts will often refuse to defend such documents / security. A recent often talked example, perhaps, is the Unicredit Bank AG v Euronav NV, where Unicredit lost as the court found that the bank would not have followed the required arrangements anyway.

The next matter to consider is the transaction itself: do the facts match the intended arrangements. What rights does a holding certificate issued in country X gives to the bank? Are the re-sale contracts made by the trading house with the importer assignable? Are there gaps in the flow of the goods where the bank neither holds any title documents, nor benefits from any assignment of value?

Now, from a trading house perspective, the facilities of this nature typically also require attention. This is because, the template initially offered by the bank would be too restrictive. For example, a self-liquidating facility should be secured on the goods financed. But many templates in fact attempt to extend security to other assets of the borrowers. This will have several negative results, including the potential inability of the trading house to raise subsequent financing.

Another important item to consider for a trading house is the various ‘limits’ – such limits dictate what type of transaction exactly can be financed – do they match the intended use?

Finally, a trading house might wish to negotiate indemnities that they are giving as part of the facility. These indemnities are meant to compensate the financiers for the risks they should not be carrying; however, typically the banks request indemnities with scope that extends well beyond matters that must be reasonably the trading house’s risk.