1- HOW CAN COLLATERAL CONTROL SERVICES BENEFIT A BANK AND ITS FRANCHISE
Under and pursuant to any financing against commodity arrangements, the main objective of the financing Bank would be to perfect its security at law. What must be ensured is that the integrity of the collateral which has been pledged to the Bank as a security against the loan extended, can be maintained throughout the duration of the financing.
One method of doing this is by appointing a “collateral controller” (and not an inspection company) to perfect the Bank’s lien by taking and maintaining custody and control of the pledged goods for the duration of the financing. In order to do this, the collateral controller must create a valid, binding and legally effective `Field Warehouse’ over the storage premises, where such premises are under the ownership or control of the depositor of the goods (whilst availing financing from the Bank).
Hence, “Field Warehousing” in essence refers to a scheme which began as a device to enable the owner of a stock of shifting goods (Borrower) to pledge it as collateral for a loan and if properly conducted, it creates a valid bailment and a resulting security interest in the Goods deposited in favor of the Warehouse Receipt holder (the Bank) and provides effective third party control and enables close regulation of the amount of the goods which are to be made available to the Depositor for subsequent use or sale.
Ideally, the field warehouseman whilst acting as the collateral manager for the lender must not only reinforce and protect the security over the pledged goods after the underlying financing terms have been finalised, but play a key role as a buffer between the borrower and the lender before the lender finalises the terms of the underlying financing transaction. This is in order to ensure that the lending terms and strategy perfectly match the ground operations and the underlying transaction flow. It is this function when properly conducted, which allows the warehouse receipt to assume its role as a financial instrument actually securing the lenders interests in the underlying commodities. It must be noted that the legal basis of Field Warehousing is the underlying scheme of the pledge which is made effective by way of a valid deposition of the goods into the custody and possession of the Collateral controller (Bailment) and the attornment by the Collateral controller to the Bank that the goods as deposited are deemed to be within the constructive possession of the Bank. Goods have to be deposited in the custody and possession of an independent third party, the third party has to acknowledge receipt of such goods for and on behalf of the Bank, and the Bank in return disburses the loan amount to the Depositor.
WHAT ABOUT CONSIDERING A FLOATING CHARGE?
The principal competitor of Field Warehousing as a method whereby a corporate customer can give security over stocks and similar assets to a lender is the floating charge. However, not only does the floating charge have many disadvantages, but Field Warehousing has certain advantages which assist in providing the Bank greater security as against floating charges. Thus:
It is also to be noted that client companies are frequently subject to restrictions in loan agreements or debenture trust deeds which prevent them giving charges. In some cases this prohibition may not extend to pledges, depending on the terms of the particular restriction.
2- Can this Model be Used for Both Islamic Finance and Conventional Finance Structures?
ACE GLOBAL DEPOSITORY has in-house expertise comprising of an accomplished and dedicated legal services team which has a wealth of experience in all aspects of international trade, corporate and commercial law, particularly in structured trade and commodity financing and related advisory work with respect to the legal and regulatory matters of collateral control and warehouse receipt financing (both Conventional and Islamic financing) under various legal systems, such as those falling under the Common Law, Civil Law including specialist jurisdictions like OHADA. Our team has developed documents enabling us to work with both conventional and Islamic financing and assists us in providing solutions which fit the operational model of the transaction with ease. Our legal contracts have been designed in a way which accommodates the standard pledge and lien structure as envisaged under the conventional banking models, as well as the Islamic Murabaha ownership structure which places the Bank in the shoes of the owner of the goods for the duration of the financing. ACE GLOBAL DEPOSITORY’s legal templates are dynamic, progressive and innovative in that they offer solutions to all lenders in order to meet the needs and requirements of the underlying financing transaction.
Our Collateral Control and other non-custodial monitoring and inspection services provide the Banks and other financiers and Traders with dynamic solutions and documentary support when considering collateralization of loans. Our documentation clearly establishes the link between pledge over goods by the Bank, acceptance of goods by ACE GLOBAL DEPOSITORY on behalf of the Bank as bailee of the goods and an effective change in possession of the goods under conventional finance, which in turn serves to enforce the validity of the security and the Bank’s collateral under the financing facility. We are also the critical link between the issuance of the Warehouse receipt and the disbursement of the finance facility to the borrower.
The practice of Field Warehousing, although well established in the United States and Europe, is relatively new to developing or emerging countries. Bank and lenders often mistakenly use the term collateral management to refer to all types of collateral control operations without understanding the core distinction between Field Warehousing and Collateral Management.
3- Specialists in Field Warehousing Operations
Field Warehousing operations essentially employ a method whereby a Depositor’s trading assets are used as security at the Depositor’s own premises for a loan or financing. It is a security instrument which enables the Depositor, to deliver to the Bank legally valid documents of title and to grant a possessory pledge over the goods stored in the Depositor’s own plant, mill, refinery or warehouse via the legal principle of “Bailment.” This creates constructive possession in the goods for and on behalf of the Bank.
“Bailment” would refer to the transfer of the possession of goods by the owner (bailor) to another (the bailee) which shall thereafter maintain notorious, continuous and exclusive possession of all the goods, for particular purposes such as hiring, financing, pledge of goods, and the delivery of goods for carriage, safe custody or repair.
Notorious possession is evidenced by numerous conspicuous signs placed at the storage premises; continuous and exclusive possession is assured by the fact that the collateral controller has one of its employees or agents or representatives on duty at all times when the premises are unlocked and that anyone permitted to enter the premises does so only at the will of the collateral controller or with its consent.
The foregoing steps accomplish an effective change in the possession of the goods and premises. Thereafter, warehouse receipts may be issued at the borrower’s premises in respect of goods stored therein and the constructive possession of the Goods is maintained by the collateral controller for and on behalf of the Bank/ Financier throughout the duration of the financing and until the goods are required to be released.
Collateral Management operations envisage use of storage premises which are owned and operated by an independent third party without the influence of the depositor over the goods.
The inventory collateral or pledged goods are therefore placed at third party premises such as independent, public or terminal warehouses. In such cases ACE GLOBAL DEPOSITORY, as the collateral controller, is required to enter into an arrangement with the store keeper/ warehouseman in order for it to devise a methodology for maintaining control, custody and possession and for effecting release within the premises, all of which binds the third party to ACE GLOBAL DEPOSITORY as the collateral controller as per the mechanism agreed by the Bank/ financier. Such an arrangement would allow ACE GLOBAL DEPOSITORY to be eyes and ears of the Bank/ financier within the independent premises.
It is therefore critical for the success of such operations that ACE GLOBAL DEPOSITORY devise a methodology for maintaining control, custody and possession and effecting release (where legally and practically permissible), all of which binds the third party to the mechanism agreed by the Bank. In such Collateral Management Operations, it is this third party which is deemed to be the original goods father in respect of such goods i.e. the first bailee of the goods.
It may be noted that under Collateral Management, a Warehouse or Silo operator will use its own warehouses and clients will deliver commodities for storage in such warehouses/ silos. In such cases, ACE GLOBAL DEPOSITORY Collateral Management Services provide the banker with on-site physical and legal control of inventory stocks, which are pledged as the operator’s collateral. They are designed to allow continuing relations with marginal or troubled operators, while retaining the flexibility to provide protection to the trader in the event of unanticipated increases in the operator’s requirement for further funding. By employing the relevant Collateral Management Services to control and secure the pledge over the operator’s inventory, the trader can customize the terms of its loan to support the operator’s specific needs.
4- Our Expertise and Procedure in Document Preparation
The heart of the transaction lies in executing accurate and comprehensive contracts and supporting documentation in order to protect the interest of the Bank, we at ACE GLOBAL DEPOSITORY ensure that our documentation encompassing such collateral control operations are close to operational and ground realities and are in compliance with local law and regulations.
Based on our past track record and experience, we are able to provide adequate legal expertise in terms of enforceability and legal framework.
ACE GLOBAL DEPOSITORY conducts its own legal due diligence and follows a systematic and detailed approach to each deal under consideration before circulating a draft contract.
The ACE GLOBAL DEPOSITORY templates of documents generally in use are as follows:
For a copy of our templates please provide us with your request and we shall send you the most relevant document pertaining to the proposed transaction.
5- Keys steps considered when constructing a valid field warehouse operation
a- Custody, Possession and Control.
In order, for ACE GLOBAL DEPOSITORY to create a valid Field Warehouse at the premises of the borrower, it is essential that ACE Global Depository constructs a legally independent warehouse within the borrower’s premises. The validity of the bailment of the goods into the custody and possession of ACE GLOBAL DEPOSITORY, and the independence of ACE GLOBAL DEPOSITORY operations at the storage premises is subject to:
ACE GLOBAL DEPOSITORY must ensure that it is granted unequivocal, exclusive, continuous and notorious possession over the storage facilities. To satisfy the test of possession, one must show control plus the intent to exclude others. Notorious possession is evidenced by placing numerous signs and continuous and exclusive possession is evidenced by the fact that ACE GLOBAL DEPOSITORY has one of its employees agents or representatives on duty at all times when the premises are unlocked.
b- Warehouse Inspection and Appraisal
ACE GLOBAL DEPOSITORY conducts its own internal inspection procedures and prepares a due diligence checklist before accepting a warehouse for providing its services. A detailed Inspection of the warehouse is conducted to ascertain that the warehouse is feasible in all respects for conducting the Field Warehousing services.
i. Suitability Of Storage Facilities – Recordal Of Prevailing Conditions
Storage Facilities must be equipped to provide for proper care of the inventory and for preservation of its quality.
Anything which can be reasonably observed to be detrimental to the care or preservation of inventory should be notified to the Bank and corrected by the borrower immediately and in any event prior to the location being approved for storage and field warehousing.
ii. Locking – Ability to exclude others
Under Field Warehousing Arrangements there is an obligation on ACE GLOBAL DEPOSITORY to control the storage, movement and release of the Goods as per the Bank’s instructions.
c- Details of Storage Facility
Under Field Warehousing, the inventory collateral or pledged goods are placed at premises which either belong to the borrower or have been leased by it, and there is accordingly either a lease or sublease granted by the borrower to ACE GLOBAL DEPOSITORY directly.
d- Lease / Sub-Lease
A lease or sub lease is a condition precedent to commencing the Field Warehousing operations. If the warehouse is owned by the borrower who becomes the depositor of the goods, (which more than often is the case under field warehousing), ACE GLOBAL DEPOSITORY obtains a direct lease over the premises owned by the borrower, being owner of the warehouse. Where the warehouse is taken on lease by the borrower, ACE GLOBAL DEPOSITORY ensures that the head lease allows for a sublease to be lawfully granted to it by the borrower and then enters into such a sub-lease. In addition, a Landlord Waiver and Consent Agreement is signed with the landlord in parallel to the sub lease document in order to confirm the landlord’s approval and consent to the underlying operations. Where the head lease prohibits or restricts the grant of a sublease, then it is advised to amend the head lease and to obtain the express and unconditional assent of the landlord.
NOTE: The provisions of the lease or sub lease will vary depending on the nature of the goods / products e.g dry, liquid, frozen, open storage etc and that it can be granted over the entire premises or only a part thereof, provided that the section under control and custody of ACE GLOBAL DEPOSITORY is clearly defined and identified in a floor plan.
e- Letter of Indemnity
As the actual operations may entail a number of third parties involved such as agents of the borrower, transporters, processors, sub-contractors etc, and because more often than not, the borrower is required to maintain continued access to the goods in the warehouse, albeit under the supervision of ACE GLOBAL DEPOSITORY, a letter of indemnity as issued by the borrower to ACE GLOBAL DEPOSITORY is essential and must be obtained. Our standard template for the Field Warehousing and Storage Agreement and all its Annexures has been attached hereto.
f- Cargo / Marine / FOG/ FOQ Insurance?
ACE GLOBAL DEPOSITORY ensures in the interests of the Bank that an adequate Cargo insurance, being a condition precedent to commencing operations (unless otherwise waived by the Bank), has been obtained by the Borrower.
This forms the backbone of the compensation structure under the tripartite Field Warehousing agreement. Hence the Borrower is required at its own cost and expense to obtain with an approved insurance company, insurance for the Goods during storage in the Premises as well as for the goods-in-transit. The insurance is preferably to be in accordance with the Institute Cargo Clauses (All Risks) and in respect of standard risks under fire and burglary policies, riots and/or strikes and/or civil commotion and/or terrorism and/or malicious damage, and all other related risks including misappropriation.
Additionally, ACE GLOBAL DEPOSITORY in light of its excellent relationships with several international insurance providers, may be engaged for the procurement of appropriate insurance for the Goods against all risks for either one or several of the following segments of operations:
WHAT IF THERE IS NO CUSTODY AND CONTROL REQUIRED?
In circumstances where the Banker/ Trader does not require ACE Global Depository to maintain custody and control, we offer exclusive non-custodial services based on the specialized templates developed by our in-house legal team pertaining to Monitoring and Inspection Services, as well as Inventory Control and Receivables services, which allow the Bank / Trader to have a first-hand view of the client’s borrowing base and the trade receivables. A brief introduction to the services is set out below however for the detailed forms of the different agreements in this regard please do not hesitate to contact us.
What other services can benefit the bank?
1- Secured distribution – what is it?
This a specialized type of Field Warehousing developed to service the needs of suppliers of commodities who wish to retain ownership of the inventory they supply, or to have a possessory lien on the goods till such time that payments are received in full against such inventory, and to regulate the delivery of the inventory to the Buyer.
To put a Secured Distribution plan in effect, ACE GLOBAL DEPOSITORY enters into a Secured Distribution Agreement with the Supplier and the Buyer. This service replicates the Field Warehousing and Storage Arrangement as analysed earlier. This service essentially comes into demand where the Buyer does not require Bank financing or where the transaction forms part of a bigger transaction which is being ring fenced by the Bank. This service has been developed by ACE GLOBAL DEPOSITORY to service both the Suppliers needs as well as the Buyers needs and the Agreement is adjusted accordingly based on the operational requirements.
2- How can the bank utilize our certified inventory control services?
Certified Inventory Control service is used by companies who would like to avail financing from banks but not by pledging their stocks specifically for this financing. Under Certified Inventory control, the company, ACE GLOBAL DEPOSITORY and the bank enter into a tripartite agreement. Since no lease is taken under Certified Inventory Control (as compared with field warehousing), the agreement provides that ACE GLOBAL DEPOSITORY shall have full right of ingress and egress to premises where inventory is stored, and that ACE GLOBAL DEPOSITORY shall have access to any of the company’s inventory records which are necessary to render its service.
The banker has ACE GLOBAL DEPOSITORY’s certificate to the extent that its reports are accurate and that the assets being controlled will not fall below an agreed minimum level. ACE GLOBAL DEPOSITORY will deliver to the Bank periodic reports and inventory certificates as and when required by the Bank.
NOTE: Under Certified Inventory Control, ACE GLOBAL DEPOSITORY has no lien perfecting responsibility; it does not take exclusive possession; there is no bailment; no signposting; no legal responsibility for taking care of goods. ACE GLOBAL DEPOSITORY `s objectives are therefore to control the withdrawal of the inventory to be able to prevent removal of the inventory when the limit specified by the Bank has been reached.
3- What can certified account receivables services achieve?
A company’s book debts may be worth as much or even more than the underlying stocks so any monitoring ACE GLOBAL DEPOSITORY provides would be enhanced by their inclusion. This can be done by employing many of the same techniques used in implementing the Certified Inventory Control services. ACE GLOBAL DEPOSITORY’s survey for example, would include the handling of book debts as well as stocks. A Certified Accounts Receivable Service Agreement would be entered into by the appropriate parties. The bank would give ACE GLOBAL DEPOSITORY and the company, instructions regarding any debts to be excluded from its reporting (such as sales to affiliated companies, employees or those covered by repurchase agreements). ACE GLOBAL DEPOSITORY then examines the company’s books, verifies the balance if necessary, prepares an ageing analysis and includes its findings on the first Collateral Control Certificate and all changes on the subsequent Certificates.
The degree to which ACE GLOBAL DEPOSITORY would control payments received by the company would be entirely at the bank`s discretion and the bank might change its instructions to ACE GLOBAL DEPOSITORY at the point when the company`s financial condition changes.
The Bank’s legal security over the accounts receivable may be a floating charge, an equitable mortgage where appropriate or other alternative means as devised.
The Collateral Control / Receivables Certificate contain a summary of changes and level of assets being controlled but does not include details such as description of inventory and information concerning debtors. This can be provided as a supplement to the Collateral Control / Receivables Certificate or rendered separately at periodic intervals as and when required.
4- What are stock monitoring and inspection services?
Under this Arrangement, the Bank appoints ACE GLOBAL DEPOSITORY to monitor and inspect the physical and documentary handling of the Goods. ACE GLOBAL DEPOSITORY provides these services for the account of the Bank and the role of ACE GLOBAL DEPOSITORY is solely one of logistical monitoring and inspection. In order for ACE GLOBAL DEPOSITORY to be responsible or liable for the condition, quality, management or control of the Goods, then ACE GLOBAL DEPOSITORY will adopt the more appropriate Collateral Control Agreement and not a Stock Monitoring Agreement.
In addition to all the above, our legal services team also assists in issuing legal opinions to Banks on an as and when requested basis depending on the type of transaction proposed to be structured by the bank, whilst taking into consideration the jurisdiction and local law requirements as well as the ground realities in respect of the specialized commodity which is being financed.
WHAT IF THERE IS NO BANK INVOLVED?
In circumstances where there is no Bank involved ACE Global Depository provides a specialized and unique type of service which replicates field warehousing operations to service the needs of suppliers of commodities who wish to retain ownership of the inventory they supply, or to have a possessory lien on the goods until such time that payments are received in full against such inventory, and to regulate the delivery of the inventory to the Buyer. Such service may be provided at either end of the spectrum – i.e. for the benefit of the Supplier or the Buyer and essentially comes into demand where the Buyer does not require Bank financing or where the transaction forms part of a bigger transaction which is being ring fenced by the Bank.
ACE Global Depository’s Secured Distribution services as illustrated in the above paragraphs, allow a Supplier to maintain or increase shipments to buyers who require deterred sale or deterred payment terms and to control the financial risk involved in such transactions. Obviously, the ultimate goal of both the Supplier and the Buyer is the same: to increase sales.
To put a Secured Distribution plan in effect, we enter into a Secured Distribution Agreement with the Supplier and the distributor (Buyer) and thereby for example, allowing a Supplier to maintain or increase shipments to its distributors or dealers on a deferred sale or deferred payment terms basis whilst controlling the risk involved in such a transaction by engaging ACE Global Depository to control the release of the goods on an as and when instructed basis.
Warehouse receipt financing – an appraisal
Set out below is a general appraisal of Warehouse Receipt Financing operations which at a glance highlight the advantages and disadvantages associated with such operations.
1- Advantageous to both borrower and lender
Most actors who borrow against warehouse receipts do so because in the very nature of their business it is the most advantageous way for them to obtain credit.
a- The Borrower
The practice enables them to:
1. Obtain a maximum of credit at reasonable rates of interest
2. Repay loans in an orderly manner through funds made available by the sale of the commodities pledged.
3. Take advantage of cash and quantity discounts and buy materials at the most advantageous times
4. Provide adequate capital for their business at periods when production and operating costs are at a peak and working capital lowest.
5. Maintain adequate inventories and avoid forced liquidation.
6. Bridge the financial gap between completion of production and sale of finished product
7. Carry certain commodities for the period necessary to age them properly
8. Obtain more working capital than ordinarily be available by most other sound financing programs
9. Permit year-round employment of competent help in the manufacture of a seasonal product, thus stabilizing employment.
b- The Lender
1. The loans are self-liquidating.they are paid as the goods are sold.
2. The loans are sound because they are well secured.
3. The loans can be made to meet the eligibility requirements of the Reserve Banks and are readily discountable
4. The loan is guaranteed by the commodities themselves. In most sensible countries there is no better way to protect the loan as most other assets (construction, equipment, transportation units, etc) are not easily “reachable” in case of problem or intend of recovery on the money loaned.
2- Warehouse receipts
NON-NEGOTIABLE & NEGOTIABLE WAREHOUSE RECEIPTS
A Warehouse Receipt is evidence of the relationship which exists among the parties to a storage transaction. A storage transaction is a commercial relationship just as is a sale or a loan.
NEGOTIABLE
The use of Negotiable Warehouse Receipts is usually limited to the storage of goods which are traded on the commodity exchanges. A negotiable warehouse receipt is one that can be given, for value, to another without the need for any formal assignment of right or transfer of interest.
Such negotiable receipt may act as documents of title (signed or certified by the warehouseman) guaranteeing existence and availability of a specified quantity and quality of a commodity, and used as an instrument of transfer in cash (spot) and/or futures transactions on a specified exchange. If releases are to be made, the Receipt is required to be presented to the warehouseman and the new balance is duly recorded and certified on the back of the receipt by the warehouseman.
NON- NEGOTIABLE
A Non-Negotiable Warehouse Receipt is made out in the name of the lender and indicates specifically that the goods called for are deliverable only to the order of the party named thereon; presentation of the warehouse receipt is not required. If partial releases are to be made, a release order from the registered holder of the Receipt is always required.
A Non- Negotiable Receipt is NOT a certificate of, or proof of ownership in the stored goods. It is merely evidence of the fact that the warehouseman has received the goods and is holding them subject to the instructions of the named party.