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1 of 10 DOCUMENTS:

Incoterms for trade finance lawyers

Produced in partnership with Sullivan & Worcester

What are Incoterms and what is their origin?

Incoterms—an abbreviation of 'International Commercial Terms'—are a set of globally recognised terms and
conditions used in international, and sometimes domestic, contracts for the sale and purchase of goods.
They comprise a set of 11 three letter acronyms/abbreviations each representing a different set of provisions
dealing with the allocation of duties, costs and risks in a sale and purchase contract.
The International Chamber of Commerce (ICC) publishes a set of rules for the interpretation of Incoterms
explaining the meaning of each of the terms. These rules were first published in 1936 and are updated peri-
odically to reflect changes in trade practices. For the full text of the latest version of these rules, see Practice
Notes:

• Incoterms® 2010—introduction
• Incoterms® 2010 Rules—EXW Ex works
• Incoterms® 2010 Rules—FCA Free Carrier
• Incoterms® 2010 Rules—CPT Carriage paid to
• Incoterms® 2010 Rules—CIP Carriage and insurance paid to
• Incoterms® 2010 Rules—DAT Delivered at terminal
• Incoterms® 2010 Rules—DAP Delivered at place
• Incoterms® 2010 Rules—DDP Delivered duty paid
• Incoterms® 2010 Rules—FAS Free alongside ship
• Incoterms® 2010 Rules—FOB Free on board
• Incoterms® 2010 Rules—CFR Cost and freight
• Incoterms® 2010 Rules—CIF Cost insurance and freight
Incoterms and the rules for their interpretation should not be confused with international private law (ie con-
tractual arrangements agreed between countries such as treaties or conventions). Incoterms are simply con-
tractual terms that reflect common trade practice and that can be incorporated in a sale and purchase con-
tract by reference.
The intention of Incoterms is to achieve a consistency of understanding and interpretation of contractual
terms, particularly where contracts involve multiple legal jurisdictions.

How are Incoterms used?

Incoterms and the rules for their interpretation can be incorporated in sale and purchase contracts by includ-
ing the relevant three-letter acronym/abbreviation for the relevant term. It is important that reference is also
made to the specific version of the Incoterms rules that is being incorporated. For example, best practice
would be to include wording such as 'FOB – Incoterms® 2010 rules'. This makes clear which version of the
relevant rules is being incorporated and also avoids any confusion relating to other possible meanings of the
terms. For example, in the United States, the term FOB, has historically been used in trade transactions with
a different meaning to FOB under ICC Incoterms.
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Along with the three letter acronym/abbreviation and the version reference, Incoterms will usually need to be
accompanied by a reference to specific geographical location. This is because Incoterms deal with a specific
physical point where delivery takes place and risk passes (see What Incoterms cover below). Incoterms do
this in the abstract, for example by reference to risk passing when it is loaded on board a ship (under FOB).
However, it is necessary to state where in the world that ship will be at the point of delivery, for example
'FOB - Santiago de Chile - Incoterms® 2010 rules'.

What Incoterms cover

Incoterms set out the agreement between a buyer and seller of goods in respect of:

• delivery of goods
• the point at which risk in the goods passes and, therefore, who bears the risk in the goods be-
ing damaged or lost
• responsibility for arranging carriage of the goods and the associated costs
• responsibility for arranging export and import authorisations and licences, security clearance
and the associated costs and duties
• the provision of delivery documents
• costs relating to checking, inspection and packaging
• who has responsibility for arranging insurance over the goods in transit, and
• assistance in relation to the provision of information (to allow the other party to meet its obliga-
tions under the relevant Incoterm and the sales contract)
Within each Incoterm there are:

• A-terms, which set out the obligations of the seller under that Incoterm, and
• B-terms which set out the obligations of the buyer

What Incoterms do not cover

It is important to understand the limitations of Incoterms in relation to the sale of goods. Whilst Incoterms do
cover several elements that need to be included in a sale and purchase contract they are not, by themselves,
a substitute for a sale and purchase contract. Notable points that are not covered by Incoterms are:

• pricing
• the transfer of title to the goods (ie where, when and how this takes place), although it is possi-
ble that transfer of title can be linked to delivery, in which case the relevant Incoterm may be
relevant
• exclusions of liability and force majeure
• consequences of breach of contract (other than in very limited circumstances)
• dispute resolution, and
• governing law
Consequently, these are all points that should be considered and included in the sales contract itself. Other-
wise the general position at law in the relevant jurisdiction will apply and this can lead to considerable uncer-
tainty.
There are a number of standard form sales contracts that can be used in conjunction with Incoterms that
cover these points.

Overview of the various terms

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Incoterms can be grouped by reference to the point at which risk in the goods passes from the seller to the
buyer. Set out below are the terms grouped by the first letter along with some of the key characteristics of
those terms.

E Term
EXW—Ex Works
The EXW term signifies the minimum obligations of the seller. Delivery takes place when goods are placed at
the disposal of the buyer at the seller’s premises or at another named place.
Any export clearances must be arranged by the buyer. The seller has no obligation to load the goods onto
any vehicle arranged by the buyer. The buyer is responsible for all costs and risks involved after the goods
have been exchanged at the agreed point.

F Terms
FCA—Free Carrier
FAS—Free Alongside Ship
FOB—Free On Board
The F terms signify that the main carriage of the goods are not paid by the seller and delivery will usually
take place in the seller’s own country, either when the goods are placed:

• on ship
• alongside the ship, or
• made available to the carrier/loaded on board the carrier’s mode of transport
(each depending on which term is used).
The seller may have to arrange for the goods to be transported to the point where the goods are to be
handed over to the carrier (for example, to the point where they are loaded on board the ship for FOB).
However, it is the buyer’s responsibility to arrange and pay for the main carriage of the goods.
The FCA term can be used for any mode of transport, whereas FAS and FOB should only be used when
goods are to be transported by ship. In each case, it is important that the place of delivery is specified.

C Terms
CPT—Carriage Paid To
CIP—Carriage and Insurance Paid To
CFR—Cost and Freight
CIF—Cost, Insurance and Freight
The C terms signify that the carriage of goods is paid by the seller. There are two important points. The point
of delivery will be in the seller’s own country but under the C terms the seller bears the costs of carriage
(and, in the case of CIP and CIF, insurance coverage) of the goods to a designated destination.
CPT and CIP can be used for any mode of transport whereas CFR and CIF should only be used when goods
are to be transported by ship.
C terms are the terms most commonly used with letters of credit, the use of which is consistent with the basic
nature of the terms. This is because the seller fulfils its shipment obligation with shipment in its own country
and only has to provide evidence with the documents stipulated in the letter of credit (such as the bill of lad-
ing issued by the carrier) that will satisfy the paying bank and the buyer that the seller has fulfilled that obliga-
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tion. For more information on letters of credit, see Practice Note: Commercial letters of credit—structure and
parties.
For the same reason, C terms are not appropriate where the arrival of goods at a specific destination at a
specific time is an element of the sales contract, as delivery has taken place in the seller’s country. The seller
does not take the risk on delays in the carriage of the goods. If this is intended to be the case, one of the D
terms should be used instead.

D Terms
DAT—Delivered at Terminal
DAP—Delivered at Place
DDP—Delivered Duty Paid
The D terms signify that the goods must arrive at a stated destination and each can be used for any means
of transport. Under DAT and DAP the buyer must clear the goods for import and pay duty, VAT and other
taxes and charges levied upon import of the goods.
Under DDP this obligation is reversed, so it is important for the seller to be sure it is able to fulfil these obliga-
tions before agreeing to DDP.

Why are Incoterms relevant for financing transactions?

The three most common scenarios where trade finance lawyers come into contact with Incoterms are:

• repo transactions/physical ownership structures—if the bank will own the physical goods then
Incoterms will be crucial in determining the window during which the bank is on risk (as would
be the case with any owner in a chain of commodity purchase transactions)
• letters of credit—if a lawyer is involved in the early stages of the negotiation or issuance of a
letter of credit it is important that the documents that are required for a complying presentation
under a letter of credit align with the Incoterm that is being used. For example the use of EXW
would be inconsistent with the provision of a bill of lading under a letter of credit, meaning that
a seller would not be able to make a valid claim under the relevant letter of credit. If the bank
requires goods to be insured under letters of credit that it issues or requires bills of lading in
order to take a pledge over the goods in transit then Incoterms will have an impact on this. In
practice, it is only likely to be on large bespoke transactions where a lawyer is involved at the
point that the terms of the letter of credit are being discussed and also have access to the un-
derlying sales contract (which banks do not usually review in plain vanilla letter of credit issu-
ances)
• pre-export finance—when relying on the payment flow from a sale of commodities by the buyer
for repayment under a credit agreement especially where goods will be secured up to the point
of delivery to the purchaser, it is important that the Incoterm used is considered and any secu-
rity taken over those commodities and any requirements to insure goods are tailored to ensure
that there are no gaps where the goods are unsecured (or secured by the 'wrong' party) or are
uninsured;

Other key issues to look out for in trade finance transactions

Where goods are sold EXW, the seller has no obligation to clear goods for export and has an obligation only
to provide such assistance that the buyer requires to effect the export. Therefore, if under local law, the seller
needs to obtain export licences a different term will need to be used or additional specific requirements will
need to be included in the sale contract to vary the standard EXW position. Delays in clearing goods can
have a significant effect on a seller’s cash flow and, therefore, on its ability to meet financing obligations.
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Often a bank will require a certain level of insurance to be maintained over goods financed by it (whether this
is under a pre-export finance or even, in some cases, where the bank has issued or confirmed a letter of
credit in relation to the purchase of goods). Where an Incoterm requires a party to arrange insurance over
goods (ie CIF or CIP), the level of insurance required is only 'minimum cover' as set out in the Institute Cargo
Clauses drafted by Lloyd’s Market Association and International Underwriting Association of London. Where
an Incoterm that requires a party to procure insurance it should be considered whether this level of insurance
is sufficient to meet contractual requirements (which will rarely be the case) and, if not, further insurance will
need to be procured.

How to avoid common mistakes

Ensure that:

• there are no gaps between the provisions covered by the sales contract and the relevant Inco-
term
• the Incoterm used will allow the seller to present the documents that are required under finance
documents
• the Incoterm used is appropriate for the form of transport being used for carriage—FOB is only
for transport by ship, so if it is followed by a location that is not a port it is clearly incorrect
• the Incoterm used requires the buyer or seller to assist where local law requires a specific party
to obtain import/export clearances, and
• the incoterm fits in with any security structure and insurance obligations
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2 of 10 DOCUMENTS:

Use of insurance in trade and commodity finance transactions

Produced in partnership with Sullivan & Worcester

Insurance plays an important role in trade and commodity finance transactions. While many of the risks in-
herent in financing trade can be mitigated or reduced through good structuring, including the taking of secu-
rity where necessary, insurance provides an additional layer of protection for a financier. For example, secu-
rity taken over goods that have been financed will be worthless to a financier if those goods are damaged or
destroyed. Taking out appropriate insurance to protect against the risk of damage or destruction of the goods
will protect the financier’s position if such risk should occur.
Insurance protection is an issue that should be considered at the outset of a transaction during the structur-
ing phase. Questions to be considered include:

• what type of risks can, and should, be covered?

• who should be responsible for taking out the insurance?
The answers to these questions will need to be determined on a case-by-case basis. In particular, although
insurance can be a useful tool in minimising risks in a transaction, it also represents an additional (and some-
times prohibitive) cost to be incurred. While attempting to cover all risks possible may seem the best position
in theory, this may not be possible in practice given the cost implications.

Types of risks to be covered

There is a whole range of risks that can be covered by insurance and these will be determined by the specif-
ics of each particular transaction. A financier should ensure that it carries out sufficient due diligence to allow
it to identify the risks involved and, if necessary, to prioritise those risks into those that need to be covered
and those that might, but need not, be covered.
While there are numerous types of insurance protection available, three common types of insurance in trade
and commodity finance transactions are:

• asset protection insurance—this type of insurance covers the risk of damage or destruction
to specific goods or class of goods. This would be relevant where, for example, a financier has
financed particular goods, the sale of which is intended to produce sale proceeds which will be
used to repay the financing
• non-payment insurance—this type of insurance protects a financier against the risk of an ob-
ligor not making a payment in accordance with the terms of the financing. For example, this
might cover a failure by a borrower to make a scheduled repayment or the failure of a guaran-
tor to make a payment under a guarantee; and
• political risk insurance—this type of insurance protects a financier against the risk of an obli-
gor failing to make a payment due to events occurring in the obligor’s country of incorporation.
For example, this might cover events such as change of law, civil war, revolution, expropriation
or confiscation of assets or inability to convert foreign currency
It is important to note that the description of an insurance policy should not be relied upon—an insurance
policy should always be reviewed thoroughly to ensure that it is clear what risks are covered. By way of an
example, a non-payment insurance policy may cover all scheduled payments of principal due under a fi-
nancing but may exclude any interest, fees or commission that are payable by the borrower.
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Who should be responsible for taking out insurance?

Whilst it would be common for an obligor to take out asset protection insurance and for a financier to take out
non-payment or political risk insurance, this is not always the case. A number of factors will be relevant to the
question of whether insurance is taken out by an obligor or by a financier. These will include the type of risk
involved, the time at which the risk comes into existence, the potential effect of third party actions or the ef-
fect of any insolvency of the obligor and whether there is a need for the financier to be able to enforce direct-
ly against the insurer.

Financier as the sole insured party

This represents the strongest position for a financier in that its rights and interests under the insurance policy
will be unaffected by the acts or omissions of any other party, including the insolvency of an obligor and the
financier will be able to enforce its rights under the insurance policy directly and will have control over the
claims process.
However, there are drawbacks to a financier being the insured party. The financier will be responsible for
paying the insurance premium and will, amongst other things, be responsible for making any warranties re-
quired under the insurance policy and for making full disclosure of all relevant information to the insurer on
an on-going basis.
Failure by a financier to comply with its obligations under the insurance policy can result in the insurers hav-
ing the right to refuse to make payment under any claim and/or to cancel the policy. The financier will need to
consider if it is in a position to give the warranties and commit to the disclosure requirements, as well as,
considering if it has an ‘insurable interest’ (see 'The insuring clause' under Standard clauses under an insur-
ance policy below).

Financier as co-assured
A co-assurance or joint insurance policy is an insurance policy where two or more parties are identified as an
insured party under the policy. Under this type of policy, English law treats each co-assured party as having
distinct rights and obligations under the policy from every other co-assured.
From a financier’s perspective, this means that its rights and obligations under the policy will not be affected
by anything that an obligor, as co-assured, does or does not do under the policy. This also extends to the
insolvency of the obligor, meaning that the financier can still exercise its rights under the policy even if the
obligor has become insolvent.
Although English law recognises the distinct nature of the rights and obligations of each co-assured, it is ad-
visable to include an express clause (referred to as a ‘non-vitiation clause’) in the policy which sets this out
explicitly.
A financier faces similar issues as a co-assured as it does where it is the sole insured. Unless there is an
express agreement otherwise, the financier will be responsible for paying the insurance premium and will be
required to make and comply with the warranties in the policy. The financier will also be subject to the
on-going obligation to make full disclosure of all relevant information. Any failure by a financier to comply with
its obligations under the policy can result in an insurer refusing to make payment under any claim made by
the financier and/or to cancel the policy in respect of the financier.
Notwithstanding the above issues, co-assured status is the strongest position that a financier can take where
it is in effect sharing the insurance with an obligor.

Financier as assignee or loss payee

There are two main options available for a financier that cannot or does not want to take out insurance solely
or jointly in its own name.
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The first option is for the financier to take a security assignment of the obligor’s rights to any proceeds paid
out under an insurance policy (see Practice Notes: Assignments by way of security and Taking security over
insurance policies). A valid assignment of this nature should be effective on the subsequent insolvency of the
obligor.
Care should be taken to ensure that any purported assignment relates to the obligor’s rights to the insurance
proceeds and not to all of the obligor’s rights under the policy. An assignment of all of the obligor’s rights
under the policy would be likely to amount to a purported transfer of the policy as a whole which would need
to take place by novation and would need the insurer’s consent. A novation of the policy would result in the
financier becoming the primary insured under the policy and assuming the obligations of the obligor (in addi-
tion to the obligor’s rights) which is often not the intended position.
It is important to be aware that a financier’s right to the proceeds can be affected by any act or omission by
the obligor under the insurance policy. As such, if the obligor breached the policy and the insurer conse-
quently cancelled the protection, the financier’s rights under the insurance policy would be extinguished as it
could not obtain a better right than the obligor.
A further issue is that an assignment of this nature is likely to take effect as an equitable assignment (for
more information, see Assignments by way of security—Assignments by way of security—legal, statutory or
equitable?). One consequence of this is that the financier would in theory need to join the obligor as a party
to any action the financier takes against the insurer to enforce its right to the proceeds.
There is also the possibility of the obligor having assigned the rights to the proceeds to more than one per-
son, giving rise to more than one claim to the proceeds. An insurer is unlikely to want to make any payment
in such a scenario until the priority of the competing claims has been resolved. One way for a financier to try
and avoid such a situation is to include a clause in the insurance policy naming the financier as loss payee.
This should give the insurer comfort that they are authorised to make payment to the financier as named loss
payee in the policy and that the financier can give good discharge of the insurer’s liability in respect of the
relevant claim.
The second option for a financier is to require that it be listed as loss payee under the policy without an as-
signment of the right to the proceeds. This is of limited value as the financier is unlikely to have any direct
right to involve itself in the claims process or to bring an action against the insurer. A loss payee may be able
to rely on the Contracts (Rights of Third Parties) Act 1999 (C(RTP)A 1999) to support an action against an
insurer for failure to make payment of proceeds to it. However, it is common to see the provisions of the
C(RTP)A 1999 excluded in insurance policies which would remove a financier’s rights in this respect.
As with a security assignment, a financier’s rights as loss payee are subject to any act or omission of the ob-
ligor under the insurance policy. However, a loss payee is likely to be in a worse position than an assignee
where the obligor becomes insolvent. This is because loss payee status does not give rise to a security in-
terest so a financier will not have any priority in respect of proceeds under the policy.

Standard clauses under an insurance policy

There are a number of standard clauses that are found in all insurance policies relating to trade and com-
modity finance transactions. A brief description of some of the most important clauses is set out below.

The insuring clause

The insuring clause is vital as it sets out both the risks covered and the extent of the coverage provided. It is
important to ensure that the risks stated in the insuring clause are those that the financier intends to be cov-
ered and that the level of coverage provided is adequate in the context of the financing. The insuring clause
should be read in conjunction with the exclusions clause which sets out certain types of losses that are not
covered by the policy notwithstanding the wording of the insurance clause.
Where the financier is the sole insured or a co-assured, it must be able to show that it has an ‘insurable in-
terest’. This is usually taken to mean that the financier must be able to show that it has a financial interest in
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the matter that is being insured or, conversely, that it would suffer a loss if the insured risk were to occur.
This is likely to be a formality in many cases but there may be scenarios where it is helpful to include drafting
in the insurance policy that specifically sets out the financier’s insurable interest.
An example would be where a financier is a co-assured under a non-payment policy covering the risk of
non-payment by a buyer of receivables that arise under a sale contract with a third party which the financier
has purchased. In such a scenario, it would be sensible to ensure that the relationship between the parties is
set out expressly so that it is clear to see how the financier would suffer loss if the buyer fails to make a
payment under the underlying sale contract.
It is also important to ensure that the risk profile of the transaction is monitored. A change in the nature of the
risk may mean that the insurer is released from its obligations under an insurance policy. For example, an
insurance policy covering the risk of damage or destruction of goods while they are in transit by ship may no
longer be valid where the goods have reached port but are not unloaded for a period of time as it is arguable
that the risk profile has changed. A financier should, therefore, make sure that it is satisfied with how the in-
suring clause is drafted and that appropriate measures are put in place to monitor the nature of the risks in-
volved.

The exclusion clause

All insurance policies will exclude certain types of losses even if such losses would otherwise fall within the
scope of the insured risk. A financier should review these exclusions carefully to ensure that they are ac-
ceptable and do not unreasonably undermine the extent of the coverage provided.

Warranties
An insurance policy is also likely to contain a number of warranties to be given by the insured party(ies). The
policy will usually state that breach of these will mean that the insurer is released from liability under the pol-
icy with immediate effect. This reflects the position under English insurance law which provides that breach
of a warranty will immediately release an insurer from liability, irrespective of the materiality of such breach.
An insurer may also require an insured to give a number of warranties prior to entry into the insurance policy.
These warranties will be stated as being the ‘basis of the contract’ and the insurer will treat these warranties
as being the basis on which it agreed to enter into the insurance policy. If an insurer can show that any of
these warranties was untrue or incorrect, it will have the right to repudiate the policy, regardless of whether
such breach was material or not.
While a financier will need to carefully consider any warranties that it is required to give as an insured or
co-assured party, the position is more difficult where the financier is relying on a policy in an obligor’s name.
In such circumstances, the financier’s due diligence should cover not only a review of the terms of the insur-
ance policy but also any warranties that the obligor has given to the insurer prior to entering into the insur-
ance policy.

Loss mitigation clause

Most insurance policies will include a clause that requires the insured to take steps at the insurer’s direction
to prevent losses arising and to minimise such losses where they have occurred.
A financier should review the terms of such a clause carefully to ensure that the insurer does not have an
unfettered right to direct the actions to be taken. This is usually resolved by including a limitation that the in-
surer may only require actions that are reasonable or necessary in the circumstances. A financier should
also ensure that the loss mitigation clause does not allow the insurer to delay the making or payment of a
claim, especially where the policy already includes a waiting period for the payment of claims.

Non-contribution clause
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It is common to see a clause in an insurance policy that provides that no loss is covered that would, if not for
that insurance policy, be covered under the terms of another insurance policy (sometimes referred to as a
non-contribution clause). This restriction on ‘double-insurance’ is important as it is likely that both insurance
policies involved would have the same restriction in place, thereby potentially invalidating any claim that the
insured could bring under either policy.
Where a financier intends to rely on a policy in an obligor’s name, part of its due diligence should include
checking whether the policy includes a non-contribution clause and, if so, whether there is any other policy in
place in the obligor’s name that covers the same risk.
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3 of 10 DOCUMENTS:

Small Business, Enterprise and Employment Act 2015 (SBEEA 2015) for
finance lawyers

Introduction
Despite its name, the provisions of the Small Business, Enterprise and Employment Act 2015 (SBEEA 2015)
are of general application to companies in the UK and not only to small-to-medium enterprises. While the
SBEEA 2015 relates mostly to corporate matters and companies' administration, some provisions may im-
pact on certain aspects of financing transactions, which finance practitioners should be aware of. These in-
clude:

• the abolition of bearer shares

• empowering provisions to nullify any ban on invoice assignment
• varying the powers of the Export Credits Guarantee Department (ECGD)
• changes to the powers of administrators and liquidators which may have an effect on insolven-
cy and restructuring practices
• streamlining public procurement practices, and
• changes to company administration
The SBEEA 2015 received Royal Assent on 26 March 2015 and will be implemented in various stages. For a
full timetable of the dates on which various provisions are coming into force, see Practice Note: Lexis®PSL
Corporate—Small Business, Enterprise and Employment Act 2015 tracker.

Bearer shares
Bearer shares (or share warrants to bearer) have been abolished by the SBEEA 2015. From 26 May 2015,
Companies Act 2006, s 779 has been amended and companies are prohibited from issuing bearer shares.
Any existing bearer shares should be surrendered to the company which issued them for exchange into reg-
istered shares by 26 February 2016. Bearer shares not surrendered by this date will be cancelled by the
company and funds will be paid into court. For more information on this, see Practice Note: The Small Busi-
ness, Enterprise and Employment Act—company law reforms — Bearer shares and News Analysis: Com-
pany law after SBEEA 2015.

References:
SBEEA 2015, s 84-86
A bearer share is a paper document that evidences title to a share in a company. A company with only bear-
er shares would have no register of members and these shares are easily transferable and held anony-
mously.
In order to take security over bearer shares, a pledge or mortgage is usually entered into. For information on
pledges and how to take security over bearer shares, see Taking security over shares—Bearer shares and
Pledges. For more general information on taking security over shares, see Practice Note: Taking security
over shares.
Bearer shares in issue need to be exchanged by the deadline imposed by SBEEA 2015—26 February 2016.
If lenders have taken security over bearer shares, they should pay attention to this date and consider the
 Page 12

effect on their security of surrendering bearer shares for exchange into registered shares. Lenders will need
to consider whether:

• hardening periods could be reset if the shares which are secured are exchanged from bearer
into registered shares. (For more information on hardening periods, see Practice Note: Can a
liquidator or an administrator challenge or unwind transactions entered into by the company
before it was wound up or entered into administration?)
• existing security documents would need to be amended or if new security would need to be
taken. If a pledge has been taken over bearer shares, it is likely that new security would need
to be taken in respect of the registered shares which the bearer shares have been exchanged
into. This is because the lender will lose possession of the bearer shares following their ex-
change into registered shares. The subject matter of the pledge, the bearer shares, will no
longer be in existence thereafter (for more information on amending security documents, see
Practice Note: Amending security documents)
• any steps should be taken for perfection requirements. If a mortgage or charge is taken over
the newly issued registered shares, parties may wish to register the security with Companies
House (although there is no legal requirement to do so under CA 2006, s 859A, as the conse-
quence of failure to register the security created by a company under that section do not apply
to fixed security over shares in a company when such security constitutes a 'security financial
collateral arrangement' within the meaning of SI 2003/3226, reg 3). For more information on
perfection and registration requirements, see Practice Notes: Perfecting security and Register-
ing security at Companies House
• the priority of the existing security would be affected (for more information on priority of securi-
ty, see Practice Note: Priority between security interests)

Nullifying ban on invoice assignment

As of 26 May 2015, the Secretary of State has been given the power to make regulations to invalidate a
clause in a contract which purports to prohibit, restrict or impose any condition on the assignment of receiva-
bles by a party to that contract. This would affect most contracts for goods, services or intangibles (including
intellectual property rights, electricity and digital data) and where one party has entered into such a contract
in connection with the carrying on of a business. The regulations (The Business Contract Terms (Restrictions
on Assignment of Receivables) Regulations 2015) have yet to be passed and their current draft form can be
seen here.

References:
SBEEA 2015, s 1
This is intended to protect companies or businesses that sell or assign their invoices or receivables from their
customers as a means of obtaining financing. Such receivables financing typically takes the form of factoring,
invoice discounting or forfaiting, where these companies rely on the sale of these credit terms to financial
counterparties to obtain financing and facilitate cash flow.
In a receivables financing, it is key that these receivables are properly sold or assigned to the receivables
purchaser, which then pays a prepayment amount and balance of the purchase price at maturity to the
company. This prepayment amount will be the financing the company obtains in respect of the as-
sets/receivables sold, without the company having to wait until the maturity date of the receivables to be paid
by its customers/debtors. The receivables purchaser as owner of the receivables will then look to the debt-
ors/customers for payment.
Prior to the implementation of this aspect of the SBEEA 2015, an attempted assignment made with a re-
striction or prohibition in the underlying contract on assigning or selling these receivables will be ineffective to
transfer such rights to the assignee. This will result in the receivables purchaser not being able to claim
payment of an assigned receivable in its own name and the debtor can validly discharge its debt by making
payment to the company and not to the receivables purchaser. To address this, parties will need to obtain
 Page 13

the consent of the debtor/customer to the assignment, which creates additional costs and inconvenience to
businesses and impedes secure financing.

References:
Linden Gardens Trust Ltd v Linesta Sludge Disposals Ltd [1993] 3 All ER 417
For more information on receivables financing, factoring or invoice discounting, see Practice Note: Invoice
discounting and factoring.
With this in mind and after a series of consultations, the government proposed removing the ban on assign-
ment of invoices. The proposed Business Contract Terms (Assignment of Receivables) Regulations 2017
(the Regulations) published in September 2017 were designed to implement the government’s plan in this
respect. However the draft Regulations were the subject of representations made by lenders stating that they
would have farreaching and unintended consequences for lenders given their impact upon certain common
protective covenants found in loan agreements see the News Analysis Business Contract Terms (Assign-
ment of Receivables) Regulations 2017: Unexpected consequences for lenders. In late 2017 the draft Regu-
lations were withdrawn for further consultation and no date has been set for their reintroduction in the near
future.

Broadening the powers of ECGD

The ECGD is the UK's official export credit agency and derives its powers from the Export and Investment
Guarantees Act 1991 (EIGA 1991).

References:
EIGA 1991
Prior to the SBEEA 2015, one of the key powers conferred on the Secretary of State (and performed and
exercised through ECGD) was the power to provide assistance 'in connection with the export of goods and
service by persons carrying on business in the UK to persons carrying on business outside the UK'. The EI-
GA 1991 stated that such arrangements could be made in connection with goods or services supplied before
the arrangements are made, which are to be supplied, or which may be supplied.
The SBEEA 2015 amended section 1(1) of the EIGA 1991 on 26 May 2015 to broaden the powers of ECGD.
The new wording of section 1 of the EIGA 1991 confers the power to make arrangements for the support and
development (whether directly or indirectly) of supplies or potential supplies of the export of goods, services
or intangible assets (including intellectual property).

References:
SBEEA 2015, s 11
EIGA 1991, s 1
In this context, 'arrangements' are arrangements for providing financial facilities or assistance for, or for the
benefit of, persons carrying on business. This includes guarantees, insurance, loans and the provision of
advice or information.

References:
EIGA 1991, ss 1(4), 1(5)
These changes have given ECGD a more generalised ability to assist and support businesses in the UK that
are, or wish to become, involved in exports or export supply chains. For further information on the powers of
ECGD, see Practice Note: The Export Credits Guarantee Department—ECGD.

Insolvency provisions
SBEEA 2015 has introduced a raft of changes to insolvency law. The key changes which banking and fi-
nance practitioners should bear in mind in an insolvency or restructuring of a company are:
 Page 14

• as from 1 October 2015, an administrator or liquidator having the ability to assign a cause of
action (including the proceeds of an action) in respect of fraudulent trading, wrongful trading,
extortionate credit transactions, transactions at an undervalue and preferences. These
measures are designed to increase the chances of action being taken for creditors' benefit—an
assignee may have access to more funding to bring an action

References:
SBEEA 2015, s 118
Insolvency Act 1986, s 246ZD
• as from 1 October 2015, an administrator being able to bring fraudulent and wrongful trading
actions. This was previously only available to liquidators under IA 1986, ss 213-214

References:
SBEEA 2015, s 117
IA 1986, ss 246ZA-246ZC
• as from 26 May 2015, liquidators are no longer required to obtain the sanction of the court of a
creditors' committee for certain actions. This brings the position of liquidators in line with ad-
ministrators who do not need to seek any sanction and is designed to save on costs and im-
prove creditors' return on insolvency, and

References:
SBEEA 2015, s 120
• as from 26 May 2015, a series of changes on how administrations are conducted, including:

References:
SBEEA 2015, ss 127-130
◦ empowering the Secretary of State to make regulations to prohibit or impose conditions
of sales or disposals of assets to connected parties when a company is in administra-
tion. This primarily affects prepack sales in administrations and should allow such trans-
actions with connected parties to be reviewed if the non-legislative solutions recom-
mended by the Graham review (ie oversight by a pool of experienced practitioners or
other measures) do not change behaviour or increase confidence in these transactions.
For more on prepack sales, see Practice Note: What is a pre-pack administration sale?,
and

References:
SBEEA 2015, s 129
◦ where there is property available for distribution to unsecured creditors (the prescribed
part), payments of the prescribed part no longer require the court's permission.

References:
SBEEA 2015, s 128

For further information on how SBEEA 2015 will affect insolvency and restructuring processes, see Practice
Notes: Small Business, Enterprise and Employment Act 2015—office-holder actions and removal of re-
quirement to seek sanction and Small Business, Enterprise and Employment Act 2015—changes affecting
administrations and News Analysis: Small Business, Enterprise and Employment Act 2015—impact on in-
solvency.

Public procurement
 Page 15

Part 3 of SBEEA 2015 gives the Secretary of State the power to implement measures intended to remove
barriers for small businesses and make public procurement practices more streamlined and efficient. These
measures may impose additional duties on contracting authorities to:

References:
SBEEA 2015, ss 39-40

• run procurement processes in a more efficient and timely manner (including timescales and the
extent and manner of engagement with potential parties to a contract)
• make available information or documents without charge, and
• the acceptance of electronic invoices
This would be of relevance to project finance lawyers involved in private finance initiatives (PFI) or pub-
lic–private partnership (PPP) projects. For further information, see Practice Note: Introduction to PFI and
PF2. For more information public procurement, see Practice Note: Public procurement—key considerations.

Changes to company administration

SBEEA 2015 has also introduced a number of changes to the administration of companies which may be
relevant to finance transactions. These include:

• introducing a requirement for companies to keep a register of people with significant control
(PSC register). The PSC register will be publicly available and held at Companies House. It
will make the direct and indirect ownership of a company's shares more transparent and give
accurate and current information on who ultimately owns or controls a company. For more in-
formation on what constitutes significant control, see The Small Business, Enterprise and Em-
ployment Act—company law reforms — The PSC register

References:
SBEEA 2015, ss 81-83
• introducing a requirement that all directors must be natural persons and prohibiting the use of
corporate directors (ie a company acting as a director of another)

References:
SBEEA 2015, ss 87-88
• extending the general statutory duties of directors to shadow directors

References:
SBEEA 2015, s 89
• replacing the filing of an annual return with a confirmation statement that a company's basic in-
formation has been filed and allowing companies to opt to keep statutory registers (eg register
of members, register of directors, PSC register and register of members) at Companies House
instead of at their registered offices, and

References:
SBEEA 2015, ss 92, 94
• streamlining the process of company registration to establish a 'one-click registration' system to
avoid having to liaise with different departments and agencies to obtain necessary permissions
to trade

References:
SBEEA 2015, ss 15,16
For further information on the changes by SBEEA 2015 that may affect company administrations, see Prac-
tice Note: The Small Business, Enterprise and Employment Act—company law reforms.
Page 16
 Page 17

4 of 10 DOCUMENTS:

The Loan Market Association Facility Agreement for pre-export finance

transactions

Produced in partnership with Sullivan & Worcester

This Practice Note looks at the recommended form of single currency term facility agreement for pre-export
finance transactions (the PXF Document) published by the Loan Market Association (the LMA) as a tem-
plate document for documenting pre-export finance transactions.

References:
Loan Market Association

What is it?
In a typical pre-export financing, the lender advances funds directly to a producer (the Borrower). The Bor-
rower will use the funds to finance the production of goods for export. The Borrower will assign to the lender
its rights under export contracts entered into with buyers of the goods. The buyers will be required to make
payments for the goods directly into a collection account. The lender will usually take security over this ac-
count. The lender may also take security over the goods before they are sold, for example, by taking a
pledge over the goods while they are stored in a warehouse.
The lender will apply funds received into the collection account to meet repayments under the facility agree-
ment on the relevant repayment dates. Unless the financing is a limited recourse financing, any shortfall
must be paid by the Borrower.
The LMA produced the PXF Document as a starting point for documenting this type of transaction. The LMA
used its existing recommended form of facility agreement for leveraged acquisition finance transactions (the
Leveraged Document) as a starting point for the PXF Document. As a result, the structure of the document
and many of the boilerplate clauses should be familiar to those who use LMA template facility documents.
The PXF Document is drafted to be governed by English law.

What transaction structure is covered in the PXF Document?

The PXF Document assumes a certain structure. There is no standard structure for a pre-export financing,
so the PXF Document is likely to need amending on a transaction-by-transaction basis.

Parties (Obligors)
Borrower—this is the producer entity that uses the facility to finance its production and which enters into the
export contracts for the sale of the underlying goods.
Parent—the PXF Document provides for the possibility of the 'Parent' entity (being a company at the top of
the Borrower’s credit group). The Parent may enter into the facility agreement as a guarantor and may also
front the administration of the facility by requesting utilisations and/or providing information on the Borrower’s
behalf.
Guarantors—the PXF Document envisages that one or more subsidiaries of the Borrower/Parent, together
with the Parent, will give corporate guarantees.
 Page 18

The PXF document assumes that all the obligor entities (being the Parent, the Borrower and the Guarantors)
are companies. It is not necessary that the obligors are incorporated in England and Wales and in a
pre-export financing the obligors are typically located abroad. It is important to obtain local law advice on
specific provisions that should be tailored depending on where a party is located.

Parties (Finance Parties)

The PXF Document is drafted as a syndicated facility, so there is an Agent, an Arranger, a Security Agent
and Lenders (together, the Finance Parties).

Guarantees
Guarantees are given by the Parent and certain subsidiaries in favour of the Finance Parties. The guaran-
tees are documented in the PXF Document (clause 19). As the obligors are likely to be located outside of
England and Wales, local law advice should be obtained on the legal and practical enforceability of an Eng-
lish law guarantee against each guarantor in that guarantor’s jurisdiction and on any local filing and/or
stamping requirements. In some jurisdictions, for example, there are limitations on intra-group guarantees. It
may be necessary to consider documenting certain guarantees separately under local law and/or in a speci-
fied form to comply with local requirements.

Security
The PXF Document provides for security to be granted by the Borrower over the collection account and over
the reserve account where funds from the collection account are swept before being applied against repay-
ments—see below. The Borrower also gives security over its rights under the export contracts between the
Borrower and the buyers of the goods. This would usually include the right to receive payment from the buy-
ers (including as beneficiary of any letter of credit issued in respect of the buyer’s obligations) and rights to
step in and perform on the Borrower’s behalf if the Borrower fails to deliver the goods.
There may be additional security taken in a pre-export financing. For example, the Borrower might grant se-
curity over the goods prior to export and/or during transportation (if, for example, the goods are delivered to
the buyers under a D-term Incoterm). The PXF Document does not provide for this. The Borrower may also
assign the proceeds of related insurance policies.
The nature of the security will depend on the location of the accounts or assets and the governing law of the
export contracts, as applicable. The transaction security is typically governed by the local law relevant to the
secured asset or right. The security is not granted in the PXF Document itself but is documented separately.
Local law advice should be obtained on how to take security in each relevant jurisdiction and local law per-
fection requirements, such as serving of notice, filing and any stamp duties that may be applicable.
The security granted by the Borrower is held by the Security Agent as security trustee for the Finance Parties
(although this might not always be possible in jurisdictions where security trusts are not recognised—see
below).
A key characteristic of a pre-export financing is that security is given over specific assets of the Borrower
relating to the goods being financed and the proceeds of its sale. It is not typically the case that the Borrower
gives full asset security (for example, a floating charge over all assets). This is of particular practical im-
portance for Borrowers who may enter into different secured financings for different consignments of goods.
For more information on taking security in a pre-export finance transaction, please see Practice Note:
Pre-export finance—taking security.

Flow of funds
The PXF Document assumes that the Borrower will draw down the facility to finance the production of speci-
fied goods. The Borrower will sell the goods to specified buyers under export contracts. It is assumed that
 Page 19

the Borrower will irrevocably instruct the buyers to make payments under the export contracts into the collec-
tion account. Funds are swept from the collection account into a debt service reserve account which is then
applied to make repayment instalments under the facility.
The PXF Document assumes that the funds will always be in the same currency. This is not always the case
in practice as export contracts could be denominated in different currencies. Where this happens there are
likely to be multiple collection accounts and the facility agreement will need to be amended accordingly, for
example, to address the movement of funds between the accounts, currency exchanges and the effect of
calculation of coverage ratios.

Use for other structures?

The PXF Document could be amended to provide for other common pre-export finance structures. For ex-
ample, where the offtake agreements are entered into through a trading entity in the Borrower’s group. In this
case, the trading entity may be required to grant third-party security over the export contracts.
For more information on the parties and risks involved in a pre-export finance structure, please see Practice
Note: Pre-export finance—structure, parties and risks.

Provisions specific to pre-export finance transactions

As stated above, the LMA based the PXF Document on the Leveraged Document, making amendments
where needed to reflect the assumed transaction structure. This section sets out some of the key elements
of the PXF Document that are important to a cross-border pre-export financing structure.

The facility
The PXF Document provides for a single currency term facility (clause 2.1, clause 5.3(a), clause 6.1(c)).
There is only one facility in the PXF Document and only one layer of debt. It is intended that the Borrower will
draw down the loan to meet the costs of production of a certain quantity, batch or consignment of goods, with
the loan to be repaid when those goods are sold. The Borrower can draw down the facility in instalments
(clause 5), and this could be adapted to expressly provide that the Borrower will use each loan to fund dif-
ferent stages of the production process.
The purpose of the facility has been left blank in the template (clause 3.1). It is likely that the purpose of the
facility will be to finance the production costs of the relevant goods.
The PXF Document envisages that the loans will be repaid either in a single bullet payment, or in instalments
(clause 6.1(a)). From a practical perspective, the repayment date(s) should correspond to when payments
are due under the relevant export contracts.

Non-English obligors and obligors in emerging markets

The PXF Document can be used for obligors incorporated outside of England and Wales. However, it will be
necessary in some cases to tailor provisions to reflect jurisdiction-specific issues. For example, representa-
tions regarding the status, power and authority of each obligor (clauses 20.2 and 20.5) may need to be
amended, and the COMI ('centre of main interests and establishments') representation might not be applica-
ble (clause 20.26).
It is often the case in emerging market jurisdictions that certain formalities must be complied with for the fa-
cility agreement and transaction security to be enforceable in an obligor’s jurisdiction. For example, local
laws might require payment of certain fees or translation of the documents into, and/or execution of the
documents in, the local language. These requirements would need to be addressed by amending the rele-
vant representations, undertaking and conditions precedent (see, for example, clause 20.6 and schedule 2).
 Page 20

The PXF Document contains an optional governing language clause providing that where the facility agree-
ment is translated, the English law version shall prevail (clause 45).
There are other provisions in the PXF Document that might be considered of particular importance for obli-
gors in emerging markets. For example, events of default triggered by the introduction of foreign exchange or
currency controls (clause 27.19), a moratorium on payments of foreign currency debt (clause 27.20) or polit-
ical and economic deterioration in the jurisdiction of an obligor or buyer (clause 27.21).

The export contracts

The PXF Document contains detailed representations about the export contracts entered into between the
Borrower and its buyers (defined as the 'Sales Contracts') (clause 20.25). This reflects the importance of the
export contracts in the structure as the source of repayment of the loans. The representations are intended
to cover the enforceability of the contracts and the capability of the Borrower to perform its obligations under
the export contracts.
There are detailed information undertakings relating to the export contracts, requiring the Borrower to provide
copies of the contracts and notify the Agent of certain matters (clause 21.6). There are also undertakings to
regulate the Borrower’s actions in relation to the export contracts (clause 25), in particular, undertakings to
perform the contracts and restrictions on the Borrower’s rights to amend and cancel the contracts. Where
repayment is coming from a small number of material contracts, these undertakings are likely to be very re-
strictive, requiring the lender’s consent for any amendments to the export contracts that are not merely me-
chanical. Where repayment is coming from a larger pool of contracts, it might be that the Borrower needs to
have greater discretion to amend and cancel export contracts, and to bring new contracts into the structure,
so long as there is no material adverse effect on the Borrower’s ability to repay the facility and any applicable
coverage ratios are maintained.

The Borrower’s business and operations

The Borrower’s ability to perform, and to continue to perform:

• Operational capabilities—the Borrower gives a representation that it can comply with its obliga-
tions under the export contracts (clause 20.25) and an undertaking to maintain its assets in
good working order and condition (clause 24.10). The Borrower’s ability to produce and deliver
the goods is key to a pre-export finance structure. As such, lenders may include stringent pro-
visions to ensure that the assets of the Borrower that are material to its operations are main-
tained. This might involve specific undertakings in relation to production facilities (such as an
undertaking not to dispose of them and to replace them as needed), or a negative pledge not to
create security over its production facilities that might put those assets at risk of seizure by an-
other creditor.
• Ability to trade—the restriction on disposals by the Borrower (clause 24.13) should not prevent
the Borrower from being able to carry out its business as a producer and exporter of goods
and, in particular, should not inadvertently prevent disposal of the financed goods to the rele-
vant buyers under the assigned export contracts.
• Access to proceeds of export contracts—in PXF structures, it is usually expected that the pro-
ceeds of the export contracts will be enough to repay the facility and also provide the Borrower
with income (ie the Borrower’s profit element in producing and selling the goods). As such, a
total restriction on the Borrower’s ability to access the proceeds of the export contracts during
the life of the facility might cause cash flow difficulties for the Borrower. The bank accounts
provisions in the PXF Document (clause 26) permit the Borrower some access to the collected
proceeds, subject to meeting debt service obligations.
The Borrower’s other financings—a traditional pre-export financing is a self-liquidating structure where the
lenders look to the specific goods being financed for repayment of the sums advanced. It is possible that a
larger Borrower might enter into a number of financings with different lenders to finance different consign-
ments of its goods. As such, relevant provisions in the facility agreement that might impact other financings
 Page 21

should be tailored to reflect what the Borrower is permitted to do. This might involve, for example, restricting
the scope of the negative pledge to allow the Borrower to enter into other secured pre-export financing ar-
rangements provided they do not affect the priority or validity of the security being granted in the transaction
at hand.

Financial covenants and coverage ratios

It is possible that the Finance Parties in a pre-export financing will require the Borrower and other obligors to
give covenants on their financial position, such as leverage ratio, interest cover and net worth. The PXF
Document provides for this (clause 22.2).
For further details, please see Practice Notes: Financial covenants—principles and Common financial cove-
nants.
However, it is far more typical to see coverage ratios in a pre-export finance facility agreement measuring the
value of the receivables due under the export contracts against the amount of the anticipated repayments
under the facility agreement. This reflects the nature of a pre-export financing as a self-liquidating structure,
with repayment coming from the sale of the financed goods. If the value of the receivables is not enough to
meet the repayments, the Borrower will have to fund repayments out of its working capital, which is more
risky for the lenders. A failure to meet the coverage ratios might also indicate financial or operational difficul-
ties for the Borrower if, for example, it is struggling to produce and deliver the relevant goods.
The PXF Document provides for coverage ratios, which should be tailored carefully for each transaction
(clause 23). These are:

• Debt Service Cover Ratio—this is the ratio of the sales value of goods to be delivered under
the assigned sales contracts during the relevant test period to the amount of the Borrower’s
debt service obligations (ie repayments of principal and payments of interest) due during the
same period. The test periods are typically each a period of one to three months during the life
of the facility. The purpose of this ratio is to ensure the Borrower is selling sufficient goods, in
the short-term, to generate income to meets its immediate debt service obligations under the
facility agreement.
• Loan Life Cover Ratio—this is the ratio of the sales value of goods to be delivered under the
assigned sales contracts from the relevant test date until the termination of the facility to the
amount of the Borrower’s debt service obligations due during the same period. In this case, the
relevant debt service obligations may be repayments of principal only, or may include pay-
ments of interest.
The purpose of this ratio is to ensure the Borrower is expected to sell sufficient goods, in the
long-term, to generate income to meet its debt service obligations over the life of the facility
agreement.
In both cases, where calculation of the applicable sales value will include goods to be delivered
in the future, an appropriate reference price will need to be used.
• Look Back Test—for this test, the Borrower must ensure that the amount of proceeds from the
assigned sales contracts credited to the collection account during the relevant test period was
not less than a certain percentage of the debt service obligations due during the same period.
The purpose of this test is to monitor, from an historical perspective, whether the proceeds of
the assigned contracts actually paid into the collection account were sufficient to meet the Bor-
rower’s debt service obligations.
A breach of a coverage ratio will trigger an event of default (clause 27.2), subject to application of the
'Top-Up' mechanism (clause 23.3) that gives the Borrower, where the breach falls within certain agreed lim-
its, a grace period to remedy the breach. For example, the Borrower could prepay a portion of the loans, in-
crease deliveries under its sales contracts during the relevant period, enter into additional sales contracts
and/or top-up the debt service reserve account (the DSRA) so that, when the relevant coverage ratio is re-
tested, it is in compliance with the requirements of the facility agreement.
 Page 22

The bank accounts

The PXF Document assumes the following structure in relation to the bank accounts:

• the proceeds of the assigned export contracts will be paid into an offshore collection account
held with the Agent or Security Agent
• funds standing to the credit of the collection account will be automatically transferred into the
DSRA until the amount standing to the credit of the DSRA at the relevant time is equal to a
specified percentage of the Borrower’s debt service obligations for the relevant period (being
the amount of repayments and interest falling due during such period); and
• provided there is no outstanding Default (as defined), the Borrower will have access to the re-
maining funds in the collection account after amounts have been swept into the DSRA. The
Borrower does not have any access to the DSRA.
It may be necessary to amend the bank accounts wording PXF Document to reflect certain requirements of a
particular financing. For example, amendments will be required if the collection account is to be held by a
third party (for, example, a local bank in the jurisdiction of the Borrower) or where regulations in the Borrow-
er’s jurisdiction require funds to be repatriated before being transferred offshore.

Environmental matters
Compliance with environmental laws will be particularly important for some trade finance transactions. For
example, the facility might be used to finance potentially harmful goods (such as crude oil) or the facility
might be financed by development banks or other institutions with strict environmental policies that require
the Borrower to comply with enhanced environment-related provisions. The Equator Principles are an exam-
ple of a framework of environmental principles adopted by certain financial institutions in relation to financing
projects that meet certain thresholds (for example, in relation to the value of the project) and criteria.
For further details on the Equator Principles, please see Practice Note: The Equator Principles.
The PXF Document contains representations on compliance with applicable environmental laws (clause
20.16) and undertakings to comply with environmental laws and to notify the Agent of any claims made
against the Borrower’s group (clauses 24.3 and 24.4, respectively). Breach of such obligations would trigger
an event of default.

Tax withholding
It is likely that the Borrower may be located in a jurisdiction where there are limited double tax treaties and,
therefore, potential withholding issues. The PXF Document provides blanket gross-up wording (clause 14.2)
applying to all obligors. Local law advice in the Borrower’s jurisdiction should be taken on whether such lan-
guage is enforceable. Depending on where the Borrower and other obligors are located, it may be appropri-
ate to use the 'Qualifying Lender' and 'Treaty Lender' concepts found in other LMA facility documents. If
withholding is applicable, the relevant representation will need to be amended to reflect this (clause 20.10).

Stamp taxes
Ad valorem stamp duty may be payable in a jurisdiction where security is being taken (although it is some-
times possible to structure a transaction to mitigate this liability). The PXF Document provides for a general
indemnity in respect of stamp taxes (clause 14.5). Local advice should be taken on whether, for example,
certain duties should be paid as a condition precedent. The representation that no stamp taxes are payable
(clause 20.9) will often need to be amended to reflect filing requirements and stamp tax liabilities in the obli-
gors’ jurisdictions.

Taking security
 Page 23

The PXF Document includes security agent provisions (clause 32). This assumes that all beneficiaries of the
transaction security are party to the facility agreement. Where there are third party beneficiaries (such as
hedging banks that are not party to the facility agreement) then the security agency provisions would need to
be moved to an intercreditor document.
The PXF Document provides that the security agent will hold the transaction security on trust for the Finance
Parties (clause 32.1). The PXF Document also contains optional parallel debt language for use where secu-
rity is being taken in a jurisdiction that does not recognise security trusts (clause 32.2). Local law advice
should be taken on the requirements for each relevant jurisdiction.

Enforcement
The PXF Document contains two options for enforcement:

• submission to the jurisdiction of the English courts; or

• submission to LCIA arbitration with a right for the lenders to opt for the jurisdiction of the Eng-
lish courts
In a cross-border transaction where judgments of the English courts might not be recognised in the jurisdic-
tion of the obligors, it might be more appropriate to opt for arbitration, particularly where the relevant jurisdic-
tion is a party to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral
Awards.

The LMA term sheet for use with the PXF Document
The LMA has produced a recommended form term sheet for use with the PXF Document (see News Analy-
sis: LMA pre-export finance term sheet). The template sets out the key heads of terms to be agreed between
the Finance Parties and the obligors for the purposes of drafting a facility agreement using the PXF Docu-
ment. The structural and practical considerations set out above should be taken into account when drafting
the term sheet using the LMA template.
For a discussion of the key terms in a pre-export finance transaction not governed by the PXF Document,
see Practice Note: Pre-export finance—key terms in the facility agreement.
 Page 24

5 of 10 DOCUMENTS:

Prepayment finance—structure, parties and risks

Produced in partnership with Watson Farley & Williams LLP

What is prepayment finance?

Buyers frequently provide finance facilities to commodity producers by way of paying in advance for goods
and commodities.
Prepayment finance (a type of trade finance) is an established structure used to provide finance directly to
buyers or traders of goods and commodities and indirectly to producers/exporters of goods and commodities.
These arrangements are useful to:

• the producers because it means that they can access credit which would not be available to
them through the banking system, and
• the buyers because it allows them to negotiate long term supply contracts with producers in
exchange for the provision of finance
They are particularly useful where the producer is based in a country which has exchange control regulations
or a taxation regime which prohibits or penalises direct lending to producers by overseas financial institu-
tions. Such regimes often permit advance payments to the producers for the purchase of goods.
A typical prepayment finance facility will have a tenor of between one and five years, although it is also
common for facilities to be extended.
Prepayment finance facilities are usually secured by two security packages:

• one which supports the producer’s obligations to the buyer under the advance payment ar-
rangements, and
• one which supports the buyer’s obligations to its lender
For more information, see Practice Notes:

• Prepayment finance—key facility terms, and

• Prepayment finance—taking security

Typical prepayment finance transaction structure

Prepayment finance facilities usually take the form of a tripartite structure whereby a producer of commodi-
ties obtains financing by way of an advance payment for its product made by the buyer of the product (usu-
ally known as the offtaker). The offtaker, which is typically a trading company whose business involves the
trading of the relevant commodities, in turn finances the advance payment it makes to the producer through
a loan facility which it receives from a lender.
The lender to the offtaker will often enter into arrangements with the offtaker whereby the risk of
non-performance by the producer is shared between the lender and the offtaker. This is done by a mecha-
 Page 25

nism under which the lender’s recourse to the offtaker for some (but not all) of the offtaker’s liability to repay
the loan from the lender is limited to the offtaker’s recoveries from the producer.

Key parties to a prepayment finance transaction

The principal parties to a prepayment finance transaction are:

• the lender, which will usually be a bank or a syndicate of banks

• the offtaker, which is usually a trading company or other purchaser of goods and commodities,
and
• the producer, which is a producer and exporter of goods and commodities
Some prepayment finance facilities will also involve an insurer. The insurer provides a credit insurance policy
to the offtaker covering the liabilities of the producer to the offtaker under the advance payment arrange-
ments with the offtaker.

Contractual structure of the financing arrangements

The financing structure of a prepayment finance facility is based on two key agreements:

• the prepayment contract under which the offtaker agrees to make payment in advance for
goods which it will purchase from the producer. The terms of the prepayment contract are typi-
cally documented either:
◦ by incorporating them into the offtake contract (ie the sale and purchase agreement for
the goods or commodities), or
◦ by the offtaker and the producer entering into a separate agreement which cross refers
to, and is read in conjunction with, the offtake contract, and

• the offtaker loan agreement under which the lender agrees to advance funds to the offtaker
for immediate disbursement to the producer by way of advance payment for goods or commod-
ities
The offtaker loan agreement and the prepayment contract typically contain certain matching provisions so
that the loan from the lender is effectively passed through the offtaker to the producer and repaid in accord-
ance with the timetable for scheduled deliveries under the offtake contract.

The prepayment contract

The prepayment contract is entered into between the offtaker and the producer. It contains provisions relat-
ing to:

• the disbursement of the advance payment by the offtaker to the producer

• the producer’s obligation to make deliveries of goods/commodities to the offtaker arising from
the producer’s acceptance of the advance payment from the offtaker
• refunding the advance payment to the offtaker if the producer defaults on its obligations under
the offtake contract to make deliveries, and
• the commercial terms on which the goods are sold to the offtaker (if not covered in a separate
offtake contract between the producer and the offtaker)
The prepayment contract will also contain representations and warranties, covenants and events of default,
in similar terms to those contained in a conventional loan agreement.

The offtaker loan agreement

 Page 26

The offtaker loan agreement is essentially a conventional loan agreement under which the lender advances
funds to the offtaker for immediate transfer to the producer in accordance with the prepayment contract. It
also includes provisions which are specific to prepayment finance, eg:

• provisions dealing with apportionment of risk between the lender and the offtaker, via a mecha-
nism under which the lender has full recourse to the assets of the offtaker to discharge a por-
tion of the offtaker’s liabilities under the loan from the lender and, for the remainder of the liabili-
ties, the lender’s recourse is limited to recoveries from the producer
• provisions dealing with the default of the producer; these usually involve co-operation between
the offtaker and the lender in seeking to recover from the producer, and
• provisions linking performance by the producer (ie deliveries under the offtake contract) to the
repayment of debt by the offtaker
For more information on the prepayment contract and the offtaker loan agreement, see Practice Note: Pre-
payment finance—key facility terms.

Risk apportionment between the lender and the offtaker

Risk apportionment structures are essential to the structure of a prepayment finance facility. They are usually
structured as follows:

• a portion of the outstanding debt is expressed to be payable with full recourse to the offtaker’s
assets. This is usually 10–15% of the facility
• the remainder of the outstanding debt is expressed to be payable only from recoveries obtained
by the offtaker from the producer (whether in the ordinary course of performance under the
offtake contract or as a result of enforcement action), and
• in certain circumstances the offtaker will accept full recourse for all outstandings under the loan
from the lender to the offtaker. This position is usually triggered by a situation in which the pro-
ducer defaults but the default was caused by the offtaker (for example, if the offtaker repudiates
the offtake contract)

Insurance of the prepayment contract

In some prepayment finance facilities, the offtaker will take out an insurance policy to cover the risk of the
producer failing to perform its obligations to the offtaker under the offtake contract and the prepayment con-
tract.
The lender to the offtaker will seek to take security over the offtaker’s rights under such an insurance policy.
For more information, see Practice Note: Taking security over insurance policies.

Security
Under a prepayment finance facility, the key security for the loan to the offtaker will be the rights of the
offtaker under the prepayment contract and the offtake contract, which is usually charged or assigned by way
of security to the lender. This confers on the lender the ability to exercise the offtaker’s rights and to receive
payments of recoveries directly from the producer in the event of the offtaker’s default or insolvency.
In some facilities the offtaker may also take security from the producer if the producer has any unencum-
bered assets to offer. If security is taken in this way, the offtaker will also grant security to the lender over its
rights under the security offered to it by the producer.
 Page 27

Where the offtaker has taken out insurance for the producer’s obligations under the prepayment contract and
the offtake contract, the lender will take security over any insurance proceeds as loss payee, or, alternatively,
will be covered under the insurance policy as co-insured.
For more information, see Practice Note: Prepayment finance—taking security.
 Page 28

6 of 10 DOCUMENTS:

Pre-export finance—key terms in the facility agreement

Produced in partnership with Watson Farley & Williams LLP

Pre-export finance (PXF) is an established structure used to provide finance to producers of goods and
commodities (see Practice Note: Pre-export finance—structure, parties and risks). It is a type of trade fi-
nance.
In a classic PXF facility, funds will be advanced by a lender or syndicate of lenders to producers to assist
them in meeting either their working capital needs (eg to cover the purchase of raw materials and costs as-
sociated with processing, storage and transport) or capital investment needs (eg investment in plant and
machinery and other elements of infrastructure).
A typical PXF facility agreement will contain various provisions which focus on the ability of the borrower to
produce a commodity or product and to generate income by exporting that commodity or product.
For information on what type of security lenders typically require in a PXF facility, see Practice Note:
Pre-export finance–taking security.

Drawdown and term

Pre-export finance (PXF) facilities are usually structured on a short to medium term basis, often from one to
five years in tenor. The period of availability of the facility will be determined by the purpose for which the
funding is required. For example, it is not unusual for a PXF facility agreement to include a term loan tranche,
consisting of a drawing of a single amount which is amortised over the full period of the facility, combined
with a revolving element involving short term loans which are repaid and can then be redrawn (subject to a
maximum amount outstanding at any time).

Provisions relating to production and regulation

A PXF facility is structured around the ability of the borrower/producer to produce a specific commodity or
other product (the 'Product') and to generate income by exporting that Product. A PXF facility agreement
will contain representations and warranties, covenants and events of default designed to ensure that the
borrower/producer is able to carry on its trade of producing and exporting the Product. In particular, these
provisions relate to the production capability of the borrower/producer and the regulatory environment in
which it is operating. Typical provisions cover:

• compliance with environmental law

• maintenance of authorisations needed by the producer to produce the goods or commodities
(for example, compliance with all requirements under mining licences and export licenc-
es)—This includes any approvals, permits or licences required from a government agency or
local authority (including a central bank or exchange control authority), and
• maintenance of production at certain minimum levels—the interaction of this requirement with
the force majeure provisions in offtake contracts can be a difficult issue to resolve in negotiating
PXF facilities (see 'Force majeure and suspension provisions in offtake contracts' under the
heading Taking security over the offtake contract and 'Force majeure' under the heading Provi-
sions relating to offtake contracts below)
 Page 29

Provisions relating to offtake contracts

The underlying sale or 'offtake' contracts are central to a PXF transaction. Under these contracts, the pro-
ducer (which is the borrower under the financing arrangement) agrees to sell a certain amount of goods or
commodities to the buyers (in a PXF transaction typically referred to as the 'offtakers').
The financing provided by the lender is linked to, and dependent on, the offtake contracts being in place and
the obligations thereunder being performed. If the offtake contracts are amended, repudiated, terminated, or
otherwise affected in an adverse manner, the lender will want certain remedies, including the ability to accel-
erate the outstanding loans and cancel the facility.
As the offtake contracts are the source of repayment of a PXF facility, the facility agreement will contain pro-
visions ensuring that the producer continues to perform its obligations under the offtake contracts and refrain
from doing anything that may affect its ability to perform those obligations in the future.
It is standard practice to include representations and warranties, covenants and events of default relating to
the existence and continued effectiveness of the offtake contracts.

Representations about the offtake contracts

Most of the representations and warranties found in a PXF facility agreement are the same as those in other
types of facility agreements. The key PXF-specific representations relate to the offtake contracts.
In a PXF facility agreement, the borrower makes representations and warranties in relation to the offtake
contracts, including that:

• it will perform all of its obligations under the offtake contracts

• it has the capability and resources required to fulfil its obligations under the offtake contracts
• no breach, event of default or force majeure has occurred (once the offtake contracts are in
place, this is as a repeating representation), and
• there are no circumstances which would entitle any party to terminate or cancel the offtake
contracts

Covenants about the offtake contracts

Typical covenants in a PXF facility agreement about the offtake contracts include:

• covenants to perform and not cancel, terminate or repudiate the contracts

• covenants to deliver a certain volume of exports in accordance with the contracts over a speci-
fied period
• covenants not to amend or waive provisions under the contracts, and
• covenants to serve notice of the lender’s security over the contracts on the buyers under the
contracts, and to require the buyers to pay amounts payable by them under the contracts into
the collection account
The facility agreement will also prohibit the producer from transferring or assigning the offtake contracts to
another party.

Force majeure
It is common for the offtake contracts to include a force majeure clause, permitting the producer to suspend
deliveries of the Product if a force majeure event occurs, for so long as such event continues. If there is such
a clause in the offtake contracts, the producer and the lender will need to agree the position under the facility
agreement in case of a force majeure event under the offtake contracts.
 Page 30

The lender may want to be able to accelerate the loan, and therefore include force majeure under any of the
offtake contracts as an event of default under the facility agreement. Alternatively, it may want to give the
producer the option to continue making payments and repayments to keep the facility in existence even while
there is no performance under the relevant offtake contracts.

Information covenants

Regular reports
It is important that the lender is provided with up-to-date information relating to the production and sale of the
Product.
The LMA recommended PXF facility agreement contains a covenant (clause 21.6 (k) and (l) (Information:
Sales Contracts)) on the borrower to provide regular (typically monthly) reports with certain details relating to
the Product, including the quantity produced, specifications, delivery details, invoiced amounts, payment
terms and payment dates.

Insurance covenants
Any risk that the borrower has in relation to the Products to be sold under the offtake contracts should be
insured for (at least) the term of the facility agreement.
Lenders can ensure they have a claim to any insurance proceeds by requiring the borrower to name the
lender (or security trustee, as relevant) as a loss payee. Being named as a loss payee means that the insur-
ance company will pay out any insurance claims to that named third party rather than the policy holder.
Where possible, lenders may also want to take a security assignment of the insurance contracts and of any
insurance proceeds. For information on taking security over insurance contracts in general, see Practice
Note: Taking security over insurance policies.

Debt service cover ratios and top-up clauses

The most important financial covenant in a PXF facility agreement is the debt service cover ratio (known also
as the 'delivery cover ratio' or 'asset cover ratio').

Calculating and testing the debt service cover ratio

A standard debt service cover ratio essentially provides for the value of sales to be measured against debt
service.
The period for which the PXF facility is scheduled to be outstanding is usually divided into periods ('Calcula-
tion Periods') of, for example, one month or three months. The calculation period will usually be the pay-
ment/repayment period, which is usually aligned with the delivery period. The purpose of the debt service
cover ratio is to ensure that the producer (ie the borrower) is selling sufficient Product to be able to meet its
payment obligations under the facility agreement.
For each Calculation Period, the debt service cover ratio must equal or exceed a particular percentage.
The debt service cover ratio is calculated by expressing:

• the value of the deliveries of Product to be made under the offtake contracts in that Calculation
Period (value of sales)
as a percentage of:
 Page 31

• the aggregate of the principal and interest payable under the PXF facility during that Calcula-
tion Period (debt service)
The percentage required will depend on the nature of the transaction and the strength of the borrower. It is
usually heavily negotiated. At a minimum, the ratio should be 100% but a lender may ask for a higher per-
centage (this may typically be up to 135%) to provide a buffer as there may be a change in the price of the
Product within the period, or the full value of the offtake contracts may not be realised in that period.
The ratio may be tested on specified dates or it may be expressed as a continuing obligation throughout the
term of the facility.
The borrower/producer will typically be required by the terms of a PXF facility agreement to submit a com-
pliance certificate at the start of each Calculation Period detailing the anticipated sales to be made in that
Calculation Period together with copies of the offtake contracts to which they relate. This enables the lender
to test the debt service cover ratio.
A breach of the debt service cover ratio will typically be an event of default under the PXF facility agreement,
subject to any top-up clause.

Determining the value of sales

The debt service cover ratio is usually heavily negotiated in terms of how the value of the deliveries are to be
determined.
The value of the deliveries is taken from individual sales contracts made between the producer and the buy-
ers pursuant to the offtake contracts. It is essential that the wording of the debt service cover ratio in the fa-
cility agreement makes it clear when a sales contract may be included in the calculation. For example, the
facility agreement may provide that a contract may only be included in the calculation of the ratio if a copy
has been provided to the lender showing the amount to be delivered and the terms of delivery.
How the price of the product is to be determined also needs to be clearly set out, including if the price is to
be determined by reference to an index and the date at which the price is to be calculated. This may differ
from the calculation of payment due by the buyers under the offtake contracts.

Deposits in the collection account

The producer may be required to maintain a collection account, into which it will be obliged to deposit sales
proceeds. There will be restrictions on the producer’s ability to withdraw from or use this account. The lender
(or security agent) will take security over it under the law of the jurisdiction in which the account is located:
usually this will be the jurisdiction of the lender (or a security agent on its behalf), i.e. an 'offshore' jurisdiction
from the position of the producer or the offtakers. For more information, see: Collection account provisions
below.
An amount equal to the balance of the collection account will be deducted from the aggregate of the principal
repayment and interest payment obligations when calculating the debt service cover ratio as the balance
represents cash that the producer has available to meet its payment obligations.

Top-up clauses
PXF facility agreements almost invariably provide for top-up provisions if the debt service cover ratio falls
below a certain level. Essentially they provide a mechanism for restoring the debt service cover ratio so as
to remedy a breach within a certain period of time and to prevent the occurrence of an immediate event of
default under the PXF facility agreement if the borrower/producer’s income from exports starts to fall.
Top-up clauses are triggered if the debt service cover ratio falls below a certain level.
 Page 32

If the debt service cover ratio falls below the specified percentage (the difference being the 'shortfall'), the
borrower will need to do one of the following things within a given time period to avoid there being an event
of default:

• enter into further sales contracts for the relevant period to increase the amount of Product to be
delivered
• prepay a part of the outstanding loans under the PXF facility, or
• deposit cash into the collection account (or into a separate cash collateral account),
in such amount to cover the shortfall and bring the debt service cover ratio back to the required percentage.

Collection account provisions

Payments into the collection account

PXF facilities are usually repaid via the proceeds of exports, which are paid into a collection account, itself
part of the security package.
The PXF facility agreement usually contains covenants requiring the borrower/producer to open and maintain
the account and setting out the circumstances in which withdrawals may be made from the account.
Collection account provisions in the PXF facility agreement sometimes incorporate provisions covering the
relationship between the account bank and the account holder (which will be the borrower/producer). If this
is the case, then the account bank will be a party to the PXF facility agreement. It is often the case that the
account bank is a lender, facility agent or security agent under the PXF facility agreement, and is therefore
made a party to the PXF facility agreement in both capacities.
The collection account security agreement will create the security over the account and include provisions
which are customarily included under the legal system which governs the security to ensure that the security
is effective.

Drawings from the collection account

In PXF facility agreements it is common to include provisions permitting the borrower/producer to make with-
drawals from the collection account provided that:

• the facility is not in default, and

• such withdrawal does not cause a breach of the debt service cover ratio
PXF facility agreements sometimes provide for a regular sweep of excess amounts from the collection ac-
count to an account nominated by the borrower/producer provided that the above conditions are met.

PXF documentation—the emergence of a standard form

The Loan Market Association has developed a standard form Pre-Export Finance Term Sheet (see News
Analysis: LMA pre-export finance term sheet) and a standard form Single Currency Term Facility Agreement
for Pre-Export Finance Transactions (see Practice Note: The Loan Market Association Facility Agreement for
pre-export finance transactions). Such standard form documentation provides benchmark boilerplate provi-
sions and enables parties to focus on commercial terms. However, an important aspect of PXF documenta-
tion is the ability to tailor it to the particular parties and commodity in question.
 Page 33

7 of 10 DOCUMENTS:

Prepayment finance—key facility terms

Produced in partnership with Watson Farley & Williams LLP

Prepayment finance is an established structure used to provide finance directly to buyers of goods and
commodities and indirectly to producers of goods and commodities (see Practice Note: Prepayment fi-
nance—structure, parties and risks).
It is a type of trade finance and involves an advance payment by a buyer (known as the offtaker) to a pro-
ducer/exporter of goods and commodities which is financed by a separate loan made by a lender (usually a
bank or syndicate of banks) to the offtaker.
There are two key documents dealing with the provision of the credit in prepayment finance transactions.
These are:

• a contract providing for the advance payment by the offtaker to the producer for the purchase
of goods/commodities (the 'Prepayment Contract'), and
• a loan agreement between a lender and the offtaker (the 'Offtaker Loan Agreement') under
which the advance payment is financed
The Prepayment Contract may be incorporated into the offtake contract (ie the contract which deals with the
terms on which the goods/commodities are sold to the offtaker), or may be documented as a separate
agreement, referring to and to be read in conjunction with the offtake contract.
For information on the security arrangements in prepayment finance structures, see Practice Note: Prepay-
ment finance—taking security.

The Prepayment Contract

Advances and amortisation schedule

The Prepayment Contract will contain provisions dealing with the disbursement of the advance payment to
the producer by the offtaker and the schedule under which the advance payment is to be discharged by de-
liveries under the offtake contract. The amortisation schedule will typically match the repayment provisions
under the Offtaker Loan Agreement, as deliveries by the producer trigger the offtaker’s repayment obliga-
tions under the Offtaker Loan Agreement.
The speed of amortisation of the advance payment will be determined by the commercial requirements of the
producer and the offtaker and may also be regulated under the exchange control or taxation regime applica-
ble in the country of the producer.

Deliveries
The provisions relating to deliveries in the Prepayment Contract fulfill two distinct functions:

• they set out the commercially agreed mechanism for delivery of the goods/commodities under
the offtake contract, including, for example, provisions relating to the transfer of title and risk in
 Page 34

the goods/commodities, which party pays the freight charges and provisions relating to re-
quirements such as quality certificates relating to the exported goods/commodities, and
• they set out how the producer will discharge the liabilities it incurs by accepting the advance
payment for goods/commodities, and thus, indirectly, trigger the liability of the offtaker to repay
the relevant instalment under the Offtaker Loan Agreement
The definition of 'delivery' is therefore specific to the commercial circumstances of the transaction and needs
to be drafted accordingly.

Indemnities
The offtaker will wish to match the liabilities of the producer under the Prepayment Contract to the offtaker’s
liabilities to the lender under the Offtaker Loan Agreement.
The lender will also be concerned that the producer is liable to pay the offtaker amounts matching all the lia-
bilities of the offtaker to the lender. This is because the source of repayment by the offtaker for the limited
recourse portion of the loan made by the lender to the offtaker (see below under The Offtaker Loan Agree-
ment) is confined to recoveries from the producer. The Prepayment Contract will therefore usually include
indemnities under which the producer will indemnify the offtaker for its liabilities under the Offtaker Loan
Agreement, including, for example, liabilities under increased costs clauses and other indemnities to the
lender which are routinely incorporated in loan documentation with bank lenders.

Representations and warranties, covenants and events of default

The Prepayment Contract will usually contain representations and warranties, covenants and events of de-
fault relating to maintaining production, compliance with licences required to carry on the business of produc-
tion and export of the goods/commodities, and compliance with its obligations under the offtake contract.

The Offtaker Loan Agreement

Full and Limited Recourse Portions

The Offtaker Loan Agreement will typically contain provisions specifying that the liabilities of the offtaker un-
der the loan from the lender are divided into:

• the full recourse portion ('Full Recourse Portion'), under which the lender has full recourse to
the offtaker and all of its assets to meet the payment obligations under the loan from the lender
to the offtaker, and
• the limited recourse portion (the 'Limited Recourse Portion') under which the lender’s re-
course is limited to the offtaker’s recoveries from the producer
The Full Recourse Portion is usually 10% to 15% of the facility, and the Limited Recourse Portion is the re-
mainder.
The Offtaker Loan Agreement will typically provide that, under certain circumstances, the Full Recourse Por-
tion will be increased to 100%. This may be 100% of a particular payment instalment, or may be 100% of the
entire amount outstanding under the Offtaker Loan Agreement. The circumstances under which the Full Re-
course Portion is so increased are often heavily negotiated between the lender and the offtaker. An event
which triggers an increase in the Full Recourse Portion is often described as a 'Full Recourse Event'.

Full Recourse Events

 Page 35

In most Offtaker Loan Agreements, a key Full Recourse Event will be a default by the producer which is di-
rectly caused by the offtaker (for example, if the offtaker repudiates the offtake contract or commits some
unlawful act which causes the producer to cease the production or export of the goods/commodities).
Other Full Recourse Events are sometimes included, such as:

• quality disputes arising between the offtaker and the producer concerning the exported
goods/commodities, and
• where the offtaker has taken out insurance for the producer’s obligations under the Prepayment
Contract, losses caused by the refusal of the insurers to pay a claim if the offtaker is responsi-
ble for the insurer’s rejection of the claim (eg for failure to pay the insurance premium or having
acted in a way which entitled the insurer to avoid the insurance policy)

Producer default provisions

The Offtaker Loan Agreement will usually include provisions dealing with the default of the producer. If this
default is not a Full Recourse Event, the offtaker and the lender will agree procedures for co-operation in
seeking to maximise recoveries from the producer via appropriate enforcement action.

Representations and warranties, covenants and events of default

The representations and warranties, covenants and events of default under the Offtaker Loan Agreement will
relate primarily to the offtaker rather than the producer. As the lender takes a credit risk against the producer
but has no direct contractual relationship with the producer, the Offtaker Loan Agreement usually includes
provisions requiring the offtaker to obtain certain representations and warranties and covenants from the
producer in the Prepayment Contract such as covenants to:

• perform and not terminate or amend the offtake contract and the Prepayment Contract
• deliver a certain volume of exports over a specified period
The events of default will normally relate to default by the offtaker, and the offtaker will be concerned to en-
sure that they do not extend to a default by the producer. If the events of default clause in the Offtaker Loan
Agreement covers the producer’s default or insolvency, the offtaker is at risk of cross defaults in its other
banking facilities being triggered, a situation which the offtaker will be anxious to avoid.

Provisions relating to insurance

If the obligations of the producer under the Prepayment Contract are covered by an insurance policy, the
Offtaker Loan Agreement will contain provisions concerning the insurance policy. They will include:

• a requirement that the offtaker maintains the insurance policy, pays the premiums and ob-
serves its obligations as the insured party
• provisions covering a default by the producer and a claim under the policy, and in particular
whether there is any remedy for the lender against the offtaker if the insurer fails to pay the
claim, and
• provisions requiring the offtaker to procure that the Lender is named as first loss payee under
the policy and/or co-insured under the policy. This is because the lender will typically take se-
curity over the offtaker’s rights under the insurance policy. For more information on the security
taken in support of Offtaker Loan Agreements, see Practice Note: Prepayment finance—taking
security.
 Page 36

8 of 10 DOCUMENTS:

Prepayment finance—taking security

Produced in partnership with Watson Farley & Williams LLP

Prepayment finance structures are based on two credit agreements:

• a prepayment contract (the 'Prepayment Contract') between the buyer/trader (known as the
offtaker) and the producer/exporter of the goods, and
• the risk-apportioned loan facility (the 'Offtaker Loan Agreement') between a lender and the
offtaker
This means that two security packages are contemplated:

• one package supports the Prepayment Contract and is granted by the producer to the offtaker
• the other package supports the Offtaker Loan Agreement and is granted by the offtaker to the
lender
For more information on prepayment facilities in general, see Practice Notes:

• Prepayment finance—structure, parties and risks and,

• Prepayment finance—key facility terms

Choice of law of security documentation

Security documentation creates rights in the nature of property (ie rights against assets), and as such needs
to be effective not only between the parties to the document but also against third parties (such as other
creditors of the offtaker or producer). To ensure legal validity and to facilitate enforcement, it is important to
select the most appropriate applicable law for the security documentation.
Security under prepayment finance structures typically includes taking security over:

• contractual rights (see Practice Note: Taking security over contractual rights), and
• bank accounts (see Practice Note: Taking security over cash deposits in bank accounts)
Where security is taken over rights under a contract, it is considered best practice for the applicable law of
the security documentation to be the same as the applicable law of the underlying contract.
Where security is taken over a bank account, it is considered best practice for the applicable law of the secu-
rity documentation to be the law of the place where the account is held (even if it is held at a branch of a
bank which is incorporated in another country).
It is important that the appropriate local law legal advice is obtained in relation to taking the security required,
and this should be factored into the timeline and budget for the transaction. See Practice Note: Instructing
and managing local counsel.

Security in support of the Prepayment Contract

In some prepayment finance facilities, the Prepayment Contract is unsecured.
 Page 37

Alternatively, if the producer has unencumbered assets which can, pursuant to the legal and regulatory sys-
tem applicable in its country, be offered as security to the offtaker, security may be granted, for example over
future production or, in those countries where it is legally possible, by way of a general security interest cov-
ering all of its assets from time to time.
The lender will be interested in whether the producer grants any security to the offtaker because it is likely to
want to take security over such rights in its own security package (ie the security provided in support of the
Offtaker Loan Agreement).

Security in support of the Offtaker Loan Agreement

The security for the loan to the offtaker will typically consist of:

• security over the rights of the offtaker under the Prepayment Contract
• if the Prepayment Contract is secured (see Security in support of the Prepayment Contract),
the lender will take security over the rights of the offtaker under the security supporting the
Prepayment Contract
• security over a collection account—in some prepayment finance facilities, a collection account
is established with the lender, into which payments are made after deliveries are completed
under the Prepayment Contact. If a collection account is used, security will be created over that
account in support of the Offtaker Loan Agreement, and
• if the offtaker has taken out insurance for the producer’s obligations under the Prepayment
Contract, the lender will take security over those rights and will require the offtaker to procure
that the lender is named on the policy as first loss payee and/or as co-insured

Assignment or charge of the Prepayment Contract and any associated security rights
Where the Prepayment Contract is governed by English law, the appropriate form of security to cover the
offtaker’s rights under the Prepayment Contract will be an English law security assignment or a charge. This
is created by a deed of assignment or charge.
Where the producer has provided the offtaker with security for its obligations under the Prepayment Contract,
the deed of assignment or charge can be drafted so as to cover:

• the offtaker’s rights under the Prepayment Contract itself, and

• the offtaker’s rights arising under the security or guarantees granted by the producer to the
offtaker in support of the Prepayment Contract
For more information on taking security over contractual rights in general, see Practice Notes: Assignments
by way of security and Taking security over contractual rights and precedent Assignment of contractual
rights: single company assignor—bilateral—specific monies.

Notification of assignment or charge

It is common practice to serve a formal notification of the security on the producer and to obtain a written
acknowledgement of that notice from the producer addressed directly to the lender (see precedent Notice of
assignment of contractual rights and form of acknowledgement for an assignment by way of security: single
company assignor—bilateral—specific monies). Obtaining such an acknowledgement is considered good
practice but is not essential under English law (the position under any other relevant legal system should be
checked) to the effectiveness of the assignment or charge (see Acknowledgement of notice of assignment).
Where the security over the offtake contract is taken under English law, the legal benefits of notification of
the security are as follows:
 Page 38

• Discharge–if the producer has been notified of the security interest of the lender over the Pre-
payment Contract (and any related security) and requested to make payment directly to the
lender, then the producer will not obtain a good discharge from its payment obligations arising
under the Prepayment Contract (or any related security) if it pays the offtaker rather than the
lender. This is a useful mechanism to protect the lender if, say, the offtaker defaults and deliv-
eries have stopped under the offtake contract
• Set-off—English law recognises a number of different types of right of set-off (see Practice
Note: Types of set-off), whereby the producer may be able to deduct amounts owing to it by the
offtaker (either under the offtake contract itself or under different, possibly unrelated, arrange-
ments involving the offtaker and the producer) from the amounts it owes under the Prepayment
Contract (or any related security). In prepayment finance the lender will require the offtaker to
agree not to exercise set-off rights in connection with the Prepayment Contract (or any related
security), but notification of the lender’s security over the offtaker’s rights to the producer cre-
ates a further legal protection as it restricts the exercise of such rights
• Priorities—under English law, priority between competing assignees/security holders over the
same debt or contract rights is determined (with rare exceptions) by the order of service of no-
tice of the security on the debtor/contractual counterparty. Notice of the lender’s security inter-
est to the producer will protect the lender against a negligent or dishonest later assignment to
another party by the offtaker of those debts or contract rights (see Security over contractual
rights and debts—how notice affects priorities)
• Direct right of enforcement—if the security assignment complies with the requirements of the
Law of Property Act 1925, s 136, which includes notification of the contract counterparty, the
assignee (ie the lender) will have a direct right to enforce the offtaker’s rights under the Pre-
payment Contract (and any related security) by legal proceedings taken in its own name
For more information, see Advantage of a legal (ie statutory) assignment over an equitable assignment and
Notice of an assignment by way of security.

Security over the collection account

Prepayment finance facilities sometimes include a collection account structure. This is not essential to the
structure as the performance by the producer of its obligations under the Prepayment Contract consists of
making deliveries of goods rather than the payment of money, and the offtaker agrees to repay instalments
under the Offtaker Loan Agreement after each delivery has been completed. However, in some facilities the
offtaker will agree to deposit monies in a collection account on completion of each delivery, or may agree to
direct payment into the collection account of the proceeds of sales of goods/commodities to subsequent
purchasers.
If the arrangements include a collection account, the lender will take security over that account. If the ac-
count is held in England and Wales, the security is usually taken by way of a deed of charge over the ac-
count. The account is frequently held with the lender itself.
For more information on taking security over bank accounts, see Practice Note: Taking security over cash
deposits in bank accounts and precedents Bank account charge (lender as account bank): single company
chargor—bilateral—specific monies and Bank account charge (third party account bank): single company
chargor—bilateral—specific monies.

Security over the offtaker’s rights under its insurance policy

If the offtaker has taken out insurance for the producer’s obligations under the Prepayment Contract, the
lender will take security over the offtaker’s rights under such a policy and will require the offtaker to procure
that the lender is named on the policy as a first loss payee and/or as co-insured.
Under a first loss payee clause the lender is entitled to be paid directly by the insurer if any claim is made
under the policy.
 Page 39

Under a co-insurance arrangement, the lender is a named insured under the policy and has a direct right to
claim under the policy if a loss occurs. Under co-insurance, the lender takes on the duties and liabilities of an
insured under the policy (such as the obligation to pay premiums and to make disclosure of material issues
to the insurer pursuant to the insured’s duty of utmost good faith).
If the producer defaults under the Prepayment Contract the insurance recoveries are effectively treated as a
recovery from the producer and, if paid to the offtaker, the offtaker will be required to pay them over to the
lender in discharge of liabilities under the Offtaker Loan Agreement.
For more information on taking security over insurance policies, see Practice Note: Taking security over in-
surance policies and precedent Assignment of insurance policies: single company assign-
or—bilateral—specific monies.
 Page 40

9 of 10 DOCUMENTS:

Pre-export finance—taking security

Produced in partnership with Watson Farley & Williams LLP

PXF facilities are usually secured by:

• security over the borrower/producer’s rights under a long term ‘offtake contract’ (ie a sale and
purchase contract between the borrower/producer and a buyer of goods or commodities).
When English law documentation is used, this will normally be by way of a deed of assignment
(see Practice Note: Taking security over contractual rights and precedent Assignment of con-
tractual rights: single company assignor—bilateral—specific monies), and
• security over one or more bank accounts, including collection accounts and sometimes debt
service reserve accounts. Where English law documentation is used, this will normally be by
way of a deed of charge (see Practice Note: Taking security over cash deposits in bank ac-
counts and precedents Bank account charge (lender as account bank): single company char-
gor—bilateral—specific monies and Bank account charge (third party account bank): single
company chargor—bilateral—specific monies)
See Choice of law of security documentation below, for information on the appropriate applicable law in re-
spect of the security documentation.
Taking security under these arrangements presents a number of concerns for the lender. This practice note
highlights those areas which practitioners should keep in mind when drafting or reviewing offtake contracts or
PXF security documentation.
For information on PXF facilities in general, see Practice Notes:

• Pre-export finance—structure, parties and risks, and

• Pre-export finance—key terms in the facility agreement

Choice of law of security documentation

Security documentation creates rights in the nature of property (ie rights against assets), and as such needs
to be effective not only as between the parties to the document but also against third parties (such as other
creditors of the borrower/producer). To ensure legal validity and to facilitate enforcement, it is important to
select the most appropriate applicable law for the security documentation.
Where security is taken over rights under a contract, it is considered best practice for the applicable law of
the security documentation to be the same as the applicable law of the underlying contract.
Where security is taken over a bank account, it is considered best practice for the applicable law of the secu-
rity documentation to be the law of the place where the account is held (even if it is held at a branch of a
bank which is incorporated in another country).
It is important that the appropriate local law legal advice is obtained in relation to taking the security required
and this should be factored into the timeline and budget for the transaction. See Practice Note: Instructing
and managing local counsel.
 Page 41

Taking security over the offtake contract

The offtake contract is the agreement which the borrower/producer under a PXF facility will enter into as the
producer of goods or commodities with a buyer. The borrower/producer will grant security to the lender over
its rights against the buyer under the offtake contract.
The offtake contract is essential to the PXF structure; the sale and purchase of goods or commodities pro-
vides the cash flow which the borrower/producer will ultimately use to repay sums borrowed from the lender
under the PXF facility.
In most PXF transactions, the buyer will usually have already been identified and approved by the lender.
The lender may wish for there to also be alternative buyers of the relevant goods or commodities lined up
(known as ‘standby offtakers’) in case of a default by the primary offtaker. Having standby offtakers reduces
the lender’s assumed payment risk (ie the risk that the primary buyer of the goods or commodities will default
in its payment obligations to the borrower/producer, thereby cutting off the payment flow).
With any offtake contract, the lender’s legal advisers should review its terms to:

• ensure that it is legally possible to take valid security over the contract, and
• determine whether the contractual rights are likely to constitute a useful security interest (ie that
the rights to be assigned would be of benefit to the lender on enforcement)
The main areas on which the lender's due diligence should focus are outlined below.

Type of offtake contract—buy/sell or option?

Offtake contracts come in a number of forms, but the most fundamental question is whether the agreement is
a ‘buy/sell’ contract or an ‘option’ contract.
Under a buy/sell contract, the buyer is contractually obliged to purchase the relevant goods or commodities
in pre-agreed quantities and for a pre-agreed price. Such an arrangement provides that there will be a con-
stant business cycle, producing an income stream (which will be paid into the collection account), from which
the lender will be repaid under the PXF facility.
In contrast, under an option contract, the buyer of goods or commodities has discretion whether to exercise
its rights under the agreement to make a purchase (for example, having taken into account prevailing market
conditions, demand and prices, for the relevant goods or commodities). Obviously such an arrangement
would be prejudicial to the lender, with no guarantee that the buyer would make a purchase. This would lead
potentially to breaks in the business cycle, with no payments being credited to the collection account.
Lenders should be careful to ensure that only buy/sell contracts form the underlying agreements for PXF fa-
cilities. As noted above, it may be possible for standby offtakers of the goods or commodities to be
pre-approved in case of a default by the primary buyer in order to mitigate payment risk.

Assignability of the offtake contract

Some contracts contain an absolute prohibition on assignment. Depending on the relevant applicable law of
the contract, this wording may render it impossible to create effective security over the contractual rights.
Under English law the effect of a clause prohibiting assignment can sometimes be negated (for example by
obtaining the consent of the non-assigning party). Generally, non-assignment provisions will mean that any
purported assignment will be ineffective against the non-assigning party, although as between the assignee
and the assignor, the assignment will be effective.
Taking the example of the offtake contract, any effective non-assignment provision would mean that the
buyer of the goods or commodities would not be required to comply with any instruction to pay amounts due
by it under the offtake contract to the lender.
For more information, see Taking security over contractual rights—Checking the terms of the contract which
is to be assigned. See also News Analysis: Invoice finance—nullifying the ban on invoice assignment con-
 Page 42

tract clauses for information on the government's plans to nullify clauses in contracts that block invoice fi-
nance arrangements.

Term and termination provisions in offtake contracts

From a commercial perspective, the offtake contract is only good security for a PXF facility if it has a term
which is at least as long as the term of the facility agreement. Offtake contracts should always be reviewed
for early termination provisions (such as early termination on notice by one party or provisions for termination
by the innocent party after a serious breach of the contract or other party’s default).

Force majeure and suspension provisions in offtake contracts

Offtake contracts regularly contain force majeure clauses, which need to be reviewed with care. Force
majeure events are events beyond the control of the parties to the contract which can be expected to render
performance impossible; examples include strikes, war, and natural disasters. A force majeure clause pro-
vides that the parties are not liable under the contract for failure to perform if the failure was caused by a
force majeure event. In a PXF facility, the ideal position for a lender is to prohibit any force majeure related
defences to performance in the offtake contract, but this is usually not commercially achievable. Lenders
usually require that the scope of a force majeure clause is limited so that:

• it permits the borrower/producer to suspend production and delivery for a limited period of time,
but does not permit the contract to be terminated, and
• it does not cover failure to meet payment obligations
Some contracts give a borrower/producer the right to suspend production for a period of time for reasons
unconnected with force majeure. Such provisions are unattractive to lenders in PXF transactions.

Pricing issues and top-up clauses in offtake contracts

Offtake contracts used as security for PXF transactions should be effective for periods covering similar terms
to the PXF facility (usually around one to five years). As these periods of time are considered long term in the
context of commodities trading, and commodities prices are volatile, pricing clauses are often a point of con-
cern to both the borrower/producer and the buyer.
Pricing can be agreed on a fixed or a floating basis. A fixed price contract provides for a fixed price per unit
of commodity throughout the period of the contract. This is convenient for PXF transactions as it is possible
to predict the exact amount of revenue generated by each shipment in advance, but is rarely used in certain
markets, particularly exchange traded commodities where current prices can be ascertained on a daily basis.
A floating price contract will provide for a mechanism whereby the borrower/producer and the buyer will
agree a date on which the price will be calculated on the basis of a published market price. Pricing mecha-
nisms may be quite complex, with a provisional price being established near the time of the loading of the
commodity at the load port and a final price being established at a later date.
If the offtake contract provides for pricing on a floating basis, then the lender is at risk of a drop in the price of
the underlying commodity leading to a breach of debt service covenants. It is standard practice for PXF fa-
cility agreements to contain a top-up clause, whereby the borrower/producer is required to increase the vol-
ume of commodity shipped to the buyer if a fall in the price of the commodity puts performance of debt ser-
vice covenants at risk. If the PXF facility agreement contains such a clause, the lender will usually require
an amendment to the offtake contract to require the buyer to accept a higher volume of commodity if the
top-up clause in the facility agreement becomes operative.

Set-off and offtake contracts

 Page 43

Offtake contracts frequently include contractual rights of set-off. Rights of set-off can also arise under the
general law. Essentially a right of set-off is a right whereby a debtor may deduct from amounts which it owes
to its creditor, any amounts which the relevant creditor owes to it, so that the amount actually paid by one
party to the other is a net sum. When a contract is used as security for a loan facility, set-off can be highly
damaging to the lender’s security, as it can reduce or even eliminate amounts payable by the offtaker to the
borrower/producer, and which have been assigned to the lender through the security mechanism.
Where the offtaker has a right of set-off which is closely connected to its obligation to pay under the offtake
contract (usually because it arises under the contract itself), it is usually unacceptable to the offtaker to agree
any restriction on that right. For example, if the goods delivered under the contract fail to meet quality speci-
fications, the offtaker is unlikely to agree to be contractually bound to pay in full. However, it is common
practice to seek to exclude rights of set-off which arise under unrelated contracts, as these could prejudice
the lender’s security even when the borrower/producer is performing its obligations under the offtake con-
tract.
Service of notice on the offtaker of the lender’s security over the offtake contract goes some way towards
eliminating unrelated set-offs (see Assignments by way of security—Notice of an assignment by way of se-
curity). It is not effective to eliminate closely connected set-off unless the offtaker expressly agrees other-
wise.
For more information on contractual set-off in general, see Practice Note: Contractual set-off.

Notification of security over offtake contracts

A lender may wish to require the borrower/producer to notify the offtaker of the creation of security over the
offtake contract. Notification is a legal mechanism to protect the lender, and advice should be taken from
legal advisers in the jurisdiction under which the security is taken as to whether notification is necessary or
recommended and the legal benefits of such notification.
Where the security over the offtake contract is taken under English law, the legal benefits of notification of
the security are as follows:

• Discharge—if the offtaker has been notified of the security interest of the lender over the
offtake contract and requested to make payment directly to the lender, then the offtaker will not
obtain a good discharge from its payment obligations arising under the offtake contract if it pays
the borrower/producer rather than the lender. This is a useful mechanism to protect the lender
even though it is more usual in PXF transactions to require payment to the borrower/producer
(via the mechanism of the collection account, which is an account in the name of the borrow-
er/producer but is secured to the lender).
• Set-off—English law recognises a number of different types of right of set-off (see Practice
Note: Types of set-off), whereby the offtaker may be able to deduct amounts owing to it by the
borrower/producer (either under the offtake contract itself or under different, possibly unrelated,
arrangements involving the offtaker and the borrower/producer) from the amounts it owes un-
der the offtake contract. This is highly damaging to the lender’s security as it may eliminate
some or all of the payment flow into the collection account. Notification of the lender’s security
eliminates some (but not all) of these set-off rights.
• Priorities—under English law, priority between competing assignees/security holders over the
same debt or contract rights is determined (with rare exceptions) by the order of service of no-
tice of the security on the debtor/contractual counterparty. Notice of the lender’s security in-
terest to the debtor or contractual counterparty will protect the lender against a negligent or
dishonest later assignment to another party by the borrower/producer of those debts or contract
rights (see Security over contractual rights and debts—how notice affects priorities).
• Direct right of enforcement—if the security assignment complies with the requirements of Law
of Property Act 1925, s 136, which includes notification to the contract counterparty, the as-
signee (ie the lender) will have a direct right to enforce the borrower/producer’s rights under the
debt or contract by legal proceedings taken in its own name.
 Page 44

For more information, see Advantage of a legal (ie statutory) assignment over an equitable assignment and
Notice of an assignment by way of security.
Where notice is served on the debtor or counterparty, it is considered good practice to obtain a written
acknowledgement of the notice from the debtor/counterparty, although this is not strictly necessary under
English law to obtain the legal benefits of notice.
For more information, see Practice Notes: Assignments by way of security and Taking security over contrac-
tual rights and precedent Notice of assignment of contractual rights and form of acknowledgement.

Interaction of offtake contract provisions with terms in the PXF facility agreement
Offtake contracts should always be read in conjunction with the clauses in the PXF facility agreement which
require the borrower/producer to maintain production and export, and to increase exports under a top-up
clause if necessary to maintain its debt service obligations. Events of default will cover situations such as a
declaration of force majeure or a material breach of the offtake contract by the borrower/producer.
For more information, see Pre-export finance—key terms in the facility agreement.

Collection account security

PXF facilities almost invariably provide that the sales proceeds of the commodity under the offtake contract
are to be paid into a collection account in the name of the borrower/producer and to be held subject to secu-
rity in favour of the lender. Debt service payments are debited from the collection account on the relevant
payment dates.
It is usual to provide for any surplus over debt service requirements to be paid to the borrower/producer so
long as the PXF facility is not in default.
PXF facilities sometimes make use of debt service reserve accounts in addition to collection accounts. A
debt service reserve account is essentially an additional security account in which the borrower/producer is
required to maintain a certain minimum deposit to provide the lender with additional security to that provided
by the offtake contract and its proceeds.
Some countries maintain exchange control regulations, and legal advice should be taken at an early stage in
any transaction to ascertain what arrangements in relation to offshore accounts are permitted. It is some-
times necessary to introduce more complex variations to the collection account structure in order to comply
with exchange control regulations.
It is considered best practice for the account security to be taken under the law of the place where the ac-
count is held. It is recommended that the relevant legal advice is taken as security documentation varies
considerably under different legal systems.
 Page 45

10 of 10 DOCUMENTS:

Pre-export finance—structure, parties and risks

Produced in partnership with Watson Farley & Williams LLP

What is pre-export finance (PXF)?

PXF is an established structure used to provide finance to producers of goods and commodities. It is a type
of trade finance. PXF structures were borne out of the fact that traditionally, many producers of goods and
commodities, particularly in emerging markets, were not considered to be sufficiently bankable for the pur-
poses of obtaining finance by more orthodox means, such as conventional corporate loans against the bal-
ance sheet of the borrower.
In a classic PXF facility, funds will be advanced by a lender or syndicate of lenders (in this Practice Note,
'lender' refers either to a single lender or a syndicate of lenders) to producers to assist them in meeting either
their working capital needs (for example, to cover the purchase of raw materials and costs associated with
processing, storage and transport) or their capital investment needs (for example, investment in plant and
machinery and other elements of infrastructure).
A typical PXF facility will have a tenor of between one and five years, although it is also common for facilities
to be amended and restated during the course of their lives.
PXF facilities are usually secured by:

• an assignment of rights by the producer under an ‘offtake contract’ (ie a sale and purchase
contract between the producer and a buyer of that producer of the goods or commodities pro-
duced by it), and
• a collection account charge (ie over a bank account into which proceeds due to the producer
from the buyer of the goods or commodities under the offtake contract are credited)
Lenders sometimes also take security over the goods or commodities themselves, although in that case the
complications inherent in taking security over tangible assets moving through multiple jurisdictions need to
be addressed.
For more information, see Practice Notes:

• Pre-export finance–key terms in the facility agreement, and

• Pre-export finance–taking security

Typical PXF transaction structure

The essential PXF transaction structure is triangular:

• a producer of goods or commodities (the borrower) will enter into a sale and purchase (ie an
'offtake') contract with a buyer
• a lender will provide a credit facility to the producer
 Page 46

• the producer will assign its rights against the buyer under the offtake contact to the lender. As
a result, the buyer will make payments otherwise due to the producer directly to the lender by
payment into an account secured by way of a charge
Under the basic PXF structure, the lender will take production risk (ie the risk that the producer stops per-
forming under the offtake contract, with the corresponding risk that the buyer stops paying).

Variations to the basic PXF structure—use of trading companies

Often a trading company will be included in the transaction structure. Trading companies are often viewed
as being more bankable than producers and generally will share with the lender some of the risk of
non-performance by the producer.
With the addition of a trading companies, the basic structure can be varied in a number of ways, in order to
share risk between the trading company and the lender. Some common examples of the role of the trading
company include:

• making advance payments (for the supply to the trading company of the goods or commodities
which are subject of a supply contract) to producers which are funded by the lender—under this
variation, there can be either limited or full recourse to the trading company by the lender. If full
recourse is taken, then the trading company may mitigate its exposure by obtaining credit in-
surance to cover the risk of a default in production by the producer
• making loans to producers which are funded by the lender— under this variation there will be
limited recourse to the trading company by the lender. Repayment of the trading company (and
in turn the lender) occurs by delivery of goods or commodities
• taking a limited risk participation (typically for 10% to 15%) in a bank funded PXF transaction
Further variations are also possible using different elements of the above examples to achieve different re-
sults, mainly as a means of allocating risk between the parties in a particular way.

The key parties to a PXF transaction

The principal parties to a PXF transaction are:

• the producer
• a buyer, and
• the lender
The nature of these parties, the roles they play in a PXF transaction and their concerns are outlined below.
Details are also given of other parties which may be present in a PXF financing, depending on the structure
adopted.

The producer and the buyer

The producer and the buyer are, respectively, the seller/exporter and the buyer/importer of goods or com-
modities under the offtake contract. The offtake contract will be for a long term and typically the tenor of the
PXF facility will match or be shorter than that term, in effect making the PXF transaction self-liquidating. The
lender may require that the producer ensures there is an alternative buyer in place as a failsafe in case the
original buyer defaults; this helps in mitigating the lender’s assumed payment risk, outlined in Key risks for
the lender below.

The lender
The lender will advance funds to the producer on the basis of the cashflow generated between the producer
and the buyer of the goods. As with any financing against cashflow, when deciding on commercial terms, the
lender will need to evaluate several kinds of risk, the key ones being:
 Page 47

• production risks
• payment risks
• political risks, and
• legal risks
For more information, see Key risks for the lender below.

Trading companies
As outlined above (see Typical PXF transaction structure), trading companies are often seen as more bank-
able by lenders than the producers themselves. Trading companies sometimes agree to take responsibility
for repayment of a certain percentage (usually 10% to 15%) of the loan facility but, in certain circumstances,
a lender may wish to have full recourse to the trading company where it is unable to recover the balance of
outstanding amounts from the producer. The trading company may obtain credit insurance to cover any
shortfalls it would suffer as a result.

Letter of credit bank

Often a lender will require that the buyer under the offtake contract makes payments due under it by way of
letters of credit issued by a bank approved by the lender. The lender will be concerned that the issuing
bank meets a minimum standard of creditworthiness.
For information on letters of credit, see Practice Notes:

• Characteristics of commercial letters of credit, and

• Commercial letters of credit—structure and parties

Key risks for the lender

PXF transactions provide a versatile means for lenders to provide financing to producers of goods and
commodities. Provided the relevant risks can be effectively allocated and mitigated, the fact that these
transactions are self-liquidating makes them attractive products in uncertain financial times.

Production risk
Production risk is arguably the most important risk that the lender will need to take into account when decid-
ing whether or not to advance funds; if the producer fails to produce and/or deliver goods or commodities,
then this may trigger disruptions to the cashflow cycle.
In its due diligence on the producer, the lender should consider:

• the nature of the goods or commodities involved, and

• what particular production risks might exist (for example, the availability of supplies of raw ma-
terials required, the state of industrial relations and whether there are any flaws in the infra-
structure of the producer’s enterprise which would affect its ability to meet its obligations under
the offtake contract).
In addition to production risks arising directly from the producer itself, certain jurisdictions also impose export
controls on particular goods or commodities which may affect the producer’s ability to trade.

Payment risk
 Page 48

The lender also takes a significant risk in respect of payments due from the buyer under the offtake contract
not being made. The lender’s due diligence should also therefore extend to cover the buyer.
Payment risk would also cover any movements in the market price of goods and commodities.
Depending on its nature, there are ways in which payment risks can be reduced. For example, if the lender
believes the buyer to be of poor standing it may require the buyer to make payments to the collection ac-
count by way of letters of credit. For information on letters of credit in general, see Practice Notes:

• Characteristics of commercial letters of credit, and

• Commercial letters of credit—structure and parties
Additionally, potential variations in commodity prices can, if necessary, be alleviated using hedging ar-
rangements if no fixed price for the relevant commodities has been agreed (although this will involve the ad-
ditional cost to the producer of the hedging arrangements). For more information, see Use of derivatives to
hedge against risk in a lending context—Hedging against commodity price risk and Practice Note: Commod-
ity derivatives.

Mitigating payment risk—debt service cover and top-up covenants

PXF facilities usually contain clauses requiring the borrower/producer to produce and export commodity of a
sufficient value to cover, with a margin, its debt service obligations under the PXF facility. These covenants
take a variety of forms but essentially provide for a ratio to be maintained of:

• the value of sales under the offtake contract during a particular period
to
• the principal and interest payable under the PXF facility for the same period.
Debt service cover covenants are combined with top-up clauses under which the borrower/producer under-
takes, if it cannot maintain the debt service cover ratio required under the PXF facility, to:

• increase the volume of sales

• partially prepay the facility, or
• top-up the security by depositing cash in a cash cover account
For more information, see Pre-export finance–key terms in the facility agreement—Debt service cover ratios
and top-up clauses.

Political risks
The range of potential political risks is very wide and varies from jurisdiction to jurisdiction. Typical political
risks include:

• introduction of international trade sanctions

• outbreak of civil war or unrest, and
• changes in law relevant to the transaction
Lenders should undertake thorough due diligence in these areas.
Of particular importance to PXF transactions are whether there are any exchange control regulations which
require earnings to be retained by producers in their jurisdictions of incorporation.

Legal risks
Legal risk will also vary from jurisdiction to jurisdiction; the lender should engage local lawyers to provide ad-
vice on all jurisdictions relevant to the transaction.
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In line with other forms of cross-border financings, a lender should understand:

• the effect of laws relating to the creation, perfection and enforcement of security
• insolvency rules
• the possibility of any imminent changes in law, and
• tax matters
When taking security, the appropriate legal system to determine the validity of the security will normally de-
pend on:

• the location of the relevant assets, and

• in the case of security over contractual rights (such as an assignment of an offtake contract),
the governing law of the relevant contract.