A Clever Carve Out – Non-Recourse Offerings As Part Of A Working Capital Solution

What is a non-recourse, off-balance sheet arrangement?

In most cases a non-recourse, off-balance sheet arrangement operates much like a standard receivables purchase facility, but with one clear advantage – it involves a one way transfer to the funder, through a sale and purchase arrangement, of the majority of the risks associated with the relevant company's receivables. These arrangements can be structured in a number of ways, such as an outright sale or a more complex trust arrangement, but all have the same aim, which is to remove the relevant receivables from the balance sheet of the company.

In a true non-recourse, off-balance sheet structure, the funder may only transfer back the receivables to the company in very limited circumstances (such as if the company has committed fraud). The removal of the receivables from the balance sheet of the company has several advantages, including:

• potential tax advantages, with the balance sheet position being improved
• financial covenant calculations under any senior funding arrangements may be improved, given the more favourable balance sheet position
• the company is no longer exposed to an underlying debtor's non-payment, with the risk of non-payment instead being assumed by the funder
• improved working capital for the company, receiving payment from the funder up front rather than waiting for debtors to pay

Non-recourse, off-balance sheet arrangements are often permitted under a company's senior debt facilities, by way of a carve out in the permitted financial indebtedness, permitted disposals and borrowings definitions. For funders who offer the non-recourse arrangements, it is sometimes a good opportunity to get a foot in the door from a relationship perspective, providing an additional, bilateral offering to companies who otherwise have funding arrangements in place with a larger syndicate of funders.

Be auditor aware, and other potential obstacles

Non-recourse, off-balance sheet facilities can be a very helpful solution for companies. However, there are certain pitfalls to be aware of when putting in place such arrangements.

Be auditor aware - are the auditors on board? Lawyers drafting the documentation may believe that the structure represents an off-balance sheet position, however it is for the company's auditors to determine if that is actually the case. The accounting interpretation of "off-balance sheet" is very bespoke, and this nuance often trips up parties looking to put in place such arrangements. There may be a request for a legal true sale opinion as part of the transaction, which can help address auditor concerns, however ultimately it will be down to individual audit teams to decide whether they are satisfied that the structure detailed in the underlying facility agreement fulfils their requirements for off-balance sheet treatment.

Are the senior permissions watertight? If non-recourse arrangements are being put in place for companies who have existing funding arrangements, do the senior documents actually permit the new facility? Whilst many senior arrangements contain the relevant carve out language within the permitted financial indebtedness, permitted disposals and borrowings definitions, there can sometimes be concerns raised where security releases have not also been catered for. Senior arrangements will usually be secured by all asset security, which will encompass security over the receivables to be transferred pursuant to the non-recourse arrangement. If the appropriate permissions are not drafted into the senior finance documents when the senior arrangements are put in place, there may need to be involvement of the senior finance parties as part of the non-recourse funding transaction to provide consents or sign releases, causing unnecessary delay and additional expense for the company.

Does the company agree to using a separate trust account for the facility; is a sweep of funds agreed? Where all of a company's receivables (whether or not funded under the non-recourse arrangement) are paid into the same account, there is far less control over the funds and a co-mingling risk for the funder. Some funders will accept the risks associated with a company's push back on opening a separate trust account or refusal to do daily sweeps; for other funders these are non-negotiable points. It is therefore important at the outset for the parties to have a conversation about expectations around the operation of the facility and bank account logistics.

Has the insurance position been considered? If company credit insurance is being used, the proceeds of such insurance will need to be assigned to the funder. If not all of a receivable is being funded, this can cause complications in terms of insurance pay outs which need to be dealt with as part of the transaction.

In a market where an increasingly holistic approach is being taken by funders who are seeking to provide the full spectrum of funding options for companies, a non-recourse arrangement can be a very valuable product for a company. Ensuring that the common pitfalls for this type of arrangement are considered prior to commencement of such transactions will ensure a much smoother process, for all parties involved.

The Addleshaw Goddard ABL and Trade Finance Team have a wealth of experience acting for both funder and borrower clients, regularly advising on working capital solutions including non-recourse, off-balance sheet arrangements. We would be delighted to discuss any elements of this topic with you, so please do get in touch to find out more.

Next steps

Please feel free to reach out to one of the key contacts or your usual contact within Addleshaw Goddard if you would like to discuss any points raised in this article.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.