Trade Credit Insurance

U.S. asset-based and cash-flow lenders[1] often rely on trade credit insurance to support foreign receivables generated by their borrowers. These policies, whether issued to the borrower or to the lender, can play an important role in protecting repayment streams, expanding availability and mitigating risk.

Goldberg Kohn helps lenders navigate this complex area. Drawing on decades of experience advising financial institutions on sophisticated financing arrangements and resolving disputes among claimants, insurers, brokers and agents, GK provides counsel at every step of the way.

Some lenders have their own policies, though most often the policy is owned by the borrower.  Even if the lender already owns a policy, the borrower may insist on using its own policy to avoid doubling up on insurance premiums.  In those cases, the lender would simply exclude the receivables in question from its policy.

Key Contacts

Gerald L. Jenkins, David J. Chizewer, Richard M. Kohn, Joseph L. Hoolihan, Paul J. Sauerteig

Use of a lender’s policy 

A key benefit of a lender’s policy is the ability to obtain coverage against missteps and shortcomings of the borrower, up to and possibly including gross negligence or fraud.  Such a policy is not, however, a substitute for due diligence and policing of the receivables, in part because insurance protection is never complete and in part because coverage will almost certainly be conditioned on conducting that very due diligence and policing. 

In addition, because trade credit policy premiums are generally based upon the volume of the receivables covered, it is a relatively simple task to allocate the premiums among multiple borrowers and to assess each borrower for its share.  (See link below to a news article about our recent victory in London against Marsh McLennan).

If the policy is owned by the lender, it can be negotiated and administered much in the same way as other policies held by the lender.  There are, however, a number of issues that are unique to trade credit risk:

• Much of the information that the insurers want to see comes from the entity generating and managing collection of those receivables, at least until the lender has delivered a notice of default to the borrower.  Therefore, the lender will need cooperation from the borrower to meet its contractual obligations to the insurer and will be at the risk of losing coverage on its policy if the borrower fails to meet its obligations to the lender.  This requires two things and suggests a third:
  • (Required) Covenants requiring the borrower to provide the lender with the needed information in a timely manner;
  • (Required) The right to step in and take control if the borrower fails to comply with those covenants; and
  • (Suggested)  Expanding coverage under the policy to include failures of the borrower up to, and possibly including, gross negligence and fraud.
• Each loan presents its own set of unique requirements and, to the extent that the underwriting decision depends on trade credit insurance coverage, it may be necessary to review the policy and its endorsements to determine whether coverage is broad enough to address those requirements.  If some requirements are not adequately addressed, it may be necessary to renegotiate the policy at that time.  Unfortunately, insurers are generally reluctant to open negotiations mid-policy.  Fortunately, a key feature of most trade credit insurance policies (i.e., its premium is a percentage of the face amount of the receivables covered by the policy) can give the insurer the incentive to renegotiate notwithstanding that reluctance.  For example, if a proposed financing increases the volume of covered receivables by 10%, premiums would also go up by 10%.  That often is enough to bring the insurer to the negotiating table.  
• Compliance and reporting obligations are generally far more extensive for a trade credit policy than for other types of policies.  For example, a lender may only add a new building to its fire policy once every year or so, but it may be constantly financing hundreds or even thousands of receivables issued by account debtors scattered across the globe.  That may require the ability to interact directly with a borrower’s team immediately upon a declaration of an event of default, but it may also require an in-house team or outside consultant to be at the ready if a borrower stops performing.  In addition, it may be possible to obtain coverage against the borrower’s failure to support the lender’s compliance and reporting obligations.
• An actual insurance claim under a trade credit insurance policy can have its own set of requirements that are more extensive than those associated with other insurance policies.  For example, a policy may require the lender to make a significant collection effort against each account debtor before the insurer is required to pay a claim.  This not only requires that the lender have the ability to do that under the financing agreement, under local law and under the agreement between the borrower and the account debtor, but the cost may be prohibitive based on the size of the receivables at issue and the costs of collection.  Although the borrower may have had the ability to do that on a cost-effective basis at the time it signed the loan agreement, it may not have that ability when the receivables become past due.  This means that the lender must anticipate these complexities at the time it negotiates the policy.
• Typically, trade credit insurance does not cover costs stemming from time value of money.  Most policies pay what the lender advanced against the receivables in question.  Therefore, if the insurer can delay payment of a claim for five years, even if it eventually pays the claim in full, from a present value standpoint it has reduced its cost by about half.  That creates a tremendous incentive to “delay, delay, delay.”  Therefore, as hard as it may be to negotiate, it may be in the lender’s best interest to ask for time value of money protection. 
• The risk noted in the previous bullet can further be exacerbated by the requirement that litigation against the insurer be brought in the country in which the insurer is domiciled.  Trade insurers in some countries, such as Australia, are known for adopting a policy of delay.  Therefore, it is important to be alert to the domicile of the carrier when evaluating a policy. 
• The insurer is not the only party that is compensated based on a percentage of receivables covered.  The insurance broker is generally paid a fee that is a percentage of the premium, so it, too, has an incentive to increase the volume of covered receivables.  Therefore, a dispute between the insurer and the lender can easily stretch into complex litigation involving multiple parties.

Adaptation of a borrower’s policy 

Although a borrower’s policy may not cover a lender as well as the lender’s own policy, it may already be in place at the time that the loan is being negotiated.  In order to avoid paying double premiums or negotiating carve-outs from an existing lender’s policy, the better path may be to adapt a borrower’s policy to meet the lender’s needs.  This is certainly the more commonly traveled path.  This path can, however, create problems that are in addition to those described above:

• The policy is not typically drafted in a way that anticipates covering a lender that will have a security interest in the receivables covered by the policy.  Loss payee status often does not work as hoped.  Also, because the size of a lender’s trade credit insurance policy is significantly larger than a borrower’s policy, many borrowers’ policies treat the insured less favorably than a lender is treated under a lender’s policy, making the negotiation of provisions that protect the lender more difficult.  In addition, creating what is, in effect, a three-party relationship is generally more complex and tedious than would be the case with a two-party policy between an insurer and a lender.
• Because the borrower typically manages its receivables until an event of default is declared, the lender will not necessarily be privy to all of the communications between the insured and the insurer, nor will it be aware of the full course of dealing between the two.  Therefore, if the lender is later required to step in and take over, it may be subject to assertions by the insurer that it is unable to challenge by itself.
• Because insurance policies are not typically assignable, the lender may not be able to force the insurer to allow the lender to replace the borrower as the policyholder if the lender forecloses.  Moreover, if the lender sells the business in a sale under Article 9 of the Uniform Commercial Code, the buyer will not be able to replace the borrower under the policy.  This may not be an insurmountable problem, because either the lender or the buyer could acquire its own policy, but the new insurer would not necessarily cover the receivables then outstanding.  Based the assumption that receivables turn about four times a year, that would mean that an inventory of receivables representing approximately 25% of the borrower’s annual sales could not be insured.

By combining its knowledge of commercial finance with insurance coverage experience, Goldberg Kohn offers lenders a trusted partner in maximizing the value of trade credit insurance and enforcing their rights when disputes arise.

[1] Many of the comments below also pertain to purchasers in receivables purchase transactions.