Trade Finance facilities have been decisive for the growth of Brazilian agribusiness over the past 20 years.
Despite the growth of Commodity Finance (CF) and Supply Chain Finance (SCF), the legal environment in Brazil still presents relevant challenges, which should be taken into account by foreign lenders at time of assessing, structuring, and closing deals in the country.
Based on a long track record of trade finance transactions assisting lenders and insurers in both blue skies and distressed scenarios, we identified 4 key strategies that should help foreign banks, funds, insurers, and investors to mitigate some relevant risks associated with CF and SCF deals with Brazilian companies.
Strategy 1: Keep track of changes in Brazilian laws affecting CF and SCF. Brazilian authorities change banking and tax laws and regulations with certain frequency. Being updated on legal developments is crucial for foreign lenders at least at two moments. One, at time of planning, structuring and closing the deal, as they may impose additional costs or limitations to the overall transaction structure. Two, after closing, at time all transaction documents are signed and the funds, as a whole or partially, have been disbursed to the borrower.
Lenders should make sure that the loan documentation, from time sheet to loan agreement to security instruments, includes a clear language indicating that, in the event of material change in Brazilian laws imposing (i) additional costs, or (ii) limitations to the transaction, which party should borne such extra costs, or how to proceed to adjust the structure or the transaction documents to any newly imposed limitation.
Strategy 2: Make detail risk assessment and due diligence prior to closing. Although detailed assessment of risks involved in a specific trade finance transaction and careful due diligence on the borrower’s business are two basic must-do procedures by foreign lenders, the reality shows otherwise. A mix of reasons as (i) pressure to close the transaction, (ii) borrowers’ and guarantors’ lack of transparency on relevant financial and operational information, and (iii) limitation by foreign financiers to access public information about borrowers and guarantors, such as updated credit history, tax, labor and environmental liabilities, relevant pending litigation.
The result, in many cases, is that lenders are caught by surprise of material adverse facts affecting borrowers’ business (ex. a major bill arising from an unnoticed tax lawsuit). Foreign lenders in particular should make all efforts to conduct a detail assessment and due diligence prior to closing, in order to reduce the chances of not apparent adverse facts happening during facility term.
Strategy 3: Surveil periodically during facility term. There are mainly 2 types of foreign lenders doing trade finance business in Brazil. One group composed by lenders that surveil borrowers and guarantors’ information periodically and follow up on relevant changes in the course of their businesses. The other group is defined by lenders that opt to not surveil and tend to knock the borrowers’ door at time of interest payment and principal repayment. Our experience shows that the first group, the vigilant one, is able to anticipate potential material adverse facts or non-compliance of relevant loan covenants, and so is capable to make strategic movements ahead of the others, such as demanding collateral enhancement, enforcing collateral, or imposing specific restrictions or oversight obligations to borrowers. The second group, the “relaxed”, not rarely are the last one to learn about material adverse facts and tend to suffer bigger losses for being the last in line.
For foreign lenders doing trade finance business in Brazil, the recommendation is that they should be part of the first group. This approach will dramatically reduce the risk of unhappy surprises and increase the odds of successful deals.
Strategy 4: Understand the collateral package, rights and limitations. Trade finance facilities, including CF and SCF, are generally structured with certain loan documents being governed by the laws of the State of New York (USA), England, Germany, etc., and certain governed by the laws of Brazil.
In a real life scenario, what if, in an one-year CF facility secured by Warrants (CDA/WA) or Mercantile Pledge over soybeans, the borrower defaults on the interest payment, and the foreign lender decides to enforce the transaction documents. Which transaction document is going to be immediately enforced in courts to secure the loan repayment? Is it the Loan Agreement or the Assignment and Security Agreement both generally governed by New York law and subject to New York City courts? Or is the Warrants (CDA/WA) or Mercantile Pledge, jointly with the Promissory Note, both governed by Brazilian law and subject to a particular court in Brazil (ex. São Paulo)? Which of the above will provide the foreign lender immediate possibility of relief? The response is the local law governed transaction documents.
In a plain vanilla CF financing, such as export prepayment of soybeans/sugar/corn/etc., out of the total facility cycle (from plantation to storage to port, and finally to export) lenders are exposed 75% to Brazilian law, and 25% to foreign law. The message to foreign financiers is that they should fully understand the collateral package in place for the specific trade finance facility, particularly which documentation can be immediately used to remedy any potential default by borrowers, with purpose of securing the financed goods and to reduce the lenders’ exposure.
We believe that the 4 key strategies above should help foreign lenders to mitigate some relevant risks associated with trade finance transactions in Brazil, and increase their changes of a successful and profitable track record in Brazil.