Womble Carlyle Supply Chain Management Blog

Following legal issues related to supply chain management.

Thursday, July 2, 2009

Global competition for the U.S. dollar?

The state-run China Daily reported two stories last week suggesting that the U.S. dollar may not be the touchstone of global trade, and that other currencies, such as the renminbi (or yuan), the official currency of the People’s Republic of China, will ascend in global importance. These stories underscore an obvious concern that sourcing prices in China will only continue to escalate in the short term. From a longer term perspective, these stories also highlight the need for vigilance in monitoring developments impacting supply chains and the contracts which define and control them.

The first story of interest was published on Thursday, May 21, when China Daily quoted Brazil’s President, Luiz Inacio Lula da Silva (while visiting the PRC) as calling for China and Brazil to trade in their own currencies and put an end to trade based on the U.S. dollar. In calling for finance ministers of the two countries to begin discussions on the matter, the Brazillian leader noted trade costs between the nations would be reduced by the elimination of fees to exchange currency into US dollars as an intermediate step to payment. Brazil already has agreements with other trading partner nations calling for trade in local currencies.

And on Friday, May 22, China Daily ran a piece predicting a greater global role for the yuan on account of China’s growing role in the global financial economy. Perhaps just as telling, in a manner casting China in the role of Queen Getrude to the world’s Hamlet, is the level of attention China continues to place on protesting (methinks too much) that it has not engaged in currency manipulation as a means to favor its own exporting industries. Consider, for example, the great pains taken to get out news, perhaps overlooked by the rest of the world, to the effect that the Obama administration (speaking through Treasury Secretary Geithner) does not view China as having manipulated the currency exchange rate for export advantage.

The emergence of such arrangements as called for by Brazil, and the push of the Chinese to elevate the global status of its own currency, could mark the beginning of a major trading shift away from U.S. dollar denominated transactions. Setting aside the likelihood of this actually coming to pass (perhaps not as far-fetched a notion as it was a year or so ago), or the time frame within which such a change would evolve, there are serious business risks and opportunities here, and some legal issues to keep in mind.

Consider, for example, all of the standing agreements in a typical global supply chain which base all of the interdependent transactions flowing through the chain on U.S. dollar demoninated pricing. Many of these agreements may be long term in nature, and while some may have termination provisions based on the convenience of a party or termination for cause under specified circumstances, major changes of this nature may likely not give a party who begins to suffer a competitive disadvantage on account of currency a right under current contracts to terminate for good cause. At best, most existing agreements would typically include a so-called “force majeure” (or temporary change in conditions) clause which would allow suspension of performance during the pendency of a currency crisis, but even then the right to terminate based on such an event is usually limited or non-existent in most iterations of this clause.

Therefore, closer attention to currency issues should be at the top of the list of external factors every supply chain manager should monitor, if not already at or near the top of the list given the current volatility in the world economy. While this truly would be a longer-term trend, if it does become a trend, currency provisions should also top the list of items for which to periodically reassess contracts, particularly as contracts are renewed or entered into during the ordinary course of business.

- Randy Hanson

Wednesday, July 1, 2009

Protecting accounts receivable for inventory sold under the UCC

In the current economic climate, sellers are increasingly seeing their sales on credit for what they are - a gamble on the buyer’s creditworthiness. If the buyer doesn’t pay its invoice, what rights does the seller have against the buyer? How do the seller’s rights compare to those of competing creditors? If there’s not enough money to pay everyone, does seller still get paid?

The Uniform Commercial Code (UCC) dictates the answers to these questions and the answer frequently depends on what steps the seller has or has not taken BEFORE the sale to protect its interests.

The UCC gives special treatment to sales of consumer goods. If the buyer is the end user of the product (the consumer), will not be reselling the product and is using it primarily for personal, family or household purposes, then a seller whose agreement with the buyer on credit (the store credit card agreement, for example) provides for a security interest in goods sold but not yet paid for, obtains an automatically perfected priority lien on the sold merchandise. No steps are required for perfection and seller’s claim to the merchandise will generally trump those of other creditors.

If, however, the goods sold constitute “inventory” in the hands of the buyer, meaning generally that they will be reselling them or will be using them in their business, then perfection is no longer automatic and affirmative steps must be taken to protect a seller’s rights if the buyer fails to pay for the goods purchased.

First, you need to be certain that your sale documents (e.g. purchase orders) contain effective language granting you a security interest in the items sold until such items are paid in full. In UCC terms this effects the “grant” of your security interest and gives you rights in the items sold as against your buyer/debtor. This does not, however, confer “perfection” of the security interest, which determines your priority among competing creditors.

In many if not most cases, you will likely be selling your products to a buyer who already has some form of general corporate financing in place, which financing is typically secured by a “blanket” lien on all assets of the debtor. That means that once you sell your products to buyer/debtor, buyer’s bank will get a lien in those assets in addition to yours. So whose lien comes first?

The answer under the UCC is that the bank’s lien on inventory will trump or prime your lien on your products sold to buyer unless you (1) file a UCC financing statement against the buyer with respect to your products sold BEFORE you sell the products to them AND (2) notify the competing bank creditor of your impending lien BEFORE you sell the products. These steps will allow your lien in products sold by you to your buyer to prime the bank or other inventory lender’s lien.

The burden of both filing the UCC and providing prior notice to an inventory lender before making a sale, as a practical matter, dictates that most sellers will pick and choose which sales and which buyers warrant this level of protection. In most cases, you, as seller, will not know if your buyer has an inventory lender or the identity of that lender, so a UCC search will need to be conducted first, an additional administrative burden. Nevertheless, for large sales and/or for buyers whose creditworthiness may be suspect (a growing group of buyers in these troubled economic times), extra diligence and action may be warranted.

- Jackie Camp