The risks of forfaiting

The risks of forfaiting

What risks do the various parties run when forfaiting? Senior consultant Michael Kenny, senior associate Ian Clements and trainee solicitor Meryl Rowlands, all representing Watson, Farley & Williams, guide us through the different aspects of forfaiting.

What is the traditional structure of forfaiting arrangements?

A well-established form of trade finance, forfaiting refers to an arrangement whereby a forfaiter (usually a bank or other financial institution) purchases, at a discount, a debt owed to a creditor, the exporter, on deferred payment terms from its debtor, the buyer. A negotiable instrument, such as a draft drawn under a letter of credit, a bill of exchange or a promissory note, is given in respect of a sale of goods from the creditor to the debtor. This is the ‘primary’ forfaiting market transaction.

As a result of the process, the creditor obtains immediate access to a reduced amount of cash from the face value of the negotiable instrument—cash that would be unavailable until the negotiable instrument matures. The forfaiter will either hold the negotiable instrument until its maturity, when it will receive the payment due from the debtor, or it may sell the negotiable instrument to another bank or financial institution active in a ‘secondary’ forfaiting market transaction.

The sale of the negotiable instrument to the forfaiter is on a ‘without recourse’ basis, meaning that should the debtor not make payment under the negotiable instrument, the forfaiter is prevented from making any form of recovery against the creditor.

How are guarantees structured in forfaiting transactions?

If a debtor’s obligations under a negotiable instrument are to be guaranteed, the customary practice in the forfaiting market is for the debtor’s bank to issue its guarantee by means of an ‘aval’.

An aval is an unconditional, irrevocable, freely assignable and freely transferable promise to pay on the maturity date of a bill of exchange or promissory note, created by the addition on the bill or note of

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About the author:

Neeta has been working as a paralegal in Banking and Insolvency for the past 4 and a half years.

She started her legal career at Allen & Overy in 2008 in the midst of the global financial crisis and the collapse of Lehmans where she gained most of her experience.

Neeta also did a short stint in litigation at the Revenue and Customs Prosecutions Office. Neeta graduated with a 2:1 honours degree from University of London, Queen Mary College and went on to obtain a distinction from the College of Law in the Legal Practice Course. She moved to Lexis®PSL in April 2013.