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Home Publications Discussion of Selected ABL Lending Policies Discussion of Selected ABL Lending Policies, July 2009

Discussion of Selected ABL Lending Policies, July 2009

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Insured A/R

In the past, insured A/R was normally only obtained for foreign accounts (located outside North America) via government sponsored programs such as EDC.  In the last few years, more and more Canadian and US A/R accounts are being insured through private insurance providers. A current practice in the ABL industry is to provide a 90% advance rate on domestically insured A/R accounts where overall dilution is less than 5%.  In other words, if an account qualifies for an 85% advance rate without A/R insurance, then the account would qualify for a 90% advance rate with credit insurance.  The justification for the increase in A/R advance rates is that the risk associated with the A/R collateral assigned to the bank is mitigated, to some extent, by the A/R insurance.  For foreign accounts, the A/R account would only be eligible if insurance was in place; the advance rate would be 85% assuming dilution of less than 5%.

Priority Payables

Not all lenders in the Canadian ABL industry reserve for all defined priority payables. Certain lenders will reserve only if the priority accounts are past due.

The statutory priority payables that are reserved are also different from lender to lender. The standard priority payables reserved in the industry are GST, PST, payroll withholdings, accrued wages limited to amounts stipulated in the recently introduced WEPP legislation, realty taxes (owned property) and to a lesser degree Workers Compensation and Employer Health Tax.

The majority of lenders reserve for Priority Payables once per month based on the month end balance in the borrowers respective general ledger accounts.

WEPP (Wage Earners Protection Program)

The Wage Earners Protection Program was enacted into law in July 2008. The primary purpose of the legislation is to fund payments of certain unpaid wages owed to employees at the time a business goes into receivership or bankruptcy. Changes were also made to the bankruptcy and insolvency act to ensure that the payment of unpaid wages and certain pension contributions had priority ahead of the interests of secured creditors.

On July 7, 2008, new legislation called the Wage Earner Protection Program Act (WEPPA) came into force in Canada. Using WEPPA, the Canadian government created the Wage Earner Protection Plan (WEPP) to fund the payment of certain unpaid wages owed to employees at the time a business goes into bankruptcy or receivership.

The legislation states that employees may apply to the WEPP for arrears of wages and compensation earned within the six months immediately preceding the bankruptcy or receivership. Their claim is the lesser of the unpaid amount and 4 weeks of insurable earnings under the Employment Insurance Act which currently equates to a maximum of $3,000 ($2,000 from the employer and $1,000 from the government). Taxes will be deducted from payments at a prescribed rate. The definition of wages for the purposes of the WEPP includes salaries, commissions, vacation pay, compensation for services rendered etc.  It does not include severance or termination pay.

It is intended that payments will be made to the eligible employees within the later of 56 days after the date of bankruptcy/receivership or their termination date. This should expedite payments to employees at a time when they may be out of work and experiencing financial hardship.

Changes to the Bankruptcy and Insolvency Act (BIA)

The statutory priority for unpaid wages and pension contributions was established with an amendment to the Bankruptcy and Insolvency Act. Under the BIA wage arrears to a maximum of $2,000 per employee (plus $1,000 for disbursements owing to traveling salesmen) rank as a super priority over the current assets of the Corporation. This means that in the event of a bankruptcy or receivership all unpaid wages up to $2,000 per employee will have priority over secured creditors.

There are other provisions related to unpaid normal costs related to pension costs and unremitted employee pension deductions. The law with regard to these payments is more complicated and no maximum amount for this priority has been set.

Effect on secured lenders

The new WEPP legislation makes the calculation of priorities related to wages simpler and more reliable than in the past. Prior to the WEPP legislation the only statutory priority for employee wages related to unpaid vacation pay. The reserve was usually based on a GL balance and was always open to interpretation. At the same time some lenders would reserve for accrued wages and commissions as a cushion against possible priorities.

The new legislation clearly defines what is owed for accrued wages, a maximum of $2,000 per employee. The secured lender can easily calculate their maximum exposure by reserving for $2,000 times the number of employees.

This process can become difficult when the Corporation has numerous part time or seasonal employees. The legislation is based on unpaid wages up to $2,000 per employee, however it is unlikely that a large percentage of part time employees would have unpaid wages equal to or exceeding $2,000. For the secured lender loans in the retail sector have become more difficult due to this new legislation. This industry normally has numerous low paid full and part time employees, a reserve of $2,000 per employee would represent a material reserve against availability.

30 Day Goods Rule

The majority of lenders in the Canadian ABL industry do not reserve for 30 day goods.

Claims for 30 day goods arise pursuant to Section 81.1 of the Bankruptcy and Insolvency Act (“BIA”). Under the provisions of the BIA an unpaid seller of goods may be entitled, in certain circumstances, to repossess those goods.

The legislative intent of the 30 day goods rule is to prevent Companies from accumulating inventory immediately prior to a business failure.  The BIA provisions, and correspondingly, the provisions governing the 30 day goods rule arise only on receivership or bankruptcy.

The following conditions must be met in order to result in a valid claim:

  • A written demand must be made within 30 days of the delivery of the goods.
  • At the time of the demand the purchaser must be in receivership or bankruptcy.
  • At the time of the demand the goods are in the possession of the receiver or trustee.
  • The goods must be identifiable as the actual unpaid for goods delivered by the supplier.
  • The goods must be in the same state as they were on delivery; and
  • The goods cannot be resold.

If all the requirements above are met then the supplier is entitled to the return of goods or payment for the goods.  The 30 days goods claim ranks above all competing claims, including the claims of any secured creditor.

If asset based lenders can be primed and inventory collateral 30 days old and unpaid for can be seized, why do certain lenders impose a 30 day inventory reserve and other lenders do not?  The reasons are as follows:

  • Historically it has been very difficult for a supplier to legally establish a right to remedy under the 30 day goods rule.
  • The requirement that goods must be identifiable with the supplier is often open to interpretation.
  • The requirement that goods must be in the same state as they were delivered is also open to interpretation (i.e., if the product has been removed from its packaging does that constitute a change in the state of the goods?)
  • The case law related to the 30 day goods claims is limited.
  • The secured lender is often in a position to determine the method, structure, and timing of the liquidation of the debtor.  As a result, the lender can minimize or eliminate any potential thirty day goods claims.
 

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