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Borrowing Base and Priority Payables - International Law Office

International Law Office

Securitisation & Structured Finance - Canada

Borrowing Base and Priority Payables

November 14 2006

Eligibility of Inventory
Eligibility of Accounts
Frequency of Reports
Deductions



The amount financed in a revolving asset-based lending transaction is directly related to the borrowing base provided by the assets. Only assets that can be turned into cash in the medium-term business cycle are financed in this way - in other words, a borrower's inventory and receivables.

A lender will finance only a proportion of these assets and only if they meet certain eligibility requirements. Typically, in the asset-based lending market 60% to 65% of the value of eligible inventory and 85% of the value of eligible accounts are counted towards a borrowing base.

Eligibility of Inventory

For inventory to be eligible for inclusion in a borrowing base, it must be in good condition, currently usable or saleable in the normal conduct of the borrower's business and not obsolete. The inventory must be located in a jurisdiction in which the lender is confident that its first priority security interest would be legally enforceable. In today's legal environment, that would include any province or territory of Canada. In addition, the lender will want to ensure that the inventory is located on property owned by the borrower or, if the property is leased by the borrower, a waiver of the landlord's remedies against the inventory is obtained. Inventory located at warehouses or with third-party processors or other bailees would also require a waiver from the relevant party in order to be eligible as part of the borrowing base.

Often lengthy negotiations ensue between the borrower and the lender in respect of whether to include certain types of inventory in the borrowing base (eg, raw materials, slow-moving inventory). Typically the borrower seeks to expand the available inventory pool while the lender seeks to narrow the type of inventory that can be included to the group of goods that can most easily be sold for cash in a realization scenario. As with any type of secured lending, the prudent lender will have obtained security searches on the borrower and any prior registrations will have to be addressed before the inventory will be included in the borrowing base. Having a first lien on this collateral is fundamental to any lender in an asset-based lending transaction.

Eligibility of Accounts

An eligible account is calculated on factors including:

  • the invoice amount;

  • the net of credit balances;

  • returns;

  • offsets; and

  • chargebacks.

Some lenders will include the goods and services tax and some will remove it from the invoice amount. A lender will typically exclude the provincial sales tax in Ontario. The account debtor must be a third party unaffiliated with the borrower and must be a solvent entity usually located in the United States or Canada - jurisdictions in which most asset-based lending lenders are comfortable. Accounts from offshore customers may sometimes be included if they are covered under a letter of credit or export insurance.

A lender will want to limit the amount of accounts included in the borrowing base from any one account debtor of the borrower. After all, the lender is lending against the credit and assets of its borrower, not against those of the account debtor. In general, 10% of the total is the upper limit of any single obligor's accounts to be included in a borrowing base. A potential borrower with a few very large accounts would not usually be a good candidate for asset-based lending against its receivables.

Frequency of Reports

Depending on the type of industry in which the borrower carries on business, a borrowing base report would be provided to the lender on a weekly or monthly basis, providing the calculations of the assets that meet the eligibility criteria and determining the amounts that can be borrowed under the asset-based lending facility.

Deductions

'Priority payables' are usually deducted from the borrowing base. These are amounts secured by statutory liens that are capable of ranking ahead of the lender's liens, including employee deductions, certain taxes, wages and vacation pay. Most asset-based lending facilities also include a fairly discretionary entitlement for the lender to decrease the borrowing base by the amount of any availability reserves that the lender wishes to maintain to address changes in the borrower, its industry, the economy in general or any other risk factors. Needless to say, lenders seek to maximize their lending discretion since their funds are at risk, while borrowers seek to make the lending commitment as firm an obligation as possible, so long as the extensive borrowing-base criteria are met.


For further information on this topic please contact Nathan Cheifetz at Blake Cassels & Graydon LLP by telephone (+1 416 863 24 00) or by fax (+1 416 863 2653) or by email (nathan.cheifetz@blakes.com).



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