Credit insurance claims for commodities financing: Investigation red flags
Baldev Bhinder, Managing Director and Shane Sim, Associate Director of Blackstone & Gold highlight the key areas to look at to avoid potential fraudulent credit insurance claims in commodities financing.
The business of credit insurance does not always sit neatly with the business of commodities or invoice financing. Underwriters tasked to provide cover largely based on the creditworthiness of buyers often do not have a full understanding over the lifecycle of the trade that lenders might be privy to. This is further exacerbated in the business of invoice financing where lenders themselves might not be able to analyse and assess underlying trades, giving rise to the practice of wrapping these invoices with credit insurance. Our investigations of such trades have revealed flaws in this practice and how it is susceptible to fraud.
The most recent trend to emerge from our investigations is the use of copy bills of lading (BLs), often deployed in invoice financing. By using photocopies of BLs of actual trades involving third party shippers and notify parties, traders have sought to represent their purported involvement in ‘high seas’ transactions, but investigations have at times revealed the actual movement of goods between completely different parties unaware of the purported trade between the insured and its obligor.
Operative terms: Does it cover a physical trade or financial structure?
Some insured trades we have investigated do not actually correspond to the physical movement of goods. Documents that are often needed for the physical movement of goods such as certificates, customs forms and appropriation notices are at times missing, raising questions as to how the obligor could take physical possession of the goods. Financing structures which do not require the physical movement of goods are also not unheard of in commodities but are done by sophisticated traders with the correct documentation and most importantly with the knowledge of their lenders and counterparts. The crux of the issue is whether coverage was extended to an insured debt arising from a physical trade or a financing structure?
Understanding the true nature of the trade
Any investigation must start with teasing out the true nature of the insured trade. Trades can be done on a back-to-back, front-to-back or pre-structured basis. Each modus requires different documentation, levels of negotiation and even contracting structures with contemporaneous correspondence being useful to understand how the trade was intended to be executed and its attendant obligations for the insured in fairly presenting the risk. As lawyers dealing with commodities contracts on a daily basis, we can quickly discern if a contract envisages a physical trade and delivery of goods. From recent experience, we have come across numerous short-form contracts with wording more conveniently designed to facilitate an insurance claim rather than a sale of goods.
Title, possession and copy BLs
The concepts of title and possession, and how they are manifested in the form of BLs, are often conflated. Title or ownership, on the one hand, and possession on the other, are two distinct legal concepts. When title is to pass between parties is a function of contract or custom. Possession, however, is evidenced by the transfer of an original BL because only an original BL gives the holder constructive possession, namely, the right to demand the goods from the carrier. In that respect, an original BL, a document typically described as a ‘document of title’ may really be better understood as a ‘document of possession’. This inherent value of a BL only exists in the form of an original. A copy BL in that regard has no value as it does not transfer possession of goods, and possession is key because it relates to the concept of delivery of goods.
Transfer of the original BL and supplier payment
The original BL is the pillar of international trade for the reason just highlighted – it gives the holder the right to possession of the goods. It is for this reason that most trades typically involve payment of goods upon receipt of the original BLs. In some sectors, bypass or other arrangements are made by parties where an original BL cannot be despatched in time, but these are arrangements which are documented and done in trusted circles.
Perhaps the most critical piece of information apart from the transfer of the original BL is the payment flow and the ability of the insured to show a direct transfer of funds to its supplier correlating to the BL value rather than by an all too convenient assertion of set-off. The payment flow is critical because it often dovetails with the passing of title from the supplier to the insured.
Due diligence, risk mitigation and purpose of credit insurance
In drawing out the web of relationships between various parties, it is not uncommon to find connections between the controllers of the insureds and their obligors. Upon further investigation, the nature of this web gets more complex – with insureds and obligors reversing their roles on other trades either directly or by using related entities. This makes it tricky to understand when the insured has increased its risk and breached warranties as to clauses such as maximum extension periods.
We also find poor credit assessments of the buyers done by the insureds and their lenders with many ironically relying on underwriters to provide that assessment. A critical understanding of how a company gives credit and its tools for risk mitigation appears lacking, which will inevitably be crucial to understanding what we see as a key issue – understanding the purpose of obtaining credit insurance. Presentation of risk during onboarding are at times fragmented at best and during investigations, the scale of over-reliance on credit insurance becomes apparent suggesting that the credit insurance product was sourced as a means to get financing rather than to act as a risk mitigant.
