Non-payment debtor risk in case of force majeure

Sergii Karasov, lawyer and project manager for international factoring, Faktoro, Lithuania, give us some hints on how to cover debtor non-payment risk based on force majeure.

In the light of the current crisis associated with the pandemic coronavirus (COVID-19), the receivables financing industry may face the increase of non-performance payment obligations risk from the debtor. Additionally, it is necessary to highlight the situation when supplying of goods or services will not be paid on time due to the fact that invoices have been issued on the ground of force majeure clause.

In principal, force majeure clause should not affect supply chain finance which is typically short dated and used as a working capital tool for suppliers. However, a force majeure clause covers coronavirus isn’t enough on its own. The debtor needs to show that he can’t perform the sales and factoring contract because of the circumstances beyond his control. He also needs to show that there were no reasonable steps he could have taken to avoid or mitigate the risk or its consequences.

If the supplier has fulfilled the obligation to deliver goods to the buyer or performed the service, he should still be paid.

In the order to perform a due diligence, it is important to determine the law which governs the commercial contract and how this contract defines the force majeure event.

Nowadays, the civil law of Lithuania, Ukraine and Russia provides that business risks (such as lack of the goods to be supplied, non-performance of payment obligations or lack of the funds) cannot be treated as force majeure events. In other jurisdictions where this wording is not explicitly stipulated in the law, it is essential to indicate it in the factoring agreements and any other related documents that are signed between the parties including the debtor.

To ensure the financial institution’s protection providing receivables financing and taking into account the risks arising from pandemic coronavirus (COVID 19), some measures can be taken such as:

  • during the due diligence process to determine which law governs the commercial contract and how the commercial contract defines the force majeure;
  • if the law applicable to the factoring agreement and commercial contract does not clearly define the exemptions of force majeure, it is necessary to directly include this in the factoring agreement itself, in the notification of the debtor and in the tripartite covenant including the debtor if any;
  • the parties to the factoring agreement should agree not to terminate the contract without the consent of the financier, so he can still have a chance to recover his finance, in case the debtor refuses to pay invoices due to force majeure;
  • allowing the financier to obtain key information and be involved in any discussion;
  • the financier should notify the debtor that force majeure will not entitle him to make any reduction in payment for goods and services already accepted from quality and quantity point of view.
  • It is very important to keep the wheels of the economy rolling and stand by the clients during the crisis, but much more valuable for factoring businesses is to protect itself against the rising non-payment risks associated with these difficult times.