Introduction
There has been a significant increase globally in (volume of) asset based financings over the last couple of years and expectations are that this trend will continue in the foreseeable future. Key drivers behind the popularity of asset based financings are, among other things, (i) cost efficiency (it provides an improved security structure to lenders, resulting in reduced margins), (ii) flexibility (an asset based facility accommodates swings in working capital requirements, contrary to traditional cashflow-based lending) and (iii) unlocking cash from assets (cash is no longer ‘locked up’ in inventory or outstanding receivables, but available immediately for application towards working capital). According to the Factoring & Asset Based Financing Association Netherlands (‘FAAN’), factoring volumes in the Netherlands alone have increased from 112 billion euros in 2019 to 168 billion euros in 2023. As a result, FAAN has recently launched its template FAAN borrowing base ancillary facility document (including guidance note and term sheet) for use in the Dutch market. The four leading Dutch asset based lenders and several (international) law firms have contributed to this template, including Stek. The format provides for receivables financing and, as an option, inventory financing. This standardisation of documentation will make it even more attractive for lenders and borrowers to opt for this type of financing.
The inventory financing option requires (in the eligibility criteria, i.e. the conditions applicable to, in this case, inventory which must be complied with to have such inventory eligible for inclusion in the borrowing base), among other things, that the inventory is stored on premises owned or leased by the borrower or held at an approved third party site, in each case in approved jurisdictions. This is too restrictive for borrowers which have inventory or other goods in transit on a continuous basis (e.g. international suppliers and producers of (raw) materials or (semi) finished products). If there is substantial value involved, they will be looking for a way to include such goods in transit in the borrowing base. For the Netherlands, this is particularly relevant given its function as a gateway to Europe. In order to allow for ‘sailing inventory financing’, the asset based lenders will set additional conditions. An important aspect the asset based lender will be looking at are title documents and security rights to be created on such title documents.
Goods in transit and the bill of lading
Each transportation method has its own transportation or title documents. This blog focuses on transportation of goods by ship (as this is what we mostly come across in the market). The title document used for transportation by ship is a bill of lading (B/L) (cognossement). The carrier of the goods will issue the B/L covering the goods that will be transported on account of that carrier and as of that moment the B/L embodies the cargo to which such B/L relates (section 8:417 Dutch Civil Code (Burgerlijk Wetboek)). The B/L entitles the holder to claim the cargo (section 8:441 Dutch Civil Code). The B/L (as a title document) is not to be confused with a ‘sea waybill’ (zeevrachtbrief, which is not a title document, but only a transportation document).
The B/L includes vital information on the shipment (such as details on the goods, ports of departure and destination and details of the shipper, carrier and consignee (reference is made to section 8:399 Dutch Civil Code, setting out the information to be included in a B/L, and section 8:412 Dutch Civil Code, stipulating the minimum requirements of a B/L) and has three primary functions: it evidences a contract of carriage (sometimes printed on the back of the B/L), it is a receipt of the transported goods and, most relevant to the asset based lender, it is a title document (reference is made to section 8:377 of the Dutch Civil Code, setting out characteristics of the B/L under Dutch law). The B/L is generally issued in multiple originals (and the number of originals and copies will be stated on the B/L), usually three originals (one for the carrier, one for the shipper and one for the consignee (i.e. the borrower)). In this respect, reference is made to section 8:413 of the Dutch Civil Code. In case of a negotiable B/L (please see the paragraph below), this section stipulates that one B/L is sufficient to claim the cargo.
Types of bills of lading
There are two main categories of bills of lading: a negotiable B/L and a non-negotiable B/L. If the B/L stipulates that the cargo is to be delivered ‘to bearer’ (a ‘bearer bill’ (cognossement aan toonder)) or to be delivered ‘to the order of (name)’ (an ‘order bill’ (cognossement aan order)), the B/L qualifies as a negotiable B/L. If the B/L instead stipulates that the shipment is to be delivered to a specific consignee, the B/L is non-negotiable (cognossement op naam). A non-negotiable B/L is not suitable for use in an asset based financing as only the named consignee is entitled to claim the goods on the basis of the original B/L (and the B/L cannot be endorsed (endosseren) to another party). Under Dutch law, the only way to assign (overdragen) a non-negotiable B/L would be by means of a deed of assignment (akte van cessie) and notification thereof (to the holder) which is evidently impractical.
An order bill (cognossement aan order) can be endorsed by the holder to a third party. In order to validly transfer an order bill (and a bearer bill) under Dutch law, the bill must (in case of an order bill, in addition to the endorsement) be brought in the possession (macht) of the transferee (verkrijger). It is also possible to have the holder endorse the order bill in a blank form (blanco endossement), without naming a specific person. A blank endorsement is often referred to in the eligibility criteria of sailing inventory imposed by asset based lenders. The main reasons (further explored below) for stipulating the requirement of a blank endorsement are (i) control over the B/L and (ii) creation of security.
It is argued in Dutch legal literature that an order bill which is endorsed in a blank form, converts into a bearer bill (cognossement aan toonder). Although there is no reference in the Dutch Civil Code to such conversion of bills of lading, a similar construction does apply to bills of exchange and cheques (wisselbrieven en cheques) under Dutch law. Certain authors therefore argue that a similar conversion should be applied to bills of lading. Relevant in this respect is that the Dutch Civil Code does not define what exactly constitutes a bearer bill (or of any type of bill of lading in fact). In the absence of such definition, it makes sense to look at the similarity between the blank endorsed order bill and a bearer bill, being that the cargo can simply be claimed by the person holding the B/L (without any need for identification or other verification of entitlement). Interestingly, the Judicial Council (Raad voor de rechtspraak) wrote an advice in February of this year in relation to the draft bill on the implementation of electronic bills of lading (wetsontwerp tot wijziging van Boek 8 van het Burgerlijk Wetboek in verband met de invoering van het elektronisch cognossement), explicitly stating that a blank endorsed order bill converts into a bearer bill. As this draft bill is only in the first stages of the legislative process, it will not be further discussed in this publication.
This (technical legal discussion) brings us to the first (technical) matter of attention for asset based lenders. Currently, the eligibility criteria often state that the B/L needs to be ‘to order’ and blank endorsed. As we have seen above, it could be argued that a blank endorsement results in the B/L to qualify as a bearer bill. In order to cover both possibilities, the criteria could simply state that the B/L as originally issued (by the carrier) needs to be an order bill, which is subsequently been blank endorsed (not stipulating explicitly how the B/L should be qualified after such blank endorsement). However, the distinction is relevant in connection with (i) the formalities required for creating a right of pledge over the B/L (as set out below) and (ii) the rules of Dutch international private law determining the law governing the property law aspects (goederenrechtelijk regime) of the B/L (being section 10:135 Dutch Civil Code in case of an order bill and section 10:136 Dutch Civil Code in case of a bearer bill).
Under Dutch law, it is ultimately a matter of interpretation (uitleg) whether a B/L is ‘to bearer’, ‘to order’ or non-negotiable. When reviewing a B/L, the asset based lenders should determine whether the B/L is by it terms set ‘to order’ (which should be stated on the B/L literally) and whether the B/L has indeed been blank endorsed.
In order to further identify the legal status of the B/L, it is important to note that a B/L does not evidence ownership of the goods. The holder of a B/L can claim receipt of the goods (afgifte vorderen). The ownership of the goods is determined on the basis of the underlying sale and purchase agreement. The B/L provides the holder ‘control over the goods’ (as it would probably be quite challenging to take receipt of 200,000 tons of raw material in person).
Right of pledge on bills of lading
Under Dutch law, order bills and bearer bills can be pledged by means of a possessory right of pledge (vuistpandrecht). In both cases, the B/L should be brought in the possession (macht) of either the pledgee or a third party in respect of whom parties have agreed that such third party takes possession of the B/L (section 2:236 paragraph 1 Dutch Civil Code). Having a third party take possession of the B/L is regularly used by asset based lenders, in particular in case such third party (another bank, often an affiliate of the asset based lender) arranges for documentary import collection (‘cash against documents’) or documentary import credit required for the payment of the cargo. A bearer bill can also be pledged by means of an undisclosed right of pledge (stil pandrecht) (section 2:237 paragraph 1 Dutch Civil Code), but asset based lenders rarely use this option as it will not provide them with the same rights they would have under a possessory right of pledge.
In addition to the above, in case of an order bill, the B/L should be endorsed (section 3:236 paragraph 1 Dutch Civil Code). It is not required that the endorsement refers to it being made for the purpose of the creation of a right of pledge, although it is not a problem if it does state this.
There is no benefit in having the endorsement made to a specific asset based lender (or security agent): the asset based lender has no interest in dealing with the cargo itself but wants to be able to transfer the cargo to a third party on enforcement, with as little formalities as possible. Therefore, in practice, the parties opt for a blank endorsement. As another upside, this avoids the necessity of further endorsement should the pledgee be replaced by a successor pledgee under the asset based financing.
Asset based lenders should ensure strict compliance with the requirements for creating a possessory pledge. Sometimes, the eligibility criteria (implicitly or explicitly) allow for the B/L to be/remain in the control of the borrower/pledgor. This does not work in case the asset based lenders expect to have a possessory right of pledge on the B/L: section 3:236 paragraph 1 Dutch Civil Code requires the pledgor to bring the B/L in the possession of the pledgee or an agreed upon third party as a constitutional requirement (vestigingshandeling). Although it is not stated literally, it follows from the system of Book 3 of the Dutch Civil Code that the pledgor should bring the B/L in the possession of the pledgee, including endorsement, and not, for instance, by the carrier sending the B/L (issued to the order of the pledgee) directly to the pledgee (for further exploration of this interesting topic, please refer to the highly recommendable article written by Van Maanen and professor Claringbould (Aspecten van pandrecht op cognossementen) in Nederlands Tijdschrift voor Handelsrecht 2017-1)).
Rights of pledge on the inventory
Additionally, asset based lenders should be aware that a right of pledge on the B/L is not the same as a right of pledge on the inventory itself. If the pledgee would enforce its right of pledge over the B/L, it effectively enforces its right of pledge on the right that the B/L represents, i.e. a right to claim goods. It is therefore that the eligibility criteria in relation to sailing inventory should always require the inventory itself to be pledged as well.
In practice, the inventory itself is pledged by means of a non-possessory right of pledge (bezitloos pandrecht) in accordance with section 3:237 paragraph 1 Dutch Civil Code. As soon as the cargo arrives in the Netherlands, it is captured by the deed of pledge as long as such deed provides for a right of pledge (i) on movable assets of the borrower located in the Netherlands from time to time and (ii) in respect of any movable asset owned by the borrower which is located outside the Netherlands on the date of the deed of pledge or afterwards, under the condition precedent of such asset being located in the Netherlands. As a result Dutch law will apply to the creation of the right of pledge in accordance with Book 10 of the Dutch Civil Code (setting out the rules of Dutch international private law) and the right of non-possessory pledge on inventory (previously in transit) is created automatically upon arrival of the cargo in the Netherlands.
It is noted that section 10:133 Dutch Civil Code refers to the lex destinationis in relation to the property law aspects (goederenrechtelijk regime) of goods in transit. On the basis thereof, the property law aspects of goods in transit may be governed by Dutch law as soon as the cargo is in transit with a port of destination in the Netherlands. However, paragraph 2 of the aforementioned section is (unfortunately) unclear on under which circumstances a choice of law (in the sale and purchase agreement or any other agreement including the obligation to transfer the goods) prevails.
