Forfaiting

Practical Law UK Practice Note 2-201-7489

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Forfaiting, Practical Law UK Practice Note 2-201-7489

Forfaiting
by Practical Law Finance

Practice notes | Law stated as at 22-Feb-2023 | England, Wales

A practice note on forfaiting, explaining the key elements of a forfaiting transaction and setting out
the advantages of forfaiting as a finance technique for the different parties involved.

What is forfaiting?
Forfaiting is a form of finance involving the purchase of a debt from a creditor (typically a seller of goods) by a
finance company (forfaiter) at a discounted price and without recourse to the creditor. It is typically used to finance
international supply chains and provides the seller of goods with ready cash, the buyer with a means of credit, and
the forfaiter with income from the discounted sale of the debt, including through fees and interest payments.

In a typical forfaiting transaction, the buyer delivers a negotiable instrument (such as a bill of exchange or
promissory note) to the seller in exchange for the goods. A forfaiter then buys the negotiable instrument from the
seller at a discounted price. The forfaiter agrees to waive its right of recourse against the seller if the buyer does
not pay the debt. Once the negotiable instrument matures, the forfaiter claims payment from the buyer, or it sells
the negotiable instrument before maturity in the secondary market.

Forfaiting deal structure

When is forfaiting used?

While forfaiting is a flexible form of finance that can be used in relation to various commodities and financial
instruments for varying periods of time, it is typically used to provide medium term finance (three to five years)
for export trade transactions worth between $100,000 and $200 million. A forfaiter would not normally expect
to finance transactions valued at less than $100,000.

Forfaiting can also be used within the structure of a larger finance transaction, for example to make a long term
loan facility liquid, and for credit periods as short as 90 days and as long as 10 years.

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Forfaiting, Practical Law UK Practice Note 2-201-7489

Since forfaiting is 100% financing (that is, it is available for the full payment amount), it is suitable for debtors
who do not wish to make a cash outlay in advance.

Key elements of a typical forfaiting transaction

Contract between seller and buyer

Under the contract, the seller agrees to sell goods to the buyer in exchange for a negotiable instrument from the
buyer. Although the payment obligation arising under the negotiable instrument is separate from the underlying
contract between the buyer and seller, the forfaiter will want to establish the nature of the contract for various
reasons, including:

• Whether the forfaiter is assuming many risks by providing the finance. For example, the nature of the
goods may have political ramifications that would affect the likelihood of the forfaiter being repaid.

• When trading in the secondary market (see The secondary market), the forfaiter may have a duty of
care to future forfaiters of the negotiable instrument to ensure that its description of the underlying
transaction is accurate. It will therefore seek representations and warranties from the seller in the
forfaiting agreement (see Forfaiting agreement) to establish the nature and good faith of the transaction,
as well as undertaking sufficient due diligence if it does not know the seller well.

Negotiable instrument

A negotiable instrument, such as a bill of exchange or promissory note, is usually used to evidence the debt
obligation of the buyer under the contract for sale. It will have a maturity date and will be for the amount of the
sale price of the goods plus interest at a fixed rate from issue date to maturity date. Alternatively, the financing
price may be included in the price of goods agreed between the seller and the buyer, in which case the amount
of the instrument will be for the sale price alone.

The negotiable instrument will usually be denominated in one of the major currencies, with euro and US dollars
being the most common.

Sale of negotiable instrument to the forfaiter at a discount

The seller sells the negotiable instrument to the forfaiter at a discount. The discount represents the risk that the
forfaiter is assuming in respect of the debt as a result of the sale being on a without recourse basis (see Risks
assumed by the forfaiter).

Forfaiting agreement
It is usual for the sale to be evidenced by a forfaiting agreement, even though the debt is evidenced by a negotiable
instrument. A forfaiting agreement gives certainty to the transaction and allows the seller and the forfaiter to set
out all the terms including the without recourse nature of the sale.

A typical forfaiting agreement will set out:

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Forfaiting, Practical Law UK Practice Note 2-201-7489

• Assignment and discounting arrangements.

• The fees for the transaction, including interest rates.

• Representations and warranties from the seller in respect of the underlying contract between the seller and
the buyer.

• The fact that the sale is without recourse to the seller (see Without recourse).

• The duration of the forfaiting agreement and provisions relating to termination.

• Standard boilerplate provisions such as governing law and jurisdiction clauses.

The International Chamber of Commerce (ICC) Uniform Rules for Forfaiting (URF 800), which came into force
on 1 January 2013, include model forfaiting agreements (see ICC Uniform Rules for Forfaiting). For a template
New York law-based forfaiting agreement, see Standard document, Forfaiting Agreement.

Master forfaiting agreement

The seller may wish to finance multiple future transactions through forfaiting. In such cases, the seller and forfaiter
may enter into a master or framework forfaiting agreement containing the terms and conditions under which
future sales of negotiable instruments can be concluded once a particular transaction has been identified. The
master agreement will have a forfaiting agreement appended to it, and will usually provide for either the seller
or the forfaiter to offer to sell or buy a negotiable instrument under a relevant underlying transaction by sending
the other party a forfaiting agreement in the form appended to the master agreement.

Without recourse

Once the seller has sold the negotiable instrument to the forfaiter, the forfaiter waives (forfeits) its right to recourse
against the seller if the buyer fails to pay. This is a distinctive feature of forfaiting that distinguishes it from other
forms of debt discounting. It is unusual because buyers of negotiable instruments usually have rights against the
seller if the instrument is not honoured. The seller will however be liable in respect of any representations it has
made to the forfaiter in relation to the debt or the debtor, for example, if it has acted fraudulently.

In order to ensure that the transaction is without recourse, the seller should check that a provision limiting liability
is included in the forfaiting agreement and that the negotiable instrument is endorsed "without recourse".

It is important to note, however, that the model forfaiting agreement annexed to the URF 800 does not explicitly
mention recourse. Instead, it incorporates the URF 800 and relies on Article 4 of the URF 800 to establish that
the forfaiter purchases without recourse. Article 4(a) states:

On the settlement date, the seller sells to the buyer and the buyer purchases from the seller
the payment claim without recourse. The buyer will have no claim against the seller or any
prior seller for the non-payment of any amount due in respect of the payment claim except
as provided under article 13 or article 4b.

URF 800 Articles 13(a) and (b) cover liabilities of the seller (exporter) to the forfaiter in cases of fraud and failure
to disclose material adverse information to the forfaiter. URF 800 Article 4(b) covers situations in which the seller
has obligations under the negotiable instrument or the bank guarantee.

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Forfaiting, Practical Law UK Practice Note 2-201-7489

If parties to a forfaiting transaction intend to modify the URF 800 model forfaiting agreement, they must be
sure to include the provision incorporating the URF 800, or they must draft their own provision stating that the
purchase is without recourse. For a sample forfaiting transaction without recourse clause, see Standard document,
Forfaiting Agreement: 3. Without Recourse.

Risks assumed by the forfaiter

Partly as a result of the without recourse nature of forfaiting, the forfaiter assumes a number of risks which the
seller would otherwise be subject to, including the:

• Credit risk of the buyer and the avaliser or guarantor of the negotiable instrument.

• Risk of adverse exchange rate movements.

• Political risk of a negotiable instrument not being paid (for example, a freeze on payments from a
particular country or the outbreak of war).

• Transfer risk posed by the unavailability of sufficient foreign currency, or the imposition of exchange
controls prior to maturity of the instruments. These constraints may be imposed by the state bank of the
buyer's country. This is a risk similar to those faced in sovereign lending transactions.

• Inherent legal risks due to the cross-border nature of the transactions and associated contractual
relationships because issues relating to international law and conflict of laws may arise. Since forfaiting
relies on simple documents, when things go wrong the forfaiter may have to rely on market practice and
local statutory or common law in the relevant jurisdictions.

Effect of on-selling in the secondary market

Although the on-selling of the negotiable instrument by the forfaiter does not generally have an impact on the
seller, the forfaiting agreement will usually contain a provision requiring the primary forfaiter to obtain an
undertaking from any subsequent forfaiter stating that it will have no recourse to the seller.

Aval or guarantee from buyer's bank

It is common for the buyer's debt under the negotiable instrument to be guaranteed or avalised by the buyer's
bank. The forfaiter can then present the negotiable instrument, once it has matured, either to the buyer or to the
buyer's bank for payment.

An aval is an unconditional, irrevocable, divisible and freely assignable and transferable guarantee to pay on the
due date. In countries such as the UK where avals are not recognised by law, bank guarantees may be used as an
alternative. The guarantee should be an unconditional, irrevocable and freely transferable guarantee under which
the guarantor is in the position of principal debtor.

Although avals do not exist under English law, English courts recognise them in respect of forfaiting transactions
involving non-English negotiable instruments.

The secondary market

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Forfaiting, Practical Law UK Practice Note 2-201-7489

Instead of holding the negotiable instrument until maturity, the forfaiter may sell it to a secondary forfaiter by re-
discounting the debt in the secondary market. This gives the primary forfaiter the benefit of immediate payment
and the ability to spread its risk.

Even though the secondary forfaiter buys the negotiable instrument without recourse to the primary forfaiter, it
is generally considered the responsibility of the primary forfaiter to establish the nature and legitimacy of the
underlying transaction between the buyer and the seller (see Contract between seller and buyer). However, if the
secondary forfaiter sells the negotiable instrument to another forfaiter, it will be liable to that forfaiter for any
misrepresentation in respect of the underlying transaction. Each party in the chain of transactions will want to
claim back from the party it bought from, so each party should ensure that there are similar grounds for recovery
under its agreement with the party it has bought the negotiable instrument from as well as the party it has sold the
negotiable instrument to, especially where the forfait is multi-jurisdictional.

Advantages of forfaiting
Forfaiting offers different benefits for each of the parties involved in the transaction.

Seller

The seller:

• Receives cash immediately in respect of the buyer’s debt.

• Is not subject to various risks associated with the transaction which are assumed by the forfaiter (see Risks
assumed by the forfaiter). This means that the seller is able to sell its goods in riskier markets. However,
as a consequence, the amount the seller receives for the transaction will be lower than if it were assuming
the credit risk itself.

• Can attract more buyers as it is able to offer credit terms.

• Incurs fewer administration costs since it is not required to carry out debt collection in the event of the
buyer’s default. However, forfaiters may use more rigorous debt collection procedures, which could sour
the relationship between the seller and its buyers. To remedy this, the seller could retain the option to
repurchase the debt from the forfaiter, and only allow the forfaiter to pursue the buyer if the seller does
not exercise this option.

Buyer

The buyer:

• Is able to get credit from the seller on more favourable terms as the seller does not assume many of the
risks associated with the transaction.

• Can forward plan and budget more easily, since all costs and revenues are pre-determined.

• Incurs generally fewer costs than if it used other sources of finance such as bank loans.

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Forfaiting, Practical Law UK Practice Note 2-201-7489

Forfaiter

The forfaiter:

• Receives income through interest payments and fees, and a profit resulting from the discounted sale of the
negotiable instrument.

• Is able to offer its customers (the sellers) an additional product.

Documentation
Documents for forfaiting arrangements will usually be limited to:

• A forfaiting agreement between the seller and the forfaiter (see Forfaiting agreement).

• The negotiable instrument.

• A copy of the supply contract between the seller and the buyer.

• A letter of guarantee (or aval) of the negotiable instrument.

• Letters of assignment and notification to the guarantor.

• A letter of credit, if the debt is payable under one.

• A copy of the signed commercial invoice.

• A copy of all the shipping documents and certificates of receipt.

Industry Custom

International Trade and Forfaiting Association

The International Trade and Forfaiting Association (ITFA) is the worldwide trade association for companies,
financial institutions and intermediaries engaged in trade and forfaiting transactions. Founded in 1999, it brings
together banks and financial institutions who are engaged in originating and distributing trade related risk.

ICC Uniform Rules for Forfaiting

On 1 January 2013, the URF 800, including Model Agreements, came into force. The URF 800 are a set of rules
that reflect a broad consensus among bankers, users and members of the forfaiting community. They cover both
the primary and secondary forfaiting markets, and aim to help avoid misunderstandings, harmonise best practice
and facilitate dispute settlement. The URF 800 were endorsed by the United Nations Commission on International
Trade Law (UNCITRAL) in July 2017.

The URF 800 apply to a forfaiting transaction only where the parties have expressly indicated that the transaction
is subject to the rules. By incorporating the URF 800 in a forfaiting agreement, the parties in effect agree that

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Forfaiting, Practical Law UK Practice Note 2-201-7489

the URF 800 rules are to be treated as agreements, covenants, and warranties in the forfaiting agreement itself.
The URF 800 does not replace or modify the law that governs a forfaiting transaction. Forfaiting agreements
usually have a separate governing law provision.

The following model agreements annexed to the URF 800, while not mandatory, aim to make it easier for parties
to incorporate the URF 800 in their dealings:

• Master forfaiting agreement (see Master forfaiting agreement).

• Forfaiting agreement (see Forfaiting agreement).

• Forfaiting agreement in SWIFT format. A forfaiting agreement to be used where the transaction is being
concluded by SWIFT.

• Forfaiting confirmation. A forfaiting confirmation contains the terms of sale of a negotiable instrument
in the secondary forfaiting market (see The secondary market). The signed confirmation is sent by a
primary forfaiter to a secondary forfaiter once the parties have agreed the terms of sale. The secondary
forfaiter must sign the confirmation and return it to the primary forfaiter.

The URF 800 can be ordered from the ICC bookshop. For further details, see Legal update, New ICC uniform
rules on forfaiting (URF).

END OF DOCUMENT

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