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What is Supply Chain Finance and How Does it Work?

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In business, a frequent cause of disquiet and disruption are disputes around payment terms between an enterprise and its suppliers.

While the process works if a business reliably honours the 30 or 60-day (or any other number of days stipulated on the invoice) payment terms, when a supplier is not paid on time for the goods or services they provide, disputes can arise which sometimes end in legal action.

A concept known as ‘supply chain finance’ (SCF) has emerged in recent years to obviate some of the common problems which arise in paying suppliers.

In essence, it involves a range of products offered by financial institutions such as banks whereby suppliers to large businesses (usually) can have their invoices paid early. Typically the financial institution enters into an agreement with the supplier, allowing the latter to nominate when they want to be paid. This method can guarantee the supplier is paid as soon as 10 days after delivery of their goods or services to the larger business.

The fee scheme for this service is based on the credit rating of the business. The higher the credit rating of the business, the lower the fees charged for requesting early payment. The size of the fee also increases depending on how early the supplier wishes to be paid or, in some instances, how much the face value of the invoice is discounted.

Telstra and Rio Tinto were examples of large corporations that previously used SCF in paying their suppliers, though both have now abandoned the practice.

SCF is also referred to as ‘reverse factoring’ because it is similar to debt factoring, which has existed for many years and allowed a supplier to sell a portion of an invoice – usually 80 per cent – to a bank or financier for payment. The bank then collected payment of the invoice later.

What are the advantages and disadvantages of supply chain finance?

For large companies SCF allows them to extend formal payment terms to suppliers through structured payments under the agreement. Depending on how early the supplier is paid, the invoice provided is also discounted, improving the cash flow position of the business.

For suppliers, the method provides more certainty as to when they will be paid and allows them access to finance on more economical terms than credit or a bank overdraft, for example, based on the purchaser’s credit rating.

The rise of SCF, however, has now brought the attention of regulators. The inequality in bargaining position between larger companies and smaller suppliers has facilitated accusations that organisations employing SCF have used it to pressure suppliers into accepting extended payment terms and discounted invoices, as well as disguising cash flow shortages in the business.

What action has been taken?

The Australian Small Business and Family Enterprise Ombudsman (ASBFEO) conducted a review of SCF activities in March 2020. The Australian Competition and Consumer Commission (ACCC) also reminded those employing SCF that small businesses who are suppliers would be protected under Australia’s competition and consumer laws.

The ASBFEO report made a number of recommendations, including:

  1. Introduction of a consistent definition of ‘small business’ for the purposes of payment times legislation and unfair contract terms (UCT) legislation;
  2. legislating a 30-day maximum payment term for small business suppliers;
  3. SCF providers ensuring that the product is only being provided to companies that have a maximum payment time of 30 days in respect of small business suppliers;
  4. Australian accounting standards to be clarified in respect of the use of SCF and guidelines to be provided in relation to the disclosure; and
  5. the ACCC and the Australian Securities and Investments Commission (ASIC) look further at the application of the competition and consumer law, and financial services law, with regard to SCF.

In November 2020, the ACCC gave an indication of its future intentions in this area when it highlighted the case of engineering company UGL.

It was alleged that UGL had of its own accord extended its payment terms from 30 to 65 days on new purchase orders and that it was advising suppliers requiring earlier payment to contact finance company Greensill Capital. It was further alleged UGL had told some suppliers that they would need to accept a discount on their invoice, in order to be paid earlier.

In response to the allegations, UGL announced it would restore shorter payment terms for its small business suppliers, by moving from 65 days back to 30 days payment terms.

‘Supply chain financing is not unlawful, and in some cases can be a good option for small businesses,’ said ACCC chairman Rod Sims. ‘However, we are keen to ensure that supply chain financing is not used to push out payment terms for small business suppliers or require them to accept a discount in order to be paid within 30 days…’

How legal advice can help

At South Geldard Lawyers we have detailed experience in business law issues such as the implications of entering an SCF agreement.

If you have encountered this method of payment for your goods or services, or are interested to know more, including the changing regulatory environment, contact us at Rockhampton lawyers today. We can help you become informed and knowledgeable about the practice, and whether it can work for your business.

It is important to seek specific advice regarding your circumstances as this fact sheet provides general information only and does not constitute legal advice.