Understanding warehouse receipts in a changing world
Morris Blumenthal and Ursula Owczarkowski, lawyers in
- DLA Piper’s structured trade and commodity finance group, briefly review the nature of warehouse receipts and some developments in Sub-Saharan Africa.
A failure to understand the value of a particular warehouse receipt can prove a costly experience. This article briefly surveys the nature and functions of warehouse receipts, their varying legal qualities and how the law is changing, incorporating a focus on several jurisdictions in Sub-Saharan Africa.
As a very general description, a warehouse receipt (WR) is a document issued by a warehouse operator (storer) which confirms that a specific quantity and quality of a particular commodity has been deposited for storage in a specific warehouse and is held to the order of a particular person.
A system of WRs can be used to facilitate trade in commodities and the provision of finance backed by them. In particular, if financiers have comfort that commodities exist as described and are being stored appropriately, it is much easier for the owner of the goods to acquire finance secured on them.
In some instances, the owner’s market and thin balance sheet might limit the availability of other types of finance. In addition, when purchasers generally have a similar confidence and the necessary information to complete a transaction without having to physically inspect goods, it becomes possible to trade in the goods on an unseen basis which is more efficient.
For producers of agricultural commodities, the ability to store produce in a reliable way in itself offers opportunities to maximise returns by spreading sales over time rather than being forced to sell at low prices during harvest time. Market regulators have also seen the value WRs can bring toward the goal of price stabilisation.
A negotiable or transferable instrument
From the perspective of a finance provider, it is important to understand that the value of a WR is dependent upon a number of legal and institutional factors which vary between jurisdictions. On the legal side, the law must prescribe the rights and obligations of each party to a WR, the means of transfer of the WR and the entitlement of each subsequent holder of the WR.
In particular, it is important to understand whether or not in the relevant jurisdiction a WR may have the qualities of being a ‘negotiable instrument’. The holder of a negotiable instrument can in some circumstances acquire the right to sue under the instrument in his own name free from defects in the title of previous holders and free also from certain adverse rights which affect previous holders.
Conversely, the holder of an instrument which is not negotiable may find his own title is defective because of circumstances relating to the manner of acquisition of the instrument by previous holders (for instance, theft). They may also be affected by counter claims and defences which arose between parties prior to their acquisition of the instrument (for instance, a right to set off unpaid sums).
Financiers concerns about this key point, in part, led to the Indian Warehouse (Development and Regulation) Bill 2005 (under consideration at the date of writing) which amongst other matters, aims to allow WRs to be negotiable instruments.
Another key variant between jurisdictions is whether or not WRs are accorded the status of being documents of title as opposed to evidencing only contractual rights. In the latter case (and under English law) a pledge of the underlying goods cannot be constituted merely by possession of a WR (written for the benefit of the party giving security) as it offers no ‘constructive possession’ of those goods (of course, attornment by the storer can offer an alternative route to that ‘constructive possession’, ie, all parties, including the storer, agreeing that the storer shall hold the goods to the order of the party intended to be secured).
For obvious reasons, in an insolvency scenario having a document of title is preferable to holding a contractual right.
Institutional and practical factors
On the institutional side, the availability of dispute resolution systems able to provide quick and certain results can significantly affect risk. There ought also to be an independent licensing and monitoring system. Some form of financial security for performance by the storer, such as an indemnity fund, is also considered by many to be a prerequisite of a proper system for using WRs.
In developing jurisdictions, a flexible approach to funding such systems is needed to avoid that requirement hindering development. The absence of such performance protection provides greater opportunities for private collateral managers, but that is more expensive for borrowers and may inhibit the use of the WR system.
Regardless of the law, the storage industry itself in the relevant jurisdiction must be sufficiently advanced and have the capacity to perform the role ascribed to it before risks can be mitigated to a bankable level.
In some jurisdictions, such as the US, the laws governing WRs are relatively well developed and the results of their application may be relied upon. The United States Warehouse Act (USWA) was established as long ago as 1916 and developed a federal licensing system for warehouses (individual states have also enacted relevant legislation).
The federal government inspects and audits warehouses licensed under the USWA to ensure that such warehouses are in compliance with the applicable regulations. A revision to the USWA was enacted in 2000 which expanded the use of electronic WRs in the US (they had been used in the cotton industry since 1993). A broader uptake of dematerialised WRs looks certain there and in other jurisdictions.
Elsewhere in the world, as you might expect, the level of development of WR systems is quite varied. In some jurisdictions there is no specific legislation (for example, Serbia), in others legislation is being drafted (for instance, Croatia) and in others new legislation has just been passed and is now being implemented (such as Indonesia).
In some instances a legal framework for WRs has been created which is relatively complex. For example, in Russia the law (under consideration for reform) includes ‘double warehouse certificates’, ‘simple warehouse certificates’s and a ‘warehouse receipts’s – all of which vary in their legal qualities. Russia also illustrates the need to appreciate security over WRs in the context of the laws on the enforcement of that security, as in the case of each of the above the process for disposal of the pledged property necessarily involves a public auction.
Three African examples
The remainder of this article focuses on three jurisdictions – Tanzania, Uganda and Zambia – in each of which the law has undergone recent change.
The Warehouse Receipts System Bill (WRS Bill) was passed by parliament in Uganda in April 2006 and awaits presidential assent. The WRS Bill recognises WRs as documents of title and provides for the regulation of warehouses and warehouse operators.
This has followed on from some ‘on the ground’ initiatives such as a cotton WR system project (almost 100,000kg of seed cotton had been deposited in warehouses owned by the Nyakatonzi Cooperative Union by February 2006 – one month into the trial).
Trials of WR systems for the coffee and cotton industries have been operating with some success in Tanzania since 2000/01. Broader uptake is certain to be encouraged by the Tanzania Warehouse Act No10 of 2005 (WRA) which was given presidential assent in June 2005.
The act, together with the accompanying regulations (2006), provides a regulatory framework in mainland Tanzania for WRs, licensing procedures and other related matters. Section 4 of the WRA established the Tanzania Warehouse Licensing Board which has been tasked a variety of functions including grading warehouses, licensing and inspecting operations, as well as with the establishment of market mechanisms to ensure the increasing involvement of the WR system in commodities trade, possibly including the establishment of a commodities exchange.
In addition to maintaining insurance against fire and theft, warehouse operators are required to provide a bond annually to the board equal to 10% of the value of the goods stored which may be called upon by any person injured by breach of the warehouse operator’s obligations under the WRA.
The WRA encourages the use of licensed warehouse inspectors by denying remedy under the act to those who don’t do so. The WRA introduced a presumption that, unless stated otherwise, WRs are negotiable.
A WR project in Zambia is regulated by the Zambian Agricultural Commodities Agency Limited (ZACA), which is owned by various industry stakeholders. ZACA certifies warehouse operators dealing in maize, wheat and soya beans.
ZACA adopted regulations in 2001 setting out the minimum standards which warehouses and warehouse operators must meet in order to be certified by ZACA. The regulations require that a certified warehouse operator maintains a minimum net worth of 10% of the value of stock which it is certified to store and in any event shall not be less than US$50,000.
A certified warehouse operator is also required to file with ZACA a copy of a performance bond or undertaking that is not less than 10% of the value of stock that it is certified to store (and may vary with the financial standing of the applicant). The regulations also contain requirements as to insurance. Provided certain conditions are met, WRs can be issued under the regulations in an electronic form.
Although there has been considerable local, small scale uptake of the system, further legislative reform is needed to stimulate growth. The government of Zambia and ZACA are currently working on a draft bill which provides for the recognition of WRs (paper and electronic) as negotiable instruments.
From the above, it’s easy to see that an understanding of the legal qualities and practical use of a warehouse receipt in a particular jurisdiction is essential for proper structuring and pricing. The position is changing in many jurisdictions. Using legal counsel familiar with this area will help you a great deal.