Hot Issue (#09 September 2013)

Secure Grain. Secured by Grain

Oleg P. Zagnitko, Zoya S. Mylovanova

This is almost a philosophical one. How does grain from one field differ from the crop from another field, when both are in the same silo? Pragmatically, the fi- nancier needs to identify its collateral under the pledge agreement if the borrower does not pay.

One of the types of inventory financing is a credit limit to the grain trader (through the short-term loan or revolving facility); the trader pays with these funds to smaller sellers, while using the proceeds from the buyer to repay the loan. The larger trader repeats the financing structure until the grain reaches the processing company or consumer — this is warehouse financing in short. The statutory basis for warehouse financing in Ukraine was created by the On the Grain Act of Ukraine 2002 (the Grain Act). The commodity-financed and similar reserves are an obvious choice for secured transaction-financial institutions create a lien. The good risk management requires that the lien, should the need arise, survives a chain of transformations in ownership and possession of the commodities purchased. The collateral is (i) a potential crop, then (ii) harvest in fields; then (iii) the raw commodity in lorries and temporary storage, if necessary, then it becomes commodity (iv) in the warehouse. Then the grain may be shipped for export and, before leaving Ukraine, can be kept (v) in rail cars, (vi) in ships. Lien can survive even upon the grain commodity’s leaving the territory of Ukraine.

With the growth of commodity trading, particularly export in agriculture, the stakes reach the heights for the financers of the trading in grain, or, more generally, in the agricultural commodity. Some say this could be another bubble in the unfortunate marketing year if the risks are not managed well. But on an optimistic note, only after the shortterm risks are mitigated a long-awaited long-term commitment from the banks may be forthcoming.

In this article, we will concentrate on the secured transactions with the goods held in the warehouses. The warehouse can be certified or uncertified, affiliated or not affiliated with the borrower. Either option brings economic and legal choices by the lender. In each case, the bank would need to monitor the collateral: lien created, the quantity and quality of the commodities stored. In our practice, the monitoring functions are too complex to in-source by the sophisticated lender (except where the trader itself finances smaller sellers); thus, the outsourcing market offers two types of services: (i) monitoring of the security documentation for the transaction, under which the attorney reviews and advises on execution, registration and termination of  lien instruments, and (ii) collateral monitoring — technical expertise in quality and quantity measurement of the grain commodities.

How long the lien lives

The 2001 Pledge Act provides a general framework for the establishment of the lien over the grain, which is an equally replaceable commodity based on few objective criteria — in terms of Ukrainian commercial law, generic chattels (odnoridni rechi). While there are several types of pledge, the basic dichotomy for the commodities as collateral is the goods in circulation (turnover) or the permanent (regular) pledge.

The Act is harsh: the sale of the goods in circulation terminates the lien; with the regular pledge the change of the owner does not end the lien, moreover, even the sale can be undone. How grave is the financiers’ risk? On the one hand, the Act looks at the goods in circulation as (i) any type of chattels that (ii) stored on the warehouse and (iii) the seller undertakes to keep the stock at certain level at all times. These vague criteria puts the secured party at risk that any chattels pledged while in the warehouse will be declared “goods in circulation” and the borrower can avoid foreclosure by selling them without moving out of the warehouse.

On the other hand, the Act does not limit the pledge to the individually defined chattels only, while requiring that the collateral under the agreement is “sufficiently identifiable”. The reasonable standard can be assumed here and hence, two practical issues should be resolved by the secured lender to avoid unwanted termination of the lien: (i) whether undertakings and covenants of the pledgor (e.g. obligation to keep the value intact and replace commodity as necessary) can be interpreted as maintaining a certain quantity minimum, and (ii) how the commodity can be sufficiently identified to avoid being a “generic good”. While the first issue requires cautious drafting and educated judges, the second calls for relevant market infrastructure and technologies to track the crop. The old-fashioned grain storage agreement provided for a warehouse certificate (kvytantsiia) that evidenced the fact of the storage but not the fact of redemption. The pawn of the receipts to the lender did not solve the problem: (i) the holder of the receipt could request the grain; moreover, (ii) the pledgor could pretend the loss of the originals and ask the storage facility to issue duplicates. As if the preceding risks were not enough, the storage contract, as a matter of law, provided for a transfer of title to the warehouse, whereas the pledgor retained the unsecured claim to the certain quantity of the goods. Consequently, warehouses often issued more receipts than the commodities they could tender.

Legal infrastructure

The 2003 Civil Code (effective as of 2004) introduced limitations on the transfer of title for the commodities to the warehouse. Adoption in 2004 of the On Certified Warehouses and Ordinary and Double Warehouse Receipts Act of Ukraine was aimed at improving the situation specifically on the grain storage market; in 2004 and 2005, a number of regulations followed to implement the Grain Act. It introduced licensing terms for the grain warehouses as well as ordinary and double warehouse receipts (svidotstvo) for confirmation of title. An ordinary receipt is a security in the paper form that serves as a contractual tender for the grain stored (similarly to the warehouse certificate) but it can be pledged through the endorsement; warehouse issues a copy of the receipt to be retained by the pledgee, if required. Double warehouse receipts consist of two parts. In case of pledge, part A and part B of the receipt should be separated, with part B being endorsed in favour of the pledgee and part A retained by the pledgor. The release of the pledge requires reverse endorsement for any type of receipt. The warehouses are liable for the damages to the pledge (pledgor) if the commodities were released prior to reverse endorsement. Endorsements must be made at the location of the warehouse, and information entered into the log simultaneously. The enforcement procedure is straightforward; if the loan is not repaid by the maturity date, the warehouse should sell the goods and pay the lender. The pledgee can claim the collateral or proceeds from its sale from the warehouse. The pledgor can only take the grain after she/he/it proved that the loan was repaid or she/he/it deposited the amount of the loan with the warehouse.

Even though the idea is taken from mature markets, we did not feel the template statutory sche- me has been working in Ukraine: it was difficult to follow the pattern outlined in the regulations. Banks keep insisting on elaborate lending and security documentation; they also want to assure foreclosure not only through reliance on the warehouse to sell the grain (and the warehouse might be or become the affiliate of the borrower) but also the option to get the title to the grain (or supervise the sale). The borrowers, on the other hand, need to ship the commodities free of any liens as soon as there is a purchaser; requiring, thus, quick and simple procedure for release of the pledge. If the secured real estate (mortgage) financing is used as a benchmark, the situation with the warehouse financing is far down.

The personal presence of the lender’s representative at the warehouse is inconvenient — large corporate business of the banks are located in large cities and abroad; the silos — in the fields and port terminals. The local log of the warehouse receipts (WHR) is administered by the warehouse itself, the Ministry of Agricultural Policy of Ukraine keeps the track of the WHR electronically while the private liens are registered in the Single Register of Liens administered by the Ministry of Justice. No warehouse has an online access to the Single Register of Liens;  WHR is a security but the securities regulator has no influence on its issue or circulation.  Issue of electronic WHRs, introduction and administration of their register similarly to the centralised stock securities (shares) depositary is an idea under consideration; the role of the warehouse as a key party in the financing is to be increased, not hindered.

For reality resisted to the straightforward utilisation of the statutory scheme, the WHR financing went through additional structures that were contractually developed and tested by the market. Depending on the preferences of the lenders, certain flexibility remains.


With cumbersome endorsement procedures the banks are willing to rely on provision of copies of the warehouse receipts, which is in direct contravention of the law. However, based on existing court practice and despite the direct wording of the statute, it appears to affect the priority rather than validity of the pledge. Some banks, concerned with the prospects of enforcement, obtain originals of both parts of the receipt, with or without endorsement.

The exchange of documents is less clear when the pledge of the ordinary warehouse receipt is concerned. Whereas the law requires endorsement and issue of additional copy to the pledgee, some of the regulations require that the receipt should be redeemed and replaced with a double warehouse receipt; it seems impossible to please both mechanisms.

As opposed to receipts (svidotstvo), a warehouse certificate (kvytantsiia) is not a title document but a mere confirmation that the warehouse accepted the commodities into storage. The warehouse may claim a title to the grain based on law (lawful possession) and the contract (storage of the commodity / generic chattels), accordingly, the warehouse will be liable in damages to the pledgor and pledgee but the grain, by the time of enforcement, may be gone. A trilateral agreement is, therefore, a highly recommended form of the security document; while the draft pledge agreement should clearly stipulate whether collateral under the warehouse certificates (kvytantsiia) is the claim (rights to demand grain) or the title to the commodities (where they are stored in separate identifiable premises). In either case, reference to warehouse certificates (kvytantsiia), even if made in the pledge agreement, is mainly for reference purposes. And the issue of the pledge of goods in circulation (floating charge) arises again.

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