The Czech Insolvency Act stipulates certain conditions under which a debtor who is subject to the insolvency proceedings (the “Insolvent Debtor”) can receive new financing in an attempt to overcome its financial difficulties and, eventually, return to its normal course of business. Tolling finance is one of the structures through which an Insolvent Debtor can obtain working capital with the aim to get its operations back under control. In this article we set out the basic principles of tolling finance.
Principles of tolling
In a tolling agreement, a tolling finance provider (the “Tolling Financier”), which can be either an entity from within the group of the Insolvent Debtor or an entirely unrelated entity, finances the purchase of raw materials which are then used to manufacture the product by an Insolvent Debtor. Although an Insolvent Debtor is not itself able to finance the purchase of the raw materials, its production capabilities usually remain unaffected. Moreover, it will also usually maintain relationships with its customers and is therefore able to keep the supplies ongoing if provided with the necessary inputs (i.e. raw materials).
Therefore, the Tolling Financier purchases the raw materials and (whilst remaining the owner of such purchased raw materials) hands them over to the Insolvent Debtor for further processing. By retaining ownership, the Tolling Financier shields the purchased raw materials from the Insolvent Debtor, therefore the purchased materials do not become part of the insolvency estate (majetková podstata) of the Insolvent Debtor. The Insolvent Debtor manufactures its products from the raw materials (such products still remaining in the ownership of the Tolling Financier) and subsequently such products are sold either directly by the Tolling Financier, or alternatively by the Insolvent Debtor who would in such a case always be acting on behalf of the Tolling Financier as owner of the product.
The Insolvent Debtor does not at any point in time become the owner of the raw materials, or the manufactured product – it merely uses the input provided by the Tolling Financier to manufacture its products and generate the required cash flow. Purchasers provide their payments directly to the Tolling Financier who in turn pays an agreed processing fee to the Insolvent Debtor.
While the banks and other lenders will be hesitant to provide new finance to an Insolvent Debtor, they may instead consider financing the Tolling Financier who has sufficient credibility, and/or will be able to provide sufficient security or other guarantees to creditors.
Use of tolling
Given the above, tolling can be used as a method of financing an Insolvent Debtor in cases where other regular ways of financing are not readily available. It may also be a temporary solution on how to keep the business activities of an Insolvent Debtor going. Tolling is typically used in the case of manufacturing companies which will usually have fixed costs related to maintaining its machinery and operations. Such costs can, at least in part, be covered by proceeds from the manufacturing (which is enabled by the tolling). In the best-case scenarios, tolling can generate sufficient cash flow which will, together with the necessary restructuring steps, help the Insolvent Debtor out of financial distress and back to normal operations.
It is also important to emphasize that the Insolvency Act stipulates conditions upon which an Insolvent Debtor can receive new funds. One of the most important conditions is obtaining consent from the credit committee of an Insolvent Debtor, as the receivables of the Tolling Financier will rank ahead of other secured and unsecured creditors, and will have regime of receivables against the insolvency estate (majetková podstata) of an Insolvent Debtor.
If you are interested in discussion regarding possibilities of tolling financing for your company or for your debtors, we are happy to help.