Wood Matters

Due to interest amongst readers and clients in harvesting and marketing of woodlots and logs, Wood Matters will now have a regular feature covering a range of topics. This issue's topic is understanding stumpage purchaser credit risk.

If a forest owner has chosen a stumpage sale to sell his or her woodlot, how do you minimise the risk of the purchaser defaulting on its payment obligations? This issue is particularly important since many prospective stumpage purchasers currently have little experience or track record in New Zealand.

Sales method

Three common stumpage sales methods are discussed along with their respective payment risk.

1. The most secure stumpage sales method is a lump sum stumpage sale with the full purchase price paid up front prior to any harvesting commencing. From a payment perspective, this is pretty secure - although not 100% secure (see later in this section).
   

   The disadvantage of this sales method is that it requires the purchaser to have considerable capital and it can reduce the pool of potential purchasers.

2. The second most secure stumpage sales method is a lump sum stumpage sale with payment in installments (usually four). Installments are usually structured to be paid in advance of the harvesting; preferably well in advance at all stages of harvesting to allow sufficient time for action to be taken in case a payment is missed. Also, very clear contractual terms are essential to give the forest owner the right to take action to protect its interests, e.g. to suspend harvesting if a payment is missed and, if non-payment persists, take over the harvesting itself. In a case recently, by the time the forest owner was aware and responded to a non-payment, the stumpage purchaser had harvested well ahead of payments due to the forest owner. By the time the forest gate was closed, the forest owner was out of pocket by over $100,000. If that wasn't enough, the purchaser turned round and sued the forest owner for obstructing his business!

   This sales method has more moderate demands on the capital of the stumpage purchaser, so is less limiting on who may be able to participate in such a sale.

3. The third common stumpage sale method is a composite pay-as-cut sale. In its basic form, logs are paid for on the 20th of the month following harvesting (standard credit terms). This is only recommended for parties considered very low credit risk.

Other factors to consider

1. Bank bond/bank guarantee. These financial instruments are most applicable for taking credit risk out of the composite pay-as-cut stumpage sale but they can also be used as back-up security for the lump sum stumpage with payments by installment.
2. Mortgage securities/cross-guarantees/personal guarantees. These may, or may not, be useful depending on the purchaser's circumstances, and willingness to agree to them.
3. While cash in the hand is a strong position to be in, it is not an absolute protection. Liquidators may have the power to claw back cash paid by purchasers if the cash was paid when the purchaser was insolvent. This could potentially apply in any of the three sales methods mentioned above.

Whilst some forest owners feel that they set aside all risk when they choose a stumpage sale method, this is never the case. Much risk can be sheeted to the purchaser but fundamental risks such as payment security can never be completely eliminated. However, well constructed sales processes and contracts (and sometimes additional financial instruments/securities) along with careful monitoring of the harvesting can greatly reduce credit risk.