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You are here: BAILII >> Databases >> The Law Commission >> Company Security Interests (Report) [2005] EWLC 296(4) (August 2005)
URL: http://www.bailii.org/ew/other/EWLC/2005/296(4).html
Cite as: [2005] EWLC 296(4)
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PART 4
SALES OF RECEIVABLES
INTRODUCTION
4.1 For many companies, a major part of their assets will be in the form of money due to them under contracts, particularly for goods or services supplied.[1] This type of asset in known by a variety of names. Traditionally English law has referred to 'book debts'. The UCC talks of 'accounts', which was the term we adopted in the CR. Here we use the more common commercial term, and refer to the monetary obligations owed to a company as 'receivables'. This avoids the legal complexities associated with the term 'book debt';[2] and avoids possible confusion with other forms of account, such as bank accounts and securities accounts. We have, however, used the term 'account debtor' to refer to the person or organisation owing money to the company.
Mortgage and charge debts, car loans, insurance premiums, credit card debts, secured consumer loans, equipment loans, freights (include sub-freights), rentals from real and personal property, debts for goods sold and services rendered are all receivables.[3]
For our purposes, however, we have included only a narrow range of 'sales of receivables' within the scheme. As we explain below,[4] the scheme we propose will be confined to sales of receivables relating to the supply of goods and services, and will not, for example, cover sales of loan repayments, insurance payments or rent.
4.3 Currently, there are several ways in which a company can raise money on the strength of its receivables. It may take a loan secured by a charge over the receivables. Alternatively, it may sell its receivables outright, for example to a factor, or under a discount arrangement, or as part of a securitisation. Under these sale arrangements the financier advances funds to the company in exchange for an outright assignment of the receivables and recoups them when the receivables are paid. The account debtor may be notified of the assignment so that payment is made direct to the financier, or the company may continue to collect the receivables on the financier's behalf.[5]
4.4 The law currently treats charges over receivables differently from sales of receivables. A floating charge over receivables must be registered, as must a fixed charge over book debts.[6] Outright assignments, however, are not registrable. They do not amount to charges,[7] even if the company agrees to repurchase any receivable that is not paid.[8]
4.5 The normal rule is that priority between competing assignments of receivables depends on the date on which notice was given to the account debtor.[9] The first assignee to notify the account debtor gains priority. However if, when it takes an assignment, a subsequent assignee knows about the first assignment (or has constructive notice of it), it cannot gain priority over an earlier assignment merely by notifying the debtor first. This means that if the earlier assignment is by way of fixed charge and the charge has been registered by the date of the second assignment, its priority will be protected.[10] Conversely an outright assignment cannot be registered, so until the account debtor has been notified, an assignee will be vulnerable to loss of priority to a subsequent assignee (whether outright or by way of fixed charge).
4.6 A further problem with using a receivable as security may arise if the contract under which the receivable arises prohibits assignment. A clause prohibiting assignment does not prevent the assignee acquiring a proprietary right to the debt as against the assignor,[11] but the account debtor is entitled to ignore any notice of assignment and may insist on paying the assignor.[12]
REGISTRATION AND PRIORITY OF SALES OF RECEIVABLES
Our proposals on consultation
4.7 In the CP we argued that in functional terms a sale of receivables is very much like a charge over them. This is particularly noticeable where the debt is sold on a recourse basis, so that if the debtor fails to pay, the seller must repurchase the debt or make good the loss. However, even for receivables sold on non-recourse basis, a similar effect may be achieved through warranties given by the assignor.[13] As sales of receivables do not have to be registered, potential creditors, investors and purchasers will not know that the receivables do not belong to the company, in the absence of information from the company itself. They will not therefore be alerted to the existence of what is very like security over the company's assets.[14] We thought that sales of receivables should be registrable, as they are under Article 9 of the UCC and all the PPSAs, and asked consultees if they agreed.[15]
4.8 We also argued that the rules of priority over receivables are unsuited to modern conditions. As we saw earlier, under the present law priority between competing assignments of receivables depends primarily on the date of notice to the account debtor.[16] Making enquiries of and giving notice to large numbers of small debtors is expensive and administratively burdensome. Often financiers do not contact debtors, with the result that they may not find out about a previous assignment. They also run the risk that a subsequent assignee will gain priority over them by giving notice. We proposed that sales of receivables should be made registrable, so that priority would normally depend on the date when the relevant financing statement was filed. It would thus be easy for a financier to see whether the debtor company had already assigned its debts. Equally, the financier could file a financing statement itself and secure priority for the future. We pointed out that under the notice-filing system it would be possible for the factor or discount house to file a single financing statement for a series of transactions.[17]
4.9 These provisional proposals were made in the context of our general proposal to adopt a functional approach, so that 'quasi-securities' in general would become registrable. Many consultees supported bringing quasi-security generally into the scheme, but even among those who opposed the inclusion of title-retention devices there was some support for registering sales of receivables, at least for the purposes of establishing priority.[18]
4.10 The scheme proposed in the CR therefore included outright sales of receivables, so that these would normally have to registered in order to be effective in the company's insolvency. Priority would normally depend on the date of filing.[19]
4.11 Finally, we proposed that the regulations should explicitly preserve the rule that an account debtor who has not been notified of an assignment and pays the assignor will receive a good discharge, whereas one who has been notified will not.[20]
Reactions to the CR recommendations
Priority
4.12 In the responses to the CR the majority[21] supported bringing sales of receivables within the scheme at least for purposes of priority. In particular the trade body for the factoring and discounting industry, the Factors and Discounters Association (FDA), were strongly in favour of this.
4.13 Other bodies were cautious. For example, the Financial Law Committee of the City of London Law Society (CLLS) initially indicated that there may be some merit in bringing in sales of receivables for purposes of priority. After some discussion of alternative schemes, however, they sent a further response arguing that no change should be made at all. [22]
4.14 The CLLS Committee thought that the rules for priority purpose should be the same as those governing when an account debtor will be discharged if it pays the assignee. In other words, the party who notifies the account debtor first will be both the one entitled to payment and the one who has priority. We see the logic of this, but it does not help a prospective financier who wants to be sure that the receivables offered are unencumbered.[23] At present the only way to check is to contact each account debtor, which is frequently impractical. Under the scheme we propose, the financier will simply search the Company Security Register. Any assignments that have not been registered before its own (and it can file in advance in order to safeguard its priority) will not affect it. We understand that this is why there is such strong support of our proposals within the receivables financing industry.
In some cases (such as financing transactions), an assignee of receivables is likely to search the register, but many types of assignee (particularly in commercial transactions) would not do so. Under the proposed law, they would be adversely affected by not doing so.
We do not wish to affect sales of receivables that do not have a financing purpose. As we explain below, the definition of receivables in the regulations is a narrow one,[24] and we have added a further exclusion for receivables sold on a 'one off' basis.[25] The draft regulations also contain a list of exceptions where, for example, the transferee is to perform the company's obligations, the whole business is being sold or the sale is made purely to facilitate debt collection.[26] Only those involved in receivables financing will be covered by our scheme, and we think they will soon adjust to the new law. It will be simpler to use than the current law, as it will be easier to search and file than to contact account debtors.
4.18 We recommend that the priority of sales of receivables by companies should depend on the date of registration of the financing statement relating to the sale in the Company Security Register.[27]
Perfection
4.23 A more telling argument that was made against the relevant draft regulations in the CR was that the definition of 'account' was very wide. It included any monetary obligation, except those evidenced by an instrument, bank accounts, investment property or loan repayments (other than credit card payments, which were within the scheme).[28] Such a broad definition might cause uncertainty, and, it was said, to impose registration so widely might interfere with securitisations. We accept these criticisms. As we explain in the next section, we now recommend that the definition of receivable in our scheme should be confined to the types of receivable commonly included in factoring or discounting agreements.
4.25 We recommend that the sale of a receivable by a company should not be effective against an administrator or liquidator of the company unless it has been registered by the onset of insolvency.[29]
The definition of 'receivable'
4.27 Our definition centres on monetary obligations arising from the supply of goods and services (with the addition of the supply of energy and brokerage fees, which might not otherwise be included). As we discussed in the CR, it does not include repayments for loans.[30] We did not wish to include loan participation agreements or interfere with borrower's right to prohibit the assignment of a loan (see below). It is also worth pointing out that the definition does not include rent, mortgage repayments or sums due under an insurance contract.
4.28 In the CR we asked whether outright sales of promissory notes should be included within the scheme for the purpose of priority only, as they are within Revised Article 9.[31] In other words, even though the sale of a promissory note does not have to registered to be perfected, should its priority date from the moment of the sale? We understand that this is not necessary. Under US law a promissory note is not necessarily a negotiable instrument but under English law it is. We have therefore excluded sales of promissory notes from our proposals.
4.29 We recommend that the definition of a receivable for the purpose of our scheme should include only a monetary obligation, whether or not it has been earned by performance, arising from goods or services supplied, energy services supplied or brokerage fees.[32]
Exceptions
4.30 The draft regulations in the CR excepted from the scheme a number of cases in which the sale of accounts did not have a 'financing purpose'. These exceptions were accepted almost without criticism[33] and we recommend that they apply to the final scheme.
4.31 We recommend that the following should be exempt from the scheme:
(1) the assignment of an unearned right to payment under a contract to a person who is to perform the transferor's obligations;[34]
(2) the assignment of receivables solely to facilitate collection on behalf of the person making the assignment;
(3) the assignment of a single receivable to an assignee in full or partial satisfaction of a pre-existing indebtedness; and
(4) the sale of receivables as part of the sale of a business out of which the receivables arose.[35]
Isolated assignments of receivables
4.32 The working group set up by the FMLC suggested that there might be a different rule for assignments of receivables made on a 'one-off' basis, to protect an assignee who did not realise that it should file. In the CR we asked whether we should adopt a rule found in Revised Article 9 of the UCC.[36] Section 9-309 has the effect that an assignment of accounts receivable 'which does not by itself or in conjunction with other assignments to the same assignee transfer a significant part of the assignor's outstanding accounts…' does not need to be registered and has priority from the date it is taken.[37] The Official Comments note that the purpose of this provision 'is to save from ex post facto invalidation casual or isolated assignments – assignments which no one would think of filing'.[38] The FMLC then expressed concern that the rule might give rise to uncertainty about whether a particular assignment amounted to a significant part of the assignor's outstanding accounts.
4.34 We recommend that a sale of receivables does not need to be registered if the sale (by itself or in conjunction with other sales to the buyer) is of such a small proportion of the assignor's receivables that it would not influence a reasonable person deciding whether to make an advance to the company. For priority purposes, it should be treated as if it had been registered on the date of the sale.[39]
PROHIBITIONS AGAINST ASSIGNMENTS OF RECEIVABLES
4.35 In the CR we considered the current rules on contractual prohibitions on assignment. If a contract provides that the debt may not be assigned without the debtor's consent, this does not prevent the assignee from acquiring a proprietary right to the debt as against the assignor.[40] However, the account debtor is entitled to ignore any notice of assignment and may insist on paying the assignor.[41] This rule is said to be 'inimical to receivables financing, where it is simply not practicable for the assignee (such as the factoring company) to examine individual contracts for assignment clauses'.[42] The FDA told us that 'contractors who would normally use invoice finance facilities as a matter of course but are prevented by such clauses are forced to turn to other, more expensive and less appropriate forms of finance to fill the finance gap'.
4.36 The UCC and the SPPSA contain express provisions that a term in an agreement between an account debtor and an assignor preventing or restricting assignment is ineffective, though without affecting the question of whether the assignment amounts to a breach of contract by the assignor.[43] So do the UNIDROIT Convention on International Factoring[44] and the 2001 UN Convention on the Assignment of Receivables in International Trade.[45]
4.37 We were urged strongly to adopt the same rule. Despite reservations that it would be awkward to have one rule for companies and another for unincorporated businesses,[46] we provisionally recommended reform. The draft regulations set out in the CR provided that a term in a contract between a company and a third party that purports to prohibit or restrict assignment of the account should be of no effect against a third-party assignee. The 'override' would apply only to prohibitions on assignment of accounts as defined in the draft regulations. Thus clauses in loan agreements, for example, would be unaffected.[47]
4.38 The proposal continued to be controversial. The FDA supported it strongly. The British Bankers Association said that it 'would remove a significant obstacle to receivables financiers – and on that basis we would support it.'[48] Others opposed it. Much of the opposition, however, was based on a misplaced concern that it would apply to loan agreements, or that 'there is no demand for the change'.[49] The latter is simply incorrect: the industry concerned supports the change strongly.
4.40 We recommend that in a contract between a company and a third party creating a receivable payable to the company, a term that purports to prohibit or restrict assignment of the account should be of no effect against a third-party assignee.[50]
TERRITORIAL APPLICATION
4.41 In Part 3 we recommended that charges created by Scottish and oversea companies over their assets in England and Wales should be within our scheme. These charges would be registrable and would be subject to the same rules of priority as charges created by companies registered in England and Wales.[51] Here we consider whether sales of receivables by Scottish and oversea companies should also be within the scheme if the receivable is 'situated' in England and Wales. We have concluded that this would not be sensible.
4.42 There is considerable uncertainty as to the 'situs' of a receivable.[52] It may be that the debt is situated where the account debtor has its business, or in the country whose law governs the contract creating the receivable. In either case, bringing sales of receivables by oversea companies within the scheme might create significant problems for their receivables financiers. A foreign financier buying the receivables of an oversea company might have no practical way of discovering that some of them were situated in England and Wales. Therefore it would not file a financing statement. It would be more likely merely to take whatever steps (if any) were necessary to perfect the sale in the country of the company's incorporation. It would be unfortunate if, in the event of the company's insolvency, it was held that the failure to register left the sale of the English receivable ineffective as against the company's liquidator.[53]
TRANSITIONAL ARRANGEMENTS
4.46 We think it is important that the Company Security Register should give a complete picture of a company's position as is practicable. Therefore existing arrangements for the sale of receivables should be registered within a transitional period, failing which they should be subject to the normal sanctions for non-registration.[54]
4.47 It is true that we have recommended that existing charges that are not registrable under current law should not have to be registered.[55] We were told that many lenders would find it very costly to identify what charges they hold, and the cost of finding out would outweigh any benefit to be gained from having more complete information on the register. This does not apply to sales of receivables. Receivables financiers tend to make advances to the company on a regular basis. They should have no difficulty in identifying the customers they do business with and registering a financing statement against each customer within a relatively short period.
4.48 We recommend that existing agreements to sell receivables should have to be registered within two years of the commencement of the scheme. During the transitional period, an interest arising under an existing agreement should have priority over any conflicting charge or sale entered into after commencement (whether registered or not). An existing sale registered within the transitional period should be treated as if it had been registered at the date of commencement.[56]
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Note 1 See CP 164 paras 6.24-6.32. [Back] Note 2 The Steering Group consultation paper, Modern Company Law for a Competitive Economy: Registration of Company Charges URN 00/1213, noted that the meaning of ‘book debts’ has been the source of constant debate (para 3.34). For further discussion, see CP 164 para 5.45. Under our scheme, this problem disappears. All charges will be included unless specifically exempted (see above, para 3.16), so the distinction between ‘book debts’ and other debts is no longer relevant. [Back] Note 3 F Oditah, Legal Aspects of Receivables Financing (1991) p 2. [Back] Note 4 See below, para 4.27. [Back] Note 5 This is referred to as ‘non-notification’ financing, which is typical of block discounting and securitisations: see CP 164 para 6.35. [Back] Note 6 See respectively Companies Act 1985, s 396(1)(f) and s 396(1)(e). The deposit of a negotiable instrument given to secure the payment of book debts is not registrable as a charge: s 396(2). The extent to which it is practicable for the lender to take a fixed charge must be considered in the light of National Westminster Bank PLC v Spectrum Plus Ltd [2005] UKHL 41, [2005] 3 WLR 58. [Back] Note 7 See CP 164 paras 6.34-6.35, which discuss the risk that a loan disguised as a sale will be ‘re-characterised’. [Back] Note 8 A ‘recourse’ agreement: see CP 164 para 7.36. [Back] Note 9 Dearle v Hall (1828) 3 Russ 1. [Back] Note 10 See R Goode, Commercial Law (3rd ed 2004) p 750. Note that if a floating charge or a fixed charge over book debts is not registered within the 21-day period it will be void against other creditors: Companies Act 1985, s 395. If a floating charge is registered, whether a subsequent assignee takes free of it depends on whether the charge contains a prohibition on the company disposing of its receivables. If it does and the subsequent assignee has notice of the prohibition, the floating charge will have priority over the subsequent assignment. We understand that, in practice, a factor or other receivables financier approached by a company that has created a floating charge will usually reach a priority agreement with the floating charge-holder before advancing funds. [Back] Note 11 See R Goode, Legal Problems of Credit and Security (3rd ed 2004) paras 3.41-3.43. [Back] Note 12 See Helstan Securities Ltd v Hertfordshire County Council [1978] 3 All ER 262, QBD; Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd [1994] 1 AC 85, HL. It also enables the account debtor to continue to rely on set-offs against the assignor that arise after the debtor has received notice of the assignment. [Back] Note 13 As the Crowther Report pointed out, a sale without recourse may contain warranties by the assignor ‘designed to ensure so far as possible that the receivables assigned are not only legally enforceable but likely to be paid. Since breach of these warranties may entitle the assignee to recover his loss from the assignor the distinction between sales with recourse and sales without recourse is not as clear cut as it might appear’: Crowther Report Appendix III, para 5. [Back] Note 14 CP 164 para 7.8. [Back] Note 15 CP 164 para 7.45. We suggested an exception for book debts sold as part of a larger transaction (such as the overall sale of the business); and that there should be an exception where negotiable instruments are delivered to the receivables financier. Current law provides that the deposit of a negotiable instrument to secure payment of book debts is not to be treated as a charge over those book debts: Companies Act 1985, s 396(2). [Back] Note 16 Above, para 4.5. [Back] Note 17 CP 164 para 7.43. [Back] Note 18 See CR para 2.87. [Back] Note 19 See CR para 2.88. The scheme of remedies in Part 5 of the CR draft regs, and in particular the rule that any surplus must be paid to the debtor, would not have applied to sales of receivables, which were treated as ‘deemed’ rather than ‘in-substance’ security interests: see CR paras 3.44-3.45. On prohibitions against assignment see below, paras 4.35-4.40. [Back] Note 20 See CR draft regs 45(3) and (4). Nor did we intend to change the rule about set-offs, see note 12 above. [Back] Note 21 We believe this to be the case although the responses are not easy to interpret, because a good number of them did not express a clear view on sales of receivables as opposed to other forms of quasi-security. [Back] Note 22 In May 2005, after they had received from us a paper outlining the scheme that Law Commissioners had asked the Team to develop. [Back] Note 23 It is relatively rare for a company to attempt to factor the same debt twice. However, there may well be conflicts between different forms of lender attempting to use the same receivable as security. A factor, a floating charge-holder and a trade supplier with a registered retention of title clause over proceeds may all lay claim to the same receivable. [Back] Note 24 Para 4.26-4.29. [Back] Note 25 Para 4.32-4.34. [Back] Note 26 Draft reg 4(1)(b)-(e). [Back] Note 28 CR draft reg 2(1). [Back] Note 29 See draft reg 20. [Back] Note 30 CP paras 3.21 and 5.33. [Back] Note 31 In the language of Article 9, sales of promissory notes are ‘automatically perfected’: see section 9-309(4). [Back] Note 32 See draft reg 2(3). [Back] Note 33 The CLLS FLC disagreed with the exception of sale of accounts as part of the sale of a business, arguing that it could have a financing purpose if the sale was part of a whole business securitisation. We cannot envisage a case that would fall within our scheme. [Back] Note 34 A further reason for this exclusion is that there is no risk of misleading third parties that the transferor retains rights under the contract: see CR para 3.62, note 79. [Back] Note 35 See draft reg 4(1)(b)-(e). [Back] Note 36 See CR para 3.97. We did not include the rule in the CR draft regs. [Back] Note 37 In other words, it will have priority over assignments that are filed later, but be subject to any that have been filed already. [Back] Note 38 Official Comment 4, which goes on to note that any person regularly taking assignments of any debtor’s accounts should file. [Back] Note 39 Draft reg 20(2). [Back] Note 40 See R Goode, Legal Problems of Credit and Security (3rd ed 2003) paras 3-41–3.43. [Back] Note 41 Ibid, paras 5-31-5-39. See Helstan Securities Ltd v Hertfordshire County Council [1978] 3 All ER 262, QBD; Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd [1994] 1 AC 85, HL. It also enables the account debtor to continue to rely on set-offs against the assignor that arise after the debtor has received notice of the assignment. [Back] Note 42 Ibid, para 3-40 at n 11. [Back] Note 43 SPPSA, s 41(9); UCC section 9-406(d). The OPPSA does not have a similar provision, although this has been criticised: J Ziegel and D Denomme, The Ontario Personal Property Security Act Commentary and Analysis (2nd ed 2000) para 40.5 (pp 334-335). [Back] Note 46 We pointed out that the law on assignment of receivables is already fragmented, as outright sales of receivables by a company do not have to be registered but a general assignment of book debts by an unincorporated business requires registration as a bill of sale: Insolvency Act 1986, s 344; see CP 164 para 8.36. We argued that it is better to make the companies-only scheme as complete as possible, even at the risk of some further fragmentation. [Back] Note 48 They expressed concern that the proposed rule might cause problems in financial markets with set-off and netting. These issues will not arise now that the scheme’s definition of ‘receivables’ is narrower. See above, para 4.29. [Back] Note 49 CLLS FLC response of May 2005. [Back] Note 50 See draft reg 35(5). [Back] Note 51 See above, paras 3.268 and 3.284` [Back] Note 52 See Dicey & Morris, The Conflict of Laws (13th ed 2000) paras 24-049–24-058. [Back] Note 53 In this respect we think sales of receivables are different from charges over them. Requirements to register charges are much more common (particularly when the charge is a floating charge or an ‘enterprise charge’, which with receivables is likely to be the case). Foreign chargees are therefore more likely to be aware of the need to register charges than to register sales. [Back] Note 54 Principally, the sale would be ineffective in the event of the company's insolvency: see above, para 3.78. [Back]
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