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Receivables Finance And The Assignment Of Receivables

Tfg legal trade finance hub, receivables finance and the assignment of receivables.

A receivable represents money that is owed to a company and is expected to be paid in the future. Receivables finance, also known as accounts receivable financing, is a form of asset-based financing where a company leverages its outstanding receivables as collateral to secure short-term loans and obtain financing.

In case of default, the lender has a right to collect associated receivables from the company’s debtors. In brief, it is the process by which a company raises cash against its own book’s debts.

The company actually receives an amount equal to a reduced value of the pledged receivables, the age of the receivables impacting the amount of financing received. The company can get up to 90% of the amount of its receivables advanced.

This form of financing assists companies in unlocking funds that would otherwise remain tied up in accounts receivable, providing them with access to capital that is not immediately realised from outstanding debts.

FIG. 1: Accounts receivable financing operates by leveraging a company’s receivables to obtain financing.  Source: https://fhcadvisory.com/images/account-receivable-financing.jpg

Restrictions on the assignment of receivables – New legislation

Invoice  discounting  products under which a company assigns its receivables have been used by small and medium enterprises (SMEs) to raise capital. However, such products depend on the related receivables to be assignable at first.

Businesses have faced provisions that ban or restrict the assignment of receivables in commercial contracts by imposing a condition or other restrictions, which prevents them from being able to use their receivables to raise funds.

In 2015, the UK Government enacted the Small Business, Enterprise and Employment Act (SBEEA) by which raising finance on receivables is facilitated. Pursuant to this Act, regulations can be made to invalidate restrictions on the assignment of receivables in certain types of contract.

In other words, in certain circumstances, clauses which prevent assignment of a receivable in a contract between businesses is unenforceable. Especially, in its section 1(1), the Act provides that the authorised authority can, by regulations “make provision for the purpose of securing that any non-assignment of receivables term of a relevant contract:

• has no effect;
• has no effect in relation to persons of a prescribed description;
• has effect in relation to persons of a prescribed description only for such purposes as may be prescribed.”

The underlying aim is to enable SMEs to use their receivables as financing to raise capital, through the possibility of assigning such receivables to another entity.

The aforementioned regulations, which allow invalidations of such restrictions on the assignment of receivables, are contained in the Business Contract Terms (Assignment of Receivables) Regulations 2018, which will apply to any term in a contract entered into force on or after 31 December 2018.

By virtue of its section 2(1) “Subject to regulations 3 and 4, a term in a contract has no effect to the extent that it prohibits or imposes a condition, or other restriction, on the assignment of a receivable arising under that contract or any other contract between the same parties.”

Such regulations apply to contracts for the supply of goods, services or intangible assets under which the supplier is entitled to be paid money. However, there are several exclusions to this rule.

In section 3, an exception exists where the supplier is a large enterprise or a special purpose vehicle (SPV). In section 4, there are listed exclusions for various contracts such as “for, or entered into in connection with, prescribed financial services”, contracts “where one or more of the parties to the contract is acting for purposes which are outside a trade, business or profession” or contracts “where none of the parties to the contract has entered into it in the course of carrying on a business in the United Kingdom”. Also, specific exclusions relate to contracts in energy, land, share purchase and business purchase.

Effects of the 2018 Regulations

As mentioned above, any contract terms that prevent, set conditions for, or place restrictions on transferring a receivable are considered invalid and cannot be legally enforced.

In light of this, the assignment of the right to be paid under a contract for the supply of goods (receivables) cannot be restricted or prohibited. However, parties are not prevented from restricting other contracts rights.

Non-assignment clauses can have varying forms. Such clauses are covered by the regulations when terms prevent the assignee from determining the validity or value of the receivable or their ability to enforce it.

Overall, these legislations have had an important impact for businesses involved in the financing of receivables, by facilitating such processes for SMEs.

Digital platforms and fintech solutions: The assignment of receivables has been significantly impacted by the digitisation of financial services. Fintech platforms and online marketplaces have been developed to make the financing and assignment of receivables easier.

These platforms employ tech to assess debtor creditworthiness and provide efficient investor and seller matching, including data analytics and artificial intelligence. They provide businesses more autonomy, transparency, and access to a wider range of possible investors.

Securitisation is an essential part of receivables financing. Asset-backed securities (ABS), a type of financial instrument made up of receivables, are then sold to investors.

Businesses are able to turn their receivables into fast cash by transferring the credit risk and cash flow rights to investors. Investors gain from diversification and potentially greater yields through securitisation, while businesses profit from increased liquidity and risk-reduction capabilities.

References:

https://www.tradefinanceglobal.com/finance-products/accounts-receivables-finance/  – 28/10/2018

https://www.legislation.gov.uk/ukpga/2015/26/section/1/enacted  – 28/10/2018

https://www.legislation.gov.uk/ukdsi/2018/9780111171080  – 28/10/2018

https://www.bis.org/publ/bppdf/bispap117.pdf  – Accessed 14/06/2023

https://www.investopedia.com/terms/a/asset-backedsecurity.asp  – Accessed 14/06/2023

https://www.imf.org/external/pubs/ft/fandd/2008/09/pdf/basics.pdf  – Accessed 14/06/2023

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1 | Introduction to International Trade Law 2 | Legal Trade Finance 3 | Standard Legal Charges 4 | Borrowing Base Facilities 5 | Governing law in trade finance transactions 6 | SPV Financing 7 | Guarantees and Indemnities 8 | Taking security over assets 9 | Receivables finance and the assignment of receivables 10 | Force Majeure 11 | Arbitration 12 | Master Participation Agreements 13 | Digital Negotiable Instruments 14 | Generative AI in Trade Law

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Assignment of Accounts Receivable: Meaning, Considerations

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.

Investopedia / Jiaqi Zhou

What Is Assignment of Accounts Receivable?

Assignment of accounts receivable is a lending agreement whereby the borrower assigns accounts receivable to the lending institution. In exchange for this assignment of accounts receivable, the borrower receives a loan for a percentage, which could be as high as 100%, of the accounts receivable.

The borrower pays interest, a service charge on the loan, and the assigned receivables serve as collateral. If the borrower fails to repay the loan, the agreement allows the lender to collect the assigned receivables.

Key Takeaways

• Assignment of accounts receivable is a method of debt financing whereby the lender takes over the borrowing company's receivables.
• This form of alternative financing is often seen as less desirable, as it can be quite costly to the borrower, with APRs as high as 100% annualized.
• Usually, new and rapidly growing firms or those that cannot find traditional financing elsewhere will seek this method.
• Accounts receivable are considered to be liquid assets.
• If a borrower doesn't repay their loan, the assignment of accounts agreement protects the lender.

Understanding Assignment of Accounts Receivable

With an assignment of accounts receivable, the borrower retains ownership of the assigned receivables and therefore retains the risk that some accounts receivable will not be repaid. In this case, the lending institution may demand payment directly from the borrower. This arrangement is called an "assignment of accounts receivable with recourse." Assignment of accounts receivable should not be confused with pledging or with accounts receivable financing .

An assignment of accounts receivable has been typically more expensive than other forms of borrowing. Often, companies that use it are unable to obtain less costly options. Sometimes it is used by companies that are growing rapidly or otherwise have too little cash on hand to fund their operations.

New startups in Fintech, like C2FO, are addressing this segment of the supply chain finance by creating marketplaces for account receivables. Liduidx is another Fintech company providing solutions through digitization of this process and connecting funding providers.

Financiers may be willing to structure accounts receivable financing agreements in different ways with various potential provisions.​

Special Considerations

Accounts receivable (AR, or simply "receivables") refer to a firm's outstanding balances of invoices billed to customers that haven't been paid yet. Accounts receivables are reported on a company’s balance sheet as an asset, usually a current asset with invoice payments due within one year.

Accounts receivable are considered to be a relatively liquid asset . As such, these funds due are of potential value for lenders and financiers. Some companies may see their accounts receivable as a burden since they are expected to be paid but require collections and cannot be converted to cash immediately. As such, accounts receivable assignment may be attractive to certain firms.

The process of assignment of accounts receivable, along with other forms of financing, is often known as factoring, and the companies that focus on it may be called factoring companies. Factoring companies will usually focus substantially on the business of accounts receivable financing, but factoring, in general, a product of any financier.

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Assignment of Accounts Receivable – Trap for the Unwary

By  Steven A. Jacobson

Most businesses are familiar with the mechanics of an assignment of accounts receivable. A party seeking capital assigns its accounts receivable to a financing or factoring company that advances that party a stipulated percentage of the face amount of the receivables.

The factoring company, in turn, sends a notice of assignment of accounts receivable to the party obligated to pay the factoring company’s assignee, i.e. the account debtor. While fairly straightforward, this three-party arrangement has one potential trap for account debtors.

Most account debtors know that once they receive a notice of assignment of accounts receivable, they are obligated to commence payments to the factoring company. Continued payments to the assignee do not relieve the account debtor from its obligation to pay the factoring company.

It is not uncommon for a notice of assignment of accounts receivable to contain seemingly innocuous and boilerplate language along the following lines:

Please make the proper notations on your ledger and acknowledge this letter and that invoices are not subject to any claims or defenses you may have against the assignee.

Typically, the notice of assignment of accounts receivable is directed to an accounting department and is signed, acknowledged and returned to the factoring company without consideration of the waiver of defenses languages.

Even though a party may have a valid defense to payment to its assignee, it still must pay the face amount of the receivable to the factoring company if it has signed a waiver. In many cases, this will result in a party paying twice – once to the factoring company and once to have, for example, shoddy workmanship repaired or defective goods replaced. Despite the harsh result caused by an oftentimes inadvertent waiver agreement, the Uniform Commercial Code validates these provisions with limited exceptions. Accordingly, some procedures should be put in place to require a review of any notice of assignment of accounts receivable to make sure that an account debtor preserves its rights and defenses.

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Assignments: The Basic Law

The assignment of a right or obligation is a common contractual event under the law and the right to assign (or prohibition against assignments) is found in the majority of agreements, leases and business structural documents created in the United States.

As with many terms commonly used, people are familiar with the term but often are not aware or fully aware of what the terms entail. The concept of assignment of rights and obligations is one of those simple concepts with wide ranging ramifications in the contractual and business context and the law imposes severe restrictions on the validity and effect of assignment in many instances. Clear contractual provisions concerning assignments and rights should be in every document and structure created and this article will outline why such drafting is essential for the creation of appropriate and effective contracts and structures.

The reader should first read the article on Limited Liability Entities in the United States and Contracts since the information in those articles will be assumed in this article.

Basic Definitions and Concepts:

An assignment is the transfer of rights held by one party called the “assignor” to another party called the “assignee.” The legal nature of the assignment and the contractual terms of the agreement between the parties determines some additional rights and liabilities that accompany the assignment. The assignment of rights under a contract usually completely transfers the rights to the assignee to receive the benefits accruing under the contract. Ordinarily, the term assignment is limited to the transfer of rights that are intangible, like contractual rights and rights connected with property. Merchants Service Co. v. Small Claims Court , 35 Cal. 2d 109, 113-114 (Cal. 1950).

An assignment will generally be permitted under the law unless there is an express prohibition against assignment in the underlying contract or lease. Where assignments are permitted, the assignor need not consult the other party to the contract but may merely assign the rights at that time. However, an assignment cannot have any adverse effect on the duties of the other party to the contract, nor can it diminish the chance of the other party receiving complete performance. The assignor normally remains liable unless there is an agreement to the contrary by the other party to the contract.

The effect of a valid assignment is to remove privity between the assignor and the obligor and create privity between the obligor and the assignee. Privity is usually defined as a direct and immediate contractual relationship. See Merchants case above.

Further, for the assignment to be effective in most jurisdictions, it must occur in the present. One does not normally assign a future right; the assignment vests immediate rights and obligations.

No specific language is required to create an assignment so long as the assignor makes clear his/her intent to assign identified contractual rights to the assignee. Since expensive litigation can erupt from ambiguous or vague language, obtaining the correct verbiage is vital. An agreement must manifest the intent to transfer rights and can either be oral or in writing and the rights assigned must be certain.

Note that an assignment of an interest is the transfer of some identifiable property, claim, or right from the assignor to the assignee. The assignment operates to transfer to the assignee all of the rights, title, or interest of the assignor in the thing assigned. A transfer of all rights, title, and interests conveys everything that the assignor owned in the thing assigned and the assignee stands in the shoes of the assignor. Knott v. McDonald’s Corp ., 985 F. Supp. 1222 (N.D. Cal. 1997)

The parties must intend to effectuate an assignment at the time of the transfer, although no particular language or procedure is necessary. As long ago as the case of National Reserve Co. v. Metropolitan Trust Co ., 17 Cal. 2d 827 (Cal. 1941), the court held that in determining what rights or interests pass under an assignment, the intention of the parties as manifested in the instrument is controlling.

The intent of the parties to an assignment is a question of fact to be derived not only from the instrument executed by the parties but also from the surrounding circumstances. When there is no writing to evidence the intention to transfer some identifiable property, claim, or right, it is necessary to scrutinize the surrounding circumstances and parties’ acts to ascertain their intentions. Strosberg v. Brauvin Realty Servs., 295 Ill. App. 3d 17 (Ill. App. Ct. 1st Dist. 1998)

The general rule applicable to assignments of choses in action is that an assignment, unless there is a contract to the contrary, carries with it all securities held by the assignor as collateral to the claim and all rights incidental thereto and vests in the assignee the equitable title to such collateral securities and incidental rights. An unqualified assignment of a contract or chose in action, however, with no indication of the intent of the parties, vests in the assignee the assigned contract or chose and all rights and remedies incidental thereto.

More examples: In Strosberg v. Brauvin Realty Servs ., 295 Ill. App. 3d 17 (Ill. App. Ct. 1st Dist. 1998), the court held that the assignee of a party to a subordination agreement is entitled to the benefits and is subject to the burdens of the agreement. In Florida E. C. R. Co. v. Eno , 99 Fla. 887 (Fla. 1930), the court held that the mere assignment of all sums due in and of itself creates no different or other liability of the owner to the assignee than that which existed from the owner to the assignor.

And note that even though an assignment vests in the assignee all rights, remedies, and contingent benefits which are incidental to the thing assigned, those which are personal to the assignor and for his sole benefit are not assigned. Rasp v. Hidden Valley Lake, Inc ., 519 N.E.2d 153, 158 (Ind. Ct. App. 1988). Thus, if the underlying agreement provides that a service can only be provided to X, X cannot assign that right to Y.

Novation Compared to Assignment:

Although the difference between a novation and an assignment may appear narrow, it is an essential one. “Novation is a act whereby one party transfers all its obligations and benefits under a contract to a third party.” In a novation, a third party successfully substitutes the original party as a party to the contract. “When a contract is novated, the other contracting party must be left in the same position he was in prior to the novation being made.”

A sublease is the transfer when a tenant retains some right of reentry onto the leased premises. However, if the tenant transfers the entire leasehold estate, retaining no right of reentry or other reversionary interest, then the transfer is an assignment. The assignor is normally also removed from liability to the landlord only if the landlord consents or allowed that right in the lease. In a sublease, the original tenant is not released from the obligations of the original lease.

Equitable Assignments:

An equitable assignment is one in which one has a future interest and is not valid at law but valid in a court of equity. In National Bank of Republic v. United Sec. Life Ins. & Trust Co. , 17 App. D.C. 112 (D.C. Cir. 1900), the court held that to constitute an equitable assignment of a chose in action, the following has to occur generally: anything said written or done, in pursuance of an agreement and for valuable consideration, or in consideration of an antecedent debt, to place a chose in action or fund out of the control of the owner, and appropriate it to or in favor of another person, amounts to an equitable assignment. Thus, an agreement, between a debtor and a creditor, that the debt shall be paid out of a specific fund going to the debtor may operate as an equitable assignment.

In Egyptian Navigation Co. v. Baker Invs. Corp. , 2008 U.S. Dist. LEXIS 30804 (S.D.N.Y. Apr. 14, 2008), the court stated that an equitable assignment occurs under English law when an assignor, with an intent to transfer his/her right to a chose in action, informs the assignee about the right so transferred.

An executory agreement or a declaration of trust are also equitable assignments if unenforceable as assignments by a court of law but enforceable by a court of equity exercising sound discretion according to the circumstances of the case. Since California combines courts of equity and courts of law, the same court would hear arguments as to whether an equitable assignment had occurred. Quite often, such relief is granted to avoid fraud or unjust enrichment.

Note that obtaining an assignment through fraudulent means invalidates the assignment. Fraud destroys the validity of everything into which it enters. It vitiates the most solemn contracts, documents, and even judgments. Walker v. Rich , 79 Cal. App. 139 (Cal. App. 1926). If an assignment is made with the fraudulent intent to delay, hinder, and defraud creditors, then it is void as fraudulent in fact. See our article on Transfers to Defraud Creditors .

But note that the motives that prompted an assignor to make the transfer will be considered as immaterial and will constitute no defense to an action by the assignee, if an assignment is considered as valid in all other respects.

Enforceability of Assignments:

Whether a right under a contract is capable of being transferred is determined by the law of the place where the contract was entered into. The validity and effect of an assignment is determined by the law of the place of assignment. The validity of an assignment of a contractual right is governed by the law of the state with the most significant relationship to the assignment and the parties.

In some jurisdictions, the traditional conflict of laws rules governing assignments has been rejected and the law of the place having the most significant contacts with the assignment applies. In Downs v. American Mut. Liability Ins. Co ., 14 N.Y.2d 266 (N.Y. 1964), a wife and her husband separated and the wife obtained a judgment of separation from the husband in New York. The judgment required the husband to pay a certain yearly sum to the wife. The husband assigned 50 percent of his future salary, wages, and earnings to the wife. The agreement authorized the employer to make such payments to the wife.

After the husband moved from New York, the wife learned that he was employed by an employer in Massachusetts. She sent the proper notice and demanded payment under the agreement. The employer refused and the wife brought an action for enforcement. The court observed that Massachusetts did not prohibit assignment of the husband’s wages. Moreover, Massachusetts law was not controlling because New York had the most significant relationship with the assignment. Therefore, the court ruled in favor of the wife.

Therefore, the validity of an assignment is determined by looking to the law of the forum with the most significant relationship to the assignment itself. To determine the applicable law of assignments, the court must look to the law of the state which is most significantly related to the principal issue before it.

Assignment of Contractual Rights:

Generally, the law allows the assignment of a contractual right unless the substitution of rights would materially change the duty of the obligor, materially increase the burden or risk imposed on the obligor by the contract, materially impair the chance of obtaining return performance, or materially reduce the value of the performance to the obligor. Restat 2d of Contracts, § 317(2)(a). This presumes that the underlying agreement is silent on the right to assign.

If the contract specifically precludes assignment, the contractual right is not assignable. Whether a contract is assignable is a matter of contractual intent and one must look to the language used by the parties to discern that intent.

In the absence of an express provision to the contrary, the rights and duties under a bilateral executory contract that does not involve personal skill, trust, or confidence may be assigned without the consent of the other party. But note that an assignment is invalid if it would materially alter the other party’s duties and responsibilities. Once an assignment is effective, the assignee stands in the shoes of the assignor and assumes all of assignor’s rights. Hence, after a valid assignment, the assignor’s right to performance is extinguished, transferred to assignee, and the assignee possesses the same rights, benefits, and remedies assignor once possessed. Robert Lamb Hart Planners & Architects v. Evergreen, Ltd. , 787 F. Supp. 753 (S.D. Ohio 1992).

On the other hand, an assignee’s right against the obligor is subject to “all of the limitations of the assignor’s right, all defenses thereto, and all set-offs and counterclaims which would have been available against the assignor had there been no assignment, provided that these defenses and set-offs are based on facts existing at the time of the assignment.” See Robert Lamb , case, above.

The power of the contract to restrict assignment is broad. Usually, contractual provisions that restrict assignment of the contract without the consent of the obligor are valid and enforceable, even when there is statutory authorization for the assignment. The restriction of the power to assign is often ineffective unless the restriction is expressly and precisely stated. Anti-assignment clauses are effective only if they contain clear, unambiguous language of prohibition. Anti-assignment clauses protect only the obligor and do not affect the transaction between the assignee and assignor.

Usually, a prohibition against the assignment of a contract does not prevent an assignment of the right to receive payments due, unless circumstances indicate the contrary. Moreover, the contracting parties cannot, by a mere non-assignment provision, prevent the effectual alienation of the right to money which becomes due under the contract.

A contract provision prohibiting or restricting an assignment may be waived, or a party may so act as to be estopped from objecting to the assignment, such as by effectively ratifying the assignment. The power to void an assignment made in violation of an anti-assignment clause may be waived either before or after the assignment. See our article on Contracts.

Noncompete Clauses and Assignments:

Of critical import to most buyers of businesses is the ability to ensure that key employees of the business being purchased cannot start a competing company. Some states strictly limit such clauses, some do allow them. California does restrict noncompete clauses, only allowing them under certain circumstances. A common question in those states that do allow them is whether such rights can be assigned to a new party, such as the buyer of the buyer.

A covenant not to compete, also called a non-competitive clause, is a formal agreement prohibiting one party from performing similar work or business within a designated area for a specified amount of time. This type of clause is generally included in contracts between employer and employee and contracts between buyer and seller of a business.

Many workers sign a covenant not to compete as part of the paperwork required for employment. It may be a separate document similar to a non-disclosure agreement, or buried within a number of other clauses in a contract. A covenant not to compete is generally legal and enforceable, although there are some exceptions and restrictions.

Whenever a company recruits skilled employees, it invests a significant amount of time and training. For example, it often takes years before a research chemist or a design engineer develops a workable knowledge of a company’s product line, including trade secrets and highly sensitive information. Once an employee gains this knowledge and experience, however, all sorts of things can happen. The employee could work for the company until retirement, accept a better offer from a competing company or start up his or her own business.

A covenant not to compete may cover a number of potential issues between employers and former employees. Many companies spend years developing a local base of customers or clients. It is important that this customer base not fall into the hands of local competitors. When an employee signs a covenant not to compete, he or she usually agrees not to use insider knowledge of the company’s customer base to disadvantage the company. The covenant not to compete often defines a broad geographical area considered off-limits to former employees, possibly tens or hundreds of miles.

Another area of concern covered by a covenant not to compete is a potential ‘brain drain’. Some high-level former employees may seek to recruit others from the same company to create new competition. Retention of employees, especially those with unique skills or proprietary knowledge, is vital for most companies, so a covenant not to compete may spell out definite restrictions on the hiring or recruiting of employees.

A covenant not to compete may also define a specific amount of time before a former employee can seek employment in a similar field. Many companies offer a substantial severance package to make sure former employees are financially solvent until the terms of the covenant not to compete have been met.

Because the use of a covenant not to compete can be controversial, a handful of states, including California, have largely banned this type of contractual language. The legal enforcement of these agreements falls on individual states, and many have sided with the employee during arbitration or litigation. A covenant not to compete must be reasonable and specific, with defined time periods and coverage areas. If the agreement gives the company too much power over former employees or is ambiguous, state courts may declare it to be overbroad and therefore unenforceable. In such case, the employee would be free to pursue any employment opportunity, including working for a direct competitor or starting up a new company of his or her own.

It has been held that an employee’s covenant not to compete is assignable where one business is transferred to another, that a merger does not constitute an assignment of a covenant not to compete, and that a covenant not to compete is enforceable by a successor to the employer where the assignment does not create an added burden of employment or other disadvantage to the employee. However, in some states such as Hawaii, it has also been held that a covenant not to compete is not assignable and under various statutes for various reasons that such covenants are not enforceable against an employee by a successor to the employer. Hawaii v. Gannett Pac. Corp. , 99 F. Supp. 2d 1241 (D. Haw. 1999)

It is vital to obtain the relevant law of the applicable state before drafting or attempting to enforce assignment rights in this particular area.

Conclusion:

In the current business world of fast changing structures, agreements, employees and projects, the ability to assign rights and obligations is essential to allow flexibility and adjustment to new situations. Conversely, the ability to hold a contracting party into the deal may be essential for the future of a party. Thus, the law of assignments and the restriction on same is a critical aspect of every agreement and every structure. This basic provision is often glanced at by the contracting parties, or scribbled into the deal at the last minute but can easily become the most vital part of the transaction.

As an example, one client of ours came into the office outraged that his co venturer on a sizable exporting agreement, who had excellent connections in Brazil, had elected to pursue another venture instead and assigned the agreement to a party unknown to our client and without the business contacts our client considered vital. When we examined the handwritten agreement our client had drafted in a restaurant in Sao Paolo, we discovered there was no restriction on assignment whatsoever…our client had not even considered that right when drafting the agreement after a full day of work.

One choses who one does business with carefully…to ensure that one’s choice remains the party on the other side of the contract, one must master the ability to negotiate proper assignment provisions.

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True sale of receivables

In this note we examine the legal characteristics of a true sale, the risk of recharacterisation and explain why true sale is an important concept.

Factoring and invoice discounting are both examples of financing techniques that involve the sale of receivables (often at a discount) by a seller to a financier, rather than the provision of a loan secured against the receivables.

Where the financing is structured as a sale, the parties will want the monies advanced by the financier to be characterised as a purchase price and the assignment of the receivables by the seller to be characterised as a sale.

Where a purported sale of receivables fails the “true sale” test, there is a risk that the payment of the purchase price will be recharacterised by the courts on the insolvency of the seller as a loan and the purported sale will be recharacterised as a security assignment.  If the seller is incorporated in a jurisdiction where security assignments must be registered, that recharacterisation may lead to the security being void against the seller’s liquidator as a security for want of registration.  The financier would then be left as an unsecured creditor of the seller.

Legal characteristics

Unfortunately, there is no one legal test by which it is possible to determine conclusively whether a transaction amounts to a true sale of receivables, rather than a secured loan.

In the case of Re George Inglefield Ltd [1933] Ch. 1, the Court of Appeal identified the following essential differences between a sale and a secured loan:

• In a sale transaction, the seller is not entitled to get back the asset it has sold by returning the purchase price to the purchaser.  A loan secured by a mortgage or charge of the asset would include this right.
• If a mortgagee sells the secured property for an amount in excess of the outstanding balance of the loan (together with interest and costs), he has to account to the mortgagor for any surplus.  In a sale transaction, however, if the purchaser subsequently sells the asset for a profit, he does not have to account to the seller for the profit. 
• If a mortgagee sells the secured property for an amount that is insufficient to discharge the outstanding loan amount, the mortgagee is entitled to recover the balance from the mortgagor.  In a sale transaction, however, the purchaser has no right to recover any such loss from the seller.

Broadly speaking, the courts will look for evidence that the risks and rewards of ownership of the receivables have transferred from the seller to the financier.

Economic substance

For a receivables purchase transaction, the main risk of ownership is non-payment of the receivables by the debtor.  In determining to what extent the risks and rewards of ownership have transferred from the seller to the financier, the economic substance of a transaction will usually be an important factor considered by the courts.

Where the financier has a right to recourse (ie sell back) the receivable to the seller in the event of non-payment by the debtor, the courts may take the view that the seller has retained the risks of ownership, such that the economic substance of the transaction is that of a secured loan, rather than a true sale.

The natural tendency of banks is to include as many repurchase events as possible in the receivables purchase agreement (RPA), as this increases recourse to the seller and is perceived to be less risky for the financier.  However, from a true sale perspective, this approach should be resisted, because the more extensive the list of recourse events the greater the risk is of recharacterisation.

This does not mean that the financier cannot set any limits on its exposure to a debtor and it is common to see financiers requiring a right of recourse where, for example, non-payment of a receivable is due to a dispute arising between the buyer and the seller, or due to an alleged breach by the seller of its obligations under the underlying sales contract.  The financier is providing working capital finance to the seller, but this does not oblige the financier to take on wider risks associated with the business relationship between the buyer and the seller.

As a general rule, a transaction is more likely to be characterised as a true sale if the financier has no, or limited, rights of recourse to the seller.  This is especially true if recourse is limited to matters other than a payment default and those which are within the seller’s control.

Objective intent

On the basis of the principles set out in Re George Inglefield, Ltd , as considered and applied by the Court of Appeal in Welsh Development Agency v. Export Finance Co., Ltd [1992] BCLC 148, the threshold for recharacterisation is a high one and a transaction structured as a sale of receivables will generally be upheld as such unless the transaction is in substance a mortgage or charge of receivables and not a sale, or a sham.

If one or more provisions of the RPA are inconsistent with a sale, then the court will look to the provisions of the RPA as a whole to determine the substance of the transaction and the nature of the legal relationship created between the parties.

The courts will only find a transaction to be a sham where the terms of the RPA do not represent the true intentions of the seller and the financier.

Off-balance sheet financing

True sale is not only a legal issue, but will have important implications for determining whether or not a transaction can be classified as “off-balance sheet” financing under applicable accounting rules.

“Off-balance sheet” in this context means that the seller is able to remove the receivables it has sold from its balance sheet and can show the payment it receives from the financier as cash.  The attraction for the seller of this is an improvement in its liquidity while avoiding the need to report additional liabilities on its balance sheet.

The correct presentation in the seller’s accounts of such a transaction is made by the seller’s accountant, rather than the financier or its lawyers.  However, accountants will often require a legal opinion confirming that a true sale of the receivables has been achieved from a legal perspective before a transaction can be classified as off-balance sheet.

Health warning

This note is intended for general information only and provides a simplified overview of English law.  It should not be used as a substitute for taking legal advice.  The law is summarised as of 19 April 2016.

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This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.

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The Business Contract Terms (Assignment of Receivables) Regulations 2018: still more to do?

The Business Contract Terms (Assignment of Receivables) Regulations 2018 (the " Regulations ") are now in force. The Regulations are intended to make it easier for small businesses to access receivables-based finance by making ineffective any prohibitions, conditions and restrictions on the assignment of receivables [1] arising under contracts for the supply of goods, services or intangible assets.

The Regulations have a somewhat chequered history. The Law Commission advocated legislation to limit the effectiveness of anti-assignment clauses in 2005, however, the proposal failed to gain momentum and lay dormant for more than a decade. Draft legislation finally appeared in 2017, but was withdrawn following criticism by the Loan Market Association and others. The final form of the Regulations addresses some of the criticisms, but adds complexity in what is already a complex area of the law.

The Effect of the Regulations

A term in a contract to which the Regulations apply is ineffective to the extent that it prohibits or imposes a condition or other restriction on the assignment of a receivable arising under that contract or another contract between the same parties. That does not necessarily mean that the term will be entirely void as a result: contractual prohibitions on assignment often do not distinguish between the right to performance of the contract and the right to be paid amounts arising under it. Prohibitions of this type will remain effective to prevent an assignment of the right to performance, even if they are ineffective to prevent the assignment of receivables arising under the contract.

The Regulations provide that a term which prevents an assignee from determining the validity or the value of the receivable or restricts its ability to enforce the receivable will be deemed to be a condition or other restriction on assignment. This, for example, includes provisions which prevent an assignee from obtaining particulars and evidence of any potential defence or set-off by a party to the contract. Therefore, the Regulations permit disclosure of matters which might otherwise be caught by confidentiality provisions in the underlying contract.

When do the Regulations apply?

Subject to specified exceptions, the Regulations apply to any contract entered into on or after 31 December 2018.

Certain types of contract are excluded from the Regulations. For example, the Regulations do not apply :

• to contracts for certain prescribed financial services or to other specific types of contract, including those in relation to real estate, certain derivatives, certain project finance and energy agreements and operating leases.
• to contracts entered into in connection with the acquisition, disposal or transfer of an ownership interest in all or part of a business, firm or undertaking, provided the relevant contract includes a statement to that effect. The need for such a statement applies even where the purpose of the contract is obvious on its face.
• where one or more of the parties is a consumer, or where none of the parties has entered into the contract in the course of carrying on a business in the UK.

The Regulations do not apply if the supplier is a "large enterprise" or a "special purpose vehicle" (the " SME Test ") at the time of the assignment. For this purpose, a special purpose vehicle is a firm that carries out a primary purpose in relation to the holding of assets (except trading stock) or financing commercial transactions, which in either case involves it incurring a liability of £10m or more.

The question of whether a limited company is a "large enterprise" depends in part on turnover, balance sheet total and number of employees assessed by reference the most recent annual accounts filed by the company or its parent prior to the assignment. Therefore, at the time the supplier and the debtor enter into a contract, they will not necessarily know whether a contractual prohibition on the assignment of receivables will be effective.

The definition of a "large enterprise" may be difficult to apply in some circumstances and to some entities. For example, the Regulations imply that limited partnerships are included in scope and some commentators argue that in this situation it would be the general partner entity which would be assessed under the SME Test, however, this is not expressly provided for by the Regulations.

If another governing law is imposed by a party wholly or mainly for the purpose of enabling it to evade the operation of the Regulations, the Regulations state that they will nevertheless have effect. Aside from the practical difficulty in determining whether the choice of law was imposed for this purpose, the effect of this provision is not entirely clear. Under Rome I, the law governing an assigned claim determines its assignability and the relationship between the assignee and the debtor [2] . Therefore, the fundamental question of whether the debtor should pay the supplier or the assignee remains determined by the governing law of the contract, but subject it seems (at least as far as the English courts are concerned) to the mandatory provisions of the Regulations.

The Regulations only affect prohibitions, restrictions and conditions on assignment contained in the contract under which the receivable arises or another contract between the same parties. For example, they would not restrict the effectiveness of a negative pledge or a restriction on the disposal of receivables contained in a financing document with a third party lender.

The term "assignment" is not defined in the Regulations and, assuming it has its normal legal meaning, does not include the creation of a charge or trust. Therefore, it appears that the Regulations do not apply to the creation of a charge or a trust.

What if the Regulations do not apply?

As a result of the SME Test and the exclusion of certain types of contracts, there will be many situations in which the Regulations are not relevant to the assignment of a receivable. Where the Regulations do not apply, the current law recognises the effectiveness of contractual prohibitions on the assignment of receivables [3] . However, case law suggests that a prohibition on assignment will not normally be construed as preventing the creation of a trust. Receivables purchase agreements will therefore often provide for the supplier to hold the receivable and/or its proceeds on trust for the assignee to the extent that the assignment is ineffective. In response, some debtors include specific prohibitions on the creation of trusts over receivables in their contracts. However, assignees will try to circumvent the practical effect of even the most widely drafted prohibition by taking a power of attorney enabling them to bring an action against the debtor in the name of the supplier.

The law is still developing in response to this escalating arms race between assignees and debtors. In part this is due to an inevitable tension between the interest of the assignee in having its proprietary interest in the receivable recognised and the interest of the debtor in choosing whether it deals with anyone other than its original contractual counterparty.

This has led some to argue that the common law should recognise all assignments of receivables notwithstanding prohibitions on assignment, at least as between the assignor and the assignee. [4] Arguably, this approach would balance the legitimate interests of all parties.

Still more to do?

Where they apply, the Regulations will make it easier for SMEs to assign their receivables and to raise finance. However, the Regulations do not mean that assignees can ignore the terms of the underlying contractual arrangements between suppliers and debtors; for one thing any existing rights of set-off will continue to bind the assignee [5] . Also, because the Regulations do not apply to contracts entered into before 31 December 2018, prohibitions on assignment will continue to apply to many receivables owed to SME suppliers for a while yet.

Assessing whether a supplier is an SME involves reviewing the most recent relevant annual accounts and the status of the supplier in this respect may change throughout the term of a contract. There are also various types of contract to which the Regulations do not apply and, in some cases, applying those exceptions is not straightforward. The Regulations add an additional layer of complexity to the law.

In practice, the question that assignees ask their lawyers is very simple: what action can they take to recover? The Regulations may enable the answer to be more positive, but they also make it more nuanced. There is more work for legislation or precedent to do to simplify the law in this area.

[1] "Receivable" is defined in broad terms as a right (whether or not earned by performance) to be paid any amount under a contract for the supply of goods, services or intangible assets.

[2] Regulation (EC) No 593/2008: Article 14(2), Rome I

[3] Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd [1994] 1 AC 85

[4] See in particular Professor Roy Goode's article " Contractual Prohibitions Against Assignment " [2009] LMCLQ 300 cited by approval by Lady Justice Gloster in First Abu Dhabi Bank PJSC and BP Oil International Limited [2018] EWCA Civ 14

[5] In recovery situations, set-off and disputes in relation to liability are often more significant issues for the debtor from a commercial perspective than the question of whether a prohibition on assignment is legally effective.

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UAE clarifies factoring and assignments of receivables

The recently enacted Federal Decree-Law No. 16 of 2021 on Factoring and Transfer of Civil Accounts Receivable (the New Law) which enters into force on 8 December 2021, being the first federal regulation in the United Arab Emirates (the UAE) dealing specifically with factoring and the assignment of receivables, has ushered in some much-needed clarity as to how these arrangements should work in the UAE. Specifically, the New Law provides a new regulatory framework which sets out the basic legal requirements for assignments and transfers of receivables, validity and perfection requirements, as well as the rules for determining priority amongst competing claims over assigned receivables.

Historically, this had been viewed as something of a 'grey' area of the law – governed in a piecemeal way, with Federal Law No. 5 of 1985 (as amended, the Civil Code) governing the assignment of debt and Federal Law No. 4 of 2020 (the Moveable Assets Mortgage Law) governing assignments over receivables which are taken by way of security. This had created some uncertainty as to which regulation should apply in particular circumstances, as well as uncertainty regarding the relationship between the different laws. The fact that the New Law seeks to provide a unified framework in relation to this area is a very welcome development. There are, however, certain key aspects of the New Law which may require further clarification as market participants seek to rely upon this new framework.

Scope of the New Law

The New Law applies broadly to any assignment of receivables made as part of commercial or civil transactions. Notable exclusions from this new law are assignments in the context of:

• personal / family transactions;
• financial contracts regulated by clearing agreements;
• foreign exchange transactions;
• interbank payment systems, net-based clearing systems and settlement related to securities, assets or other financial instruments;
• repurchase of securities, assets or financial instruments deposited with a broker;
• the right to financial payments fixed in endorsable bonds;
• the right to payments deposited in credit accounts with banks; and
• the right to payments under securities, documentary credits and letters of guarantee.

What is an Assignment?

The New Law governs " Assignments ", which is defined to cover an arrangement where " contractual rights to settle a cash sum owed by the Debtor are transferred to the Assignee, and the Assignment constitutes the agreement to create a security right on the Debtor's debt, transfer it as a security, and sell it in a final sale ". One possible interpretation of this particular definition would be that the New Law only governs arrangements which not only assign a debt but which also create a security interest over that debt. However, many factoring arrangements and debt assignments simply involve a debt being assigned absolutely and do not necessarily involve a security right being created over that debt. The New Law also does not elaborate on the different types of factoring arrangements that can exist, such as the purchase or sale of receivables, discounting and reverse factoring.

Given that the New Law appears (on the face of it) to be intended to cover all factoring arrangements and assignments of debts, the prudent course of action for market participants would be to ensure that all of their factoring arrangements and assignments of debt comply with the New Law, regardless of whether those arrangements involve security being created.

Form of Assignment

When it comes to the form that an assignment of receivables should take, the New Law is not prescriptive, and simply provides that an assignment shall be considered effective provided that the receivables that are subject to the assignment are described in a general or specific manner in order to allow for their identification.

Importantly, the New Law goes on to clarify some of the key points around how to describe the receivables being assigned (in relation to which there previously was some uncertainty). Specifically, we highlight the following:

• It is acceptable for the purposes of the New Law to describe the assigned receivables generally, for example by simply saying that the assignment is of all receivables that are currently owed by a debtor, all receivables that will be owed by a debtor in the future, or a specific class or specific or general type of such receivables.
• The New Law therefore appears to confirm that, in an assignment agreement, it is not necessary to individually list out each particular contract under which a debt is assigned.
• The New Law confirms that if the subject of the relevant assignment is receivables which are owed by a debtor in the future, then that assignment may be effective without the need to enter into any new transaction to assign each future debt in due course.

Effectiveness and Priority

One key point which the New Law clarifies is in relation to the effectiveness of debt assignment agreements against third parties: with specific provisions of the Moveable Assets Mortgage Law being incorporated by reference in order to establish that such assignments, in order to be effective towards third parties, must be declared on the electronic register created under the Moveable Assets Mortgage Law (which is currently operated by the Emirates Integrated Registries Company (EIRC)). While, prior to the introduction of the New Law, it was common for market participants to register assignments of receivables with the EIRC, it was not previously clear whether this was strictly necessary with respect to absolute assignments of receivables under the Civil Code which did not create security interests.

Regarding any specific requirements which need to be met in order for an assignment of receivables to be effective against a debtor (which have traditionally been governed by the Civil Code and relevant cases), the New Law does not specifically repeal or replace the Civil Code in this respect, and so the prudent course would be for market participants to continue to satisfy the applicable conditions derived from the Civil Code. This essentially means that, in order for an assignment of receivables to be enforceable against a debtor, notice of the assignment is required to be provided to the relevant debtor and (depending on the exact circumstances) with it also being advisable for the assignment of receivables to be acknowledged by the relevant debtor. The New Law does however give an assignee the clear right to send a notification and payment instructions to the relevant debtor in relation to receivables that have been assigned to that assignee (even if that notification gives rise to a breach of the underlying contract as between the assignor and the debtor), and does also seem to indicate that the debtor must agree to the assignment particularly in the context where the underlying contract is being amended.

Similar to what we see with registration, when it comes to determining priority among competing claims over receivables, the New Law relies on the Moveable Assets Mortgage Law to allocate the priority (determined by the date and time of registration) of the rights of assignees over the accounts receivable, to determine the priority of the assignor's obligation and to determine the priority of the assignment towards non-contractual rights.

To conclude, the New Law has clarified certain key issues regarding the assignment of receivables, and in doing so has created a more unified framework. It is now clear that any receivables which are subject to an assignment (which may include future receivables) need only be described in the assignment in general terms, and it is also now clear that certain elements of the Moveable Assets Mortgage Law apply to assignments of receivables (such as the registration requirements and rules regarding priority). Question marks do, however, remain over how the New Law treats certain types of debt assignments and factoring arrangements (particularly ones that involve absolute assignments and not security rights), as well as the question of how a court would interpret the relevant provisions of the Civil Code in light of the New Law.

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English law assignments of part of a debt: Practical considerations

United Kingdom |  Publication |  December 2019

Enforcing partially assigned debts against the debtor

The increase of supply chain finance has driven an increased interest in parties considering the sale and purchase of parts of debts (as opposed to purchasing debts in their entirety).

While under English law part of a debt can be assigned, there is a general requirement that the relevant assignee joins the assignor to any proceedings against the debtor, which potentially impedes the assignee’s ability to enforce against the debtor efficiently.

This note considers whether this requirement may be dispensed with in certain circumstances.

Can you assign part of a debt?

Under English law, the beneficial ownership of part of a debt can be assigned, although the legal ownership cannot. 1  This means that an assignment of part of a debt will take effect as an equitable assignment instead of a legal assignment.

Joining the assignor to proceedings against the debtor

While both equitable and legal assignments are capable of removing the assigned asset from the insolvency estate of the assignor, failure to obtain a legal assignment and relying solely on an equitable assignment may require the assignee to join the relevant assignor as a party to any enforcement action against the debtor.

An assignee of part of a debt will want to be able to sue a debtor in its own name and, if it is required to join the assignor to proceedings against the debtor, this could add additional costs and delays if the assignor was unwilling to cooperate. 2

Kapoor v National Westminster Bank plc

English courts have, in recent years, been pragmatic in allowing an assignee of part of a debt to sue the debtor in its own name without the cooperation of the assignor.

In Charnesh Kapoor v National Westminster Bank plc, Kian Seng Tan 3 the court held that an equitable assignee of part of a debt is entitled in its own right and name to bring proceedings for the assigned debt. The equitable assignee will usually be required to join the assignor to the proceedings in order to ensure that the debtor is not exposed to double recovery, but the requirement is a procedural one that can be dispensed with by the court.

The reason for the requirement that an equitable assignee joins the assignor to proceedings against the debtor is not that the assignee has no right which it can assert independently, but that the debtor ought to be protected from the possibility of any further claim by the assignor who should therefore be bound by the judgment.

Application of Kapoor

It is a common feature of supply chain finance transactions that the assigned debt (or part of the debt) is supported by an independent payment undertaking. Such independent payment undertaking makes it clear that the debtor cannot raise defences and that it is required to pay the relevant debt (or part of a debt) without set-off or counterclaim. In respect of an assignee of part of an independent payment undertaking which is not disputed and has itself been equitably assigned to the assignee, we believe that there are good grounds that an English court would accept that the assignee is allowed to pursue an action directly against the debtor without needing the assignor to be joined, as this is likely to be a matter of procedure only, not substance.

This analysis is limited to English law and does not consider the laws of any other jurisdiction.

Notwithstanding the helpful clarifications summarised in Kapoor, as many receivables financing transactions involve a number of cross-border elements, assignees should continue to consider the effect of the laws (and, potentially court procedures) of any other relevant jurisdictions on the assignment of part of a debt even where the sale of such partial debt is completed under English law.

Legal title cannot be assigned in respect of part of a debt. A partial assignment would not satisfy the requirements for a legal assignment of section 136 of the Law of Property Act 1925.

If an assignor does not consent to being joined as a plaintiff in proceedings against the debtor it would be necessary to join the assignor as a co-defendant. However, where an assignor has gone into administration or liquidation, there may be a statutory prohibition on joining such assignor as a co-defendant (without the leave of the court or in certain circumstances the consent of the administrator).

[2011] EWCA Civ 1083

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• Home News and Insights Assignment of Receivables

Assignment of Receivables

3rd November 2017

The draft Business Contract Terms (Assignment of Receivables) Regulations 2017 (the “ Draft Regulations “) are currently before Parliament. If approved, these would contain provisions to nullify contract terms which attempt to restrict the ability of a party to assign a receivable.

In December 2014, the Department for Business, Innovation & Skills (BIS) consulted on an earlier version of the Draft Regulations. These earlier regulations contained a provision that allowed a party to rely on a confidentiality clause to prevent assignment of a receivable. This was included in the event that a debtor is unwilling for a receivable to be assigned because the disclosure of the debt to a third party compromises the debtor’s confidentiality. In August 2015, BIS published a response to the consultation.

Businesses often have to wait for a considerable length of time to be paid, which can cause cash flow issues. As a way of raising finance, a business may choose to assign an unpaid invoice to a third party, such as an invoice finance provider. This works by the finance provider lending the money to the business on the basis that the invoice is assigned to the finance provider. The finance provider will then pursue the debtor for the unpaid amount which will cover the earlier loans to the business.

Most contracts contain boilerplate provisions preventing the assignment of any rights under the contract unless the other party consents. A receivable is a right to be paid and a boilerplate non-assignment clause is broad enough to prevent invoices from being assigned.

Certain contracts are excluded from these rules. These include contracts for: an interest in land; for financial services; consumers where one or more of the parties is acting for purposes which are outside a trade, business or profession; for national security; and for certain energy and petroleum contracts.

Noticeably, the Draft Regulations do not include the confidentiality clause that was included in the earlier version.

Controversially, “assignment” is not defined. It is clear that this law would apply to outright assignments of receivables, but it is unclear the extent which it will apply to security interests. On the face of it, the new law will extend to security assignments but not charges or trusts. This may have the result that the parties cannot prevent a security assignment but can prevent a lesser interest such as a charge.

One of the reasons why restrictions on assignment are included in contracts is to protect the payer from having to pay more to an assignee than it would have to pay to the assignor. However, there is nothing in the Draft Regulations to protect the payer. It can only rely on its rights under the general law, which are extensive but not as good as an effective prohibition on assignment.

If approved, the Draft Regulations will not only apply to small companies. It will also read so that it covers all contracts, including those in existence at the time the new law comes into effect, which is expected to be in November or December 2017.

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Receivables security assignment

Practical law uk legal update 6-106-9076  (approx. 2 pages).

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12 Jan 2022

New Federal Decree Law No. (16) of 2021 on Assignment of Receivables and Factoring

Authored by: Howrey Kamal

In Brief: This article discusses the recent enactment of Federal Decree Law No. (16) of 2021 on Assignment of Receivables and Factoring ( Assignment and Factoring Law ) and in particular it discusses:

• assignment under the Civil Code;
• assignment and factoring under the Assignment and Factoring Law; and
• priority and enforcement.

Assignment under the Civil Code

Historically, the law relating to assignment in the UAE has been governed by Federal Law No. 5 of 1985 on the Civil Transactions Law (the Civil Code ). The Civil Code deals with assignment in detail through Article 1106 to Article 1132.

Article 1106 of the Civil Code defines assignment to mean “an assignment of debt and claim from the liability of the assignor to the assignee”. An important note to make here is that the assignment provisions under the Civil Code only deal with assignment of ‘debt and claim’; that is, assignment of obligations rather than assignment of rights.

In an assignment of an obligation, A assigns to C its obligation to discharge a contractual claim or its obligation to pay B, whereas in an assignment of rights, A assigns to C its right to receive payment from B. One of the key provisions of assignment is that in order for it to be perfected or valid, notice has to be served to the counterparty and acknowledgment must be obtained. Article 1109 of the Civil Code states that “the validity of an assignment is conditioned upon the acceptance of the assignor, the assignee and the counterparty.” This means an assignment of an obligation (whether debt or claim) is not enforceable against the counterparty unless it agrees to it.

Assignment of rights has been governed by case law. The UAE Courts have been consistent in ruling that ‘consent’ or ‘acknowledgment’ in an assignment of rights from the ‘payor’ is not required and notice to the payor will suffice to perfect the assignment. The rationale for this is that in an assignment of rights no additional burden is imposed on the payor. For example, the Abu Dhabi Court of Cassation in Case No. 597 of 2012 stated that “an assignment of rights shall be established by mutual consent between the assignor and the assignee without the need to obtain the debtor’s consent. If the debtor has not been served with notice of assignment, the debtor can deal with its original creditor as the sole creditor.” The Court further stated that the counterparty will be bound by the assignment once it has become aware of the assignment.

Assignment and Factoring Law

The Assignment and Factoring Law was published on 9 September 2021, the first federal law in relation to assignment of right to payment and it came into force on 7 December 2021. As noted above, previously there was no UAE law on assignment of rights.

Assignment is defined in the Assignment and Factoring Law to mean “an agreement whereby the assignor assigns to the assignee its contractual rights for collecting a monetary amount owed by the Receivable's Debtor. The assignment involves an agreement to create a security interest over the receivable, to assign as a collateral and irrevocably sell the same.”

Article 2(2) of the Assignment and Factoring Law says that it applies to all commercial and civil transactions except for assignment of receivables that arise out of the following situations:

• a transaction carried for personal, family or household purposes;
• financial contracts regulated by netting agreements;
• foreign exchange transactions;
• systems and agreements of interbank payment, netting systems and adjustment relating to securities, assets or other financial instruments; and
• buyback of securities, assets or financial instruments deposited with a broker.

Article 2(3) of the Assignment and Factoring Law further says that it shall not apply to the following cases:

• the right to payments proven under endorsable instruments;
• the right to payments deposited into the credit accounts with banks; and
• the right to payments under securities, documentary credits and letters of guarantee.

Key provisions of the Assignment and Factoring Law

• The receivables must be generally or specifically described so that they can be identified (Article 4(4) of the Assignment and Factoring Law).
• Assignment of receivables can apply to future receivables (Article 4(5) of the Assignment and Factoring Law).
• Assignment will be effective regardless of any contractual agreement obliging the assignor not to assign its right to payment under the original agreement (Article 5(2) of the Assignment and Factoring Law).
• The counterparty will enjoy the same rights it has against the assignor under the original agreement and this includes right of set-off, however this can be contracted out (Articles 16 and 17 of the Assignment and Factoring Law).
• Once payment is made to the assignee the counterparty cannot claim it back from the assignee even if the assignor is in breach of the original contract (Article 19 of the Assignment and Factoring Law).
• Existing assignments can be registered in the Moveable Collateral Register within six months from 7 December 2021.

Enforceability of assignment and notice requirements

Article 4(2) of the Assignment and Factoring Law says that an assignment will be enforceable, once executed, between the assignor and the assignee even if notice has not been served on the counterparty (payor). This implies that if notice is not served on the counterparty, the assignment is still valid but in order for the assignment to be binding on the counterparty notice must be served, otherwise the counterparty will continue to pay the assignor.

As noted above, the Courts in the UAE have historically been consistent in ruling that an assignment of right does not requires consent of the counterparty and notice will suffice to perfect an assignment. The Assignment and Factoring Law maintains this position and does not require the counterparty to provide consent. However, the counterparty will only be bound by the assignment once notified and when payment instructions are received in accordance with Article 14 of the Assignment and Factoring Law.

Article 11(1) of the Assignment and Factoring Law provides that the assignor and the assignee may each serve notices and payment instructions to the counterparty and once notice is served, the counterparty is obliged to take payment instructions only from the assignee.

Priority and third-party rights

Articles 7 and 8 of the Assignment and Factoring Law provide that in relation to priority, the relevant provisions of the Federal Law No. (4) of 2020 on Securing Interest in Movable Property ( Movable Pledge Law ) will apply. Article 7(2) of the Assignment and Factoring Law particularly says that an assignment is not enforceable against third-parties (in other words, against competing creditors) unless it is registered in the Movable Collateral Register which is currently managed by Emirates Integrated Registries Company.

Under Article 10(1) of the Movable Pledge Law, a security right is effective against third-parties if:

• it is registered in the Movable Collateral Register;
• possession has been transferred to the pledgee; and
• the pledgee has taken control of the security assets.

The above priority in relation to assignment means that once an assignment of the right to receive payment is perfected by registration in the Movable Collateral Register, it will be binding against any subsequent assignment of the same right. This means a creditor under an assignment by way of security should immediately register the assignment in the Movable Collateral Register, in order to ensure priority over competing claims.

Factoring is defined in the Assignment and Factoring Law to mean a “transaction whereby the assignor assigns the current and/or future receivables to the assignee, or an agreement between the parties that the assignor shall retain the entries relating to and collect the receivable transferred and to afford protection to the assignee in case the Receivable's Debtor defaults on payment.”

A significant point to make is that the Assignment and Factoring Law provides that factoring can only be exercised by entities licensed by the UAE Central Bank. Although further guidance is anticipated from the UAE Central Bank in accordance with Article 25 of the Assignment and Factoring Law, no such guidance has been issued as at the date of the publication of this article. For any entities wishing to carry out factoring activities, it is important that they monitor any updates on this point and seek the relevant licence from the UAE Central Bank at the appropriate time.

Enforcement

The Assignment and Factoring Law does not provide a specific mechanism for enforcement should the counterparty refuse to pay the assignee upon receipt of payment instructions. However, Article 21 of the Assignment and Factoring Law says that the assignee can enforce its rights in accordance with provisions of the assignment or alternatively can take enforcement action under Chapters 7 and 8 of the Movable Pledge Law.

Chapter 7 of the Movable Pledge Law provides that the assignee can enjoy self-help (out of court enforcement) subject to notice being served on the counterparty and Chapter 8 of the Movable Pledge Law provides for an expedited court enforcement process. Under Chapter 8 of the of the Movable Pledge Law, the enforcement application is made to the Judge of Urgent Matters and the matter is considered by the Judge within a short timeline as set out in detail therein.

For enquiries in relation to the Assignment and Factoring Law, please contact the Banking & Finance team.

This article, together with any commentary, does not constitute legal advice. It is provided solely for information purposes on a complimentary basis, without consideration of any specific objectives, circumstances or facts. It reflects then current views of the writer which may modify in time and based on differing objectives, circumstances or facts. A writer's view may differ from views of colleagues and/or the firm. You should seek legal advice on each specific matter. Access to this article does not form an attorney-client relationship.

Howrey Kamal

Senior associate, +971 2 205 5300, [email protected].

In this Article, Howrey Kamal, Trainee Solicitor, discusses Federal Decree Law No. (16) of 2021 on Assignment of Receivables and Factoring which came into force on 7 December 2021.

Hadef successfully obtained a judgment in relation to the applicability of a Bank’s General Terms & Conditions to a party’s right to apply set-off

In this article, Howrey Kamal, Trainee Solicitor Dispute Resolution, discusses a significant judgment from the Abu Dhabi Court of Cassation regarding the applicability of a Bank’s General Terms & Conditions and the principles of set-off

Law of Assignment of Receivables

– Vinod Kothari

– With edits/updates by Richa Saraf

[Updated as on 08th April, 2020]

Assignment of receivables out of transactions is growing astronomically; though without any numerical evidence, but one can say that the total volume of sale of loans and sale of receivables might be exceeding global trades in goods and services put together. Assignment or transfer of receivables is taking place for variety of purposes – securitisation, loan sales, originate-to-transfer transactions, security interest, transfer of servicing or collection function, sale of distressed loans to loan resolution companies, and so on.

While the global usage of assignment of receivables has become so common, the body of law that defines what can be assigned, what is the impact of restrictions on assignment, what happens upon assignment, etc., is still anchored in 19 th Century principles, and in most countries, there may not be a specific law dealing with assignments. This is a pity, given such clear laws dealing with sale of goods.

Before getting into the subject, just a bit of clarity on the jargon. Assignment of debt, assignment receivables, assignment of actionable claims, assignment of choses in action, assignment of things in action, transfer of receivables, sale of receivables, loan sales, etc are all terms that point to the same thing. This article is relevant for each of these. Assignment may lead to securitisation –this article does not deal with the law of securitisation.

Commercial risks in originate-to-transfer model:

This article is on the legal issues of assignment; however, as most assignments take place in context of loan trading or receivables acquisition business, it is important to mention some significant commercial risks of the originate-to-transfer model.

The subprime crisis of 2007-8 brought to focus the risks of what came to be known as the originate-to-distribute model. The word “distribute” pertains to securitisation transactions – a more generic word is “transfer”. There are plenty of commercial transactions today which are originated and sold by the originators to others. Banks/brokers originate loans and sell them; vendors originate leases and sell them; within the world of financial institutions, trading in loans takes place very commonly. Hence, it may sound highly anachronistic to talk of the risks of originate-to-distribute model, but then, some significant risks are as follows:

• The originator extracts the whole or substantially the whole of his equity in the transaction; therefore, originator does not have significant skin-in-the-game. In most cases, originators may also be putting the assets off the balance sheet – hence, originators may not have sufficient stakes, to be vigilant about the transaction.
• The originator’s business model may be non-compliant with several applicable laws. Hence, the assignee’s rights would be subjected to all such counterclaims that the originator would have faced.
• Since originator extracts equity upfront, originator may have business policies aimed at the short-term, compromising the long term.
• After all, the assignee acquires such rights as the originator has, in the originating agreement. Assignee would not have drafted/approved the origination agreement. Hence, if there are any deficiencies, gray areas or weaknesses in the origination agreement, the same will be inherited by the assignee as well.
• If the originator has made any promises, representations or other averments, at the time of doing the transaction, the assignee will be affected thereby. Sometimes, there may be correspondence, mail trails etc which may not have been disclosed to the assignee.

All this highlights the need for the assignee to be extra vigilant.

Meaning of assignment:

While the current level of commercial use of assignment has never been seen in the past, assignment of debt or contractual benefits has been there ever since law of contract has existed, and has almost been the same over the ages.

The word assignment is used in context of incorporeal, that it, intangible assets. Corporeal assets are transferred; incorporeal assets are assigned, as the physical dimension of transfer, meaning change of hands, is not applicable in case of intangible assets. As physical assets may be transferred either for sale, or security, or exchange, or gift, likewise, assignment of incorporeal assets may be done either for sale, or exchange, or gift, or pledge or creation of security interest. If it is a sale, gift or exchange, the assignment will be absolute; if it is merely by way of a security interest, it may be conditional or specific.  

Assignment of contract or assignment of benefits under contract:

Users are quite often confused as to whether a contract is being assigned, or benefits under a contract are being assigned. A contract is a bunch of mutual rights and obligations. Assignment of a contract would mean assignee steps in the shoes of the assignor and assumes all the rights and obligations of the assignor. For example:

• X enters into a contract of sale with Y where X is the seller. The contract would obviously provides for rights and obligations of either party. X will have the obligation to deliver what he promised to sell, and to ensure that the subject matter adheres to such specifications, conditions and fitness as is either explicitly agreed upon or implied. X has the right to receive the price. Y has the obligation to pay the price, and the right to receive goods.

o Assignment of the benefits under the contract by X would mean the receivables under the contract, that is, the price for the goods, may be assigned to P.

o Assignment of the contract by X would mean P becomes the counterparty to the contract of sale, which is now a contract between P and Y.

• This is true for most contracts, as any contract would imply a bunch of mutual rights and obligations.

The general position in law is that a contract is assignable only with the consent of the counterparty. This is most logical, because holding otherwise would expose the counterparty to obligations of a party with whom it never dealt. Holding otherwise would land up Y in contract with P, who Y had never selected.

On the contrary, assignment of the benefit of contract, that is, rights arising out of contract, does not at all impact the counterparty, as the counterparty can still enforce his rights, that is, the assignor’s obligations, against the assignor. All assignor transfers is his rights. In the example above, if X transfers the receivable to P, there is no adverse implication for Y.

In  Khardah Company Ltd v. Raymon & Co (India) Private Ltd. AIR 1962 SC 1810 [1] , the Constitution Bench laid out the principle as follows:

“An assignment of a contract might result by transfer either of the rights or of the obligations thereunder. But there is a well-recognised distinction between these two classes of assignments. As a rule obligations under a contract cannot be assigned except with the consent of the promisee, and when such consent is given, it is really a novation resulting in substitution of liabilities. On the other hand, rights under a contract are assignable unless the contract is personal in its nature or the rights are incapable of assignment either under the law or under an agreement between the parties.”

Similarly, in  Indu Kakkar v. Haryana State Industrial Development Corporation Ltd. and Another (1999) 2 SCC 37 [2] , a two-judge Bench of the Apex Court held, in reliance upon Khardah Company (supra), that:

“Assignment by act of parties may cause assignment of rights or of liabilities under a contract. As a rule a party to a contract cannot transfer his liabilities under the contract without consent of the other party. This rule applies both at the Common Law and in Equity (vide para 337 of Halsbury’s Laws of England, Fourth Edition, Part 9). Where a contract involves mutual rights and obligations an assignee of a right cannot enforce that right without fulfilling the co- relative obligations.”

Even in a case of assignment of rights simpliciter , an assignment would necessarily require the consent of the other party to the contract if it is of a ‘personal nature’. This is elucidated by learned authors Pollock and Mulla in their commentary on The Indian Contract and Specific Relief Acts (R. Yashod Vardhan, and Chitra Narayan eds., 15 th edn., Vol. I) at page 730:

“A contract which is such that the promisor must perform it in person, viz. involving personal considerations or personal skill or qualifications (such as his credit), are by their nature not assignable. The benefit of contract is assignable in ‘cases where it can make no difference to the person on whom the obligation lies to which of two persons he is to discharge it.’ The contractual rights for the payment of money or to building work, for e.g., do not involve personal considerations.”

In Kapilaben vs Ashok Kumar Jayantilal Sheth (2019) [3] , the Supreme Court observed as follows:

“10. It is important to note that in the modern context where parties frequently enter into complex commercial transactions, it is perhaps not so convenient to pigeonhole contracts as being either ‘general’ or of ‘personal nature’ or as involving the assignment of purely ‘rights’ or ‘obligations’. It is possible that a contract may involve a bundle of mutual rights and obligations which are intertwined with each other. However, as this Court has held in Indu Kakkar (supra), the same rule as laid down in  Khardah Company (supra) and as stated in  Section 15(b) of the Specific Relief Act, may be applied to such contracts as well. Where the conferment of a right or benefit is contingent upon, or coupled with, the discharge of a burden or liability, such right or benefit cannot be transferred without the consent of the person to whom the co-extensive burden or liability is owed.

It further has to be seen whether conferment of benefits under a contract is based upon the specific assurance that the co- extensive obligations will be performed only by the parties to the contract and no other persons. It would be inequitable for a promisor to contract out his responsibility to a stranger if it is apparent that the promisee would not have accepted performance of the contract had it been offered by a third party. This is especially important in business relationships where the pre-existing goodwill between parties is often a significant factor influencing their decision to contract with each other. This principle is already enshrined in  Section 40 of the Contract Act:

“40. Person by whom promise is to be performed.- If it appears from the nature of the case that it was the intention of the parties to any contract that any promise contained in it should be performed by the promisor himself, such promise must be performed by the promisor. In other cases, the promisor or his representative may employ a competent person to perform it.” It is clear from the above that the promisor ‘may employ a competent person’, or assign the contract to a third party as the case may be, to perform the promise only if the parties did not intend that the promisor himself must perform it. Hence in a case where the contract is of personal nature, the promisor must necessarily show that the promisee was agreeable to performance of the contract by a third person/assignee, so as to claim exemption from the condition specified in Section 40 of the Contract Act. If the promisee’s consent is not obtained, the assignee cannot seek specific performance of the contract. B. Application of the above principles to the present case.”

General rule on assignment of benefits under contract:

The general rule on assignment is:

• Assignment of a contract is permissible only with the consent of the counterparty;
• Assignment of rights of benefits under a contract is permissible without the consent of the counterparty.

If the assignment of the contract is done with the consent of the counterparty, that amounts to a novation- that is, partial re-writing of the terms of the original contract.

Exceptions to the assignability of benefits under a contract:

The rule that the benefits under a contract are assignable, is subject to some important exceptions:

• Contracts involving the credit, skill or personality of the assignor cannot be assigned. For example, a bank agrees to give a loan to X. X cannot assign the right to receive the loan to P, as the loan was based on the credit of X. Likewise, if a tailor agrees to stitch a suit for X, X cannot assign the right to have a suit stitched to Y.
• Contracts of personal service cannot be assigned. For example, if Y agrees to serve the office of X, X cannot assign the service contract to P.
• If the contract expressly prohibits the right of a party to assign his receivables or benefit under a contract, then such receivables/benefit are not assignable, or not assignable without the consent of the counterparty. There have been several rulings on the impact of prohibition under contract on assignability of benefits under, particularly, something a like a debt. More than a century ago, in Re Turcan (1888) 40 Ch.D.5 , it was held that if a life insurance policy was not assignable, it did not prevent the insured from declaring himself as a trustee for the assignee. In Barbados Trust Company Ltd Bank of Zambia and Anr [2007] EWCA Civ 148 [4] , the House of Lords held that a prohibition on assignment operates only between the assignor and the counterparty to the contract, and not between the assignor and assignee- hence, the contract to assign would still operate as equitable assignment.

Whether receivables can be assigned?

Section 3 of the Transfer of Property Act, 1882 (“ TP Act ”) defines ‘actionable claim’ as follows:

““actionable claim” means a claim to any debt, other than a debt secured by mortgage of immoveable property or by hypothecation or pledge of moveable property, or to any beneficial interest in moveable property not in the possession, either actual or constructive, of the claimant, which the Civil Courts recognise as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent”

Sections 130-137 of the TP Act contains provisions with regard to assignment of actionable claims and lays down the procedure for assignment of receivables. Section 130 of the TP Act states that:

“(1) The transfer of an actionable claim whether with or without consideration shall be effected only by the execution of an instrument in writing signed by the transferor or his duly authorised agent, shall be complete and effectual upon the execution of such instruments, and thereupon all the rights and remedies of the transferor, whether by way of damages or otherwise, shall vest in the transferee, whether such notice of the transfer as is hereinafter provided be given or not:

PROVIDED that every dealing with the debtor other actionable claim by the debtor or other person from or against whom the transferor would, but for such instrument of transfer as aforesaid, have been entitled to recover or enforce such debt or other actionable claim, shall (save where the debtor or other person is a party to the transfer or has received express notice thereof as hereinafter provided) be valid as against such transfer.

(2) The transferee of an actionable claim may, upon the execution of such instrument of transfer as aforesaid, sue or institute proceedings for the same in his own name without obtaining the transferor’s consent to such suit or proceeding and without making him a party thereto.”

So, the assignment of receivables shall be effected upon execution of an instrument and the transferee shall, on the strength of the instrument, attain lawful rights to recover the claims from the debtor in his own name without any reference to the transferor.

In the case Mulraj Khatau v. Vishwanath Vaidya (1913) 15 BOM LR 9 [5] , the Bombay High Court held that an assignment by a debtor when effectuated by a written instrument is governed by Section 130(1) of the TP Act and only thereafter all the rights and remedies are vested in the transferee [6] .

Therefore, it appears from the above, the receivables are assignable in accordance with the provisions of the TP Act.

Principles for assignment of receivables:

For a valid transfer of receivables, the following principles are generally accepted:a)        The receivables must exists at the time of assignment;b)        Receivables must be identifiable;c)        Assignment of rights and not obligations;d)       No contractual restriction on transfer;e)        There must not be a right of set-off or claims against the assignor. As held by the Apex Court, in ICICI Bank Limited v. Official Liquidator of APS Star Industries Ltd. & Others [7] , “ rights under a contract are always assignable unless the contract is personal in its nature or unless the rights are incapable of assignment, either under the law or under an agreement between the parties. A benefit under the contract can always be assigned. That, there is, in law, a clear distinction between assignment of rights under a contract by a party who has performed his obligation thereunder and an assignment of a claim for compensation which one party has against the other for breach of contract.”

The benefits arising out of a contract are assignable from the assignor to the assignee, and in this context, the relevant case is Mulkerrins (formerly Woodward (FC)) v. Pricewaterhouse Coopers [2003] UKHL 41 [8] . The House of Lords held that, “ The general rule is that the benefit of a contract may be assigned to a third party without the consent of the other contracting party. If this is not desired, it is open to the parties to agree that the benefit of the contract shall not be assignable by one or either of them, either at all or without the consent of the other party.”

Assignment of future benefits under contract vs. assignment of benefits under future contracts:

A contract may give rise to benefits in future- for example, a contract of sale on credit creates a right to receive the sale price at the appointed time. This is an existing debt, though payable in future. There is no doubt as to the assignability of such debt.

A contract may also create future receivables, which either do not exist now, or are contingent, conditional or uncertain right now. For example, if a landlord has let out property to a tenant, the tenant will have rentals to pay in future, but as these rentals are based on continuing performance, they have not become unconditional or non-contingent right now. The rule on assignability of future debt is that future debt is also assignable, though such an assignment would operate when the receivable comes into existence. There is elaborate discussion on assignment of future debt in Vinod Kothari: Securitization: Financial Instrument of the Future .

However, as regards assignability of contracts in future, that is, contracts not yet entered into, it is highly speculative and contingent, and other than as a promise on the part of the assignor to assign benefits of such contracts as may be entered into in future, such an assignment has no relevance.

Assignment of receivables in case of pending litigation: Whether disputed receivables can be assigned?

Another major question that arises is that whether future debt or receivables is assignable. This question must be answered in affirmative keeping in mind the case law of Tailby v. Official Receiver [1888] 13 A.C. 523, in which it has been held that all future debts, properties and expectancies are assignable. In the case of Mc Dowell and Co. Ltd. v. District Registrar 2000 (3) ALD 199 [9] , the Andhra Pradesh High Court held that “the definition of actionable claim has been extended so as to include such equitable choses in action as debts or beneficial interest in moveable property whether existent, accruing, conditional or contingent.”

Rights of the assignee:

Rights of assignee are no better than those of the assignor, as the assignee steps into the shoes of the assignor. A very old text [ Alfred W. Bays American Commercial Law Series, 1920, sec 122] puts it as follows: “ The theory of contract being that it is a personal relationship between two or more persons who have chosen each other, assignment of rights thereunder, without the other party’s consent, is permitted, as we have seen, upon the theory that the contractual arrangement is not thereby disturbed. It follows from this, that such assignment cannot be permitted to increase the obligations of the other party thereunder. Therefore, the assignee will take the right as it actually exists, not as it may seem to be; and will take it subject to all adjustments and defenses to which the assignor would have been subject had there been no assignment ”. That is to say, the counterparty to the contract cannot be put to a disadvantage by virtue of an assignment, as assignment is merely a transfer of rights that the assignor had.

Assignment of receivables vs. sale of the asset:

Practitioners are sometimes not clear about assignment of receivables, versus sale of the asset from which receivables arise. Take, for instance, the case of a lease of an asset. Assignment of receivables would mean sale of the lease rentals, not the asset. In that case, the leased asset still remains the property of the assignor – that is, the assignor has retained the residual interest in the asset. However, it would be different if the lessor sells the asset that has been leased out.

Assuming that it is contractually possible to sell the leased asset, if X sells the asset to P, there is no need to separately assign the receivables arising out of the lease. The lease rentals flow from the asset- if the asset has been transferred, the receivables automatically flow from the asset.

Whether consent from debtor required? Whether notice to debtor required?

The general rule is if the assignment is silently done between the assignor and assignee, and has not been notified to the debtor, it would nevertheless be good as between the assignor and assignee, but would not be operative against either the debtor or the world at large. Such an assignment is called equitable assignment.

The proviso to Section 130 of the TP Act provides that dealing of debt/actionable claim by the debtor shall be valid as against the transfer between the assignor and the assignee, save where the debtor is a party to the transfer or has received express notice thereof.

Issues pertaining to assignment:

There are host of legal/taxation/accounting issues that pertain to assignment of receivables, and the complete matrix may be indeed very complex. Following is only a brief pointer to the legal issues that may arise:

Legal formalities on assignment:

Legal systems of most countries would lay down what is required to give effect to assignment. For example, sec 136 of the UK Law of Property Act deals with the procedural formalities to give effect to a transfer of a “thing in action”, that is, actionable claims. Section 130 of the TP Act in India deals with assignment of actionable claims. These legal provisions essentially provide that an assignment must be by way of an agreement in writing, and such assignment must be notified to the debtor. Why is notice to the debtor required? The answer is obvious – how is the debtor expected to reconise the rights of the assignee, who he never dealt with, and has not been notified of. The interpretation of this requirement is that if the assignment is silently done between the assignor and assignee, and has not been notified to the debtor, it would nevertheless be good as between the assignor and assignee, but would not be operative against either the debtor or the world at large. Such an assignment is called equitable assignment.

Stamp duty on assignment:

As per Indian Stamp Act and mostly all state stamp acts (such as Maharashtra), a “conveyance” includes every instrument, by which property, whether movable or immovable, or any estate or interest in any property is transferred to, or vested in, any other person,  inter vivos , and which is not otherwise specifically provided for by Schedule I. Therefore, the respective stamp act will have to be looked into to determine the stamp duty payable on assignment. For instance, Clause 25(a) of Schedule- I of the Maharashtra Stamp Act shall be applicable on assignment transactions, which provides that stamp duty shall be payable at 3% of the market value of the property.

Implication of inquorate stamp duty:

Section 35 of the Indian Stamp Act, 1899 provides that instruments not duly stamped are inadmissible in evidence and cannot be acted upon for any purpose. The relevant extract is reproduced below for reference:

“35. Instruments not duly stamped inadmissible in evidence, etc.- No instrument chargeable with duty shall be admitted in evidence for any purpose by any person having by law or consent of parties authority to receive evidence, or shall be acted upon, registered or authenticated by any such person or by any public officer, unless such instrument is duly stamped:

Provided that- (a) any such instrument shall be admitted in evidence on payment of the duty with which the same is chargeable, or, in the case of an instrument insufficiently stamped, of the amount required to make up such duty, together with a penalty of five rupees, or, when ten times the amount of the proper duty or deficient portion thereof exceeds five rupees, of a sum equal to ten times such duty or portion.”

In SMS Tea Estates Private Limited vs. Chandmari Tea Company Private Limited , (2011) SCC 66 [10] and Garware Wall Ropes Limited vs. Coastal Marine Constructions and Engineering Limited , (2019) 4 SCC 2019 [11] or in Chilakuri Gangulappa vs. Revenue Divisional Officer, Madanpalle (2001) [12] , the Hon’ble Supreme Court of India while holding that an insufficiently stamped instrument cannot be relied upon for any purpose, however, observed that the concerned court has to follow the procedure provided under the Indian Stamp Act, 1899 for impounding the instrument before permitting a party to enforce the said insufficiently stamped instrument.

Initiation of insolvency petition in case of assignment transactions:

Section 5(7) of the Insolvency and Bankruptcy Code defines a “financial creditor” to mean “ any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to .”

There have been umpteen cases where the assignee of the debt has initiated insolvency petition against the corporate debtor on occurrence of default, and the same has been admitted by the Adjudicating Authority. However, there have been cases where the petition was challenged on grounds of technical issues, such as non- registration of assignment agreement or inadequate stamp duty. In this regard, it is pertinent to refer to the following rulings to understand what will be the consequences in such a case:

• In Lalan Kumar Singh, Executive Director (under suspension) & shareholder of M/s. GPI Textiles Ltd., vs. M/s. Phoenix ARC Pvt. Ltd., & Anr. [13] , the Hon’ble National Company Law Tribunal Appellate Tribunal held that- “ The assignment cannot be challenged in the petition under Section 7 and that too by a party who had the knowledge of ‘Assignment Deed’ as back as in the year 2012 ”. In fact in the said case, the Tribunal relied on a letter written by the ‘Corporate Debtor’, from which it was clear that the ‘Corporate Debtor’ agreed for assignment by HSBC in favour of ‘Phoenix’, and accordingly, held that – “in this background, it is not open to the appellant either to raise allegation of mala fide against the HSBC or to allege that the assignment is illegal.”
• In the case of Edelweiss Asset Reconstruction Co. Ltd. vs. Sejal Glass Ltd . [14] , the Corporate Debtor had not contended that the debt does not exist or the default did not occur but had only raised technical defences as to the validity of documents being not duly stamped. Here, the Hon’ble National Company Law Tribunal, Mumbai Bench held that even if the agreements, as alleged, are not admissible as an evidence of debt and default, there are several other documents that show the admission by the corporate debtor of the debt that it owes to the petitioner, and accordingly, the petition was admitted.
• In Edelweiss Asset Reconstruction Company Limited vs. M/s Winsome Yarns Ltd. [15] , the issue in hand was w.r.t. the maintainability of the petition as the entitlement of the petitioner to file the petition under Section 7 of the Code as a financial creditor of the corporate debtor, which was solely dependent on the enforceability of assignment agreement. In the said case, the Hon’ble National Company law Tribunal, Chandigarh Bench did not allow the petition, observing as follows:

“In normal circumstances, the presumption of the validity and enforceability goes in favour of the document on record. The onus of proving a document as invalid and unenforceable is heavily on the person who is challenging the said document. Bald allegations without sufficient basis cannot shift the onus from the person questioning the validity to the person placing reliance on a particular document. In the instant case, the respondent-corporate debtor by placing reliance on the above referred documents of the Revenue Authorities whereunder a categorical finding was given that the Assignment Agreement is inadequately stamped and that the petitioner was directed to pay an amount of ₹1,45,85,000/- towards the deficit stamp duty, able to shift the onus to the petitioner.

Once the corporate debtor by placing reliance on the orders of the relevant Revenue Authorities able to show that the Assignment Agreement is unenforceable and the petitioner not is not able to produce any stay order thereof, this Adjudicating Authority has no other option except to reject the petition.”

Off balance sheet treatment following assignment:

One of the most tricky questions for parties to ask is – does the assignment lead to an off-the-balance sheet treatment for the assignor? The answer may not be short, but some quick rules are as follows:

• Assignment is a case of a sale – sale may be a true sale or just a sale. However, for accounting off-balance sheet treatment (also called “de-recognition”), what is required is not a legal sale, but a transfer of risks and rewards. Hence, there may be cases where there is no legal sale, and yet, because of transfer of risks and rewards, the receivables in question may go off the books. Contrary, there may be cases where there has been a legal sale, and yet, off balance sheet treatment is not allowed.
• The accounting off-balance sheet is determined as per accounting rules, contained in IFRS 109 [Ind AS 109] These rules focus on transfer of substantial risks and rewards, or retention of substantial risks and rewards, and put up the next condition where there is no substantial transfer of risks and rewards – whether there has been a surrender of control.

For details of IFRS 9/IndAS 109, see our write-ups here – http://vinodkothari.com/category/corporate-laws/accounts-and-audit/ .

IFRS 9 was preceded by IAS 39 – see Vinod Kothari’s article on IAS 39 – see http://vinodkothari.com/ifrs_9/

True sale, which is usually an issue in case of securitisation/direct assignment transactions, has been discussed at length in our write up here – http://vinodkothari.com/2019/01/assignment-of-receivables-in-financing-transactions/

Our write up on GST on assignment of receivables can be viewed here –

http://vinodkothari.com/2018/06/gst-on-assignment-of-receivables-wrong-path-to-the-right-destination/

[1] https://indiankanoon.org/doc/1986314/

[2] https://indiankanoon.org/doc/1664346/

[3] https://indiankanoon.org/doc/165234715/

[4] https://www.casemine.com/judgement/uk/5a8ff71b60d03e7f57ea79a3

[5] https://indiankanoon.org/doc/1275075/

[6] Singheshwar Mandal v. Smt. Gita Devi and Anr AIR 1975 Pat 81, available at https://indiankanoon.org/doc/1829491/

[7] https://indiankanoon.org/doc/118222303/

[8] https://publications.parliament.uk/pa/ld200203/ldjudgmt/jd030731/mulkrn-1.htm

[9] https://indiankanoon.org/doc/143906316/

[10] https://indiankanoon.org/doc/24736/

[11] https://indiankanoon.org/doc/26596259/

[12] https://indiankanoon.org/doc/1225176/

[13] https://nclat.nic.in/Useradmin/upload/18622573155c1b69ddd0df3.pdf

[14] http://www.sejalglass.co.in/docs/EDELWEISS-ASSET-RECONSTRUCTION-CO-LTD-vs-SEJAL-GLASS-LIMITED-CP-1799-OF-2018-NCLT-ON-13.02.2019-FINAL.pdf

[15] https://nclt.gov.in/sites/default/files/Feb-final-orders-pdf/CP%20IB%20NO%20291%20OF%202018%20EDELWEISS%20ASSET%20VS%20WINSOME%20YARNS.pdf

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