The City of London Law Society (CLLS) has written to the Department for Business, Energy & Industrial Strategy concerning its issues with the Business Contract Terms (Assignment of Receivables) Regulations 2017. The chair, Dorothy Livingstone states that the letter is to explain why the CLLS believes the Regulations ‘will create substantial uncertainty in a wide range of financial transactions and may adversely affect access to finance for UK businesses if they are adopted’. The CLLS believes the best outcome would be for the Regulations to not be approved and the terms be reconsidered.
What are the draft Regulations intended to do?
The aim of the Regulations, made under the Small Business, Enterprise and Employment Act 2015 (the Act), is to make it easier for small and medium-sized business to raise finance by using their receivables as collateral. The primary effect of the draft Regulations would be to make ineffective any contract term that prohibited the assignment of receivables. By doing so it is hoped that small and medium-sized enterprises (SMEs) would be able to use all of their customer debts to raise finance through invoice discounting (sometimes called ‘factoring’ of debts) not just those customer debts arising under contracts which did not contain a prohibition on assignment of the contract or rights arising under it.
When are the Regulations intended to become effective?
The date upon which the Regulations may come into force depends upon their being approved by Parliament but it could be before the end of 2017.
What contracts would be affected by the Regulations?
It was originally thought that the Regulations would only affect the business contracts made between the relevant business and its customer and then only to the extent necessary to make ineffective any term prohibiting the assignment of any receivable. Given that the Regulations would derogate from English law’s hallowed principle of freedom of contract it was also thought that the Regulations would apply only to new contracts and not those already in existence at the time the Regulations came into force.
Although the stated aim of the Regulations is to improve the ability of small and medium-sized business to obtain finance, the Regulations apply to most contracts between businesses irrespective of the size of the contracting parties.
Certain contracts were always expected to be exempt from the impact of the Regulations. The most important categories of contracts falling outside of the Regulations are financial service contracts and contracts involving interests in land.
The Regulations will not apply to contracts governed by foreign law unless it is clear the foreign law was chosen to circumvent the operation of the Regulations. Where English law has been chosen to govern the contract but the parties are situate in another jurisdiction so that apart from that choice, the governing law would be the law of another country the Regulations will not apply.
What type of contract terms would be affected by the Regulations?
Regulation 2 sets out that:
2. A term in a contract has no effect to the extent that it—(a) prohibits the assignment of a receivable arising under that contract or any other contract, (b) prevents a person to whom a receivable is assigned (“the assignee”) from determining its validity or value (including determining their ability to enforce the receivable), or (c) hinders the assignee’s ability to enforce the receivable.
Unfortunately, the Regulations do not make it clear whether they apply only to assignments which are absolute, assignments by way of security or other restrictions on disposal of an interest in a receivable such as the creation of a trust over the rights to payment under a contract and the proceeds when received.
There is no indication in the Regulations whether it makes any difference to the efficacy of the relevant prohibition on assignment if the prohibition is expressed to be absolute, requires a consent from a party or is subject to some other criteria which must be met whether as to the identity of the assignee or the impact on the relevant debtor.
Another uncertainty is whether or not a clause which prohibits the assignment of a contract (that is any right under it not just the right to payment) is invalid in its entirety or just to the extent it would prevent an assignee of the receivable from enjoying the fruits of the assignment.
The Regulation is in terms intended to affect not just prohibitions on assignment of receivables but other contract terms which hinder the purported assignee’s rights to recover the value comprised in the receivable. The extent of the restriction contained in the regulations on the parties contractual freedom is therefore potentially very wide. For example, would a provision requiring an assignee to obtain an approval or certificate in some respect prior to enforcing the right to payment of the receivable be invalidated as hindering an assignee’s rights?
Why are lenders affected?
Essentially, the problem lenders face is ascertaining the extent to which the Regulations would invalidate some common provisions found in most well drawn loan agreements and bonds.
Both the Loan Market Association (LMA) (membership and login required) and the City of London Law Society (CLLS) have written to the Department for Business, Energy & Industrial Strategy to express their concerns over the draft Regulations in this context.
The main areas of concern raised by the LMA and CLLS are as follows:
- the Regulations appear to operate so as to retrospectively invalidate prohibitions on assignment and certain other contract terms
- the type of assignment and other clauses which fall within the scope of the Regulations and are rendered ineffective are not sufficiently well described in the Regulations eg would a certification provision be ineffective?
- negative pledge covenants in loan agreements, bond terms and security documents (all of which could fall within the meaning of the words—‘any other contract’—used in Regulation 2) would appear to be within the scope of the Regulations and potentially invalidated by them
- the Regulations are drafted so widely that there is the possibility that they are ultra vires because the Act under which they are promulgated did not envisage any contract other than that between business and customer being affected and the Regulations potentially go much further in invalidating provisions in any other contract
- while the Regulations are not intended to apply to contracts governed by English law made between two or more parties who are situate in another jurisdiction it is not clear whether the Regulations will apply where the contract is made between one party resident in England and another in some other jurisdiction; and
- there is no protection afforded to the relevant debtor who may have stipulated for a non assignment clause in the expectation that its rights of set off will be preserved eg prohibitions on assignment of construction contracts have as one of their aims the preservation of rights of set off and the Regulations are silent on whether set off rights would be affected. Loss of set off rights against a contractor could seriously affect a lender to an employer under a construction contract and this effect could cascade down a chain of sub-contractors.
Both the LMA and the CLLS have expressed their hope that the Regulations will not be approved in their current form by Parliament and their belief that a rethink and redraft of the Regulations is necessary to avoid uncertainty in the finance markets.
Everyone agrees that the intent behind the Regulations is laudable. Allowing small and medium-sized businesses to use their portfolios of receivables to gain greater access to finance to promote and grow their businesses is to be encouraged. However, in an attempt to deal briefly with a complex subject (the draft Regulations are extremely short) the Government has failed to take into account the potential repercussions on the finance markets as a whole. Some further thought needs to be given as to the extent to which particular clauses will be rendered ineffective. It is also not entirely clear why the Regulations should be retrospective in their operation. In particular the territorial scope of the proposed new law and its affect on lenders, bondholders and other participants in the debt and capital markets needs to be properly analysed so that the efficacy of negative pledge and other widely used and accepted protective provisions are not thrown into doubt.