Richard Calnan, partner at Norton Rose Fulbright, and Rebecca Oliver, knowledge of counsel, consider the background to the draft Business Contract Terms (Assignment of Receivables) Regulations 2018 and how they could affect the drafting of provisions in contracts and security structures.
SI 2018/Draft: Provisions are proposed to facilitate access to finance for businesses, by nullifying terms in business contracts, which prohibit or restrict the assignment of receivables in England, Wales and Northern Ireland. This includes terms which prevent an individual to whom a receivable is assigned from enforcing it or determining its validity or value.
What is the background to the regulations?
The government has decided that it should be easier for small and medium-sized businesses (SMEs) to raise finance on their receivables. To do this, businesses need to be able to transfer their receivables to financiers, but their contracts sometimes restrict assignments. The concern is that smaller businesses are likely to enter into standard terms of business provided by larger corporate debtors which include restrictions on assignment, and that in practice it will not be possible for the SME to have the restriction removed.
The Small Business, Enterprise and Employment Act 2015 allows regulations to be made to invalidate restrictions on the assignment of receivables in particular types of contract. A draft of the regulations intended to implement that power was published in September 2017, but was withdrawn following concerns raised by the City of London Law Society that it had been drafted in wider terms than necessary, and as a result would unintentionally restrict certain provisions in financial services contracts. Since then the Department for Business, Energy and Industrial Strategy has worked with interested parties to redraft the regulations.
Draft Business Contract Terms (Assignment of Receivables) Regulations 2018 were published on 6 July 2018. The regulations are due to be debated in autumn 2018 and, if approved by both Houses of Parliament, will invalidate restrictions on assignments included in certain types of contract.
What types of contract do the regulations apply to?
- they only apply to contracts entered into on or after 31 December 2018
- they only apply where the person who supplies the goods, services or intangible assets concerned, and is therefore entitled to the receivable, is an SME which is not a special purpose vehicle. Whether or not an entity qualifies in any particular case requires a detailed examination of the precise wording of the regulations. Counter-intuitively, the test is not applied at the time the contract is entered into, but at the time the assignment takes place
- there is a specific exemption for contracts ‘for, or entered into in connection with, prescribed financial services’—these are widely defined to include ‘any service of a financial nature’
- there are specific exclusions for particular types of contract, including certain commodities, project finance, energy, land, share purchase and business purchase contracts and operating leases
- as a general rule, it would seem that the regulations only apply to contracts governed by English law or the law of Northern Ireland, but they prevent the parties from choosing a foreign law if it can be established that the purpose of doing so was to evade the regulations
- the Regulations do not apply if none of the parties to the contract has entered into it in the course of carrying on a business in the UK
What do the draft regulations cover?
The regulations provide that ‘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’.
A ‘receivable’ is the right to be paid any amount under a contract for the supply of goods, services, or intangible assets. The regulations do not prevent the parties from restricting the assignment of other contract rights.
More difficult is to establish what is meant by ‘assignment’. Receivables are transferred in various ways in practice. Sometimes the transfer is outright (for instance, by way of sale); and sometimes it is by way of security (for instance, to secure a loan). The transfer may be effected by a statutory assignment, an equitable assignment, a charge or a trust. ‘Assignment’ is not defined in the regulations, so there is some doubt as to which of these transactions are covered. Although charges are not expressly referred to, they might be covered by the expression ‘assignment’ if it is given a broad interpretation.
Non-assignment clauses come in a variety of forms. They will be covered by the regulations if they ‘prohibit or impose a condition, or other restriction’ on the assignment of a receivable. The regulations expressly invalidate terms which prevent the assignee from determining the validity or value of the receivable or their ability to enforce it.
How will this affect the drafting of provisions in contracts and security structures?
If the regulations apply, a restriction on the assignment of a receivable will be ineffective. There is no necessity to alter standard form contracts to take account of the regulations—they will simply override the contractual provision. But, where practicable, it is obviously sensible for contracts to reflect the underlying law. Over time, it is likely that contracts will make express reference to the regulations in order to do this.
The regulations are not intended to apply to sale and purchase contracts relating to purchase of shares or whole or part of a business, but in order to take advantage of the exemption, the relevant contract must state that it is such a contract.
Receivables financiers will need to consider the extent of the regulations when drafting assignments and security documents. Because it is not clear whether charges are covered by the regulations, when taking security, the best course will be to take an assignment by way of security over a receivable where there is, or might be, a restriction—that way, it is clear that the regulations will apply.
The regulations will also be of concern to businesses receiving goods, services and in tangible assets under supply contracts. They will no longer be able to restrict the assignment of the receivable under the contract if the regulations apply. This can create a problem if the business concerned is relying on rights of set-off under future contracts with its counterparty. Although rights of set-off which exist at the time it receives notice of assignment will continue to be effective, new rights of set-off will not. Debtors under supply contracts will need to consider how best to protect themselves against this problem.
What are the differences between these new regulations and the previous draft regulations of September 2017?
The new regulations are substantially more limited in their effect than the previous draft regulations. The most important change is that the regulations now only apply where the supplier is an SME.
The new regulations also contain a very large number of new exemptions, including certain commodities and project finance contracts and operating leases. There is also a specific exemption for share purchase and business purchase contracts which means that M&A contracts should not be affected by the regulations.
There was also a concern that the earlier draft of the regulations would have prohibited negative pledges and restrictions on assignments in loan agreements, and that is no longer a concern under the new regulations.
As a result, the regulations will now be focused on the mischief they were intended to remedy—invalidating restrictions on assignments imposed by larger buyers on small and medium-sized suppliers.
Interviewed by Alex Heshmaty.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.