Buying Debt - Factoring in more Diligence
Companies purchasing debt must now ensure they undertake even more thorough due diligence of the debt they purchase before going ahead with such transactions.
In Bibby Factors Northwest Limited v HFD Limited and another  EWCA Civ 1908, the Court of Appeal held that ordinarily there is no duty on a company whose debt has been purchased to inform the purchasing company of any pre-existing contractual arrangements it has with the company assigning the debt. If the purchasing company wants this information it must directly request it.
The facts of the case (illustrated below) are interesting in understanding the court's process in coming to this conclusion, and providing warning for anyone considering buying debt. Bibby Factors ("Bibby") bought a debt owed to Morleys Limited ("Morleys") by debtors HFD Limited ("HFD") and MCD Group Ltd ("MCD").
Morleys went into administration, and Bibby claimed against the debtors HFD and MCD in respect of unpaid invoices. Unknown to Bibby, the two debtors had invoice discounting agreements in place with Morleys, where they were entitled to a 10% rebate on annual sales. The debtors argued they were entitled to this rebate, even against Bibby, and should be allowed to exercise set-off rights against the amounts claimed by Bibby to the value of these discounting agreements.
Bibby had not made any enquiries to either Morleys or the original two debtors HFD and MCD regarding the existence of any such rebate or invoice reduction mechanisms. Bibby merely sent a letter to the debtors at the outset when taking on the debt, advising them of the debt purchase and stating that any "right of set-off in respect of any sale you make to our client is not permitted". The letter requested that the debtors inform Bibby if there was any potential dispute with this. Neither HFD nor MCD brought the rebate to Bibby's attention, nor their right of set-off, although the effect of the notice was that they were now very much aware that their debts had been assigned to Bibby.
The Court of Appeal ruled that the debtors were under no obligation to notify Bibby of the rebate arrangement and that it was up to Bibby to make the proper investigations into the debts they were buying. Just because Bibby had tried to prevent set-off in its letter confirming HFD and MCD of its purchase of their debts, did not mean this was effective to negate the effect of the discount arrangement or rights of set-off. MCD and HFD were under no obligation to volunteer such information about the rebates and other restrictions in the Contracts, despite knowing their debts had been assigned, and knowing of Bibby's attempt to prevent set-off in their letter. It is also worth noting that MCD and HFD's rights were not extinguished by their silence. The court noted that Bibby was completely within its power to have contracted on terms which would have required additional information to be given over by Morleys about the debts that Bibby was about to acquire.
The Bibby decision makes it very clear to financiers that the courts will not be sympathetic to financiers that are affected by clauses which they should have discovered having engaged proper due diligence of underlying assets purchased or offered as security. The principles of "buyer beware" (caveat emptor) must continue to be borne in mind. Additionally it is important to note that the decision would suggest third parties do not lose rights they have merely by being silent in this sort of situation. Processes will need to be tightened and due diligence broadened to ensure that all such risks are identified for factored debts and other types of assets where these sorts of side arrangements may exist.
Following on from the decision in Bibby, purchasers of debts of financiers taking security over debts should:
- ensure that proper due diligence is conducted on the debts;
- include a representation in the sale contract of security agreement that the debt terms provided to the financier or purchaser represent the whole relationship between the debtor and the creditor in respect of such debt
- in the notice issues to the debtor ensure that an acknowledgement provision is included and chase the debtor until such acknowledgement is agreed
Consideration should also be given to existing debts which have been sold or subject to security to ensure that appropriate steps have been taken to avoid a Bibby-like situation arising in respect of such debts.
For more information, please contact the author or your usual Fieldfisher contact.
The author wishes to acknowledge the contributions of trainee Robert Grannells to this article.