The Business Contract Terms (Assignment of Receivables) Regulations 2018: still more to do?
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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 Draft legislation finally appeared in 2017, but was withdrawn following criticism by the Loan Market Association and others.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.