Debt purchasers should carry out due diligence that goes beyond industry practice in light of ruling, says expert

In a judgment handed down recently, a High Court judge said that debtors and assignors of debt are not under an obligation to inform debt purchasers about pre-existing contractual arrangements relevant to that debt unless asked directly to do so.

The judge said that financiers cannot claim to have been misled by debtors or assignors of debt if they are not provided with information about such contractual arrangements. He also found that assignors of debt cannot transfer greater rights to a debt buyer than they themselves possess.

Asset based lending expert Edward Sunderland of Pinsent Masons, the law firm behind Out-Law.com, said the ruling would place greater emphasis on funders to undertake robust due diligence before agreeing to buy others' debt.

"Funders will have to be careful to make full enquiries of all contractual arrangements in place between the assignor and the debtor before acquiring and funding against debts," Sunderland said. "Funders should ensure that due diligence is as extensive as possible and that any questions are much wider than merely enquiring about disputes. Debtors and assignors should also ensure that they answer any queries from funders accurately and in full."

The High Court was ruling in a case between factoring service provider Bibby Factors Northwest Ltd and carpet and floor covering distributor Headlam Group Plc and its subsidiary, MCD Group Ltd. Pinsent Masons acted for Headlam in the case.

The dispute related to Bibby's claim that Headlam had been underpaying invoices owed to them in debt repayments. Headlam and its subsidiary contracted with supplier Morleys Ltd but when Morleys assigned debt Headlam owed it to Bibby it failed to notify the financier that its contractual arrangements with Headlam and its subsidiary entitled the debtors to certain rebates on their repayments and further enabled the companies to set-off those rebates against future unpaid invoices.

Bibby said, because it had written to Headlam and its subsidiary to inform them that it had taken on Morleys' debt and that repayment of the debt should be directed to it, that the debtors should have notified it of their previous contractual arrangements. In its letter the company asked the debtors to notify it of "any dispute likely to defer payment beyond the terms of sale". Bibby claimed that this request for information was sufficient to trigger the debtors' duty to notify it of their rebate and set-off arrangements with Morleys, but the judge disagreed.

"In this case, the funder had not made a direct enquiry to either the assignor or the debtor regarding whether or not there were any contractual arrangements in place and had merely requested that it be informed of any potential dispute, as is standard industry practice," Sunderland said. "However, the judge did not consider that the set-off arrangement could be regarded as a 'dispute' and further considered that this merely amounted to a request by the funder and did not give rise to an actual obligation on the debtor to disclose this information."