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Ruling stresses need for due diligence when debt is being transferred, say experts


Companies whose debt has been purchased do not ordinarily have to inform the company acquiring the debt of any pre-existing contractual arrangements they have with businesses assigning that debt, the Court of Appeal in London has ruled.

Only when a direct request for such information is made will disclosure of that information be required, it said.

The judgment means funders should conduct their own due diligence on underlying contractual arrangements when purchasing debt from an assignor, experts in dispute resolution and asset-based lending at Pinsent Masons, the law firm behind Out-Law.com, said.

The Court of Appeal's ruling upholds a judgment issued by the High Court last year.

The court was ruling in a case between factoring service provider Bibby Factors Northwest Ltd and two subsidiaries of the carpet and floor covering distributor Headlam Group Plc. Pinsent Masons acted for Headlam and its subsidiaries 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 Bibby 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 had argued that 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.

However, that argument was rejected by the Court of Appeal.

"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," Jason Kirwin, dispute resolution expert at Pinsent Masons, said. "Funders should ensure that due diligence is as extensive as possible and that any questions are much wider than merely enquiring about disputes. Funders should consider amending their standard discounting and factoring agreements to include a clause placing assignors under a duty to provide full disclosure in respect of any pre-existing contractual arrangements with debtors."

Asset based lending expert Edward Sunderland also of Pinsent Masons said: "Funders can ask questions of debtors, but cannot impose an obligation upon debtors to respond. Debtors and assignors should also ensure that they answer any queries from funders accurately and in full. 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."

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