Ban on contractual terms restricting invoice finance arrangements will give SMEs a boost, experts say

The UK government is expected to pass regulations nullifying 'bans on assignment' in certain commercial contracts shortly, to enter into force early in 2016. The new regulations will give legal effect to a power contained in the 2015 Small Business, Enterprise and Employment Act ('the Act') and will apply to English contracts only at this stage. Separate legislation will be required in Scotland to extend the ban to contracts governed by Scots law.

The invoice finance and factoring industry has welcomed the proposed legislation, which follows similar bans in the US, Canada and Australia. It is anticipated that the nullification of contractual bans on assignment will promote the expansion of invoice financing to businesses that are currently prevented from accessing funding by restrictions in their contracts with the businesses that they supply, offering a much-needed new source of finance to small and medium-sized enterprises (SMEs) in particular.

What is changing?

Ban on assignment clauses are typically used to prevent a supplier from sub-contracting work. However, these clauses often have the unintentional consequence of blocking invoice finance arrangements, which allow businesses to apply for finance using invoices for money owed to them as security. According to the Asset Based Finance Association, which represents the UK invoice finance industry, more than 44,000 businesses receive over £19 billion of funding this way at any one time.

The government's intention is to nullify those clauses that block invoice finance, while retaining the customer's right to prevent the supplier from sub-contracting the work in the traditional way.

The regulations applying to English contracts will:

• apply to business to business contracts only, excluding any contracts with consumers. There was a suggestion when the Act was first published that the rules should apply only to SMEs, for whom access to finance is a particular concern. However, this has not been carried forward into the regulations, which will extend to all businesses regardless of size.
• exclude financial services contracts. This is because the functioning of some financial markets products, such as bank loans or derivative products, rely on assignment not being permitted beyond the original parties. The proposed definition of financial services is very wide, covering "any service of a financial nature" including lending, leasing, derivative products and exchange rate and interest rate products. It also includes insurance-related services including life assurance, reinsurance and insurance intermediation.
• exclude contracts relating to interests in land, including tenancy agreements. There are specific rules applying to contracts relating to land which should not be displaced by the regulations.
• not create any special provisions for supply chain finance arrangements. Exclusivity provisions in supply chain finance arrangements, which allow a supplier only to access the creditor's own supply chain finance scheme and prevent assignment of the invoice to other providers of finance, will be nullified under the regulations. This will allow suppliers to opt into supply chain financing arrangements or seek alternative arrangements with other invoice financers.
• permit debtors to take action against suppliers if they breach commercial confidentiality. The regulations will not override contractual confidentiality provisions. In practice, this may prevent the contract from being assigned if the information a supplier is able to give about a contract it wishes to assign is limited by confidentiality provisions.
• begin from commencement of the regulations. They will not apply to contracts retrospectively.
• only apply to contracts governed by English law where at least one of the parties carries on business within the UK. If suppliers intend for the regulations to apply to their contracts, they should ensure that they contain a clause providing for English law as the governing law to prevent any questions being raised about which law governs the contract.

It appears that Scottish companies may be able to take advantage of the English ban on nullification pending the introduction of equivalent legislation in Scotland by selecting English law as the governing law of their contracts. This will become clearer once the draft regulations are published.

The process of drafting and enacting the new regulations will begin as soon as possible, with the regulations set to come into force in early 2016.

Edward Sunderland and Lucy Shurwood are banking law experts at Pinsent Masons, the law firm behind Out-Law.com.