Banks gain certainty on use of trusts in receivables finance deals when underlying contracts restrict assignments

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Banks gain certainty on use of trusts in receivables finance deals when underlying contracts restrict assignments

ANALYSIS: Banks can be more confident about offering companies receivables finance after the UK's Court of Appeal's decision  (22-page / 411KB PDF) confirmed that restrictions on assignments in a company's contracts should not be a barrier to receivables finance deals. 02 Feb 2018

The Court has said that a company did not misrepresent to a bank when it said that it was not prohibited from disposing of receivables evidenced by its invoice to a client. The contract with the client restricted assignments, but the Court said that because the value of the debt could be passed to the bank by means other than an assignment of receivables, the company's agreement with the bank was valid.

The Court also confirmed that the use of trusts to transfer proceeds of receivables to funders is a valid technique. The Court of Appeal had previously ruled this way, in a 2007 case between Barbados Trust Company and Bank of Zambia, and the fact that the Court of Appeal has backed the approach a second time means that banks can be confident that receivables finance deals do not need to be derailed by assignment restrictions.

Receivables finance has become important for many companies in the aftermath of the 2008 financial crisis. Companies can receive cash from funders in respect of receivables evidenced by their invoices in advance of when those invoices are due to be paid.

In this case, BP Oil International (BPOI) had a contract with Société Anonyme Marocaine de L'Industrie de Raffinage (SAMIR) for the sale of crude oil. The contract with SAMIR contained a restriction on assignment of the contract or rights or obligations under it. BPOI then made a receivables finance deal with National Bank of Abu Dhabi PJSC (NBAD) by which the bank paid 95% of the invoice value to BPOI in return for the right to receive SAMIR's payment.

As part of the receivables finance agreement with the bank, BPOI represented that there was no prohibition on its ability to dispose of the receivables evidenced by its invoice to SAMIR.

When SAMIR took steps to file for insolvency, NBAD sued BPOI, claiming that BPOI's representation was at odds with the underlying contract's restriction on assignment. NBAD claimed compensation for breach of representation.

In an earlier hearing, the High Court agreed with NBAD but the Court of Appeal has now overturned that. It said that because BPOI's agreement with NBAD provided a number of ways for the economic value of the debt to pass to NBAD, BPOI did not misrepresent its position when it said that it wasn't prohibited from disposing of the receivable evidenced by its invoice to SAMIR. Other avenues than assignment were available for the transfer of value.

In this case, the Court said that a restriction on assignments in underlying contracts does not stop companies from paying amounts received by them under those contracts over to funders, nor does it prevent companies from creating trusts over proceeds of receivables or debts owed to them in favour of funders in receivables finance arrangements.

You can read about the case in more detail in our legal update.

So while the ruling may restrict banks' ability to claim compensation for breach of broadly drafted representations where there are more narrowly drafted assignment restrictions, it shows how to structure these deals in the future so that they are effective even when assignment restrictions exist in underlying contracts.

This effectively reduces the impact of assignment restrictions, though in conducting due diligence banks should be careful to make sure that underlying contracts do not restrict the use of trusts as well as assignments. The bank's claim for breach of representation in this case failed because the company represented to the bank that there were no prohibitions on "disposal" of the receivables and the transfer of value of the receivables to the bank was wider than the limited restriction on "assignment" in the underlying contract.

Since the Barbados Trust case in 2007, many banks have relied on this use of trusts to provide receivables finance. A second Court of Appeal ruling backing that approach is a significant vote of confidence in that approach.

The use of receivables finance by companies which struggle to access loans or other financing has recently become a political issue. The UK government proposed legislation last autumn that would neuter the effect of assignment restrictions to ensure small and medium sized companies could access receivables finance. It later withdrew the plans following opposition from businesses.

This ruling means that such legislation may not be so important – banks and funders can put in place other techniques including trusts to receive the proceeds or value of debts even if there is a restriction on assignments in an underlying contract.

How to read contracts in general

The ruling also made an important point for all companies about how contracts should be read. It said that companies should be careful not to take language from contracts and read them in isolation. Rather they should look at the full scheme of the contract and read parts of it in the context of the commercial and legal reality.

NABD in this case had referred to the restriction on assignments in the underlying contract between BPIO and SAMIR. But the Court said it erred when it failed to refer to other parts of NBAD's agreement with BPIO which set out ways other than assignment of transferring the value of the debt to it.

There is always a balance in interpreting contracts between focusing on the meaning of a small number of important words or phrases and taking into account the overall contractual arrangements and commercial context and business reality of the deal. This ruling makes it clear that companies, and courts, should take the whole contract into account and not focus unduly on isolated phrases.

Sharon E Smith is a banking and finance expert at Pinsent Masons, the law firm behind Out-Law.com