New publication of proposed 2018 Regulations for banning prohibitions on assignment
Last week the government published its revised proposals for the Business Contract Terms (Assignment of Receivables) Regulations 2018 (the “2018 Proposals”). The previous proposed 2017 version was withdrawn from parliamentary proceedings in November 2017 after much criticism from various professional and market commentators.
To recap, there has been an ongoing consultation about increasing the accessibility of receivables finance to SME suppliers for several years with attention focussing on the use of clauses prohibiting the assignment of receivables and subsequent legislation (in the form of The Small Business, Enterprise and Employment Act 2015) providing for further regulations to be implemented by way of Statutory Instrument. Initial draft regulations were published for consultation at the end of 2014 and subsequent proposals (the “2017 Proposals”) were published in September 2017. The draft published last week is the government’s latest proposal for further consideration following the various consultations and dialogues about the intended scope and effects since the 2017 Proposals were withdrawn in November 2017.
As a law firm heavily involved in the trade and receivables finance sectors, we are considering the details and the full potential impact resulting from the 2018 Proposals. We have, however, summarised in this short article the main features and have identified some of the remaining concerns that will persist with the new draft.
The 2018 Proposals are expressed as applying to contracts to which the regulations apply which are put in place on or after 31 December 2018. It is not yet clear when the 2018 Proposals will actually be adopted and come into effect.
Effect of the 2018 Proposals
The regulations will make a term in a contract which imposes a condition or other restriction on the assignment of a receivable void and unenforceable. This will include any term preventing a person to whom a receivable is assigned from determining the validity or value of the receivable or their ability to enforce the receivable. It therefore encompasses terms restricting the provision of commercial information relevant to assigned invoices (eg. parties names, addresses, amounts, VAT information, contractual delivery and performance related information, evidence of set-off or counterclaims). These provisions have not changed significantly between the 2017 Proposals and the 2018 Proposals.
One of the key criticisms of the 2017 Proposals was that there was no differentiation in applying the regulations as between large and small companies and that the financing of the supply of goods and services by SMEs was not sufficiently identified as the particular finance sector to which the regulations should apply. There was significant concern that large businesses should not have the benefit of such regulations overriding contractual terms with their customers and that the much wider finance markets which use receivables finance (eg. securitisation, project finance, derivatives trading and many others) should not be brought within the scope of the regulations. The chief purpose of the regulation was, after all, to assist SMEs with raising invoice finance.
In apparent reaction to such concerns, the 2018 Proposals have been modified so as to apply only to SMEs with large enterprises and SPVs being excluded. There have also been a number of new specific exceptions added to the previous list.
Previous specific exceptions:
- Contracts concerning “prescribed financial services”
- Contracts concerning interests in land
- Contracts where one or more parties is not engaged in business, trade or profession
- Contracts where none of the parties has entered into it in the course of carrying on a business in the UK
- Contracts involving national security interests
- Contracts for differences under the Energy Act 2013
- Petroleum licences or contracts with petroleum licensees
- Contracts for the acquisition, disposal or transfer of a business interest
Further new specific exceptions introduced in the 2018 Proposals:
- Certain classes of options, futures, swaps, forward, contract for difference or other derivatives contract not otherwise caught within the term “prescribed financial services” relating to commodities, energy and other variable indices traded on regulated markets or otherwise reliant on close-out netting
- Certain contracts entered into by project companies
- Qualifying contracts entered into by trusts, funds or other entities connected with funding of decommissioning programmes
- Lease or hire contracts not otherwise falling within “prescribed financial services”
Clash of principles
Whilst the additional exceptions included show that some of the concerns which had been raised have been, at least partially, taken on board, there are a number of issues which remain. These are both in terms of overall points of principle as to whether any regulation is advantageous where it seeks to override what is a contractually agreed prohibition on assignment and confidentiality of information made between consenting parties and also further specific points of concern.
The further publication of the 2018 Proposals after the withdrawal of the 2017 Proposals indicates that the government considers that the public policy desire to improve access to finance for SMEs overrides what many consider to be the wider public policy imperative under English law that commercial parties should have freedom to contract on terms of their choosing without one party being favoured by statutory intervention. The ability for suppliers to negotiate specific conditions with their customers which allow for assignment of receivables for the purpose of raising finance into the contracts has seemingly not been considered sufficient.
Even if the public policy benefits of banning prohibitions on assignment are considered worth undermining the principle of freedom of contract and the ability to restrict access to what could be commercially sensitive information, there remain specific matters which have not been addressed in the 2018 Proposals which could lead to continued confusion.
Specific concerns and problems include:
- No distinction is made between an equitable or a statutory (or legal) assignment
- Are security assignments (or equivalent charges) caught by the regulations? – presumably the answer is yes so secured lending on receivables will also be captured
- How will negative pledge clauses in finance agreements which seek to restrict a borrower from assigning their receivables to a third party be treated?
- Payment flows under commercial contracts (even with SMEs) commonly go both ways during the lifetime of contracts so assigned claims will need to take account of set-offs or counterclaim rights which buyers may specifically have sought to prevent through prohibiting assignment
- Petroleum licences are excluded – are there other licensed sectors (such as broadcasting, telecommunications, newspapers, pharmaceuticals) which should have the same treatment for public policy reasons?
- There is a risk that finance companies will be tempted not to carry out sufficient due diligence on the contracts their customers are seeking them to finance in the mistaken belief that the only concern was to check if there was a prohibition on assignment. Discounts, penalties, termination rights, tenors, set-off rights, among others, will continue to be important matters which receivables financiers should be aware of.
- The regulation is not limited to assignments of receivables for the purpose of raising finance by the supplier and assignees are not limited to such finance companies
- If prohibitions on assignment are not enforceable, will restrictions on who assignments can be made to be defeated by the regulations so that, for example, buyers’ competitors could be able to acquire receivables which could be sensitive for a number of reasons
- There appears to be no restriction on receivables being assigned a second or further times in secondary markets which is a step beyond the ability of the supplier raising its finance initially
- How will future amendment or novation of contracts signed before the 31 December 2018 cut-off point be treated? Novation may catch parties unawares as they technically create a new contract and therefore the regulations would apply but uncertainty is likely to arise in relation to amendments
In conclusion, at a practical and commercial level, a number of improvements have been made to the draft regulations to shield the wider finance sector from effects which were only intended for SME supply chain finance. However, there remain a number of potential problems which have not been addressed or which will likely arise from their introduction. It will be interesting to see if the regulations have a noticeable effect in supporting access to finance for the SME sector which its supporters argue justifies what many see as an unwarranted erosion of the principle that commercial parties should be entitled to contract on their own commercial terms.