As block discounting over the last few years has become such a prevalent source of finance for secondary lenders, this may be an opportune moment to scotch the myth that block discounting cannot be undertaken in Scotland, writes Bruce Wood of Morton Fraser
Securitisation or warehousing transactions and even simple invoice finance facilities involve the same legal issues as block discounting – the transfer by way of assignment of the right to receive a payment or a stream of payments (receivables). Such types of facility are commonly available in Scotland, so what is the problem?
Scots law does create obstacles which English law does not, but these can be overcome – otherwise, there would be no invoice finance in Scotland. So this note addresses two things:
- What these obstacles are and how to overcome them
- English law may often be more relevant than Scots law with Scottish borrowers.
Let us take the second of these first.
We often see a knee-jerk reaction, that all the Scottish problems will come into play if a borrower is Scottish. This is simply not true. It is not the location of your borrower which dictates how you acquire a receivable.
To put this in a wider context, the general international rule is that the acquisition of title to any asset, outright or in security, is governed by the law of the place where the asset is. It would never occur to anyone to think otherwise if, say, a house were the asset in question. Exactly the same is true of an asset such as a receivable.
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The difficulty is that it is not so obvious where a receivable is situated. The EU has a regulation which covers this. The Rome I Regulation tells us that for all purposes between EU member states (and this has been extended to apply within the UK), the law which has to be satisfied to determine whether or not the purchaser of a receivable has obtained title to it, is the law of the contract under which the receivable arises. While this is an EU rule, it also commonly applies between countries outside the EU under general conflicts of law principles.
To clarify this: it is the law of the contract between the assignor and its customer (the debtor) which determines what a purchaser of the receivables under that contract has to do to get title to them. Therefore, if you have a contract between A in Scotland and B in England which is governed by English law, the EU Regulation tells us that it is only English law which has to be satisfied to buy the relevant receivables.
On this basis, block discounting facilities made available to a Scottish borrower, whereby the finance company buys receivables arising under contracts entered into by that Scottish borrower with its customers under English law, should be validly assigned if assigned in accordance only with the English requirements.
At this point, we should confess there is another fly in the ointment: a recent decision of the Scottish Courts, contrary to an earlier English decision, tells us that this simple rule may not work where the debtor is in Scotland, even though the underlying contract of sale is governed by English law.
This is a gloss on the EU regulation which was probably wrongly decided and which the EU may itself yet clarify. However, the case sits there in the law reports and funders may worry about it when buying receivables arising under an agreement governed by English law but where the debtor is in Scotland.
So that takes us to what the obstacles are in Scots law and how they can be overcome. In effect, there are two obstacles.
Firstly, no title in a Scottish receivable, whether transferred outright or by way of security, passes to the assignee until notice is given to the debtor. That notice cannot be given until the debtor’s obligation exists and is ineffective against other creditors of the assignor if given after the assignor’s insolvency.
Secondly, it is unsettled in Scots law whether an assignment can be given in advance of an obligation coming into being. Thus, if an assignment is given of all debts present and future, it is unclear that this assignment has any effect in relation to the future debts.
In relation to both of the above in a block discounting transaction, where what is being purchased is the right to a stream of payments under, say, a lease agreement, it is important to understand that the obligations in question exist once the lease agreement has been entered into, even though the payment dates may stretch out into the future. The issue, of course, is the impracticality or uncommerciality of giving notice to an array of potential debtors.
So how can these problems be overcome?
Scots law does recognise trusts. It is an accepted methodology in invoice finance, securitisation and similar facilities where Scots law may be relevant to the passing of title in a receivable, that a trust is set up whereby the assignor of the receivable agrees to hold it in trust for the purchaser, the block discounter in our case, until that block discounter has a proper legal title to the receivable. As that legal title will only arise on notice being given to the debtor, this means that the block discounter is relying on the trust.
Admittedly, there is some greater formality in Scots law to establish this trust than to establish an equivalent English trust, but that greater formality is not an insuperable problem. As long as the detailed legal advice is followed, the trust will be valid to give the block discounter title to the receivables in preference to the assignor’s other creditors.
The remaining risk of the debtor paying the assignor and not the assignee is no different from the equivalent risk in England.
The other problem, that a present assignment of a future receivable may be ineffective, is also easily dealt with. Block discounting involves the regular passing of listing schedules to the discounter.
That listing schedule is given when the stream of receivables to which it refers has come into existence because the lease agreements have been entered into by the assignor with its customers.
It is a simple matter, therefore, to amend the listing schedule to have it operate as an assignment of the relevant Scottish receivables listed in it now that they have come into existence, thus curing the second problem.
Of necessity, this is a brief overview of the legal situation and the documentation has to be prepared carefully, but I hope it is enough to assuage some anxieties about the blocking of Scottish receivables.