Thinking and Assessing Charge and Assignment Under English Law
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1 International In-house Counsel Journal Vol. 7, No. 27, Spring 2014, 1 Thinking and Assessing Charge and Assignment Under English Law ALESSIA FRISINA Chief Legal and Compliance Counsel, De Lage Landen Leasing Limited, UK Abstract Introduction I have been working as a lawyer for several years in Europe, in countries governed by different legal systems. I have learned to love English law because of its practical approach: rights precede the law, not the other way around as is the case in most civil law systems. Proponents of English law argue that one of its main strengths is its flexibility and its approach to not pre-judge any situation. The intention is that one takes a specific situation and arrives at a legal decision based on the specific circumstances, as opposed to codified regimes which aim to fit a specific situation into existing codes. In practice, things are vastly more complicated under both approaches but, for the sake of this article, I will try and stay with my simple intent of English law. I think one downside of English law is that, when we apply it, sometimes we rely a bit too much on the search for the same scenario or same kind of things having been done before. We must always think why we do things in a certain way and not in any other. On a separate but related note, I have also always been interested in the economic analysis of law, particularly the application of economic theories to the analysis and effects of law. In my opinion, this is, after all, the real intent of any legal structure we employ: we want optimal efficiency under envisaged scenarios. I have been lucky to work both in private practice and in-house. I found that working as in-house legal counsel makes one look at things in a slightly different way. We think more about why we need such a contract and more about the practical consequences of such a contract for our company. While a private practice lawyer has a multitude of clients, in-house counsel has only one the company we work with. We often advise a number of different businesses within the same company or group and we are incentivised to get to know our company in greater detail. Based on the above, I have framed this article with these two concepts in mind thinking through why a given legal approach is being used and assessing what the impact is in practice for a business. Bearing this in mind, I am going to take a look at a particular type of security agreement, charge, and its correlation with another type of agreement, assignment. I will address these aspects: 1. How a charge works and why it matters. 2. Assignment - legal and equitable by way of charge and by way of security. 3. Why a charge contains assignment provisions. 4. What happens if a contract contains prohibition of assignment provisions can a charge be created over that contract. International In-house Counsel Journal ISSN print/issn online
2 2 Alessia Frisina I have said that, in practice, legal issues are more complicated than the prescribed theories but, in the matter of negotiating charges and assignments in English law, an understanding of these concepts followed by a process of assessing what benefit one intends and how a given legal approach delivers that, should stand the practitioner in good stead. 1. HOW A CHARGE WORKS AND WHY IT MATTERS A charge is a basic type of security that can be created under English law. The term charge is sometimes used in a non-technical way to indicate any form of security. If used in a technical way, it refers to an agreement by means of which one party (Chargor), as security for the payment and discharge of certain liabilities owed (by the Chargor or a third party 1 ) to another party (Chargee), charges in favour of the Chargee certain assets. A charge does not transfer title to the relevant assets and possession of the assets is not delivered to the Chargee. Any asset which can be recognised as property, whether tangible or intangible, can be charged and it does not necessarily have to be created by a debtor of the Chargee. A charge may be created by a third party. An example: Borrower B asks lender L for a loan and a third party T grants a charge over T s property to secure repayment of the loan by B. (Any parent guaranteeing a student s borrowings from a bank should know the concept and shudder!) Strictly speaking, a charge exists only in equity, except in case of land where a charge must be expressed to be by way of legal mortgage (section 1(2)(c), Law of Property Act 1925). Equity is not an easy concept to explain outside of common law systems and a full treatise is beyond the scope of this article. However, as I do refer to equity and equitable in this article, it is worth spending a few words on these concepts. We know that the English legal system does not have a civil code basis, relying instead on common law, that is the law created by custom. However, there were occasions where common law failed to provide acceptable solutions and over time the rules of equity were introduced as a sort of additional resort to provide resolution in situations where strict adherence to common law could not. We could say that equity began as a response to the rigid procedures of English courts and the common law which had been developed. We said that a charge can be created over different types of assets, whether tangible or not. We can take a charge over a car (tangible) but we can also charge intellectual property rights (intangible). Depending on the nature of the assets and whether those assets can be subject to effective control by the Chargee, the nature of the charge and the priority such charge will give to the Chargee will work differently. As an example, if the charge is created over a shifting pool of assets, which cannot be individually identified, it is likely to be a floating rather than fixed charge. The main difference between a fixed and a floating charge is that in the latter the pool of assets may fluctuate from time to time, from which the name floating, while a fixed charge is a charge over an identified asset. A great advantage of floating charge is that it is effectively secured on the fluctuating assets of an operating business and these assets only need to be defined when an event, such as a default, crystallises the charge. At the same time, this can be a disadvantage as the Chargor has freedom to dispose of or acquire assets in the normal course of its business. The Chargor could conceivably dispose of all its assets, leaving nothing to the 1 For the sake of this article, any reference to the Chargor s debt herein, will be a reference to the secured debt, whether owed by the Chargor or any other party.
3 Charge and Assignment 3 Chargee as its security. The floating charge crystallises upon occurrence of certain events (e.g. events of defaults) and, at that stage, it is converted to a fixed charge over the (at that point in time, identified) assets that it covers. The main consequence of the different structure between fixed and floating charge is that, in an insolvency scenario, a fixed charge holder will effectively rank prior to a floating charge holder. I will not dwell further on the different terms of floating and fixed charges here and will move on to the main term of a charge. The core of a charge is the clause describing means by which the security over the assets is created. The charge will provide for the creation of an encumbrance over the asset which is the subject matter of the charge. Although the right under the assets will remain with the Chargor, the Chargee shall have the right to appropriate the money raised from sale of the charged right towards repayment of the Chargor s debt. A charge will also typically contain assignment provisions or be incorporated in a security document which provides for both charging and assigning. We must come back to thinking about why this approach is necessary and what benefit is derived and for this we need to look at what an assignment is and how it works under English law. 2. ASSIGNMENT LEGAL AND EQUITABLE BY WAY OF CHARGE AND BY WAY OF SECURITY Assignment is a term used to identify the transfer of rights held by one party (Assignor) to another party (Assignee). Assignment is a transfer of rights only; no obligations are transferred by way of assignment. If you hear anything to the contrary, the term assignment has been used incorrectly 2. An example: Lender L and Borrower B enter into a loan agreement by means of which L grants to B a Sterling loan facility. B will need to repay the loan facility to L in accordance with the terms and conditions set out in the loan agreement, i.e. L has the right to be repaid back. L decides to transfer L s right to receive those payments to a third party, C. C becomes the new creditor and B will now have to repay the loan to C, instead of repaying to L. Notwithstanding the transfer of rights, L will remain party to the loan agreement with B. Any obligations and any undertaking L may have under such loan agreement will remain an obligation which L has to comply with. One thing to bear in mind is that L can only transfer existing rights; an assignment does not create new rights. This means that C will not be able to enforce rights that L did not have under the loan agreement and C s rights of enforcement will be necessarily subject to any limitations (e.g. B s right of set-off) that the loan agreement contained. An assignment can be entered into for different reasons. An Assignor may want to sell its rights under a contract for a price to raise cash or may need to sell its rights as security for a new borrowing from a third party. The latter is what is usually referred to as security assignment or assignment by way of security. 2 Novation (not assignment of contract) is the instrument by means of which a party transfers its rights and obligations under a contract to another party. To be precise, it is not an actual transfer as the novation terminates the existing contract between the original parties and replaces it with another one between the continuing party and the incoming party. This is the reason why a novation is, necessarily, a tripartite agreement: all the parties to the original contracts must consent, plus the new incoming party which will take the place of the outgoing party.
4 4 Alessia Frisina An assignment by way of security is not, strictly speaking, the same as an assignment by way of charge, by means of which the Chargor and the Chargee agree that the benefit of the asset is assigned to the Chargee directly and can be used to discharge the Chargor s debt 3. We will come back to this later. An assignment is legal, rather than equitable if the following requirements are met (section 136 of the Law of Property Act 1925 (LPA)) 4 : 1. The assignment is in writing and it is signed by the Assignor; 2. It is an assignment of the whole debt (not just part of it); 3. The assignment is notified in writing to the debtor against whom the Assignor could enforce its rights. If any of the above requirements are not met, the assignment is equitable. It still is a valid and enforceable contract between the Assignor and the Assignee, but the Assignee will not be entitled to sue the debtor directly in its own name because, before the debtor, the creditor remains the Assignor and any and all actions against the debtor shall be brought by the Assignor. Typically, an equitable Assignee will join the Assignor as a party in any action the Assignee brings against the debtor. 3. WHY A CHARGE CONTAINS ASSIGNMENT PROVISIONS I have said that a charge would typically contain charge provisions and assignment provisions but I also said that we should think why a given approach is used rather than following what we assume fits. So, why do we have charge provisions and assignment provisions? A charge is a security whereby personal property is appropriated for the discharge of a debt, but which does not transfer title and/or possession to that property. A charge per se does not give the Chargee the right to enforce without a court order as it does not transfer any legal or beneficial interests in the asset from the Chargor to the Chargee. This means that if a Chargee wants to realise its security interest in charged assets, it has the right to do so by applying to court to seek to seize the charged assets and, consequently, to sell those assets to realise the amount owed. The economic impact of this is the cost of recovery, in money, time and uncertainty, of the court process. This is the reason why we will often see that a charge document contains also assignment provisions usually referred to as assignment by way of charge. Broadly speaking, an assignment by way of charge refers to circumstances where the creditor and the debtor contractually agree that the creditor has a charge over certain assets and the effect of such charge is that the benefit of the asset is assigned to the creditor to discharge the Chargor s debt. Somewhat different, but often confused with the assignment by way of charge, is the above-mentioned assignment by way of security. If a charge incorporates an assignment by way of security, it is typically referred to as a mortgage. As an example, a mortgage over choses in action 5 is often created by way of assignment whereby the mortgagor assigns the chose in action to the mortgagee. Broadly 3 See Bexhill (UK) Ltd v Razzaq [2012] EWCA Civ 1376, where the Court of Appeal has considered whether an assignment was absolute or by way of charge only. 4 Since the enactment of the Financial Collateral Arrangements Regulations 2003, some of the requirements have changed in relation to specific types of assets (cash, financial instruments and credit claims). 5 A chose in action is a personal right which can only be claimed or enforced by action (see Torkington v Magee [1902] 2 KB 427). Examples are: receivables, book debt, financial instruments.
5 Charge and Assignment 5 speaking, an assignment by way of security is where a creditor takes a straightforward assignment of the chose in action (whether legal or equitable). In either case, assignment by way of charge or assignment by way of security, the goal is to improve efficiency for the Chargee. These provisions are designed to make the process for the Chargee to enforce its security more straightforward. It seems to be fairly logical. Nevertheless, as in-house legal counsel, I have found myself explaining why we need such provisions in a charge on numerous occasions. Those clauses are not there as a matter of law, they are there as a matter of practice, because (i) they are not unreasonable at the end of the day, they would be exercised mostly upon default when the Chargee is in a position of not otherwise being able to recover its credit, (ii) they make satisfaction of a debt quicker and (iii) they are efficient, as they potentially save legal costs. 4. WHAT HAPPENS IF A CONTRACT CONTAINS PROHIBITION OF ASSIGNMENT PROVISIONS CAN A CHARGE BE CREATED OVER THAT CONTRACT Some contracts are personal as they contain rights so connected and linked to a specific person or entity that they cannot be transferred to anybody else. Even a contract that is not strictly personal may be non-assignable if the parties to that contract agreed a nonassignment clause. The parties may intentionally and contractually agree that either or both cannot assign the benefit and the rights of their contract. There could be many reasons for doing so, including simply that the parties do not want to deal with any other party, other than the one they have chosen to contract with. In practice, a non-assignment provision may be construed in many different ways the power of negotiation and bargaining but, despite such prohibition to assign, if one of the parties decides to assign its rights, that assignment will still be valid and enforceable between the Assignee and the Assignor. It will not be effective against the debtor, though. We would have an equitable, rather than legal assignment, as we discussed earlier, which means that the debtor will be validly discharging its payment obligations to the Assignor and the Assignor will have an obligation to transfer any and all amounts received from the debtor to the Assignee as those payments have been assigned to the Assignee Let s consider the following scenario. Lender L and borrower B have entered into a lease agreement which contains a nonassignment provision. Creditor C may be willing to purchase L s rights under the lease agreement, i.e. payments from B, but L cannot assign its credit under the lease agreement because of the non-assignment provision. Therefore L and C decide to enter into a loan agreement secured by way of charge over the L s rights under the lease agreement. The contractual structures of (i) C purchasing L s rights directly and (ii) C granting a loan to L secured by those rights, are different but the ultimate result is the same. In the first scenario, C pays a purchase price to L buy the receivables under the lease agreement, in the second scenario C lends money to L for an amount equal to the purchase price and is secured by the charge over those same receivables. Taking into account that the lease agreement contains a prohibition of assignment (not a prohibition of charge), can L and C effectively agree on a loan agreement secured over A s lease agreement by way of charge? This is certainly a complication over the basic theory of charge and assignment espoused thus far. But, by applying the same principles of thinking through the legal approach and
6 6 Alessia Frisina assessing the impact, one should consider the following factors which we have discussed earlier: i. A charge is a security over personal property, ii. If the charge is only meant to create an encumbrance over the assets without any assignment provisions, i.e. the Chargee will enforce its rights by first obtaining a court order, and therefore the prohibition of assignment is irrelevant, iii. If the goal is to put in place a proper security assignment, i.e. assignment by way of security or a mortgage which provides for the transfer of title to an asset by way of security, a prohibition of assignment will be relevant and the assignment/security will not be enforceable TO CONCLUDE SOME FOOD FOR THOUGHT Let s (re)focus on the main points discussed herein: i. Thinking and assessing: This article has tried to offer my understanding of charge and assignment in English law, so to determine the consequences and effects of assignment provisions in a charge. We should be rigorous in considering the reason a legal approach is used in a particular case and assessing if it derives the benefit we are seeking, without reinventing any wheel, but at the same time without excessive reliance on existing approaches; ii. Charge: we can charge a property, tangible or intangible, shifting pools or identified assets, whether owned by the same debtor or a third party; iii. Assignment: we can assign rights (not obligations) even if the underlying contract says that we cannot. The assignment will not be enforceable against the debtor but it will still be a valid assignment between the assignor and the assignee; iv. Charge and assignment: if the underlying contract prohibits assignment, we will not be able to create a security assignment. We can still create charge, but we may need to suffer a bit more to enforce our rights I have always found it challenging to conclude an article I read somewhere that concluding is bringing your article to a convincing end, which does not leave the reader feeling dissatisfied. I hope this is one of them. BIBLIOGRAPHY If you wish to know more about contracts under English law, I would suggest you start with the following: Chitty on Contracts, 31 st Edition, Published by Sweet & Maxwell Roy Goode, Commercial Law, 4 th Edition, Published by Lexis Nexis Fisher and Lightwood, Law of Mortgage, 13 th Edition, Published by Lexis Nexis If you wish to know more about law and economics, I would suggest you start with the following: Ronald Coase, The Firm, The Market and the Law, Published by University of Chicago Press, reprint edition Richard A. Posner, Economic Analysis of Law, 7 th Edition, published by Aspen Guido Calabresi, The Cost of Accidents: A Legal and Economic Analysis, published by Yale University Press Pietro Trimarchi, Economia e diritto nel sistema della responsabilità civile, Responsabilità civile nei sistemi di common law, published by Cedam
7 Charge and Assignment 7 *** Alessia Frisina is the chief legal and compliance counsel for the UK. De Lage Landen is a global provider of leasing, business and consumer finance solutions, including vendor finance and factoring. It was founded in 1969 as a fullyowned subsidiary of the Rabobank Group to meet a growing need among larger agricultural operations for more sophisticated and far-reaching financial services. De Lage Landen moved its first international steps in 1987, when it began offering services in neighbouring European countries. De Lage Landen international network has been growing since then and it now present in more than 30 countries around the world. In De Lage Landen has been named European Lessor of the Year at the Leasing Life Conference and Awards in Berlin. Please note that this article is not representing De Lage Landen s views or opinions, which are solely those of the author.
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