Fairness and equity in factoring arrangements

The recent case of Bibby Factors Northwest Ltd v HFD Ltd & Anor [2015] EWCA Civ 1908 in the English Court of Appeal confirmed the position under English law of a debtor's right to set-off against an assignee. 

In England and South Africa alike, the issue of the validity of a debtor's right to set-off against an assignee or cessionary is particularly relevant where companies access credit by selling their debt to a bank or factoring company.

In the Bibby matter, Morleys Limited had supplied goods to certain customers and had assigned the debts owed to them by these customers to Bibby Factors Northwest Limited. Bibby, in turn, had sent a notice to Morleys' debtors advising them that all their debts owed to Morleys had been assigned to Bibby. The notice also directed the debtors to deal only with Bibby in relation to the debts and noted that, in the course of repayment, "any right of set-off in respect of any sale [they] make to [Morleys] is not permitted".

Morleys went into insolvency proceedings in England, and Bibby began court proceedings against the debtors to recover amounts due under the assigned debts. The debtors counterclaimed, arguing that they were entitled to, among other things, a rebate from Morleys of 10% of the price paid by them for every supply made in a given calendar year (payable in January of the following year). They argued that the amounts of their rebates should be set off against the amounts owed to Morleys.

At first instance the judge gave summary judgment allowing the debtors to set-off the rebate against the amount owed to Bibby. Bibby appealed, principally arguing that the notice notifying the debtors of the assignment of their debts excluded any set-off rights in relation to the rebate. They contended that the debtors should have informed Bibby that the assigned debts owed to them would be subject to rebate arrangements. However, they had not done so over the course of the 13 years during which they periodically confirmed the balances of the amounts they owed to Bibby.

The English legal system is supported and augmented by the doctrine of equity, which grants a judge the discretion to consider the facts and circumstances of a case and assess whether granting an "equitable remedy" (in this case set-off) would prevent injustice to the parties. Where the claim by the debtor does not arise under the same contract as that which gives rise to the assigned debt, the Court of Appeal confirmed that the test for whether equitable set-off can be applied is whether the "cross-claim is…so closely connected with [the plaintiff's] demands that it would be manifestly unjust to allow him to enforce payment without taking into account the cross-claim" (Geldof Metaalconstructie NV v Simon Carves Limited [2010] EWCA Civ 667). 

Notwithstanding that the obligation to pay the rebate may not have arisen out of the same contract that gave rise to the debt, the Court of Appeal held that there was a sufficiently close connection between the cross-claim and the outstanding debts. As a result, the debtors were entitled to deduct the rebate payments from their debts to Bibby. 

It was also held that debtors had no obligation to volunteer information about contractual arrangements to which Bibby was not a party once they received notice that their invoices had been sold to Bibby.

The general position on a debtor's right to set-off against a cessionary (assignee) under South African law is that a debtor is not permitted to set off amounts owed to it by a cedent against a debt it owes to a cessionary if those claims are still unliquidated at the date of cession notwithstanding those amounts becoming liquidated by the time the cessionary brings the claim against the debtor (Oudtshoorn Town Council v Smith 1911 CPD 558). This general position is subject to the following two qualifications:

  • If the debtor only became aware of the cession after the mutually owing debts were capable of being set off against one another, then the debtor is entitled to set-off amounts owed to it by the cedent against a debt it owes the cessionary despite the mutual debts being unliquidated at the date of the cession. Once the debtor is notified of the cession, however, it can no longer rely on any unliquidated claim against the cedent; except 
  • If the cession was made by the cedent for the purpose of frustrating the debtor's claim and the cessionary knew the cedent's motive, then the debtor is entitled to rely on a counterclaim it has against the cedent to stay judgment on the cessionary's claim until the counterclaim has been disposed of.

Based on this, the notice to the debtors would have been adequate to prevent set-off in respect of debts that had not accrued (become liquidated) by the date on which notice was given, had the facts in the Bibby case come before a South African court. This is because the rebate claims arose in arrears on an annual basis after notice of the cession was delivered.

However, under English law, as long as the claims arose from the same, or a closely linked, agreements the amount owed to the assignor (cedent) by the debtor need not have accrued (become liquidated) at the time of the assignment (cession) to be eligible for set-off against debts owed to the assignee (cessionary). As mentioned, an English court would apply principles of equity to determine whether debts are closely connected.

Equity and equitable remedies under English law try, as far as possible, to achieve fairness between opposing parties. In this case, the Court of Appeal held that it would be "manifestly unjust" to allow Bibby to enforce payment of their debt without taking into account the debtor's cross claim for a rebate, even if those debts did not arise under the same contract. 

The judgment in Bibby does not create new law, but it contains a useful overview of the principles of equitable set-off. The case also highlights the importance, for a factor or other assignee, of carrying out sufficient due diligence in relation to the provisions of assigned contracts and the business models of assignors to identify provisions and arrangements that may dilute the claims being purchased. While giving notice to the debtor of the assignment is otherwise helpful, specifying that the debtor has no rights of set-off in relation to the assigned contract will not be effective to defeat equitable rights of set-off under English law, even if they became liquidated after notice of the assignment was received. 

While the analysis under South African law is not identical, purchasers of invoices in South Africa and England alike would be well advised to carefully investigate potential rebates, discounts and similar arrangements and, where possible and practical, to obtain express waivers of any rights of set-off from debtors in an acknowledgment addressed to the cessionary (assignee).

As published in Without Prejudice in April 2016.

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