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13 Apr 2016

Factors – Do you really know what you are buying?


Bibby Factors Northwest Ltd v HFD Ltd and another

This Court of Appeal case decided towards the end of 2015 provides a definitive reminder to factoring companies to undertake the necessary due diligence prior to purchasing debts from another entity. It also highlights the importance of understanding which amounts a debtor may be entitled to set-off or otherwise apply in reduction of the debt. The main principle that was emphasised in this case is that, except in certain limited cases, there is no duty on a debtor to inform the purchaser of debts of any pre-existing contractual arrangements between the debtor and the seller.

The initial claim and counterclaim

Bibby Factors Northwest Ltd (Bibby) had entered into a factoring arrangement with Morleys Limited (Morleys) pursuant to which Bibby had purchased the debts owing to Morleys by HDF Limited and another (the Customers) together with any debts which arose after the date of the factoring agreement each arising from arrangements between Morleys and the Customer to supply the Customer with certain goods from time to time. 

Some years after the factoring arrangements had been entered into Morleys went into administration. Shortly thereafter Bibby began proceedings against the Customers for failure to pay certain of the debts assigned by Morleys. The Customers claimed in their defence and by way of counterclaim that: (i) the arrangements with Morleys entitled them to a 10% rebate of the supply price for each calendar year; (ii) pursuant to their arrangements with Morleys, they were entitled to a further 2.5% discount if all payments were made in accordance with Morleys' terms of supply; and (iii) they were entitled to credit in respect of certain debit notes raised in respect of faulty goods.

The High Court granted judgment in favour of the Customers in respect of all three limbs of their counterclaim, with summary judgment being granted in respect of both the 10% rebate and the debit notes. Bibby subsequently appealed this decision. 

The importance of equitable set-off 

The key contention made by the Customers in their counterclaims was that they should be entitled to set off certain rebates and debit notes. Set-off is a device that is regularly utilised in finance transactions to enable one party to reduce (so that only the balance is due) or eliminate completely a liability it may owe to another party. 

Bibby contended that a right of set-off should not apply to the counterclaims. In particular Bibby sought to rely on a number of points including a "take-on letter" sent to the Customers at the time of the factoring agreement which advised them that Bibby had purchased the debts and stated that "any right of set-off in respect of any sale you make to our client is not permitted" and also stickers said to have been affixed to the invoices raised in respect of the debts which Bibby had purchased. The take-on letter also stated that the Customers should advise Bibby of any dispute which was likely to lead to a reduction in the debt owed. Bibby argued that the link between the 10% rebate and Bibby's claim was not sufficient if considering "the justice of the case" on the grounds that the Customers had been involved in verifying outstanding invoices for a protracted period and had been aware that Bibby had purchased the debts but had not made Bibby aware of the rebates.

The courts took the view that the correct test was not the decision as to the justice of the case but whether "the connection between the claim by the Supplier and the cross claim by the Customer is so close that it would be unjust to allow the Supplier (and hence Bibby) to maintain the one without giving credit to the Customer for the other". 

In this instance distinction was made between equitable set-off (which they considered did apply on the grounds set out above) and independent set-off (in respect of which they did not express a final opinion). Equitable set-off applies in respect of  claims which equity regards the party to be entitled to set-off against a debt and which would apply (subject to any estoppel) in respect of both statutory and equitable assignments regardless of whether the cross claim accrued before the debtor had notice of the assignment. On the other hand, independent set-off, that is in respect of a cross claim independent from the claim against the debtor, would not apply in respect of a cross claim arising after the debtor had notice of the assignment. 

Obligations cannot be unilaterally imposed

The court was also clear that the take-on letter did not create a direct contractual relationship between Bibby and the Customer which would have been required to impose any obligation on the Customer to disclose prior contractual arrangements. If Bibby had wished to be informed of any rebate arrangements the Customers had with Morleys it should, in the courts view, have included terms in the factoring agreement requiring Morleys to provide such information or in the alternative, Bibby could have asked Morleys or the Customer whether there were any rebate arrangements in place. The only instance in which the court envisaged that such an obligation could arise without a separate contractual arrangement would be where the debtor was aware that the purchaser of the debt had been deceived as to the existence of a rebate. 

A note of caution to factors

This case serves to highlight that if a purchasing factor company wants to be informed of any pre-existing contractual arrangements it should directly request this either from the vendor under the factoring agreement or from the underlying debtor but that the latter will require a direct contractual arrangement between the debtor and the purchaser in order to create an obligation on the debtor. 

It is also an important reminder that certain equitable rights of set-off will, if they are sufficiently closely linked to the debt being claimed, continue to apply against both statutory and equitable assignments even after notice of assignment has been given to the debtor. 

On a practical note, factors should ensure that they complete all necessary due diligence on the underlying contracts under which they are purchasing debts and whether they are subject to any credit or rebate arrangements. Factors should also be careful when drafting notices of assignment pursuant to such factoring agreements and ensure that customers acknowledge by way of confirmation that there are no such credit or rebate provisions in their arrangements with the respective debt vendor.


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