BOOK DEBT FINANCING1

• Published date: 01 December 1993
• Date: 01 December 1993
• Author: HO PENG KEE

“Factoring is now a highly developed form of finance in England, yet there remains widespread ignorance both as to its basic purpose and as to the law and practice governing factoring operations. From a legal viewpoint factoring is both fascinating and complex, because it spans so many different branches of law and poses numerous questions on which the law is unclear.” (Professor R M Goode in Foreword of Salinger, Factoring Law and Practice (Sweet & Maxwell, 1991)

I. INTRODUCTION

BOTH worldwide and in Singapore, the use of book debts as a form of financing has increased in importance in recent years. Locally, the move to upgrade local smaller enterprises has intensified: for example, the government recently announced the setting up of a Retail Promotion Centre to help retailers upgrade their businesses.2 The use of sound financing methods is vital to any successful business management. For Singapore businesses, these methods include trade credit from suppliers, mortgage of real property, bank overdraft secured by chattel mortgage and inventory financing by way of floating charge. Another important method is the raising of finance through the sale (factoring) or mortgage or charge (accounts receivables financing) of book debts.3

Despite its importance in facilitating the transfer of goods and services worth millions of dollars and the fact that, in itself, it has grown into a multi-million industry, the legal regime supporting the raising of finance through the sale of and mortgage or charge of book debts is still not totally clear. This is so because businessmen have run ahead of lawyers.4 They have creatively adapted a somewhat ancient legal device to suit modern requirements.5 Some areas of law are still not definitively settled, as this article will show.

Two forms of financing are available: factoring or sale of book debts6 and

accounts receivables financing. The essential differences between the two are:7

FACTORING	ACCOUNTS RECEIVABLES FINANCING
1. constitutes a sale either with or without recourse to the seller	constitutes a loan whereby the security interest created is that of a charge
2. no registration is required8	registration is required under the Companies Act if the client is an

	incorporated body9
3. notice of the assignment is given to the debtor	the debtor is not notified
4. unless the factor takes the assignment with recourse, he to bears the risk of bad debts	the risk of bad debts remains with the client who continues to handle the collection process
5. the factor bears the responsibility of collecting the debt	the client continues to bear this responsibility
6. ad valorem stamp duty is payable on a legal assignment	different tax rates apply
7. factor assumes administrative task of monitoring payment of debt	client continues to bear this responsibility

The focus of this article is on factoring as, of the two, it is a more common form of financing.

II. TYPES OF ASSIGNMENTS

There are two types of assignments: legal (or statutory) and equitable. In a legal assignment, legal interest is assigned. In an equitable assignment, equitable interest is assigned. For a statutory assignment to be validly effected, the requirements of section 4(6) of the Civil Law Act10 must be complied with. They are:

1. 1. The assignment must be absolute;11

2. 2. The assignment is of a “debt or other legal chose in action”;12

1. 3. The assignment must be in writing under the hand of the assignor;

2. 4. Express notice in writing must be given to the debtor.13

The formal requirements of an equitable assignment, on the other hand, are more relaxed. An assignment that fails to satisfy the requirements of section 4(6) may still be valid as an equitable assignment. An equitable assignment need not be in writing although it is normally the case. No particular form of words is required provided the meaning is clear that the assignor intends the assignee to have the benefit of the debt.14 The words must however indicate that more than a mere mandate or authority to receive the debt has been given to the assignee.15 The efficacy of an equitable assignment is not affected by absence of notice to the debtor. Nevertheless, notice is normally given for three reasons:

1. 1. to prevent the situation where the debtor pays the assigned debt to the assignor thereby obtaining a good discharge;

2. 2. to prevent the debtor from setting up further equities against the assignee;16

3. 3. to obtain priority, so far as is possible, over other competing interests.17

An equitable assignment may be created by:

1. 1. transfer or agreement to transfer. This is the most common method in the case of book debts;

2. 2. declaration of trust by the assignor where he declares himself a trustee of the debt for the intended assignee;

3. 3. direction to debtor to make payment to assignee. For this to be effective, it must either be given pursuant to prior agreement between the assignor and assignee, or communicated to the assignee subsequently.

In order to avoid payment of stamp duty, agreements are usually structured

in such a way so as to constitute the assignments equitable ones. The point is to be able to argue that no document falling within the Stamp Duties Act exists.18

A Singapore decision on equitable assignment is Interschiff Schiffahrtsagentur GmbH. v Southern Star Shipping & Trading Pte. Ltd.19 In that case, Lai J. decided, as an alternative ground, that there was an equitable assignment of a debt. The debtor received notification of the assignment from the assignor. Despite this notification, he nevertheless paid the assignor who subsequently became insolvent. The debtor was held liable to pay once more to the assignee. In the process, the learned judge construed the effect of two telexes as tantamounting to an equitable assignment.20 The House of Lords decision in William Brandt’s Sons & Co. v The Dunlop Rubber Co.21 was cited and the description of what constitutes an equitable assignment was adopted:

“…the document does not on the face of it purport to be an assignment nor use the language of an assignment. An equitable assignment does not always take that form. It may be addressed to the debtor. It may be couched in the language of command. It may be a more courteous request. It may assume the form of mere permission. The language is immaterial if the meaning is clear. All that is necessary is that the debtor should be given to understand that the debt has been made over by the creditor to some third person. If the debtor disregards such a notice, he does so at his peril. If the assignment be for valuable consideration and communicated to the third person, it cannot be revoked by the creditor or safely disregarded by the debtor…”22

In contrast, another local decision on assignment that leaned towards the opposite conclusion is American Express International Banking Corporation v United Bearings and Machinery Pte Ltd.23 In that case, the Court of Appeal held that the content of several letters written by the plaintiff to a bank did

not amount to an assignment and were “merely instructions to the Bank…and no more.”

What are the legal consequences of adopting either a legal or equitable assignment to transact one’s business? They are firstly, payment of ad valorem stamp duty: legal or statutory assignments are subject to stamp duty whilst equitable assignments are not as there is usually no document setting out the terms of the assignment which is taxable;24 enforcement procedures: a legal or statutory assignee can sue in his own name whilst an equitable assignee has to take proceedings to join the assign or as plaintiff or as defendant and lastly, priority contests: legal interest is transferred in a legal or statutory assignment whilst equitable interest is transferred in an equitable assignment.

III. PROBLEM AREAS

Several issues have given rise to uncertainty in this area of the law. These issues have defied clear and easy answers. They can be broadly divided into two areas; namely, problems arising from the legal relationship between assignor(seller) and debtor(buyer) which impact on the assignee and problems involving competing claims and priority situations which may arise between assignee(factor) and third parties such as a “romalpa seller”.

A. Problems arising from the legal relationship between Assignor and Debtor which impact on the Assignee

1. Effect of term in underlying contract between assignor and debtor prohibiting assignment of debt

If the contract between assignor and debtor (“underlying contract”) contains a clause prohibiting assignment of the resultant debt and the assignor nevertheless assigns the debt, can the debtor resist an action by the assignee (factor) to enforce payment of the debt? Would it make any difference if the assignee knew of the clause when he took the assignment?25

Prima facie, it may be argued that if the debtor makes clear that his

undertaking to pay is made only to the assignor, that is to say, it is of a personal nature, there are no grounds to force a variation of this contractual undertaking upon him. Any variation of contract should be mutual.26 A prohibition clause is capable of four interpretations, the consequences of which are now set out in ascending order of severity. First, as a mere personal undertaking by the assignor to the debtor not to assign, breach of which exposes the assignor to a claim in damages but which does not prevent the assignee from recovering the debt from the debtor, that is, the assignment is still valid. Secondly, it is void between assignee and debtor, but does not prevent the assignee from having rights against the assignor. Thirdly, it renders the assignment void as between assignee and debtor as well as between assignor and assignee. Lastly, it entitles the debtor not merely to claim damages for breach of...