Commercial Law - Purchase of Debts - Beware of Hidden Rebates
COMMERCIAL LAW - PURCHASE OF DEBTS
BEWARE OF HIDDEN REBATES
Recent cases have reinforced the rule that debtors do not have to inform their creditors of agreed rebates whether they are the original creditor or debt funder who has purchased those debts from the creditor.
The decision reinforces the wisdom of creditors/debt funders making their own enquiries about the outstanding debts. If they fail to do so, significant penalties may follow.
The relevant decision was in Bibby Factors North West v. HFD andMCD which was a decision of the English Court of Appeal in 2016. This case is highly persuasive as a precedent in Australia.
The facts involved debts which had been purchased by Bibby under a factoring agreement whereby invoices were discounted. The original creditor was Morleys Limited. Bibby issued legal proceedings against two of the purchased debtors owed by HFD and by MCD in respect of unpaid invoices.
What Bibby was unaware of was that HFD and MCD had entered a binding legal contract with Morleys whereby the debtors were entitled to a 10% rebate on annual sales. Although Bibby had investigated whether any of the debts purchased involved any dispute over the goods or services, Bibby did not properly look at the overall contract between Morleys as original creditor on the one hand and the debtors on the other hand. Specifically, Bibby did not make enquiries either of Morleys or of any debtor about any rebate arrangements which are relatively common in modern business transactions.
HFD and MCD were aware that their debt had been assigned to Bibby. They had not brought the rebate arrangements to Bibby’s attention.
When Bibby sued to collect the debts, both debtors filed a defence and counterclaim on the basis that they were entitled to set-off the rebates against the assigned debt. Set-off is a valid defence under both English and Australian law. It is shield and not a sword. It must be inherently connected to the principal claim. Set-off allows a debtor to deduct the amount of any cross-claim from the debt owed. The debtor is only obliged to pay the balance of the debt to the creditor. The trial judge gave a summary judgment in favour of the debtors in relation to their set-off defence. Bibby appealed that decision to the Court of Appeal and lost. Bibby tried to rely on a letter sent to the debtors informing them of the debt purchase and stating that any right of set-off is not permitted. Bibby used this letter to argue that it should have been informed by the debtors of the pre-existing rebates/set-off arrangement. The Court of Appeal rejected Bibby’s argument and ruled that debtors had no obligation to notify Bibby about the rebate arrangements and that Bibby should have made its own enquiries. The Court of Appeal also held that the fact that Bibby sought to prevent set-off by way of letter did not oblige HFD or MCD to volunteer information about the rebates. This could only have been enforced if the debtors agreed which they did not.
The Court of Appeal noted as follows:
The correct test for set-off is whether there is a cross-claim so closely connected with the claimant’s demands that it would be unjust to allow the claimant’s enforcement of the debt without taking the cross-claim into account;
Where there is a right of set-off, it cannot be avoided except by agreement with the beneficiary of that right which in the subject case was the debtor. Bibby could not unilaterally attempt to prevent set-off after its debt purchase by merely writing a letter asserting that set-offs were prohibited to debtors;
There is no duty on a company whose debt has been purchased to inform the purchaser of any pre-existing contractual arrangements unless if this is specifically warranted in the factoring or debt funding agreement;
Purchasers should closely review contractual arrangements. Factoring contracts should require the assignor of the debt (Morleys) to provide information (to Bibby) about relevant pre-existing contractual arrangements and Bibby should generally ask for that information both from the assignor and from the debtors;
The existence of a right of sett-off does not constitute a dispute which should be disclosed in answer to general or standard due diligence enquiries relating to disputed debts; and
An assignor (Morleys) cannot transfer to any purchaser (Bibby) greater rights than it itself already possessed.
In summary, purchasers of debts should:
Include a continuing contractual obligation or warranty on the assignor to declare any rebate arrangements;
Search for evidence of rebates during the due diligence process;
Include a search for rebates in on-going audits; and
Include a request to be notified of any reason for non-payment in notices of assignment.
This article is intended only to provide a summary of the subject matter covered. It does not purport to be comprehensive or to render legal advice. No reader should act on the basis of any matter contained in this article without first obtaining specific professional advice.
DISCLAIMER: We accept no responsibility for any action taken after reading this article. It is intended as a guide only and is not a substitute for the expert legal advice you can get from De Marco Lawyers and other relevant experts.