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INVOICE FINANCE IN SCOTLAND - ANOTHER NEW PROBLEM

An important appeal court decision in Scotland raises the spectre of yet further difficulties for invoice financiers in buying Scottish debts.  The decision involves a deliberate change in the law by the court on a question where a previous appeal court judgment had been much criticised.

Three background issues need to be explained:

  • As invoice financiers know, an invoice financier can only get full ownership of a purchased Scottish debt by giving notice to the debtor of the assignment.  As that's not the way invoice discounting operates, invoice financiers rely on the trust established in the Debt Purchase Agreement to protect their right to the debt.  In that trust the invoice financier's client is both the truster (the creator) of the trust and its trustee.  The courts have agreed this is valid provided the invoice financier as beneficiary of the trust is notified of what debts are held in the trust.
  • What is called a garnishee order in England has a rough equivalent in Scotland, namely, an arrestment.  This is a process by which the creditor of a client can "secure" his claim by "arresting" the debtor's obligation to pay the client in the hands of the debtor before it is paid.  An arrestment can be used either to secure payment of a judgment the arresting creditor holds against the client or to freeze the sums due in the debtor's hands pending the arresting creditor successfully suing the client and obtaining judgment.
  • In a controversial judgment in 1977 the Scottish appeal court decided in effect that a floating charge took priority over an arrestment unless the arresting creditor had taken court action to enforce its arrestment.

The appeal court has now reversed that 1977 judgment in the case of Macmillan v T Leith Developments Limited ("Macmillan").  The decision is to the effect that an arrestment is a type of security and removes the arrested debt from the property of the granter of the floating charge over which property the floating charge floats (though only in a question of ranking or priority as between the arrester and the floating charge holder and not otherwise).

So far, so uninteresting.  Apart from any general interest in the case as noting a new limitation on the priority in ranking of the floating charges invariably taken by invoice financiers from corporate clients, why is this important?

It's important because of the unasked and unanswered question in Macmillan - given the new strength accorded to an arrestment by the court, might it now prevail over the trust in the Debt Purchase Agreement to defeat the invoice financier's right to the purchased but arrested debt?

Why might it prevail?  Because the arrestment is now being treated as akin to a fixed security and the arrester knows nothing of the existence of the trust - and Scots law looks unfavourably on devices like the trust in the Debt Purchase Agreement which transfer property where the transfer is secret and not open and transparent. 

Will it prevail? I don't think so because the transfer of the debt into the trust is completed (and supposedly made transparent) by notifying the invoice financier of the transfer.  That appears to be the logic of the judgment in a 2004 Scottish House of Lords case in a different context, dealing with a competition between the trustee of a bankrupt transferor of land and a purchaser of that land who hadn't completed title to it.  The trustee won because the purchaser hadn't done what was needed to complete the transfer of the title - and anyway the court followed what had always been thought to be the leading Scottish case dating from 1892.

So why am I bothered?  Because, first, while there is court authority that notification to the invoice financier of the transfer of the debt to the trust completes the transfer, there is no true transparency to the outside world in simply notifying the invoice financier of the transfer.  Secondly, none of the earlier cases determining the competition between a trust over an asset and the purchaser of that asset relate specifically to a truster as trustee trust nor to the purchase of debts.  While, therefore, I believe that invoice financiers can mount a robust defence to any challenge to the trust by an arresting creditor (or an administrator of the client) I believe that a challenge may well be made in the future based on Macmillan - in effect trying it on to see what happens.  And, as we all know, the outcome of any litigation is rarely a foregone conclusion, so there's a new risk in town.