The Court of Appeal has reiterated some important rules for funders involved in debt purchase. Banking Litigation specialist Alasdair Urwin looks at the recent case of Bibby Factors Northwest v HDF and MCD [1].

Buyer beware

This case concerned a factoring agreement, pursuant to which a funder (Bibby) purchased unpaid invoices from another company (the Assignor), including debts owing from the defendant companies (the Customers).

It is common in factoring and other debt purchase arrangements for purchasers to investigate whether any of the debts which they are buying the right to collect are disputed. However, this case demonstrates that such enquiries may not amount to sufficient due diligence to protect the purchaser.

Bibby did not make specific enquiries as to the contractual terms underlying the unpaid invoices it was purchasing. It was therefore unaware that the Assignor’s contracts with the Customers contained provisions entitling the Customers to certain rebates. When Bibby sued to collect the Customers’ debts, the Customers brought a defence and counterclaim on the basis that it was entitled to set-off rebates against the debt.

Equitable set-off

Set-off is a ground of defence, often described as a shield not a sword, which arises out of, and must be inherently connected to, a claim. Set-off allows a debtor to deduct the amount of any cross-claim which he has from the debt he owes, and therefore to tender only the balance of the debt, if any, to the creditor.

In an earlier hearing, a High Court judge had given summary judgment in the Customers’ favour in relation to their set-off defence. Bibby appealed that decision. Relying on a letter which it had sent to the Customers informing them of the debt purchase; asking for payment to be made to Bibby instead of to the Assignor; and stating that “any right of set-off… is not permitted”, Bibby argued that the Customers should have informed it of the pre-existing rebate/set-off contractual arrangements, and sought to avoid the set-off defence.

The appeal was dismissed. The Court of Appeal reiterated the following legal and practical points, of which all those involved in debt purchase should be aware.

Points to note

  • The correct test for equitable set-off is whether there is a cross-claim so closely connected with the claimant’s demands that it would be manifestly unjust to allow him to enforce payment of the debt without taking into account the cross-claim. (That test was met in this case.)
  • Where there is a right of set-off, that cannot be avoided except by agreement with the beneficiary of that right. (In this case it was certainly not possible for Bibby to unilaterally attempt to prevent set-off post debt-purchase by the statement contained in its letter to the Customers.)
  • There is ordinarily no duty on a company whose debt has been purchased to inform the purchaser of any pre-existing contractual arrangements.
  • Purchasers should review contractual arrangements; contract on terms which require the assignor to provide information about relevant pre-existing contractual arrangements; and/or should ask for such information from assignors and debtors.
  • The existence of a right of set-off does not constitute a ‘dispute’ which should necessarily be disclosed in answer to standard due diligence enquiries as to disputed debts.
  • An assignor cannot transfer to any purchaser greater rights than he himself already possess.

Whilst due diligence is a recognised process during the purchase of debt, this decision is a stark reminder to purchasers to ensure that they ask the right questions and carry out the appropriate levels of due diligence before signing on the dotted line.