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The third-party effects of cross-border assignments of claims – Draft EU Regulation aiming to achieve legal certainty

Proposal of the EC of a Regulation on the law applicable to the third

The third-party effects of cross-border assignments of claims – Draft EU Regulation aiming to achieve legal certainty

19.03.2018

On 12 March 2018, the European Commission (EC) published proposals on covered bonds, cross-border distribution of investment funds and cross-border transactions in claims and securities. The proposals are linked to the 2015 Action Plan on Capital Markets Union (CMU) and the European Commission's Mid-term Review that was published in June 2017.

The objective of the CMU is to remove barriers to cross border investments and to lower the costs of funding. The EC has stated that the completion of the CMU is an urgent priority and it has expressed its commitment to put in place all building blocks of the CMU by mid-2019. 

With respect to cross- border transactions in claims, the proposal of the EC consists of a draft Regulation on the law applicable to the third-party effects of an assignment of claims (1) (the Regulation). It aims to reduce existing legal uncertainty through the adoption of EU wide, uniform conflict of laws rules, i.e. by providing EU wide uniform answers to the question which country's law applies to the third-party effects of assignments of claims in cross-border transactions. According to the EC, enhancing legal certainty will result in promotion of cross-border investment, access to cheaper credit and market integration.

Background

The Regulation defines the term "assignment" as 'a voluntary transfer of a right to claim a debt against a debtor'. The term includes outright transfers of claims, contractual subrogation, transfers of claims by way of security and pledges or other security rights over claims.

Assignment of claims or granting security over claims is often used by companies to obtain liquidity and have access to financing, such as factoring, secured loans or securitisation. Banks and companies more generally also use the assignment of claims to optimise the use of their capital (in other words, 'freeing up capital'), in particular by means of “true sale” securitisation transactions.

At the moment, the law applicable to the contractual relationship between the assignor (the original creditor) and assignee (the creditor of the claim after the assignment) as well as the effects of the assignment on the relationship between the assignee and the debtor is already determined in a uniform way by the Rome I Regulation: the national law that governs the assigned claim. (2)

However, no conflict of laws rules have to date been adopted at a EU level on the law that should govern the third-party effects of assignment of or security over claims. The third-party effects relate to who has ownership rights over a claim, especially to: (i) which requirements must be fulfilled by the assignee to ensure that he acquires legal title over the claim as a consequence the assignment; and (ii) how to resolve priority conflicts between the assignee and third parties, e.g. (a) in case  a claim has been assigned twice (whether by accident or on purpose); or (b) when facing the assignor’s creditors in case of insolvency of the assignor.

Currently these issues must be resolved by national conflict of law rules on third-party effects of assignment of claims at a Member State level. The Member States have conflict rules that diverge substantially: e.g. the law governing the assigned/pledged claim, the law governing the assignment/pledge contract or the law of the habitual residence of the assignor/pledgor. The inconsistency in these rules often results in uncertainty as to which law parties need to comply with to achieve the desired third-party effects of the assignment. Courts in different Member States may thus arrive at different results as to the law that is to be applied and possibly thereby apply different and potentially conflicting formal requirements to recognise third-party effectiveness. The impact of the uncertainty and the risk of unhelpful outcomes in potential litigation or insolvency proceedings is further enhanced by the diversity of transactions and situations where an assignment of claims is used. In practice assignments can be effected by way of sale or for collateralisation, can apply to one or a limited number of related claims or to a large portfolio (e.g. securitisation or intra-group factoring) and may involve a wide range of different types of claims (invoices, loan receivables, bank account receivables, claims arising from financial instruments or securities, future claims). In many cases three jurisdictions may be involved, i.e. where each of the assignor, the assignee and the debtor of the claim are resident in different jurisdictions (not necessarily all Member-States). Many more jurisdictions may be involved if multiple claims are assigned with debtors resident in different jurisdictions. Finally, for many larger or regulated financial transactions where the assignment of claims is a key feature (e.g. multi-jurisdictional trade receivables purchase programmes, securitisation, capital relief transactions) formal legal opinions are often required to confirm the third party effects of the assignments.

The Regulation wants to reduce this type of uncertainty and complexity through the adoption of EU wide, uniform conflict of laws rules on the third-party effects of assignment of claims. Below, we will discuss the most important provisions of the Regulation.

Article 1 – Scope

Article 1 (1) stipulates that the Regulation applies, in situations involving a conflict of laws, to the third-party effects of assignments of claims in civil and commercial matters. It takes into account the scope of the Rome I Regulation. Article 1 (2) excludes certain assignments from the scope of the Regulation, to a great extent similar to the obligations excluded from the scope of the Rome I Regulation.

Article 2 – Definitions

The Regulation defines the term "claim" as 'the right to claim a debt of whatever nature, whether monetary or non-monetary, and whether resulting from a contractual or a non-contractual obligation'. According to the EC, the definition is a codification of the general understanding of what a claim is under the Rome I Regulation.

The Regulation extends to 'traditional claims' (i.e. arising from a contractual relationship), 'financial claims' (i.e. arising from derivative contracts), and 'cash credited to a credit institution' (i.e. cash standing to bank accounts). It does not cover the transfer or novation of contracts (whereby both the rights and the obligations under a contract are transferred) nor the trading in financial instruments and the clearing and settlement of these instruments.

The Regulation defines the term 'habitual residence" for companies and other bodies, corporate or unincorporated as 'the place of central administration; for an individual acting in the course of his business activity, his principal place of business'. The explanatory memorandum to the Regulation mentions that this definition is line with and will generally coincide with the concept of the 'centre of main interest' (COMI) used in the Insolvency Regulation. (3)

Article 3 – Universal application

The Regulation has universal application, meaning that the national law designated as the applicable law can be either the laws of a Member State or those of a third country. More generally, it will apply where the assignment is connected with one or more jurisdictions that are not Member States.

Article 4 – Applicable law

The general rule is set out in article 4 (1): the law that governs the third-party effects of assignments of claims is the law of the country where the assignor has its habitual residence at the relevant time. Article 4 (1) also addresses the issue of 'conflit mobile', by stipulating that in case of a change in habitual residence between two assignments of the same claim, the relevant time will be the moment on which the first of the two assignments becomes effective.

Conflicts regarding priority between assignees/pledgees and third parties (in particular creditors of the assignor/pledgor) will typically arise in an insolvency of the assignor/pledgor.

Article 4 (2) provides for three exceptions: (i) for claims arising from financial instruments (4), the law of the assigned claim; (ii) for cash credited to an account in a credit institution, the law of the assigned claim; and (iii) for securitisations (5), an option to choose the law of the assigned claim instead of the law of the habitual assignor’s residence. The motivation for each of these exceptions is summarily set out in the explanatory memorandum. The reason given for cash credited to a bank account, is that in today's market practice it is generally assumed that the claim is governed by the law of the country where the credit institution is based. For financial claims arising from financial instruments, it is assumed that the governing law should be the same as the law governing the underlying contract, because having a uniform governing law for all aspects of such complex contracts, is deemed necessary to preserve the stability and functioning of the financial markets.

Article 5 – Scope of the applicable law

The Regulation determines the term "third-party effects" as 'proprietary effects, that is, the right of the assignee to assert his legal title over a claim assigned to him towards other assignees or beneficiaries of the same or functionally equivalent claim, creditors of the assignor and other third parties'.

Article 5 of the Regulation further sets out the scope of the "third-party effects" in an non-exhaustive list. The two main topics in order to determine whether the assignee has acquired title are (i) the effectiveness against third parties other than the debtor (in particular which formalities might be required to achieve effectiveness) and (ii) priority issues, including priority between an assignee and another beneficiary of the same claim, also where the claim was subject to a novation or transfer of contract.

Article 6 and 7 – Overriding mandatory provisions and public policy

The Regulation provides for an exception for overriding mandatory provisions of law and a public policy exception, similar to the ones found in the Rome I Regulation.

Observations

Habitual residence vs. COMI

The general rule as set out in the Regulation is that the law of the country where the assignor has its habitual residence governs the third-party effects of assignments of claims. By choosing the habitual residence as the relevant factor for its conflict of laws rule, the Regulation seeks consistency with the approach taken in the Insolvency Regulation (COMI) and by doing so in addition could achieve further alignment of EU legislation. This alignment would facilitate the predictability of the outcome of assignment transactions and the resolution of cross border insolvencies. However, the definitions are not fully aligned. In addition, the presumption that the habitual residence of a corporate debtor is that of its registered office – as is the case for determining the COMI – is not included in the Regulation. This will potentially lead to conflicts in the future where a person's habitual residence differs from its COMI.

Syndication

With respect to syndication, the proposal notes that if a lender assigns its participation in a loan made to a borrower, the third-party effects of an assignment by a lender of his share will be governed by the lenders' habitual residence. Consequently, if lenders in a syndicate have different habitual residences, various laws could apply to the assignment of participations of the syndicated loan. Whilst trades in the secondary market are often done by way of novation or transfer of contracts, a transfer by way of assignment is also frequently used. The Regulation could therefore have an effect on the trading in syndicated loans on the secondary market as market participants may have to deal with various governing laws, depending on the habitual residence of the relevant lender. It would perhaps have been appropriate to include an exemption for syndicated loans, similar to the exemption made under the Regulation with respect to securitisation transactions.

Bank accounts

The Regulation includes an exemption for assignment of bank account claims  by providing that the law applicable to the assigned claim shall govern the third-party effects of an assignment. In practice this means the governing law of the bank account agreement between the bank and its customer. Where for this special type of claim this solution is certainly to be preferred over the choice for the habitual residence, it would have been better and more logical to align this exception with article 4 (4) of the EAPO Regulation (6) by making the third-party effects of such assignment subject to the law of the Member State in which the bank account is maintained and which in most cases can simply be determined by the IBAN of the relevant account pursuant to the EAPO Regulation. This would also constitute an important alignment of EU law for dealing with conflicts between different proprietary entitlements (assignments, security interests, freezing orders, trusts) in relation to bank accounts.

Financial instruments

The particular nature of financial instruments and their role in financial markets does seem to warrant particular treatment. However, for such instruments there is a strong market practice to select English or New York law as their governing law. The new conflict of laws rule will thus risk to impose additional costs on EU assignors outside the UK (or NY) to make sure their assignments comply with these foreign systems of law (including adequate English or NY law advice and legal opinions).

Overriding mandatory provisions

The Regulation aims to harmonise the conflict of laws rules, in particular the requirements to ensure the effectiveness of the assignment/pledge such as registration or publication requirements. However, in the explanatory notes on article 6, the registration of the assignment in a public register is mentioned as an example of overriding mandatory principles. This leads to uncertainty as based on this provision, there may still be additional requirements in other jurisdictions other than the jurisdiction where the assignor/pledgor has its habitual residence. It would have been helpful if the Regulation would have explicitly excluded registration or publication requirements in other jurisdictions (7). The aim of creating legal certainty is therefore not sufficiently achieved.

Dutch/Belgian observations

From a Dutch law perspective, the coming into effect of the Regulation would mean a departure of its current conflict of laws rules based on the law governing the assignment contract. The choice for the habitual residence is consistent with the current Belgian conflict of laws rule, which has since its introduction in 2004 received a lot of praise, in particular in view of the fact that Belgium has a very open economy (many debtors abroad and many different laws governing claims).

Conclusion

The harmonisation of conflict of laws rules adopted at a EU level on the law applicable to the third-party effects of assignment of claims is desirable and required in order to increase legal certainty and reduce costs for cross-border financing .

Assignments of or security over claims by their nature involve tri-lateral relationships (assignor/pledgor, assignee/pledgee, debtor) and often even more jurisdictions due to different debtors being resident in different jurisdictions. Finding conflict rules that always satisfy the different (private or national) interests is clearly impossible, although the Regulation has important merits. One must wonder whether it would not be a more effective approach not to focus on conflict of laws, but to follow the highly successful example of the full harmonisation approach of the EU financial collateral directive. (8)


[1] Proposal for a Regulation of the European Parliament and of the Council on the law applicable to the third-party effects of assignments of claims (COM/2018/096 final - 2018/044 (COD)).

[2] Regulation (EC) No 593/2008 of the European Parliament and of the Council of 17 June 2008 on the law applicable to contractual obligations (Rome I Regulation), in particular article 14.

[3] Regulation (EU) 2015/848 of the European Parliament and of the Council of 20 May 2015 on insolvency proceedings (recast) (Insolvency Regulation).  

[4] As such term is defined in Section C, Annex I of the Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU, OJ L 173, 12.6.2014, p. 349–496, i.e. including derivatives and securities traded on financial markets.

[5] Unfortunately the term “securitisation” is not defined in the Regulation, whereas a number of definitions are used in other EU (financial) legislation.

[6] Regulation (EU) No 655/2014 of the European Parliament and of the council of 15 May 2014 establishing a European Account Preservation Order procedure to facilitate cross-border debt recovery in civil and commercial matters (EAPO Regulation).

[7] Article 6 could e.g. result in mandatory rules of the forum of the jurisdiction of the debtor being applied, also for assignments where a large number of debtors in a large number of jurisdictions would be involved.

[8] Directive 2002/47/EC of the European Parliament and of the Council of 6 June 2002 on financial collateral arrangements.

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