NPLs in the UK and the Means of Transfer

The evolving landscape or Non-Performing Loans (“NPLs”) in the UK

The introduction of Directive (EU) 2021/2167 on credit servicers and credit purchasers (the “NPL Directive”) ignited a swathe of developments related to the NPL market in the EU as Member States seek to transpose the NPL Directive into domestic legislation. The NPL Directive has no direct effect in the UK by virtue of Brexit, however it does affect our clients in cross-border transactions or those involving EU-originated debts.

Whilst data suggests that the UK’s NPL market is still in a period of cautious stability, recent trends suggest a subtle but significant shift in the volume and character of NPLs available for trading in the UK market. In particular, there was an 18% increase in the value of UK NPLs in the quarter to December 2024 (up from 16% in the quarter to September 2024), which is the fastest rate of increase since March 2021 and there is a further expected increase of approximately 21% to be reported in the quarter to March 2025. Macroeconomic factors such as rising inflation and higher interest rates as well as sector-specific vulnerabilities (notably in the commercial real estate sector) are expected to continue to drive an increase in NPL volumes.

In light of the evolving landscape of the NPL sector and the expected increase in activity in the UK, it is worth a reminder as to the primary means by which debts may be transferred under English law. The means of debt transfer is often a key focus for our clients as certain transfer mechanics are preferable when trading NPLs or in any other form of secondary debt trading.  

Means of transfer under English law

The primary options for transferring debt are by way of novation, assignment and sub-participation. We also discuss securitisation at a high level below.  

Novation

A novation involves a form of three-way agreement in which a new contract is substituted for an old one on the same terms with the effect of extinguishing the rights and obligations that were in effect under the original contract and replacing them with new rights and obligations.

The key characteristics of a novation are:

• Both a party’s rights and obligations are transferred under a contract to a third party. In the case of a novation of a loan agreement between lending entities, the borrower remains the same and although there is a new contract, the new lender’s rights and obligations will replicate, on the whole, those of the existing lender (subject to any specific changes agreed).
• All parties to the original contract (e.g. the existing lender and the borrower) and the transferee are required to consent to the novation for it to be valid.
• Usually documented by way of a transfer certificate or novation agreement.

Assignment

An assignment involves the transfer of rights under a contract from one party (e.g. an existing lender) to another (e.g. a new lender).

The key characteristics of an assignment are:

• The burden of (or the obligations under) a contract is not transferred, although, in practice, the parties seek to deal with this by agreeing that the assignee ‘assumes’ the obligations of the assignor (and regardless, in the context of a loan, a lender’s obligations are often relatively limited after it has advanced its commitments to the borrower).
• Consent of any other parties to the relevant contract is not required as a matter of law (i.e. the borrower), with notice only being given after the fact to perfect a legal assignment (see below). We note, however, that a contract can, and often will, provide that an assignment requires the consent of the other parties.
• Will not be legally perfected (i.e. it will be equitable only) until such time as notice is given in writing to the other original contracting parties (i.e. the borrower).
• Usually documented by way of an assignment agreement.

Novation or Assignment?

There are a number of points to consider when determining whether to transfer debt by way of novation or assignment:

• Does the lender have outstanding obligations in the loan agreement? If yes, consider novation if the incoming lender is to take on all rights and obligations. This may also be achievable by way of an assignment with a corresponding assumption of liabilities.
• What effect does a novation have on the security structure in different jurisdictions and on priority and hardening periods? As novation extinguishes the original loan agreement and replaces it with a new contract, this may pose issues for the existing security rendering it ineffective, or inadvertently released, or may cause hardening periods to re-start given the security is effectively re-granted. This may not be an issue if there is a security trust structure in place.
• Is assignment and/or novation expressly permitted under the terms of the loan agreement? The terms of the loan agreement may prescribe which route to choose.
• Is borrower consent required for assignment to be effective? Check the terms of the loan agreement.

In the NPL market, we typically see assignment as the default transfer option in the UK, for both bilateral and syndicated facilities.

Funded sub-participation

A sub-participation transfers the economic interest in a loan from the “grantor” to the “participant” without changing the legal relationship between grantor (who remains the lender of record) and borrower. It is often used where, for example, a novation/assignment is not possible or not permitted under existing contractual terms but where the existing lender wishes to decrease its exposure to the borrower or where the incoming lender has regulatory or internal restrictions such that it would prefer to avoid direct exposure to a particular jurisdiction or borrower.

The key characteristics of a funded sub-participation are:

• It does not involve the transfer or assignment of rights or obligations to the incoming participant, who will have no proprietary interest in the original underlying transaction between the existing parties.
• A creditor and debtor relationship is created between the existing lender and incoming lender, with the incoming lender entitled to receive amounts from the existing lender equal to the amount received by it under the loan(s).
• It does not create any relationship between the participant and the borrower. In many cases, the borrower will not even be aware of the participant’s existence.
• The participant takes a double credit risk, in respect of both the borrower and the existing lender; the participant's return is conditional on the borrower complying with its payment obligations under the loan agreement and on the existing lender complying with its payment obligations under the sub-participation agreement.
• The participant will expect significant/full control and voting rights in respect of the loan, given it is now the party holding the economic risk/with “skin in the game”.

Securitisation

Whilst not strictly a form of legal transfer, there has been a remarkable rise in NPL securitisations in the last decade, driving a rise in regulation of this market too. The aim of a NPL securitisation is the same. i.e. to remove non-performing assets from balance sheet, but this is done by way of issuing securities backed by the loans to one or more third-party investors.

Usually, an outright sale is preferable given its simplicity, but securitisations can open up a new pool of investors who, for example, cannot hold NPLs directly.

Which method of transfer or securitisation is chosen will depend on the context, factual circumstances and, in some cases, transferability restrictions in facility agreements.

We are well versed in all of the different transfer methods and mechanics mentioned above, so please do reach out to the authors of this article if you would like to discuss further.