Proposed EU assignment law regulation and its impact on receivables financing transactions

Introduction 

Using receivables, such as claims resulting from the supply of goods and services, as a source of funding is a popular way of working capital financing. Receivables can be sold as part of a factoring, securitisation or similar transaction, or can be pledged or assigned as security for obligations under loan facilities or other forms of debt financing.

If the transaction relating to the receivables has an international character, for example the debtors of the receivable are located in different countries, the receivables are governed by foreign law or the purchaser or pledgee of the receivables is located abroad, then it may be necessary to determine what law applies to the various elements of which an assignment or pledge is composed. For example, (i) what should be the governing law of the agreement to assign or pledge the receivables, (ii) what laws applies to the assignment or pledge itself in order to ensure that the receivable is actually transferred or pledged and that such transfer or pledge is effective against the assignor or pledgor and its creditors (i.e., the proprietary (in rem) effect of the assignment or pledge), and (iii) what law determines what needs to be done in order to make the assignment or pledge effective against the receivable's debtor. 

Rome 1 Regulation 

Within the European Union, the first and the third question are addressed in the so-called Rome 1 Regulation  With regard to the first question, the Rome 1 Regulation provides that the governing law of a contract for an assignment with an international character must be determined in accordance with the rules of the Rome 1 Regulation that apply to contracts. This means that the parties are free to choose such governing law. In relation to the third question, what law determines what needs to be done in order to make the assignment effective against the receivable's debtor, the Rome 1 Regulation provides that this is the law governing the relevant receivable. 

It was for a long time unclear whether the Rome 1 Regulation (and its predecessor, the Rome Convention on the law applicable to contractual obligations) also covered the second question, i.e., what law applies to the assignment itself. The laws of some member states provide, and numerous legal scholars have argued, that that this question should be answered in the same way as the first question, and that the Rome 1 Regulation did not intend to differ between the law that governed the agreement obliging the parties to assign a receivable, and the law that applies to the assignment itself. Since the parties are free to choose the governing law of the assignment agreement, it could therefore also choose the law applying to the assignment. 

This implies that, where the receivables transaction has an international character, the parties can choose the governing law of the assignment. By making such choice they can avoid cumbersome assignment formalities that apply for example pursuant to the governing law of the receivables. For example, under Dutch law it is a requirement that the instrument effecting an undisclosed assignment is included in a notarial deed or is registered with the Dutch tax authorities. By making the assignment of these Dutch law receivables subject to English law, the assignment formalities are those that apply under English law (which are much easier to comply with), so that the complicated Dutch law formalities can be avoided.

However, the view of other scholars is that the Rome 1 Convention does not deal with the assignment itself and that therefore the question what laws should govern an assignment should be determined in accordance with each member state's private international laws. This created uncertainty as to what law applies to an assignment of receivables. The laws of a considerable number of member states accepted that the parties are free to choose the governing law of the assignment. However, there are various exceptions. For example, the leading German law position is that the assignment has to be effected under the laws that apply to the receivables themselves. The position under Belgian law is that the assignment is subject to the laws of the country in which the assignor is located.

Proposed EU Assignment Law Regulation 

Although it can be argued that the financial community was able to live with these differences and did find practical solutions to deal with them, the European Commission nonetheless considered it necessary to regulate this matter. It intends to do so by way of the proposed Regulation of the European Parliament and of the Council on the law applicable to the third-party effects of assignments of claims (the "Assignment Regulation"). The latest text version of this proposal dates from 28 May 2021. As it did with the Rome 1 regulation, the European Commission has decided to regulate this matter by way of a regulation, which has direct effect in the member states. This means that it automatically overrides the laws of member states that have different rules from those set out in the Assignment Regulation. Because of the special status of these countries, the Assignment Regulation will not apply in Denmark and Ireland.

The Assignment Regulation can be considered as a supplement to the Rome 1 Convention and the scope of the type of contracts and other legal arrangements to which it applies are intended to be broadly similar. It removes the ability of parties to an assignment to choose the governing law of the assignment of a claim. Its basic rule is that an assignment of a claim should be governed by the law of the country in which the assignor of the claim is habitually resident. However, for certain types of claims, the assignment should be governed by the laws applying to the claims. The rules also provide that in respect of particular transaction the parties can choose to effect the assignment under the laws of the country in which the assignor of the claim is habitually resident or the laws that apply to the relevant claim.

Unfortunately, the current draft of the Assignment Regulation (the text of which is however not expected to be amended in any material way) could potentially create quite a bit of confusion in practice, for example, due to the various exceptions that apply to its scope and the application of two different rules, depending on the nature of the claims involved. 
Scope. 

The Assignment Regulation applies in situations involving a conflict of laws, to the third-party effects of voluntary assignments of claims in civil and commercial matters. This means that the courts in all concerned member states should apply the rules set out in the Assignment Regulation if they are asked to consider a question regarding an assignment of claims that involves more than one jurisdiction. The Assignment Regulation therefore not only applies to claims that are governed by the laws of one of the member states, but also to claims that are governed by laws of other states. Equally, the courts of the EU member states will also need to apply the rules if it concerns a claim that is governed by the laws of a member state, but the assignor and/or assignee of the claim are located outside the EU. However, the Assignment Regulation does not apply to arrangements whereby the rights as well as the obligations under a contract are being transferred (including by way of novation).

Analysis

Below we will set out how the new rules could affect cross-border receivables transactions that involve parties located in member states of the European Union (other than Denmark and Ireland). A first point to note is that according to the Assignment Regulation, it will no longer possible for the assignor and assignee to choose the governing law of the assignment. Therefore, choosing a law with less complicated assignment formalities, or applying a single law applying to the assignment for receivables that include assignors in various jurisdictions or receivables with different applicable laws will no longer de possible.

As mentioned above, there are various categories of claims to which the Assignment Regulation does not apply. Although most of these exceptions are less relevant in the context of receivables resulting from the supply of goods or services, the excluded claims include those resulting from revenue, customs or administrative matters, crypto-assets, claims under bills of exchange, cheques and promissory notes and other negotiable instruments and claims incorporated in a certificate or represented by a book-entry.

General Rule 

As a general rule, the assignment of receivables to which the Assignment Regulation applies must be governed by the laws of the country in which the assignor has its habitual residence at the time of the conclusion of the assignment contract. This rule also applies if the assignor's habitual residence is not located in the EU. For example, if the assignor's habitual residence is located in South Africa, then the assignment of claims should be governed by South African law, even if the governing law of the claims is Dutch law and the assignee and the debtor under the claim are located in The Netherlands.

Alternative Rule 

An alternative rule applies to certain categories of claims. Pursuant to this rule, the assignment should be governed by law applicable to the assigned claim. Categories of claims to which this alternative rule applies are, amongst others, claims arising out of financial contracts, such as commodities sale and purchase agreements, and loan agreements. 

In the context of a trade receivables transaction, claims often originate from commodities contracts. Although trade and service-related claims are in general unlikely to be considered as loans, there are situations where a supplier or service provider extends credit to a customer and reflects this as a loan. As a result, the assignment of claims resulting from the commodities contract or the loan will need to be governed by the law of the commodities contract or the loan (as the case may be). 

Securitisations and covered bonds

The Assignment Regulation provides that for particular transactions, the parties can choose between the general rule and the alternative rule. This is the case for transactions that qualify as securitisations and covered bonds under applicable EU regulations. These options are therefore only available for transactions that actually meet these regulatory criteria and not for transactions that are akin to them. For example, a structure whereby an SPV purchases claims and receives senior and subordinated funding, is likely to be considered as a securitisation, because it involves debt-tranching, and can therefore benefit from the special regime. A similar structure where the funding to the SPV would be provided on a pari passu basis, would not qualify, since it is not considered as a securitisation under applicable EU regulations. The assignment of claims in the latter transactions would therefore need to be effected in accordance with the general rule or, if the claim results from a commodities contract or a loan, the alternative rule.

Security Rights 

The Assignment Regulation will, like the Rome 1 Regulation, also apply to the creation of security rights in receivables, such as pledges and security assignments. The same rules that apply to assignment also apply to the creation of such security rights. 

Implementation and Application

The drafting discussions regarding the Assignment Regulation have already been going on for quite a while, with different rules having been proposed. However, given the current advanced stage of the proposal, it is unlikely that there will be material amendments to the rules set out in the Assignment Regulation. It is also expected that the Assignment Regulation will be adopted in the course of 2022. It will then become effective 20 days after its publication in the EU's Official Journal and start to apply 24 months after its coming into force. It shall then apply to assignments that have been concluded after the first day of its application. It is likely that it shall apply from that date also to assignments that are made under master or framework agreements that have been concluded prior to the application date, since the reference is to the assignment itself rather than the agreement pursuant to which such assignment is made.

Impact on transactions

The Assignment Regulation will have a considerable impact on cross-border receivables financing transactions. Firstly, most transactions are being structured on the basis that the assignment is effected either under the chosen law by the parties or in accordance with the law applying to the receivables. However, the general rule will now be that the law of the habitual residence of the assignor must apply to the assignment. This is therefore quite different from current market practice. Furthermore, the current private international law rules of member states do not distinguish between receivables resulting from loans or commodities contracts and those resulting from other contracts when determining the law that should apply to the assignment. 

Another complication is that under the Rome 1 Regulation, the law applying to the claim determines what needs to be done to make the assignment effective against the receivable's debtor. When according the to Assignment Regulation, the assignment needs to be effected in accordance with the general rule (i.e., laws of the country in which the assignor has its habitual residence at the time of the conclusion of the assignment contract), it will still be necessary to apply with the law applying to the receivable itself to make the assignment effective against the receivable's debtor.

Furthermore, the rules under the Assignment Regulation could result in a situation that receivables that qualify as claims under loans and commodities contracts need to be assigned in accordance with the laws applying to such claims, and other receivables under the laws applying in the habitual residence of the assignor. This is not really helpful from a cost and transaction management perspective if a transaction includes both types of receivables. 

If the Assignment Regulation's drafters considered it undesirable that parties to a transaction have the freedom to choose the law applicable to an assignment, it would from a practical point of view have been better if they would have made it possible to opt for the general rule or the alternative rule in all transactions rather than limiting this option to securitisations and covered bonds only.

Although the Assignment Regulation will probably only become applicable in 2024, parties may wish to take the rules into account when structuring receivables financing transactions that are intended to have a lifespan (at least as far as the structure and legal documentation is concerned) beyond 2023. Where possible, the parties could anticipate the new rules by already applying them to their transaction (in particular where they can currently choose the governing law of the assignment), so that there is no need to amend and restructure the transaction to make it compliant with the Assignment Regulation before it starts to apply.