assignment of receivables governing law

• France (FR)
• Germany (DE)
• Netherlands

United Kingdom

• United States

The Business Contract Terms (Assignment of Receivables) Regulations 2018: still more to do?

The Business Contract Terms (Assignment of Receivables) Regulations 2018 (the " Regulations ") are now in force. The Regulations are intended to make it easier for small businesses to access receivables-based finance by making ineffective any prohibitions, conditions and restrictions on the assignment of receivables [1] arising under contracts for the supply of goods, services or intangible assets.

The Regulations have a somewhat chequered history. The Law Commission advocated legislation to limit the effectiveness of anti-assignment clauses in 2005, however, the proposal failed to gain momentum and lay dormant for more than a decade. Draft legislation finally appeared in 2017, but was withdrawn following criticism by the Loan Market Association and others. The final form of the Regulations addresses some of the criticisms, but adds complexity in what is already a complex area of the law.

The Effect of the Regulations

A term in a contract to which the Regulations apply is ineffective to the extent that it prohibits or imposes a condition or other restriction on the assignment of a receivable arising under that contract or another contract between the same parties. That does not necessarily mean that the term will be entirely void as a result: contractual prohibitions on assignment often do not distinguish between the right to performance of the contract and the right to be paid amounts arising under it. Prohibitions of this type will remain effective to prevent an assignment of the right to performance, even if they are ineffective to prevent the assignment of receivables arising under the contract.

The Regulations provide that a term which prevents an assignee from determining the validity or the value of the receivable or restricts its ability to enforce the receivable will be deemed to be a condition or other restriction on assignment. This, for example, includes provisions which prevent an assignee from obtaining particulars and evidence of any potential defence or set-off by a party to the contract. Therefore, the Regulations permit disclosure of matters which might otherwise be caught by confidentiality provisions in the underlying contract.

When do the Regulations apply?

Subject to specified exceptions, the Regulations apply to any contract entered into on or after 31 December 2018.

Certain types of contract are excluded from the Regulations. For example, the Regulations do not apply :

• to contracts for certain prescribed financial services or to other specific types of contract, including those in relation to real estate, certain derivatives, certain project finance and energy agreements and operating leases.
• to contracts entered into in connection with the acquisition, disposal or transfer of an ownership interest in all or part of a business, firm or undertaking, provided the relevant contract includes a statement to that effect. The need for such a statement applies even where the purpose of the contract is obvious on its face.
• where one or more of the parties is a consumer, or where none of the parties has entered into the contract in the course of carrying on a business in the UK.

The Regulations do not apply if the supplier is a "large enterprise" or a "special purpose vehicle" (the " SME Test ") at the time of the assignment. For this purpose, a special purpose vehicle is a firm that carries out a primary purpose in relation to the holding of assets (except trading stock) or financing commercial transactions, which in either case involves it incurring a liability of £10m or more.

The question of whether a limited company is a "large enterprise" depends in part on turnover, balance sheet total and number of employees assessed by reference the most recent annual accounts filed by the company or its parent prior to the assignment. Therefore, at the time the supplier and the debtor enter into a contract, they will not necessarily know whether a contractual prohibition on the assignment of receivables will be effective.

The definition of a "large enterprise" may be difficult to apply in some circumstances and to some entities. For example, the Regulations imply that limited partnerships are included in scope and some commentators argue that in this situation it would be the general partner entity which would be assessed under the SME Test, however, this is not expressly provided for by the Regulations.

If another governing law is imposed by a party wholly or mainly for the purpose of enabling it to evade the operation of the Regulations, the Regulations state that they will nevertheless have effect. Aside from the practical difficulty in determining whether the choice of law was imposed for this purpose, the effect of this provision is not entirely clear. Under Rome I, the law governing an assigned claim determines its assignability and the relationship between the assignee and the debtor [2] . Therefore, the fundamental question of whether the debtor should pay the supplier or the assignee remains determined by the governing law of the contract, but subject it seems (at least as far as the English courts are concerned) to the mandatory provisions of the Regulations.

The Regulations only affect prohibitions, restrictions and conditions on assignment contained in the contract under which the receivable arises or another contract between the same parties. For example, they would not restrict the effectiveness of a negative pledge or a restriction on the disposal of receivables contained in a financing document with a third party lender.

The term "assignment" is not defined in the Regulations and, assuming it has its normal legal meaning, does not include the creation of a charge or trust. Therefore, it appears that the Regulations do not apply to the creation of a charge or a trust.

What if the Regulations do not apply?

As a result of the SME Test and the exclusion of certain types of contracts, there will be many situations in which the Regulations are not relevant to the assignment of a receivable. Where the Regulations do not apply, the current law recognises the effectiveness of contractual prohibitions on the assignment of receivables [3] . However, case law suggests that a prohibition on assignment will not normally be construed as preventing the creation of a trust. Receivables purchase agreements will therefore often provide for the supplier to hold the receivable and/or its proceeds on trust for the assignee to the extent that the assignment is ineffective. In response, some debtors include specific prohibitions on the creation of trusts over receivables in their contracts. However, assignees will try to circumvent the practical effect of even the most widely drafted prohibition by taking a power of attorney enabling them to bring an action against the debtor in the name of the supplier.

The law is still developing in response to this escalating arms race between assignees and debtors. In part this is due to an inevitable tension between the interest of the assignee in having its proprietary interest in the receivable recognised and the interest of the debtor in choosing whether it deals with anyone other than its original contractual counterparty.

This has led some to argue that the common law should recognise all assignments of receivables notwithstanding prohibitions on assignment, at least as between the assignor and the assignee. [4] Arguably, this approach would balance the legitimate interests of all parties.

Still more to do?

Where they apply, the Regulations will make it easier for SMEs to assign their receivables and to raise finance. However, the Regulations do not mean that assignees can ignore the terms of the underlying contractual arrangements between suppliers and debtors; for one thing any existing rights of set-off will continue to bind the assignee [5] . Also, because the Regulations do not apply to contracts entered into before 31 December 2018, prohibitions on assignment will continue to apply to many receivables owed to SME suppliers for a while yet.

Assessing whether a supplier is an SME involves reviewing the most recent relevant annual accounts and the status of the supplier in this respect may change throughout the term of a contract. There are also various types of contract to which the Regulations do not apply and, in some cases, applying those exceptions is not straightforward. The Regulations add an additional layer of complexity to the law.

In practice, the question that assignees ask their lawyers is very simple: what action can they take to recover? The Regulations may enable the answer to be more positive, but they also make it more nuanced. There is more work for legislation or precedent to do to simplify the law in this area.

[1] "Receivable" is defined in broad terms as a right (whether or not earned by performance) to be paid any amount under a contract for the supply of goods, services or intangible assets.

[2] Regulation (EC) No 593/2008: Article 14(2), Rome I

[3] Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd [1994] 1 AC 85

[4] See in particular Professor Roy Goode's article " Contractual Prohibitions Against Assignment " [2009] LMCLQ 300 cited by approval by Lady Justice Gloster in First Abu Dhabi Bank PJSC and BP Oil International Limited [2018] EWCA Civ 14

[5] In recovery situations, set-off and disputes in relation to liability are often more significant issues for the debtor from a commercial perspective than the question of whether a prohibition on assignment is legally effective.

Sign up to our email digest

• Search Menu
• Advance articles
• Author Guidelines
• Submission Site
• Open Access
• Why Publish?
• About Uniform Law Review
• About UNIDROIT
• Editorial Board
• Advertising and Corporate Services
• Journals Career Network
• Self-Archiving Policy
• Dispatch Dates
• Journals on Oxford Academic
• Books on Oxford Academic

Article Contents

• I. Introduction
• II. Hybrid nature of the assignment of receivables
• III. Relationship between the assignor and the assignee
• IV. Relationships with the debtor
• V. Effectiveness against third parties
• VI. Conclusion
• < Previous

Cross-border assignment of receivables: conflict of laws in secured transactions

• Article contents
• Figures & tables
• Supplementary Data

Yuko Nishitani, Cross-border assignment of receivables: conflict of laws in secured transactions, Uniform Law Review , Volume 22, Issue 4, December 2017, Pages 826–841, https://doi.org/10.1093/ulr/unx052

• Permissions Icon Permissions

In the era of globalization, the determination of the law applicable to cross-border assignment of receivables is becoming a crucial issue. In light of highly divergent conflicts rules among various jurisdictions, this paper explores appropriate conflicts rules, with a view to paving the way for a future harmonization. The underlying study examines, in particular, the 2001 UN Receivables Convention, the 2016 UNCITRAL Model Law on Secured Transactions and other relevant instruments including the 2008 Rome I Regulation of the EU, as well as the Japanese, the US and other domestic legal systems in a comparative perspective.

Email alerts

Citing articles via.

• Recommend to your Library

Affiliations

• Online ISSN 2050-9065
• Print ISSN 1124-3694
• Copyright © 2024 Unidroit - The International Institute for the Unification of Private Law
• About Oxford Academic
• Publish journals with us
• University press partners
• What we publish
• New features  
• Open access
• Institutional account management
• Rights and permissions
• Get help with access
• Accessibility
• Advertising
• Media enquiries
• Oxford University Press
• Oxford Languages
• University of Oxford

Oxford University Press is a department of the University of Oxford. It furthers the University's objective of excellence in research, scholarship, and education by publishing worldwide

• Copyright © 2024 Oxford University Press
• Cookie settings
• Cookie policy
• Privacy policy
• Legal notice

This Feature Is Available To Subscribers Only

Sign In or Create an Account

This PDF is available to Subscribers Only

For full access to this pdf, sign in to an existing account, or purchase an annual subscription.

Trending News

Related Practices & Jurisdictions

• Bankruptcy & Restructuring
• Litigation / Trial Practice
• Administrative & Regulatory
• European Union

The validity of an assignment of receivables cross-border depends on the law that applies to the assignment.

What might amount to a valid assignment in one jurisdiction does not mean that it is valid in another, and where there are competing claims to the receivables and competing jurisdictions, the question of which law applies - and therefore whether there has been a valid assignment - significantly affects the ability of the assignee to rely on the assignment.

This question arose in the context of a German bankruptcy where the issue was referred to the European Court of Justice (“ECJ “) for a preliminary ruling. The recent decision of the ECJ of 9 October 2019 surprised many because it went against the commonly held view that in determining jurisdictional questions Article 14 of the European Union Rome I Regulation applied.

In this blog we consider the implications of the ECJ judgment in Case C-548/18 BGL BNP Paribas SA vs. TeamBank AG Nürnberg and how this affects assignees and the priority of competing claims. We also consider the proposed EU Assignment Regulation and how that might assist in determining the question of jurisdiction in the future.

A national of Luxembourg (the “employee”) but resident of Germany was employed by a Luxembourg employer under Luxembourg law. A German bank granted a German law governed loan to the employee and the employee assigned to the German bank all its claims to receive remuneration from the Luxembourg employer.

Three months later the employee obtained another loan, this time from a Luxembourg bank and assigned the same remuneration claims as security for that second loan to the Luxembourg bank under a Luxembourg law governed assignment contract. The Luxembourg bank notified the assignment to the Luxembourg employer, the German bank did not do so.

The employee became insolvent and German insolvency proceedings were commenced.

Under German law notification of an assignment is not required to perfect the assignment, but under Luxembourg law it is. Accordingly, in this case if German law applied the assignment to the German bank would have had priority over the assignment to the Luxembourg bank but if Luxembourg law the priority position would have been reversed.

Which law therefore took precedence? The German court requested the ECJ give a preliminary ruling on the question.  Contrary to the commonly held view, the ECJ concluded that Article 14 of the Rome I Regulation did not assist and was therefore unable to provide for an answer to the question leaving the German court in a challenging situation particularly so, because the relevant rules for determining the conflict of law were actually deleted from German law in 2009.

So which law do the courts apply when determining whether there has been a valid cross-border assignment of receivables? Currently the answer depends on which country is being asked to consider the question:

(i)             It could be the law which is expressed to govern the contract from which the assigned receivable arises. This is the approach normally adopted in Germany.

(ii)            In England, the Netherlands and Spain it is in principle the law chosen by the assignor and the assignee to govern the contract under which the receivable is assigned;

(iii)           Whereas in the U.S., for example it is in principle the law of the jurisdiction in which the assignor is situated.

The position is far from clear meaning that an assignees of receivables cannot always be certain whether the assignment is valid and enforceable.

Hope for the future? -The proposed EU Assignment Regulation

Thankfully the European Union intends to introduce new legislation that will help clarify the position. The Assignment Regulation proposed in March 2018 is currently being discussed in the Council of the European Union. However it is likely to be subject to extensive negotiation before adoption.

The principles set out in Article 4 of the Assignment Regulation are that the law of the habitual residence of the assignor will apply (Article 4 (1)) unless:

the claim is cash credited to a bank account or claims arising from financial instruments, in which case the law governing the account or the financial instrument will apply (Article 4 (2)), or

there is a securitization, in which case the assignee and the assignor can chose the law applicable to the assignment (Article 4 (3)).

Once adopted (subject to a 18 month waiting period) the Assignment Regulation will be directly applicable. This means that whilst EU Member States do not need to implement it into their domestic laws the courts of the Member States are bound to apply it in respect of all assignments which are concluded on or after the date it comes into effect.

However, the Assignment Regulation will not apply in Denmark, it will only apply in Ireland if Ireland opts into the Assignment Regulation and will not apply to the UK since it is expected that the UK will no longer be a EU Member State at the time the regulation is adopted and becomes effective.

The Assignment Regulation does not allow parties to contract out of it or to agree the applicable law which shall regulate the assignment of claims.

Major impact on international trade finance

The Assignment Regulation is expressed to have Universal Application, which means that it will apply the law designated by the assignment, even if this is not the law of any Member State.

For example, if a US exporting company assigns an invoice or other claim arising from a contract governed by German law to an EU assignee, then US law will apply in determining whether the assignment was effective vis-à-vis third parties, and not German law.

Because of this rule the Assignment Regulation will have a major impact on international trade finance involving the assignment of receivables. It could also create uncertainty over which law is applicable if the relevant third country’s law does not recognize the rule contained in Article 4(1).

What is the effect of the Assignment Regulation on Bank Accounts?

Bank accounts and account pledges will continue to be governed by the law of the country where the relevant bank is situated, provided that the account mandate prescribes that the law of that country shall govern the banking relationship.

However, this will only apply to bank accounts held with banks where the head office is situated within the European Union and to branches of third country banks which are located within the European Union.

In respect of banks situated outside of the European Union Article 4 (1) applies and the relevant account security will be governed by the law of the country where the bank has its place of central administration. .

What is the effect of the Assignment Regulation on Financial Instruments?

The law that applies to Financial Instruments will be the law governing the instrument. Article 2 (i) of the Assignment Regulation defines “Financial Instrument” as the instruments specified as such in the MIFID II Directive (Section C of Annex I of Directive 2014/65/EU of 15 May 2014).

It is unclear how this will affect the German Schuldschein -Market, since Schuldscheine with a term of more than 397 days may not qualify as a Financial Instrument. This could mean that secondary trading in such Schuldscheine becomes quite complex since the assignment of the relevant Schuldscheine will not be governed by German law, but by the law of the jurisdiction where the previous holders of the Schuldscheine is situated – and this could be any number of jurisdictions

What is the effect of the Assignment Regulation on securitization?

Presently the Assignment Regulation provides that the assignor and the assignee of a receivable/claim may choose the law applicable to the assignment of the securitization. However, the European Parliament propose to delete this exemption. This is disappointing because the proposal made by the European Commission could make securitization much easier and less complex than is currently the case.

What is the position in respect of Factoring, Asset Based Lending and Invoice Discounting?

Article 4(1) will apply to all other forms of receivable finance such as factoring, asset based lending, invoice discounting or other forms of supply chain finance. Accordingly the law of the central place of administration of the assignor determines the effectiveness and perfection of the assignment vis-à-vis third parties.

In practice that rule will make the financing of portfolios of receivables (which could be subject to a multitude of jurisdictions) much easier, where they are owned by one assignor situated in one jurisdiction. In that case it will be much easier to identify the one relevant law applicable.

Conversely, it will make it more difficult to finance portfolios of those receivables where assignors are situated in various jurisdictions but the receivables themselves are governed by the same law.

How does the Assignment Regulation apply to cross-border assignments in insolvency?

The difficulty here, is that the relevant test for the purposes of Article 4(1) of the Assignment Regulation in determining the “habitual residence” of the assignor is the “ place of central administration ” whereas the test under the EU Insolvency Regulation is the “centre of main interests” (COMI) and the presumption that the COMI is the company’s registered office. There is no such assumption under the Assignment Regulation.

Applying either of those tests may result in the same answer but it cannot be excluded that the location of the assignor could be different in some circumstances, resulting in uncertainty as to which law might apply to cross-border assignments in insolvencies.

Further, unlike under the EU Insolvency Regulation where the definition of COMI requires the company to have held its centre of main interests for 3 months, the same does not apply under the Assignment Regulation. Therefore, it could make it difficult to identify the “place of central administration” if the assignor has recently changed location, and again, the ability to identify the relevant applicable law.

The principles set out in the Assignment Regulation are welcome because they provide much needed clarity on which law applies when determining the validity of an assignment of receivables cross-border. It will provide more certainty to assignees, and hopefully lead to less litigation as a consequence.

Current Legal Analysis

More from squire patton boggs (us) llp, upcoming legal education events.

Sign Up for e-NewsBulletins

• Trade Finance
• Letters of Credit
• Trade Insurance & Risk
• Shipping & Logistics
• Sustainable Trade Finance
• Incoterms® Rules 2020
• Research & Data
• Conferences
• Purchase Order Finance
• Stock Finance
• Structured Commodity Finance
• Receivables Finance
• Supply Chain Finance
• Bonds and Guarantees
• Find Finance Products
• Get Trade Finance

• Incoterms® 2020
• Letters of Credit (LCs)

Receivables Finance And The Assignment Of Receivables

Tfg legal trade finance hub, receivables finance and the assignment of receivables.

A receivable represents money that is owed to a company and is expected to be paid in the future. Receivables finance, also known as accounts receivable financing, is a form of asset-based financing where a company leverages its outstanding receivables as collateral to secure short-term loans and obtain financing.

In case of default, the lender has a right to collect associated receivables from the company’s debtors. In brief, it is the process by which a company raises cash against its own book’s debts.

The company actually receives an amount equal to a reduced value of the pledged receivables, the age of the receivables impacting the amount of financing received. The company can get up to 90% of the amount of its receivables advanced.

This form of financing assists companies in unlocking funds that would otherwise remain tied up in accounts receivable, providing them with access to capital that is not immediately realised from outstanding debts.

FIG. 1: Accounts receivable financing operates by leveraging a company’s receivables to obtain financing.  Source: https://fhcadvisory.com/images/account-receivable-financing.jpg

Restrictions on the assignment of receivables – New legislation

Invoice  discounting  products under which a company assigns its receivables have been used by small and medium enterprises (SMEs) to raise capital. However, such products depend on the related receivables to be assignable at first.

Businesses have faced provisions that ban or restrict the assignment of receivables in commercial contracts by imposing a condition or other restrictions, which prevents them from being able to use their receivables to raise funds.

In 2015, the UK Government enacted the Small Business, Enterprise and Employment Act (SBEEA) by which raising finance on receivables is facilitated. Pursuant to this Act, regulations can be made to invalidate restrictions on the assignment of receivables in certain types of contract.

In other words, in certain circumstances, clauses which prevent assignment of a receivable in a contract between businesses is unenforceable. Especially, in its section 1(1), the Act provides that the authorised authority can, by regulations “make provision for the purpose of securing that any non-assignment of receivables term of a relevant contract:

• has no effect;
• has no effect in relation to persons of a prescribed description;
• has effect in relation to persons of a prescribed description only for such purposes as may be prescribed.”

The underlying aim is to enable SMEs to use their receivables as financing to raise capital, through the possibility of assigning such receivables to another entity.

The aforementioned regulations, which allow invalidations of such restrictions on the assignment of receivables, are contained in the Business Contract Terms (Assignment of Receivables) Regulations 2018, which will apply to any term in a contract entered into force on or after 31 December 2018.

By virtue of its section 2(1) “Subject to regulations 3 and 4, a term in a contract has no effect to the extent that it prohibits or imposes a condition, or other restriction, on the assignment of a receivable arising under that contract or any other contract between the same parties.”

Such regulations apply to contracts for the supply of goods, services or intangible assets under which the supplier is entitled to be paid money. However, there are several exclusions to this rule.

In section 3, an exception exists where the supplier is a large enterprise or a special purpose vehicle (SPV). In section 4, there are listed exclusions for various contracts such as “for, or entered into in connection with, prescribed financial services”, contracts “where one or more of the parties to the contract is acting for purposes which are outside a trade, business or profession” or contracts “where none of the parties to the contract has entered into it in the course of carrying on a business in the United Kingdom”. Also, specific exclusions relate to contracts in energy, land, share purchase and business purchase.

Effects of the 2018 Regulations

As mentioned above, any contract terms that prevent, set conditions for, or place restrictions on transferring a receivable are considered invalid and cannot be legally enforced.

In light of this, the assignment of the right to be paid under a contract for the supply of goods (receivables) cannot be restricted or prohibited. However, parties are not prevented from restricting other contracts rights.

Non-assignment clauses can have varying forms. Such clauses are covered by the regulations when terms prevent the assignee from determining the validity or value of the receivable or their ability to enforce it.

Overall, these legislations have had an important impact for businesses involved in the financing of receivables, by facilitating such processes for SMEs.

Digital platforms and fintech solutions: The assignment of receivables has been significantly impacted by the digitisation of financial services. Fintech platforms and online marketplaces have been developed to make the financing and assignment of receivables easier.

These platforms employ tech to assess debtor creditworthiness and provide efficient investor and seller matching, including data analytics and artificial intelligence. They provide businesses more autonomy, transparency, and access to a wider range of possible investors.

Securitisation is an essential part of receivables financing. Asset-backed securities (ABS), a type of financial instrument made up of receivables, are then sold to investors.

Businesses are able to turn their receivables into fast cash by transferring the credit risk and cash flow rights to investors. Investors gain from diversification and potentially greater yields through securitisation, while businesses profit from increased liquidity and risk-reduction capabilities.

References:

https://www.tradefinanceglobal.com/finance-products/accounts-receivables-finance/  – 28/10/2018

https://www.legislation.gov.uk/ukpga/2015/26/section/1/enacted  – 28/10/2018

https://www.legislation.gov.uk/ukdsi/2018/9780111171080  – 28/10/2018

https://www.bis.org/publ/bppdf/bispap117.pdf  – Accessed 14/06/2023

https://www.investopedia.com/terms/a/asset-backedsecurity.asp  – Accessed 14/06/2023

https://www.imf.org/external/pubs/ft/fandd/2008/09/pdf/basics.pdf  – Accessed 14/06/2023

International Trade Law

1 | Introduction to International Trade Law 2 | Legal Trade Finance 3 | Standard Legal Charges 4 | Borrowing Base Facilities 5 | Governing law in trade finance transactions 6 | SPV Financing 7 | Guarantees and Indemnities 8 | Taking security over assets 9 | Receivables finance and the assignment of receivables 10 | Force Majeure 11 | Arbitration 12 | Master Participation Agreements 13 | Digital Negotiable Instruments 14 | Generative AI in Trade Law

Access trade, receivables and supply chain finance

Contact the trade team, speak to our trade finance team, want to learn more about trade finance download our free guides.

Learn more about Legal Structures in Trade Finance

Digital Negotiable Instruments

Electronic Signatures

Force Majeure

Master Risk Participation Agreements In Trade Finance

What is a Creditor?

What is a debtor (debitor).

About the Author

Trade Finance Global (TFG) assists companies with raising debt finance. While we can access many traditional forms of finance, we specialise in alternative finance and complex funding solutions related to international trade. We help companies to raise finance in ways that is sometimes out of reach for mainstream lenders.

Add a bookmark to get started

UAE clarifies factoring and assignments of receivables

The recently enacted Federal Decree-Law No. 16 of 2021 on Factoring and Transfer of Civil Accounts Receivable (the New Law) which enters into force on 8 December 2021, being the first federal regulation in the United Arab Emirates (the UAE) dealing specifically with factoring and the assignment of receivables, has ushered in some much-needed clarity as to how these arrangements should work in the UAE. Specifically, the New Law provides a new regulatory framework which sets out the basic legal requirements for assignments and transfers of receivables, validity and perfection requirements, as well as the rules for determining priority amongst competing claims over assigned receivables.

Historically, this had been viewed as something of a 'grey' area of the law – governed in a piecemeal way, with Federal Law No. 5 of 1985 (as amended, the Civil Code) governing the assignment of debt and Federal Law No. 4 of 2020 (the Moveable Assets Mortgage Law) governing assignments over receivables which are taken by way of security. This had created some uncertainty as to which regulation should apply in particular circumstances, as well as uncertainty regarding the relationship between the different laws. The fact that the New Law seeks to provide a unified framework in relation to this area is a very welcome development. There are, however, certain key aspects of the New Law which may require further clarification as market participants seek to rely upon this new framework.

Scope of the New Law

The New Law applies broadly to any assignment of receivables made as part of commercial or civil transactions. Notable exclusions from this new law are assignments in the context of:

• personal / family transactions;
• financial contracts regulated by clearing agreements;
• foreign exchange transactions;
• interbank payment systems, net-based clearing systems and settlement related to securities, assets or other financial instruments;
• repurchase of securities, assets or financial instruments deposited with a broker;
• the right to financial payments fixed in endorsable bonds;
• the right to payments deposited in credit accounts with banks; and
• the right to payments under securities, documentary credits and letters of guarantee.

What is an Assignment?

The New Law governs " Assignments ", which is defined to cover an arrangement where " contractual rights to settle a cash sum owed by the Debtor are transferred to the Assignee, and the Assignment constitutes the agreement to create a security right on the Debtor's debt, transfer it as a security, and sell it in a final sale ". One possible interpretation of this particular definition would be that the New Law only governs arrangements which not only assign a debt but which also create a security interest over that debt. However, many factoring arrangements and debt assignments simply involve a debt being assigned absolutely and do not necessarily involve a security right being created over that debt. The New Law also does not elaborate on the different types of factoring arrangements that can exist, such as the purchase or sale of receivables, discounting and reverse factoring.

Given that the New Law appears (on the face of it) to be intended to cover all factoring arrangements and assignments of debts, the prudent course of action for market participants would be to ensure that all of their factoring arrangements and assignments of debt comply with the New Law, regardless of whether those arrangements involve security being created.

Form of Assignment

When it comes to the form that an assignment of receivables should take, the New Law is not prescriptive, and simply provides that an assignment shall be considered effective provided that the receivables that are subject to the assignment are described in a general or specific manner in order to allow for their identification.

Importantly, the New Law goes on to clarify some of the key points around how to describe the receivables being assigned (in relation to which there previously was some uncertainty). Specifically, we highlight the following:

• It is acceptable for the purposes of the New Law to describe the assigned receivables generally, for example by simply saying that the assignment is of all receivables that are currently owed by a debtor, all receivables that will be owed by a debtor in the future, or a specific class or specific or general type of such receivables.
• The New Law therefore appears to confirm that, in an assignment agreement, it is not necessary to individually list out each particular contract under which a debt is assigned.
• The New Law confirms that if the subject of the relevant assignment is receivables which are owed by a debtor in the future, then that assignment may be effective without the need to enter into any new transaction to assign each future debt in due course.

Effectiveness and Priority

One key point which the New Law clarifies is in relation to the effectiveness of debt assignment agreements against third parties: with specific provisions of the Moveable Assets Mortgage Law being incorporated by reference in order to establish that such assignments, in order to be effective towards third parties, must be declared on the electronic register created under the Moveable Assets Mortgage Law (which is currently operated by the Emirates Integrated Registries Company (EIRC)). While, prior to the introduction of the New Law, it was common for market participants to register assignments of receivables with the EIRC, it was not previously clear whether this was strictly necessary with respect to absolute assignments of receivables under the Civil Code which did not create security interests.

Regarding any specific requirements which need to be met in order for an assignment of receivables to be effective against a debtor (which have traditionally been governed by the Civil Code and relevant cases), the New Law does not specifically repeal or replace the Civil Code in this respect, and so the prudent course would be for market participants to continue to satisfy the applicable conditions derived from the Civil Code. This essentially means that, in order for an assignment of receivables to be enforceable against a debtor, notice of the assignment is required to be provided to the relevant debtor and (depending on the exact circumstances) with it also being advisable for the assignment of receivables to be acknowledged by the relevant debtor. The New Law does however give an assignee the clear right to send a notification and payment instructions to the relevant debtor in relation to receivables that have been assigned to that assignee (even if that notification gives rise to a breach of the underlying contract as between the assignor and the debtor), and does also seem to indicate that the debtor must agree to the assignment particularly in the context where the underlying contract is being amended.

Similar to what we see with registration, when it comes to determining priority among competing claims over receivables, the New Law relies on the Moveable Assets Mortgage Law to allocate the priority (determined by the date and time of registration) of the rights of assignees over the accounts receivable, to determine the priority of the assignor's obligation and to determine the priority of the assignment towards non-contractual rights.

To conclude, the New Law has clarified certain key issues regarding the assignment of receivables, and in doing so has created a more unified framework. It is now clear that any receivables which are subject to an assignment (which may include future receivables) need only be described in the assignment in general terms, and it is also now clear that certain elements of the Moveable Assets Mortgage Law apply to assignments of receivables (such as the registration requirements and rules regarding priority). Question marks do, however, remain over how the New Law treats certain types of debt assignments and factoring arrangements (particularly ones that involve absolute assignments and not security rights), as well as the question of how a court would interpret the relevant provisions of the Civil Code in light of the New Law.

Related Capabilities

• Capabilities
• Find an office

DLA Piper is a global law firm operating through various separate and distinct legal entities. For further information about these entities and DLA Piper's structure, please refer to the Legal Notices page of this website. All rights reserved. Attorney advertising.

© 2024 DLA Piper

Unsolicited e-mails and information sent to DLA Piper or the independent DLA Piper Relationship firms will not be considered confidential, may be disclosed to others, may not receive a response, and do not create a lawyer-client relationship with DLA Piper or any of the DLA Piper Relationship firms. Please do not include any confidential information in this message. Also, please note that our lawyers do not seek to practice law in any jurisdiction in which they are not properly permitted to do so.

Walker Morris / Insights / Receivables Finance: the prohibition on assignment is now in force

• GCs & In-house
• International
• Diversity & Inclusion
• The Environment
• Wider Society

Our Clients

• Banks & Alternative Lenders
• Commercial Developers
• Energy, Waste & Infrastructure Companies
• Food & Drink Companies
• Manufacturing Companies
• Private Equity
• Residential Builders & Operators
• Retail & Leisure Providers
• illuminate – For GCs and In-house
• Factory of the Future
• Digital transformation in business
• Building Safety Act 2022
• Environmental law in practice
• International Alliances
• Inward Investment
• Newsletters
• Company News
• Sectors (Our clients) Banks & Alternative Lenders Commercial Developers Energy, Waste & Infrastructure companies Food & Drink Companies Logistics Manufacturing Companies Private Equity Residential Builders & Operators Retailers & Leisure Providers
• Services Banking & Finance Block Management Business Immigration City & Estates Commercial Competition Construction & Engineering Consumer Finance Corporate Dispute Resolution Dispute Resolution>Real Estate Litigation Employment & Immigration Environment Finance Dispute Resolution Housing Management & Litigation HR Infrastructure & Energy Intellectual Property, Trade Marks & Designs International International Trade Living Logistics Net Zero Pensions Planning & Environment Private Equity Public Sector Real Estate Regulatory & Compliance Restructuring & Insolvency Retail Sports Law Supply Chain Tax Technology & Digital Uncategorized
• Reset Search
• View all services

Receivables Finance: the prohibition on assignment is now in force

18th January 2019

The Business Contract Terms (Assignment of Receivables) Regulations 2018 came into force on 31 December 2018 meaning that parties to a contract in the UK may no longer be able to prohibit the assignment of receivables arising in respect of supplies made under it, even if it is a long term supply contract providing for multiple deliveries.

As we reported in December 2017 , draft regulations were laid before Parliament in September of that year which proposed to make any term in a business contract that prohibited or restricted the assignment of receivables automatically ineffective. Those draft regulations were subsequently withdrawn amid concerns that they would create uncertainty in the finance markets.

The main areas of concern were that:

• the legislation appeared to be retrospective therefore catching contracts that were already in place;
• the types of assignment which fell within the regulations were not described sufficiently well enough to create certainty; and
• there was no protection for the debtor who may have stipulated for a non-assignment clause in the expectation that its rights of set off would be preserved.

However, the government has since revisited the legislation and on 24 November 2018 the Business Contract Terms (Assignment of Receivables) Regulations 2018 (the Regulations ) came into force. The Regulations apply to contracts (with a few exceptions described below) created after 31 December 2018 and mean that parties will no longer be able to prohibit the assignment of receivables in the UK. The Regulations make it clear that the prohibition is not retrospective and so the Regulations only apply to new contracts. In effect, this means that one party to a contract cannot prevent the other party from choosing who should receive payments under a contract for the supply of goods, services or intangible assets.

The Regulations also render unenforceable any terms which prevent a person who has been assigned the receivable from being able to enforce the contract, or determine its validity or value (for example by preventing the disclosure of the information required to commence court proceedings for its collection).

The Regulations are aimed at improving access to invoice financing for small and medium-sized enterprises and the government speculates that this will provide a £1 billion, long-term, boost to the economy. Invoice financing allows businesses to assign their right to be paid by a customer to a finance provider. In return the finance provider provides the business with up-front funds, thereby speeding up the business’ working capital cycle (provided the debtor ultimately pays the assigned invoice). Before 1 January 2019, smaller businesses would usually be forced to engage with larger customers on those customers’ standard terms, which often contained non-assignment clauses. As a result, some smaller businesses were restricted from engaging with invoice financing opportunities. This should now change.

The Regulations apply to contracts for the supply of goods, services or intangible assets where the supplier has the right to be paid under the contract. There are, however, a number of exceptions including:

• a large enterprise or part of a large group (as defined by the Companies Act 2006); or
• a special purpose vehicle, set up to hold assets or finance commercial transactions involving it incurring a liability under an agreement of £10 million or more.
• The Regulations also do not apply to services of a financial nature. The definition of ‘financial nature’ is construed widely and includes, amongst other things, leasing, loan relationships and all types of securitisation and derivative transactions.
• The Regulations do not apply to contracts which have as their purpose the acquiring, disposing or transferring of ownership in a firm (as defined in the Companies Act 2006) whether incorporated or established, or of a business or undertaking. However, for this exemption to apply, the contract must include a statement to that effect.
• The Regulations generally do not apply to contracts that relate to non-UK businesses. However, parties cannot contract out of the Regulations by changing the contract’s governing law, if the only reason for doing so is to circumvent the regulations.
• There are also a number of other types of contracts which the Regulations do not apply to, including consumer contracts, real estate contracts, public-private partnership contracts and rental contracts. Interestingly, the Regulations will apply to building contracts which, up to now have been impossible to finance, in practice, through an invoice discounting arrangement.

Practical application

The Regulations will lead to the need for certain changes to the drafting and implementation of commercial contracts:

• No assignment clauses –  An eligible supplier will be able to assign their receivables to a debt purchaser without having to seek their customers’ prior consent. This means a blanket non-assignment clause will no longer work for on its own to preserve rights of set off;
• Confidentiality provisions –  Confidentiality obligations can still be imposed on suppliers, except for any “essential information” that enables the identification of the receivables following assignment. This means information that enables the identification of receivables (so as to facilitate their collection) may be disclosed by a supplier to a third party purchaser for the purpose of receivables assignment or transfer without constituting a breach of confidentiality.
• Set-off –  The Explanatory Note to the Regulations clarifies that a contractual right to set-off is not considered as a restriction on transfer of receivables for the purpose of the Regulations. Although the right to set-off is maintained, businesses may want to consider the practical impact of the Regulations on the mechanism to exercise the right to set-off, such as how cash flow will be affected if you are no longer able to consolidate future transactions to set-off against one original invoice that has already been assigned to a third party.

Many commercial arrangements will be unaffected by this change in legislation. However this will depend, in relation to contracts entered into this year and beyond, on the terms of the contract and the nature of what is being supplied under it. A key point to note is that the Regulations will not nullify the contract as a whole or, indeed, the whole of the clause restricting assignment, but only to the extent applicable to receivables.

Providers of invoice finance will still need to carry out due diligence, at least for now, on taking on any new invoice discounting client to ascertain the extent to which the debtor book may still contain debts which are subject to restrictions on assignment or are otherwise subject to rights of set off.

Small and medium sized companies seeking to avail themselves of the new rules should seek advice before doing so. Invoice discounting products can be an extremely effective way of assisting a growing business meet its working capital needs. However, lumpy cash flow, or bad debt experience (including habitual slow payers in the customer base) can lead to disaster if not properly managed.

If you need advice on how the Regulations may affect your business please get in touch.

• assignments basic law

Assignments: The Basic Law

The assignment of a right or obligation is a common contractual event under the law and the right to assign (or prohibition against assignments) is found in the majority of agreements, leases and business structural documents created in the United States.

As with many terms commonly used, people are familiar with the term but often are not aware or fully aware of what the terms entail. The concept of assignment of rights and obligations is one of those simple concepts with wide ranging ramifications in the contractual and business context and the law imposes severe restrictions on the validity and effect of assignment in many instances. Clear contractual provisions concerning assignments and rights should be in every document and structure created and this article will outline why such drafting is essential for the creation of appropriate and effective contracts and structures.

The reader should first read the article on Limited Liability Entities in the United States and Contracts since the information in those articles will be assumed in this article.

Basic Definitions and Concepts:

An assignment is the transfer of rights held by one party called the “assignor” to another party called the “assignee.” The legal nature of the assignment and the contractual terms of the agreement between the parties determines some additional rights and liabilities that accompany the assignment. The assignment of rights under a contract usually completely transfers the rights to the assignee to receive the benefits accruing under the contract. Ordinarily, the term assignment is limited to the transfer of rights that are intangible, like contractual rights and rights connected with property. Merchants Service Co. v. Small Claims Court , 35 Cal. 2d 109, 113-114 (Cal. 1950).

An assignment will generally be permitted under the law unless there is an express prohibition against assignment in the underlying contract or lease. Where assignments are permitted, the assignor need not consult the other party to the contract but may merely assign the rights at that time. However, an assignment cannot have any adverse effect on the duties of the other party to the contract, nor can it diminish the chance of the other party receiving complete performance. The assignor normally remains liable unless there is an agreement to the contrary by the other party to the contract.

The effect of a valid assignment is to remove privity between the assignor and the obligor and create privity between the obligor and the assignee. Privity is usually defined as a direct and immediate contractual relationship. See Merchants case above.

Further, for the assignment to be effective in most jurisdictions, it must occur in the present. One does not normally assign a future right; the assignment vests immediate rights and obligations.

No specific language is required to create an assignment so long as the assignor makes clear his/her intent to assign identified contractual rights to the assignee. Since expensive litigation can erupt from ambiguous or vague language, obtaining the correct verbiage is vital. An agreement must manifest the intent to transfer rights and can either be oral or in writing and the rights assigned must be certain.

Note that an assignment of an interest is the transfer of some identifiable property, claim, or right from the assignor to the assignee. The assignment operates to transfer to the assignee all of the rights, title, or interest of the assignor in the thing assigned. A transfer of all rights, title, and interests conveys everything that the assignor owned in the thing assigned and the assignee stands in the shoes of the assignor. Knott v. McDonald’s Corp ., 985 F. Supp. 1222 (N.D. Cal. 1997)

The parties must intend to effectuate an assignment at the time of the transfer, although no particular language or procedure is necessary. As long ago as the case of National Reserve Co. v. Metropolitan Trust Co ., 17 Cal. 2d 827 (Cal. 1941), the court held that in determining what rights or interests pass under an assignment, the intention of the parties as manifested in the instrument is controlling.

The intent of the parties to an assignment is a question of fact to be derived not only from the instrument executed by the parties but also from the surrounding circumstances. When there is no writing to evidence the intention to transfer some identifiable property, claim, or right, it is necessary to scrutinize the surrounding circumstances and parties’ acts to ascertain their intentions. Strosberg v. Brauvin Realty Servs., 295 Ill. App. 3d 17 (Ill. App. Ct. 1st Dist. 1998)

The general rule applicable to assignments of choses in action is that an assignment, unless there is a contract to the contrary, carries with it all securities held by the assignor as collateral to the claim and all rights incidental thereto and vests in the assignee the equitable title to such collateral securities and incidental rights. An unqualified assignment of a contract or chose in action, however, with no indication of the intent of the parties, vests in the assignee the assigned contract or chose and all rights and remedies incidental thereto.

More examples: In Strosberg v. Brauvin Realty Servs ., 295 Ill. App. 3d 17 (Ill. App. Ct. 1st Dist. 1998), the court held that the assignee of a party to a subordination agreement is entitled to the benefits and is subject to the burdens of the agreement. In Florida E. C. R. Co. v. Eno , 99 Fla. 887 (Fla. 1930), the court held that the mere assignment of all sums due in and of itself creates no different or other liability of the owner to the assignee than that which existed from the owner to the assignor.

And note that even though an assignment vests in the assignee all rights, remedies, and contingent benefits which are incidental to the thing assigned, those which are personal to the assignor and for his sole benefit are not assigned. Rasp v. Hidden Valley Lake, Inc ., 519 N.E.2d 153, 158 (Ind. Ct. App. 1988). Thus, if the underlying agreement provides that a service can only be provided to X, X cannot assign that right to Y.

Novation Compared to Assignment:

Although the difference between a novation and an assignment may appear narrow, it is an essential one. “Novation is a act whereby one party transfers all its obligations and benefits under a contract to a third party.” In a novation, a third party successfully substitutes the original party as a party to the contract. “When a contract is novated, the other contracting party must be left in the same position he was in prior to the novation being made.”

A sublease is the transfer when a tenant retains some right of reentry onto the leased premises. However, if the tenant transfers the entire leasehold estate, retaining no right of reentry or other reversionary interest, then the transfer is an assignment. The assignor is normally also removed from liability to the landlord only if the landlord consents or allowed that right in the lease. In a sublease, the original tenant is not released from the obligations of the original lease.

Equitable Assignments:

An equitable assignment is one in which one has a future interest and is not valid at law but valid in a court of equity. In National Bank of Republic v. United Sec. Life Ins. & Trust Co. , 17 App. D.C. 112 (D.C. Cir. 1900), the court held that to constitute an equitable assignment of a chose in action, the following has to occur generally: anything said written or done, in pursuance of an agreement and for valuable consideration, or in consideration of an antecedent debt, to place a chose in action or fund out of the control of the owner, and appropriate it to or in favor of another person, amounts to an equitable assignment. Thus, an agreement, between a debtor and a creditor, that the debt shall be paid out of a specific fund going to the debtor may operate as an equitable assignment.

In Egyptian Navigation Co. v. Baker Invs. Corp. , 2008 U.S. Dist. LEXIS 30804 (S.D.N.Y. Apr. 14, 2008), the court stated that an equitable assignment occurs under English law when an assignor, with an intent to transfer his/her right to a chose in action, informs the assignee about the right so transferred.

An executory agreement or a declaration of trust are also equitable assignments if unenforceable as assignments by a court of law but enforceable by a court of equity exercising sound discretion according to the circumstances of the case. Since California combines courts of equity and courts of law, the same court would hear arguments as to whether an equitable assignment had occurred. Quite often, such relief is granted to avoid fraud or unjust enrichment.

Note that obtaining an assignment through fraudulent means invalidates the assignment. Fraud destroys the validity of everything into which it enters. It vitiates the most solemn contracts, documents, and even judgments. Walker v. Rich , 79 Cal. App. 139 (Cal. App. 1926). If an assignment is made with the fraudulent intent to delay, hinder, and defraud creditors, then it is void as fraudulent in fact. See our article on Transfers to Defraud Creditors .

But note that the motives that prompted an assignor to make the transfer will be considered as immaterial and will constitute no defense to an action by the assignee, if an assignment is considered as valid in all other respects.

Enforceability of Assignments:

Whether a right under a contract is capable of being transferred is determined by the law of the place where the contract was entered into. The validity and effect of an assignment is determined by the law of the place of assignment. The validity of an assignment of a contractual right is governed by the law of the state with the most significant relationship to the assignment and the parties.

In some jurisdictions, the traditional conflict of laws rules governing assignments has been rejected and the law of the place having the most significant contacts with the assignment applies. In Downs v. American Mut. Liability Ins. Co ., 14 N.Y.2d 266 (N.Y. 1964), a wife and her husband separated and the wife obtained a judgment of separation from the husband in New York. The judgment required the husband to pay a certain yearly sum to the wife. The husband assigned 50 percent of his future salary, wages, and earnings to the wife. The agreement authorized the employer to make such payments to the wife.

After the husband moved from New York, the wife learned that he was employed by an employer in Massachusetts. She sent the proper notice and demanded payment under the agreement. The employer refused and the wife brought an action for enforcement. The court observed that Massachusetts did not prohibit assignment of the husband’s wages. Moreover, Massachusetts law was not controlling because New York had the most significant relationship with the assignment. Therefore, the court ruled in favor of the wife.

Therefore, the validity of an assignment is determined by looking to the law of the forum with the most significant relationship to the assignment itself. To determine the applicable law of assignments, the court must look to the law of the state which is most significantly related to the principal issue before it.

Assignment of Contractual Rights:

Generally, the law allows the assignment of a contractual right unless the substitution of rights would materially change the duty of the obligor, materially increase the burden or risk imposed on the obligor by the contract, materially impair the chance of obtaining return performance, or materially reduce the value of the performance to the obligor. Restat 2d of Contracts, § 317(2)(a). This presumes that the underlying agreement is silent on the right to assign.

If the contract specifically precludes assignment, the contractual right is not assignable. Whether a contract is assignable is a matter of contractual intent and one must look to the language used by the parties to discern that intent.

In the absence of an express provision to the contrary, the rights and duties under a bilateral executory contract that does not involve personal skill, trust, or confidence may be assigned without the consent of the other party. But note that an assignment is invalid if it would materially alter the other party’s duties and responsibilities. Once an assignment is effective, the assignee stands in the shoes of the assignor and assumes all of assignor’s rights. Hence, after a valid assignment, the assignor’s right to performance is extinguished, transferred to assignee, and the assignee possesses the same rights, benefits, and remedies assignor once possessed. Robert Lamb Hart Planners & Architects v. Evergreen, Ltd. , 787 F. Supp. 753 (S.D. Ohio 1992).

On the other hand, an assignee’s right against the obligor is subject to “all of the limitations of the assignor’s right, all defenses thereto, and all set-offs and counterclaims which would have been available against the assignor had there been no assignment, provided that these defenses and set-offs are based on facts existing at the time of the assignment.” See Robert Lamb , case, above.

The power of the contract to restrict assignment is broad. Usually, contractual provisions that restrict assignment of the contract without the consent of the obligor are valid and enforceable, even when there is statutory authorization for the assignment. The restriction of the power to assign is often ineffective unless the restriction is expressly and precisely stated. Anti-assignment clauses are effective only if they contain clear, unambiguous language of prohibition. Anti-assignment clauses protect only the obligor and do not affect the transaction between the assignee and assignor.

Usually, a prohibition against the assignment of a contract does not prevent an assignment of the right to receive payments due, unless circumstances indicate the contrary. Moreover, the contracting parties cannot, by a mere non-assignment provision, prevent the effectual alienation of the right to money which becomes due under the contract.

A contract provision prohibiting or restricting an assignment may be waived, or a party may so act as to be estopped from objecting to the assignment, such as by effectively ratifying the assignment. The power to void an assignment made in violation of an anti-assignment clause may be waived either before or after the assignment. See our article on Contracts.

Noncompete Clauses and Assignments:

Of critical import to most buyers of businesses is the ability to ensure that key employees of the business being purchased cannot start a competing company. Some states strictly limit such clauses, some do allow them. California does restrict noncompete clauses, only allowing them under certain circumstances. A common question in those states that do allow them is whether such rights can be assigned to a new party, such as the buyer of the buyer.

A covenant not to compete, also called a non-competitive clause, is a formal agreement prohibiting one party from performing similar work or business within a designated area for a specified amount of time. This type of clause is generally included in contracts between employer and employee and contracts between buyer and seller of a business.

Many workers sign a covenant not to compete as part of the paperwork required for employment. It may be a separate document similar to a non-disclosure agreement, or buried within a number of other clauses in a contract. A covenant not to compete is generally legal and enforceable, although there are some exceptions and restrictions.

Whenever a company recruits skilled employees, it invests a significant amount of time and training. For example, it often takes years before a research chemist or a design engineer develops a workable knowledge of a company’s product line, including trade secrets and highly sensitive information. Once an employee gains this knowledge and experience, however, all sorts of things can happen. The employee could work for the company until retirement, accept a better offer from a competing company or start up his or her own business.

A covenant not to compete may cover a number of potential issues between employers and former employees. Many companies spend years developing a local base of customers or clients. It is important that this customer base not fall into the hands of local competitors. When an employee signs a covenant not to compete, he or she usually agrees not to use insider knowledge of the company’s customer base to disadvantage the company. The covenant not to compete often defines a broad geographical area considered off-limits to former employees, possibly tens or hundreds of miles.

Another area of concern covered by a covenant not to compete is a potential ‘brain drain’. Some high-level former employees may seek to recruit others from the same company to create new competition. Retention of employees, especially those with unique skills or proprietary knowledge, is vital for most companies, so a covenant not to compete may spell out definite restrictions on the hiring or recruiting of employees.

A covenant not to compete may also define a specific amount of time before a former employee can seek employment in a similar field. Many companies offer a substantial severance package to make sure former employees are financially solvent until the terms of the covenant not to compete have been met.

Because the use of a covenant not to compete can be controversial, a handful of states, including California, have largely banned this type of contractual language. The legal enforcement of these agreements falls on individual states, and many have sided with the employee during arbitration or litigation. A covenant not to compete must be reasonable and specific, with defined time periods and coverage areas. If the agreement gives the company too much power over former employees or is ambiguous, state courts may declare it to be overbroad and therefore unenforceable. In such case, the employee would be free to pursue any employment opportunity, including working for a direct competitor or starting up a new company of his or her own.

It has been held that an employee’s covenant not to compete is assignable where one business is transferred to another, that a merger does not constitute an assignment of a covenant not to compete, and that a covenant not to compete is enforceable by a successor to the employer where the assignment does not create an added burden of employment or other disadvantage to the employee. However, in some states such as Hawaii, it has also been held that a covenant not to compete is not assignable and under various statutes for various reasons that such covenants are not enforceable against an employee by a successor to the employer. Hawaii v. Gannett Pac. Corp. , 99 F. Supp. 2d 1241 (D. Haw. 1999)

It is vital to obtain the relevant law of the applicable state before drafting or attempting to enforce assignment rights in this particular area.

Conclusion:

In the current business world of fast changing structures, agreements, employees and projects, the ability to assign rights and obligations is essential to allow flexibility and adjustment to new situations. Conversely, the ability to hold a contracting party into the deal may be essential for the future of a party. Thus, the law of assignments and the restriction on same is a critical aspect of every agreement and every structure. This basic provision is often glanced at by the contracting parties, or scribbled into the deal at the last minute but can easily become the most vital part of the transaction.

As an example, one client of ours came into the office outraged that his co venturer on a sizable exporting agreement, who had excellent connections in Brazil, had elected to pursue another venture instead and assigned the agreement to a party unknown to our client and without the business contacts our client considered vital. When we examined the handwritten agreement our client had drafted in a restaurant in Sao Paolo, we discovered there was no restriction on assignment whatsoever…our client had not even considered that right when drafting the agreement after a full day of work.

One choses who one does business with carefully…to ensure that one’s choice remains the party on the other side of the contract, one must master the ability to negotiate proper assignment provisions.

Founded in 1939, our law firm combines the ability to represent clients in domestic or international matters with the personal interaction with clients that is traditional to a long established law firm.

Read more about our firm

© 2024, Stimmel, Stimmel & Roeser, All rights reserved  | Terms of Use | Site by Bay Design