Jump to Content Jump to Main Navigation
Signed in as:

Part II Description of Interests, 7 Financing Devices Involving the Transfer or Retention of Title

From: The Law of Security and Title-Based Financing (3rd Edition)

Hugh Beale, Michael Bridge, Louise Gullifer, Eva Lomnicka

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: null; date: 06 June 2023

Credit — Guarantees and security

(p. 261) Financing Devices Involving the Transfer or Retention of Title

A.  General


7.01  This section considers financing devices that, although performing an equivalent function to security interests, are not generally considered ‘security’ under English law.1 They fall into two main categories: those involving the retention and those involving the transfer of title. Such financing devices are often called ‘quasi-security’ interests, to acknowledge that their economic function, in ‘securing’ the performance of obligations, is the same as that of true ‘security’. This section will consider in more detail the characteristics that they normally display, dividing up the discussion by the nature of the collateral involved: goods, investment products, and receivables.


7.02  The term ‘retention of title’ is sometimes used very generally to refer to all devices whereby an owner retains title to ‘secure’ an obligation owed to him2 and sometimes more specifically to refer to retention of title (ROT) clauses in supply contracts.3 We have not found a satisfactory alternative to this double usage but have endeavoured always (p. 262) to make it clear which sense we mean. Similarly, ‘conditional sale’ is used sometimes in the broad sense of any sale under which the passing of property is made conditional on the payment of the price (thus prima facie including retention of title clauses in supply contracts4) and sometimes in the narrow sense of a sale, where the price is payable by instalments.5 Again we have tried to make it clear which sense we mean.

Retention of title

7.03  As has been explained above,6 a security interest cannot be created under English law by retention of interest; it must be granted by the debtor to his creditor over assets the debtor already owns or will own.7 Thus those transactions (sometimes called ‘title finance’) where a creditor ‘secures’ a payment (or other) obligation by retaining title to the goods whilst giving the purchaser possession, do not give rise to ‘security’ in the true sense. One category of such transaction involves so-called ‘vendor-credit’, where a vendor of goods retains title in order to ‘secure’ the payment of the price. Retention of title clauses in supply transactions8 and conditional sale contracts,9 are one example. Another example is hire purchase10 which, although legally different (a hire contract with an option to purchase), performs the same economic function as conditional sale: the purchase11 of goods by instalments, the payment of the instalments being ‘secured’ by title retention. A second category of such retention of title transactions is the finance lease,12 a contract of hire where an owner of goods merely confers possession for the duration of the useful life of the goods, and never title. As the lessee obtains possession of the goods for their useful life whilst paying rentals, the economic result is equivalent to that in a conditional sale or hire purchase of such goods. Thus, from an economic point of view, it is insignificant that in a finance lease title never passes whilst in vendor credit it does, if the value of the goods is minimal at the end of the agreement. Moreover, most finance leases provide that the lessee may keep any proceeds of sale of the goods and this reduces to vanishing point the economic distinction between the three types of retention of title transactions.

Relief from forfeiture

7.04  That retention of title often performs a security function has been expressly recognized by the courts when exercising their jurisdiction to give relief against forfeiture.13 It is now well-established that the court has an inherent equitable jurisdiction (p. 263) to give relief against the forfeiture14 in contracts concerning the ‘transfer or creation of proprietary or possessory rights’ in goods15 as well as in land. The circumstances in which such relief will be given are where the forfeiture provision is essentially ‘security’ for the payment of money or ‘is added by way of security for the production’ of some other result that is the object of the contract.16 Thus, in so-called ‘finance leases’17 where it is recognized that the interest of the owner retaining title is purely financial (and hence that the forfeiture provision acts merely as ‘security’) the courts have been ready to give relief,18 whilst in so-called ‘operating leases’19 where this is not the case, relief has been refused.20 Nevertheless, whilst the courts expressly acknowledge that retention of title may perform a security function, they have reasserted that they will not ‘disregard legal rights and obligations in favour of economic substance’.21 The fact that retention of title acts as ‘security’ is merely relevant to the issue of whether the discretion to order relief from forfeiture will be exercised.

Transfer of title

7.05  As regards transfer of title, the legal difference between a transaction that creates a security interest and one that transfers an absolute interest or title has already been noted.22 Again, a number of transactions that in economic terms are functionally equivalent to secured loans are sometimes structured as absolute transfers. This is particularly the case in ‘receivables financing’23 and ‘repos’,24 but financing transactions involving goods may also entail a sale of the goods and then a lease-back or resale to the ‘creditor’.25 The question of whether such financing devices will be recharacterized as true ‘security’ has also been discussed above,26 where it was noted that the common forms of such devices have generally27 survived challenge.

Reasons for retention or transfer of title

7.06  There are a number of historical and practical reasons why parties have chosen, and still choose, not to create true ‘security’ interests in relation to collateral but to retain or obtain title to it. These will be noted in relation to each device28 but one common factor is that there are no registration requirements for such transactions and thus the associated administrative burdens and unwelcome publicity are avoided. On the other hand ‘charges’ created by a company are registrable under the Companies Act 2006, section 859A29 whilst the Bills of Sale Acts30 presently catch security (p. 264) interests granted by individuals over goods they already own. A further reason is that ownership of an asset usually confers superior rights than a charge over those assets. A person with a charge over assets, especially a floating charge,31 faces competition for those assets from subsequent creditors32 and, when the assets are realized he must account for any surplus, being only entitled to his loan plus interest.33 An owner, on the other hand, unless one of the exceptions to nemo dat applies,34 prevails over subsequent claimants to the assets and, when the assets are realized, he is generally entitled to all the proceeds of sale.35

B.  Goods

Retention of title clauses in supply agreements


7.07  It is clear that a seller of goods may, whilst conferring possession on the buyer, retain title until some condition is fulfilled.36 Hence suppliers of goods on credit frequently include a clause in their supply contracts whereby they retain title to the goods supplied until the outstanding liability for the price is discharged. In practice, these clauses take a variety of forms, depending on the nature of the goods supplied and how the purchaser intends to use them.37 In particular, the clause often seeks to confer on the supplier rights to one or more of three categories of asset. First, the clause invariably retains title to the actual goods supplied until one or other of a variety of payment obligations owed by the purchaser to the supplier38 are satisfied.39 Second, if the goods are the raw material for some end product, the clause sometimes seeks to confer ownership of that end product on the supplier, usually subject to residual rights of the purchaser in respect of his profit.40 Third, the clause may cover the proceeds of sale of the original goods themselves and/or of the products made from the goods.41 Whether or not the supplier inserts an express contractual provision making claim to the second and third types of assets, the question also arises (p. 265) whether he may nevertheless rely on the retention of his title to the original goods themselves in order to make a successful tracing claim to such assets.42

‘Romalpa’/ROT clauses

7.08  Such retention of title clauses were historically referred to as ‘Romalpa’ clauses after the first English case in which their effect was considered: Aluminium Industrie Vaassen BV v Romalpa Aluminium Ltd.43 Since then, there has been a great deal of reported case law and commentary44 concerning such clauses,45 which are now more generally referred to as ‘retention of title’, or ROT, clauses. Normally, the supplier relies on the clause to claim the various assets from the purchaser, whether the original goods supplied, the products made from them or the proceeds of sale, whilst the other creditors of the purchaser of the goods contest those claims on a number of grounds. The main ground46 has been a denial that the supplier has effectively ‘retained’ title to the original goods or a denial that he has a tracing47 or absolute48 right to the products or proceeds. Rather, such competing creditors argue that the supplier only has a ‘charge’ over them which, being unregistered, is void.49

Supplier’s ‘windfall’

7.09  When it comes to claiming the products or proceeds, their value almost invariably exceeds the amount the purchaser owes, either because the purchaser has expended significant labour in transforming the goods or because other suppliers (or the purchaser himself) have contributed their goods to the end product or simply because the purchaser has resold the original goods at a profit. Moreover, the value of the goods themselves may be greater than the amount actually owed by the purchaser.50 Recognizing that the supplier is absolute owner to such assets gives the supplier a ‘windfall’ at others’ expense.51 Sometimes the parties provide for the ‘windfall’ and seek to limit the supplier’s rights by reference to what the supplier is owed.52 The problem with such express (p. 266) provisions is that the courts have consistently characterized them, at least in the context of products or proceeds,53 as giving rise to a charge.54 Such a characterization is clearly correct if the purchaser grants such a limited interest to the supplier. As Slade J said in Re Bond Worth: ‘any contract which, by way of security … confers an interest in property defeasible or destructible on payment of such debt … must necessarily be regarded as creating a mortgage or charge’.55 However, just because the supplier’s interest is ‘defeasible or destructible’ on payment, it does not follow that his interest is necessarily a ‘charge’;56 to be a ‘charge’, the interest must also be ‘conferred’ or granted by the purchaser over his property. Thus it is clear57 that, as regards the original goods, the fact that the supplier’s title is ‘defeasible’ (that is, passes to the purchaser) on discharge of the purchaser’s liability, does not mean the supplier does not have absolute ownership (as opposed to a charge) in the meantime. Similarly, a successful tracing claim whether to products58 or proceeds,59 although giving rise to a ‘defeasible’ interest, would appear not to be ‘granted’ by the purchaser, since it arises by operation of law, and hence does not give rise to a ‘charge’.60

Claim to original goods supplied

7.10  As noted above,61 there is no legal difficulty in a supplier retaining title62 to the actual goods supplied until some condition is fulfilled.63 Moreover it is clear that such a retention of title does not give rise to a charge.64 The condition to be fulfilled for title to pass may be the payment of the price of the goods (p. 267) themselves65 or (if the parties enter into a series of supply contracts) of all the goods supplied.66 It has been confirmed that the second, more extensive (‘all accounts’ or ‘all moneys’) type of clause is effective in the sense that it does not give rise to a charge,67 but it does pose problems on enforcement in that title to the goods themselves never passes to the purchaser (unless the purchaser has no outstanding liability to the supplier) and there is therefore no correlation between the value of goods still owned by the supplier and the amount owed by the purchaser.68 It also seems clear that there is no need to impose any conditions as to the storage or use of the original goods for the title retention clause to be legally effective, as far as the original goods themselves are concerned.69 However, when it comes to trying to establish a tracing claim into products or proceeds of sale, how the original goods may be dealt with is a relevant consideration in deciding if a fiduciary relationship exists to support such a claim.70

7.11  Claiming the original goods themselves is of limited use in practice.71 This is especially so if they become indistinguishable from goods belonging to the purchaser or supplied by other suppliers72 or are used immediately in the manufacturing process.73 In addition, if the original goods are on-sold to third parties, the supplier usually loses title either as a result of having given the purchaser authority to sell on74 or under the ‘buyer in possession’ statutory exception75 to the nemo dat rule, although case law in the building contracts context (p. 268) (where retention of title to goods supplied by the sub-contractor to the main contractor is common76) shows that this will not always be the case.77 In Caterpillar v Holt,78 an ROT clause that gave permission for the purchaser (holding the goods as ‘fiduciary agent’) to on-sell to a sub-buyer was interpreted as an agency contract (not a sale contract) whereby title passed directly from the supplier to the sub-buyer without momentarily vesting in the (agent) purchaser. Moreover, the supplier also generally loses title to goods when they become ‘fixtures’ and hence part of the land79 and, as will now be considered, when the goods are used to create a new product.

Claim to products

7.12  The goods supplied may be used by the purchaser in a variety of ways to create a new ‘product’. There are a number of possible permutations.80 The goods may remain identifiable but may be processed81 or attached to other goods.82 Alternatively the goods may ‘lose their identity’ and be converted into new products.83

General principles

7.13  The first question to ask is whether the retention of title to the original goods themselves can still operate in relation to the ‘product’. This depends on the view the law takes of the effect of the various processes listed above on the supplier’s retained title to the original goods and whether the parties can modify that prima facie effect by contractual term. The case law and commentators84 have grappled with both issues and the position is not entirely settled.85 However, it seems clear that the supplier retains title to his goods if they do not ‘lose their identity’86 by being transformed (by a (p. 269) process of specification) into new products. This was held to be the case where engines with serial numbers were bolted into generators and could easily be removed.87 It also seems clear that the supplier retains title even if the original goods have been the subject of a degree of irreversible (and hence, a fortiori, reversible88) processing as long as the goods retain their essential identity, for example if steel strips are cut into sheets89 or logs are sawn into timber.90

7.14  On the other hand, if the original goods ‘lose their identity’ and are used to create a new product, that new product belongs by operation of law to its maker and the supplier loses title to the constituent goods.91 Moreover, the supplier has no tracing claim to the product itself. This was established in Borden (UK) Ltd v Scottish Timber Products Ltd,92 which concerned the supply of resin that was combined, in an irreversible process, with wood chippings to make chipboard. The supplier lost the title they had retained to the resin and had no tracing claim to the chipboard. Any tracing claim was extinguished when the resin ceased to be identifiable.93 The retention of title clause was, in terms, limited to the original goods themselves and hence there was no express provision on which the supplier could base any claim to the chipboard.94 Moreover, the court refused to imply any such term.

7.15  It does not seem to matter that the new product is made predominantly from the original goods. Hence the supplier lost title when his leather was converted into handbags,95 his cardboard made into boxes,96 his cloth cut and worked on,97 his livestock cut up into carcasses,98 his steel made into pressure cylinders99 and his plastic pellets moulded into jars.100 It is sometimes difficult to draw the line between such cases and those (few) cases noted above101 where the goods have ‘merely’ been processed and have not lost their identity. (p. 270) No clear principle has yet emerged from the cases, which merely assert102 that the original goods have (or have not) ‘lost their identity’ and/or have been ‘transformed’ into a ‘new product’. The position is complicated by the fact that in some cases,103 the contract made express provision as to the supplier’s title to the ‘product’ and hence they could be regarded as based on the agreement of the parties that, when the original goods were used, the supplier’s title to the goods was lost and they acquired an interest in the product.104 Nevertheless, it has been suggested that, contractual provisions apart, whether the supplier’s title is lost or retained in the product should depend on ‘economic realities’ and ‘issues such as whether reversing the process is economically realistic, and whether the goods have increased in value to make them a qualitatively different thing’.105 A cursory survey of the cases certainly suggests that if the processing increases the value of the original goods significantly, then the supplier’s title is lost and this accords with an understandable reluctance to confer a ‘windfall’ on the supplier by holding that the more valuable products are still his.

Contractual provision as to title to product

7.16  Given the loss of the right to trace once a ‘new’ product is created, retention of title clauses often make express provision concerning the supplier’s entitlement to that product. Early versions merely conferred an equitable interest on the supplier,106 but given the freedom the purchaser had to deal with the products, such interests were characterized as floating charges.107 More recent clauses purport to confer legal title on the supplier, not by way of grant back from the prima facie new owner of the product (the purchaser/maker) but by way of reservation or immediate vesting once the product is created. In Clough Mill Ltd v Martin108 the clause provided that title to the product ‘shall be and remain with the seller’ and the majority of the Court of Appeal,109 in obiter dicta,110 saw no reason in principle why the parties could not contractually provide that ‘the property in [the product] ipso facto vests’ in the supplier.111 The suggestion that a contractual provision can confer title to the product on the supplier otherwise than by way of grant appears to be contradicted by Borden (UK) Ltd v Scottish Timber Products Ltd112 (p. 271) and has been convincingly criticized.113 The better view is that the new product automatically belongs to the purchaser/producer and that he grants114 a new interest, or even ownership, to the supplier. However, if the supplier acquires his interest by way of grant, the result is that unless the grant is of an absolute interest, the supplier necessarily obtains a charge.115 The question then resolves itself into the familiar one of whether the transfer is absolute or by way of charge, the latter characterization being almost inevitable.116 But if, on the other hand, the supplier can acquire title ‘ipso facto’, then it is theoretically possible for him to agree to hold the product on trust for himself (as to the amount he is owed) and the purchaser/producer (as to the surplus) and the supplier’s beneficial interest would then not be by way of grant and hence not a charge.117

7.17  The case law (even Clough Mill, obiter) has consistently construed ‘products’ clauses as creating charges granted by the purchaser (the maker of the new product), mainly on the basis that the windfall118 to the supplier consequent on conferring absolute title to the product on him could not have been intended.119 This windfall problem is especially acute if the product is made from the raw materials of a number of suppliers, each with their own retention of title clause claiming the products. Therefore, although Goff J in Clough Mill suggested that an implied duty to account or even a trust for sale might partly solve the ‘windfall’ problem when a supplier claimed his retained title to the original goods,120 he was disinclined to extend that reasoning to products and construed the claim of the supplier as one by way of charge. Moreover, when drafters have sought to meet the ‘windfall’ problem by qualifying the supplier’s ownership of products by reference to what he is owed,121 such clauses have also been interpreted as creating charges over the product.122 If it is accepted that the product vests in the purchaser, then any ‘defeasible’ interest that the supplier obtains must necessarily be by way of grant.123

Claim to proceeds

7.18  Suppliers have also made claims to the proceeds of sale, whether of the original goods themselves or their products, again on the basis either of a tracing claim or of an express provision in the retention of title clause conferring rights on them (p. 272) to proceeds. As the purchaser (the seller in relation to the on-sale of the original goods or product) acquires the legal title to both the debt and the proceeds generated, any interest the supplier obtains is necessarily equitable. The tracing claim is based on the application of the principles set out in Re Hallett124 which require the establishment of a fiduciary duty between the supplier and the purchaser.

Right to trace

7.19  In the original retention of title case Aluminium Industrie Vaassen BV v Romalpa Aluminium Ltd,125 the court recognized a tracing claim to the proceeds of sale of the original goods, regarding the purchaser as a fiduciary and implying a term into the supply contract that the purchaser was accountable to the supplier for those proceeds. However, that case has since been consistently distinguished and regarded as one decided on ‘special facts’.126 In particular, the supply contract expressly designated the purchaser a ‘fiduciary’127 and the proceeds (which had been paid by the receiver into a separate account) related to the original goods and there was no suggestion of the supplier receiving a ‘windfall’128 at another’s expense. Subsequent cases have consistently held that purchasers are not fiduciaries in relation to the original goods with a consequent obligation to keep the proceeds of sale separate.129 On the contrary, purchasers have generally been found to have sold the original goods for their own account using the proceeds in their own business, so that their relationship with the supplier is one of mere debtor.130 This is especially so if the purchaser is given credit by the supplier.131 Hence, merely retaining title to the original goods delivered on the basis that they can be dealt with by the purchaser,132 does not, in itself, confer on the supplier a tracing claim to the proceeds of sale of the goods.

7.20  Even if the purchaser is expressly designated a ‘fiduciary’ and agrees to hold the proceeds as ‘trustee’, if he is permitted to use the proceeds in his own business, then such a provision will at best create a (registrable) floating charge.133 If the purchaser agrees to keep the (p. 273) proceeds in a separate account, the supplier’s beneficial right will inevitably (either expressly or by necessary implication) determine when the purchaser’s liability to him is discharged. Such a defeasible interest in proceeds has been held to be ‘more consistent with the existence of a charge … than with a fiduciary obligation … operating as a retention or vesting of the absolute interest in all the proceeds automatically in [the supplier]’,134 although such a conclusion would not appear inevitable if the supplier can establish a tracing claim.135

7.21  When it comes to tracing into the proceeds of sale of products, the first step is to establish that the supplier’s title survives in the product. This will only be possible if the original goods have not ‘lost their identity’136 or, in the case of a ‘new product’, if there is a contractual provision that successfully vests title in the product in the supplier without this occurring by way of grant.137 Even if the supplier establishes title to the product, he faces the same difficulties in tracing into the proceeds of those products as he does in tracing into the proceeds of the original goods themselves.138

Tracing claim not a charge

7.22  If the supplier manages successfully to establish a tracing claim to the proceeds, it seems clear that the claim does not give rise to a ‘charge’.139 As far as the original goods are concerned, assuming that a fiduciary obligation giving rise to the right to trace can be imposed by (the supply) contract, this does not mean that the right to trace is a right granted by contract and hence a ‘charge’. The contract merely constitutes the purchaser a fiduciary and the right to trace arises by operation of law as a consequence of that status. As far as new products are concerned, it is suggested above that, contrary to the majority obiter views in Clough Mill Ltd v Martin,140 the better view is that any interest acquired by the supplier must be by way of grant from the purchaser.141 However, if the majority’s view that a contractual term can confer an interest on the supplier ‘ipso facto’ prevails, it is clear that this similarly is not a charge.142

7.23  As to the ‘windfall’ issue143 in relation to a tracing claim to the proceeds, in principle it seems that as long as it is clear that the purchaser is a fiduciary and the supplier has an equitable interest by tracing and not grant, there is no reason why this interest cannot be one that is limited in extent by reference to what the supplier is owed.144 However, as noted (p. 274) above,145 once it is found that the supplier’s interest in the proceeds is defeasible on payment of his debt, then the cases have held his claim to be by way of charge.146 However, those cases all concerned ‘proceeds clauses’ and hence could be regarded as cases where the supplier was held to have a defeasible interest by way of grant (under the clause) from the purchaser rather than by way of a tracing claim.

Contractual provision as to proceeds

7.24  Retention of title clauses sometimes expressly deal with the proceeds of sale and traditionally seek to confer the entire beneficial interest in the proceeds on the supplier.147 However, given the ‘windfall’ issue,148 that interest is either expressly149 or impliedly150 qualified so that the supplier is only entitled to recover what he is owed and so has a ‘defeasible’ interest. As noted above, the case law has regarded such interests arising under ‘proceeds clauses’ as being by way of charge.151

An effective proceeds clause?

7.25  An Australian High Court decision suggests that it may be possible to draft a clause that on the one hand does deal with the ‘windfall’ issue and yet does not give rise to a charge. Thus in Associated Alloys Pty Ltd v ACN 001 452 106 Pty Ltd,152 the purchaser agreed to hold part of the proceeds on trust for the supplier, that part corresponding to the amount owing to the supplier at the time of the receipt of the proceeds, in circumstances where the constitution of that trust discharged153 the purchaser’s debt to the supplier in relation to the goods to which the proceeds related.154 Put another way, the clause gave the supplier a beneficial interest under a trust in part of the proceeds (that part corresponding to his entitlement) in exchange for his corresponding debt, which was extinguished. Assuming such a trust of a quantified part of a fund is possible,155 the question remains whether it gives rise to a charge or not. The majority156 held that it did not, on the basis that a mere beneficial interest under a trust (there of after-acquired (p. 275) property, the proceeds) was not a registrable charge.157 ‘The remedy of the beneficiary is to proceed in equity for the performance of the trust’158 whereas the remedy of a chargee was ‘for the sale of trust property to satisfy a secured liability’.159 As the purchaser’s obligation to pay the supplier was discharged as soon as the trust was constituted by the receipt of the proceeds, the supplier no longer had a (secured) liability but only a beneficial interest in the trust, which did not secure an existing liability and hence was not a charge. The majority stressed the importance of the supplier’s interest being defined in terms of what he was owed and added that had the clause given the supplier a windfall ‘this might have provided a footing for the treatment of the interest of the [supplier] as no more than a charge upon the proceeds to secure the indebtedness of the buyer’. Thus the majority left open what the result would have been had the clause resulted in ‘residual trust property vesting in’ the purchaser (as was the case in the English cases on proceeds clauses160). Moreover, they also left open the position of ‘a trust defeasible upon payment of the debt’,161 presumably on the basis that if the supplier’s debt has not been extinguished, the beneficial interest can be regarded as securing that debt. On the facts however, the supplier could not demonstrate that the requisite trusts had been constituted, as they could not establish which proceeds related to which of his goods. Thus, as in all claims to proceeds, in order to succeed the supplier must ensure that his purchaser adopts a system of dealing with the goods supplied that identifies which goods are on sold or which goods are used to make which products162 and which proceeds relate to which goods or products.

Conditional sale

Conditional sale163

7.26  As its name suggests, a conditional sale is a sale of goods164 where title remains in the seller until the fulfilment of a condition,165 usually the payment of the full price, with possession passing to the buyer immediately at the time the contract is entered into.166 Until the fulfilment of the condition, the purchaser has no right167 to dispose of the goods. Indeed, the conditional sale agreement normally contains an express undertaking (p. 276) by the buyer that he will retain possession168 and not dispose of or otherwise encumber169 the goods without the seller’s (usually written) consent. A great deal of ‘vendor credit’ is by way of conditional sale,170 whether in the consumer context by way of instalment sale171 or in the business or manufacturing sector by way of retention of title clauses in sales contracts.172 By retaining title, the seller is able to exercise his rights as owner should the buyer not fulfil the condition, in particular should the buyer not pay the full price or otherwise default.173 In this way the retention of title performs a ‘security’ function. However, it was established long ago in McEntire v Crossley Bros174 that a conditional sale agreement did not create a ‘security’ for the purposes of the Bills of Sale Act 1882, even in cases where the seller had the right to repossess and sell the goods on default,175 as this right was not granted by the buyer over his own goods but was reserved by the seller. For the same reason, a conditional sale to a corporate buyer does not give rise to a registrable company charge.176

Loss of seller’s title

7.27  The seller’s ‘security’ can be precarious in that he may lose his retained title if the buyer sells to a good faith purchaser.177 Under the Sale of Goods Act 1979, section 25(1)178 a buyer in possession is generally179 able to pass good title to a good faith purchaser without notice of the original seller’s rights. However, section 25(1) only applies if the buyer ‘has bought or agreed to buy goods’ and not, as is the case in hire purchase, where the ‘buyer’ merely has an option to purchase.180 In order to eliminate the distinction between conditional sale and hire purchase agreements within the Consumer Credit Act 1974, section 25(2) of the Sale of Goods Act 1979 now provides that section 25(1) does not apply to a conditional sale agreement that is a ‘consumer credit agreement’ within the 1974 Act.181 There is a separate and much more limited exception to the nemo dat rule applicable to hire purchase that is also applicable (p. 277) to condition sale.182 As will be discussed in the hire purchase section below,183 Part III of the Hire Purchase Act 1964184 enables a hirer under a hire purchase agreement and a conditional buyer (but not a finance lessee) to pass title185 in relation to a ‘motor vehicle’186 in certain circumstances. As hire purchase agreements have always been outside the ‘buyer in possession’ provision in section 25(1), this exception to the nemo dat rule is of particular significance in such agreements. However, now that conditional sale agreements that are within the Consumer Credit Act 1974 are similarly outside section 25(1), Part III of the Hire Purchase Act 1964 has become important for these transactions also.

Conditional sale or hire purchase?

7.28  In deciding whether the agreement is a conditional sale or hire purchase agreement, the crucial issue is whether the buyer has bound himself to buy the goods.187 Most hire purchase agreements give the hirer a contractual right to terminate the agreement188 but if an agreement does not, and the hirer is obliged to pay all the instalments, then he must be given an option to purchase the goods, otherwise the agreement will be a conditional sale agreement.189 The option must be a true option in the sense that, for title to pass, the hirer must make some positive decision to buy. Thus an agreement that was stated to be a ‘hire purchase’ agreement in which the ‘hirer’ was obliged to pay all the instalments, was recharacterized as a conditional sale agreement even though the ‘hirer’ was said to have an ‘option’ to purchase, where he was deemed to have exercised that option on paying all the instalments unless he elected to the contrary.190 It was held that the ‘true nature’ of the agreement was that the buyer had agreed to purchase the goods in that he was obliged to pay all the instalments and this was not affected by the ‘option not to take title, which one would only expect to be exercised in the most unusual circumstances’.191 The Court of Appeal left open whether a contract where the ‘hirer’ is committed to pay all the instalments and has the option to acquire title on taking the positive step of paying an additional nominal sum would be similarly recharacterized192 but a subsequent first instance decision has held that, as long as the hirer has to make a positive decision to exercise the option, it does not matter that the option to purchase fee is nominal.193

Core obligations

7.29  The ‘credit’ aspect of a conditional sale agreement, the deferment of the payment of the purchase price, is reflected in the payment obligations that the buyer (p. 278) undertakes. Thus in a typical conditional sale agreement, the instalments are calculated by adding a ‘finance charge’ to the ‘balance financed’ (the cash price of the goods minus the deposit paid by the buyer) and dividing the total into the requisite number of instalments, which then become payable by the buyer periodically. The agreement obliges the buyer to pay all the instalments194 and usually provides that title to the goods will pass when the buyer has paid all of them and any other sums payable by him. The seller invariably reserves the right to terminate the agreement and recover possession on the occurrence of various specified events, including any195 breach of contract by the buyer and certain other non-breach but prejudicial events such as steps leading up to and including the buyer’s insolvency.196 Express provision is also invariably made requiring the buyer to pay to the seller such a sum as seeks to ensure that the seller is not out of pocket as a result of the termination. The relevant clause usually provides that the seller may recover payments already due but unpaid, the unpaid balance together with any other amounts owing to the seller,197 minus any proceeds of sale of the goods198 and a discount for the accelerated receipt of those amounts that are recovered early. The effectiveness of such a payment clause is considered further below.199

‘Direct collection’

7.30  In practice, dealers wishing to give their customers the facility of purchasing goods by instalments often enter into an arrangement (under a master agreement) with a financial institution (historically known as a ‘finance house’) whereby the financier buys the goods from the dealer and then itself enters into a conditional sale agreement with the customer.200 As the customer is in a direct contractual relationship with the financier who collects the instalments,201 this arrangement is known as the ‘direct collection’ business. The dealer normally has a stock of the financier’s conditional sale agreement documentation on his premises and often helps the customer to complete it.202 When communicated to the financier, this completed documentation constitutes an offer by the customer to enter into the conditional sale agreement with the financier.203 The dealer transmits it for acceptance to the financier, simultaneously with the dealer’s offer to the financier to sell the goods to it. If the transaction is acceptable to the financier, it will accept (p. 279) the two offers and the dealer will release the goods to the customer. In this way, the dealer obtains payment for the goods immediately and the financier provides credit to the customer. Although from an economic point of view the financier ‘lends’ the balance of204 the purchase price to the customer (by paying it over to the dealer) and the customer ‘repays’ by instalments under the conditional sale agreement, in law the dealer sells the goods to the financier, who then sells them on to the customer under a conditional sale agreement. Therefore the financier is the ‘seller’ as far as the customer is concerned and subject to all the liabilities205 (and regulatory consequences206) that this status brings with it.207 In recognition of the economic realities that the financier is essentially only the ‘lender’ and the dealer the true supplier of the goods, the master agreement normally gives the financier rights of recourse against the dealer should the financier become liable as ‘seller’ to the customer, for example if the goods prove defective.208 Moreover, the dealer will also usually guarantee the buyer’s obligations209 or agree to indemnify the financier against loss caused by the buyer’s default.210

Consumer credit regulation

7.31  Conditional sale agreements made with individuals211 are usually ‘regulated credit agreements’212 within the consumer credit regulatory regime (p. 280) imposed by the Financial Services and Markets Act 2000 (FSMA) and the retained provisions of the Consumer Credit Act 1974.213 Indeed, in recognition that conditional sale entails the provision of ‘credit’ (in the sense of deferred payment of the price214), the regime calls the seller the ‘creditor’ or ‘lender’ and the buyer the ‘debtor’ or ‘borrower’.215 The original £25,000 financial limit was abolished,216 but is retained for agreements made for ‘business purposes’.217 If the conditional sale agreement is a ‘regulated credit agreement’, the regulatory regime imposes a number of obligations on the seller/creditor/lender. A seller, such as a financier or dealer218 who carries on the business of making such agreements, needs to be authorized.219 Advertisements promoting such agreements need to comply with the so-called ‘financial promotions’ regime220 and the form and content of the agreements themselves also need to satisfy specific requirements.221 Departing from the usual position at common law,222 in the tripartite ‘direct collection’ dealer-financier-customer situation,223 the dealer is deemed to be the agent of the financier in relation to ‘antecedent negotiations’.224 Hence the financier-seller is liable for any misrepresentations made by the dealer, which may enable the customer to rescind the conditional sale agreement.225 The Consumer Credit Act 1974 also confers a number of rights on the buyer (the ‘debtor’) that cannot be curtailed by the terms of the conditional sale agreement.226 An important protection is the right of the buyer to terminate227 a conditional sale agreement before it has run (p. 281) its course. The Act gives all ‘debtors’ (not only buyers under conditional sale agreements) a statutory right to complete payment ahead of time by serving a notice and tendering the total amount due minus a rebate for early settlement.228 However, buyers under conditional sale (and hirers under hire purchase) agreements have an additional right: the voluntary termination right (VTR).229 The protections conferred by the regulatory regime when regulated conditional sale agreements are enforced are considered below.230

Voluntary termination right

7.32  There is a special provision, applicable only to conditional sale (and hire purchase) agreements, which confers the so-called ‘voluntary termination right’ or ‘VTR’ on buyers (and hirers). Essentially, this enables the buyer (and hirer) to walk away from the agreement on returning the goods and paying (or having paid) half the amount due.231 Thus the buyer (and hirer) is given a statutory right232 to terminate the agreement at any time before the final payment,233 if he pays any sums that have already accrued234 and, in addition, the amount (if any) by which half of the total price exceeds the aggregate of the amounts he has paid and that were due before termination.235 If (unusually236) title has already passed to the buyer, it revests in the seller on termination.237 This ‘one-half rule’ is qualified (downwards) in two respects. First,238 the agreement itself may impose a lesser (but not greater239) liability. Second,240 a court may order that a lesser sum be paid if satisfied that such a sum ‘would be equal to the loss sustained by the [seller] in consequence of the termination’.241

‘Unfair relationships’

7.33  The Consumer Credit Act 1974242 confers a very wide discretion on the court to reopen and rewrite243 credit agreements244 with individuals245 if the (p. 282) ‘relationship between the creditor and the debtor’ arising as a result of the credit agreement and certain ‘related agreements’246 is ‘unfair to the debtor’ on one or more of three grounds.247 The first ground, the terms of the credit agreement (or any ‘related agreement’), is uncontroversial.248 However, the court may also consider how the creditor has exercised or enforced any of his rights (whether under the credit agreement or any ‘related agreement’) and ‘any other thing done (or not done)’ by (or on behalf of) the creditor whether before or after the conclusion of the agreement (or any ‘related agreement’). These factors are novel in rendering pre- and post-contracting behaviour relevant and in controlling the exercise of contractual rights that the creditor has. The threshold for intervention was deliberately249 lowered by the Consumer Credit Act 2006 to the establishment of an ‘unfair relationship’ and in making the pre- and post-contracting behaviour of the creditor relevant.250 Thus all conditional sale agreements made with individuals251 are vulnerable to attack if they are regarded as giving rise to an ‘unfair relationship’, whether at the outset or as a result of the seller’s behaviour before or during the agreement (in particular in relation to the exercise of his rights or their enforcement).

Hire purchase

Hire purchase252

7.34  As its name suggests, a hire purchase agreement is a contract where an owner of goods hires them (i.e. bails them for valuable consideration) to a hirer (or bailee), on terms that the hirer has the option to purchase those goods at some point.253 The fact that the hirer has an option to purchase—and is not bound to do so—distinguishes hire purchase from conditional sale.254 In both cases title is retained by the owner of the goods and the hirer/buyer has possession on terms that he continues to make periodic payments. However, title will not necessarily pass to the hirer in a hire purchase contract, usually because he is given the right to terminate the hire before exercising the option to purchase255 or, even if he has bound himself to make a fixed number of ‘hire’ payments,256 because he needs to exercise an option to purchase on payment of a further (p. 283) (usually nominal)257 sum. Most current forms of hire purchase agreement give the hirer both the right to terminate the hire and an option to purchase at the end of it. The hirer has no right258 to dispose of the goods. Indeed, the hire purchase agreement normally contains an express undertaking by the hirer that he will retain possession259 and not dispose of or otherwise encumber260 the goods.

7.35  Despite this important legal difference between conditional sale and hire purchase—that in hire purchase the hirer is not contractually bound to purchase the goods—in practice the two transactions are used as alternative forms of ‘vendor credit’, with the periodic ‘hire payments’ or ‘rentals’ corresponding to the conditional sale instalments, but with a nominal ‘option fee’ being payable when the hirer completes the hire payments and ‘opts’ to purchase.261 Hence again262 the retention of title by the owner in hire purchase performs a ‘security’ function in giving him rights as such in relation to the goods, should the hirer not fulfil his agreement.

Loss of owner’s title

7.36  As has already been noted,263 the distinction between hire purchase and conditional sale is of particular importance should the hirer/conditional buyer seek to sell the goods to a third party. As a ‘buyer’ in possession, the conditional buyer is generally264 able to pass good title265 under the Sale of Goods Act 1979, section 25(1), whilst a hirer with a mere option to purchase cannot.266 This distinction accounted, at least historically, for the initial popularity of hire purchase over conditional sale and still accounts for its popularity where the distinction still applies. However, the distinction has been eroded by subsequent statutory intervention in two major respects.

7.37  First, as noted above,267 a buyer under a conditional sale agreement that is a consumer credit agreement under the Consumer Credit Act 1974268 can no longer pass title as ‘buyer in possession’ under section 25(1). Hence, to that extent, a buyer under a consumer credit (p. 284) conditional sale agreement has the same inability to pass title under section 25(1) as a hirer under a hire purchase agreement. Second, Part III of the Hire Purchase Act 1964,269 enables both a conditional buyer and a hirer under a hire purchase agreement to pass title270 in the case of a ‘motor vehicle’271 in three main circumstances.272 First, a disposition273 by a hirer (and conditional buyer)274 under a hire purchase agreement (or conditional sale agreement) of a motor vehicle to a ‘private purchaser’275 in good faith and without notice276 of the agreement, operates as if the title of the owner277 had been vested in the hirer (or buyer) immediately before the disposition.278 Moreover, provision is also made for a series of dispositions279 and for the situation where a subsequent disposition is itself a hire purchase (or conditional sale) agreement.280 In essence, as long as the first ‘private purchaser’ is in good faith and without notice, he and those claiming from him are protected in a similar way. The protection is not absolute but merely extends to conferring on that good faith first private purchaser such title as the owner had under the original hire purchase (or conditional sale) agreement.281 To overcome evidential difficulties involved in establishing the exact chain of transactions or the good faith of previous parties, certain rebuttable presumptions apply in any court proceedings.282

Core obligations

7.38  The ‘credit’ aspect of a hire purchase agreement, the effective deferment of the payment of the purchase price,283 is reflected in the hire payment obligations that the hirer undertakes. Thus in a typical hire purchase agreement, the hire payments are calculated by adding a ‘finance charge’ to the ‘balance financed’ (the cash price of the (p. 285) goods minus the deposit paid by the hirer284) and dividing this so-called ‘total hire purchase price’ into the requisite number of hire payments,285 which then become payable by the hirer periodically. However, in contradistinction to a conditional sale agreement, the hirer is almost invariably286 given a contractual287 right to terminate the hiring on payment of an amount that seeks to ensure that the owner is not out of pocket as a result of the termination. Moreover, the owner retains title until the hirer pays all the rentals and exercises his option to purchase, usually on payment of a further (nominal) sum.288 As in the case of conditional sale, the owner also invariably reserves the right to terminate the agreement and recover possession on the occurrence of various specified events, including any289 breach by the hirer and certain other non-breach but prejudicial events such as steps leading up to and including the hirer’s insolvency.290 However, as noted below,291 in the case of a hire purchase agreement it is theoretically possible to terminate the hiring aspect of the agreement without terminating the agreement itself,292 and contractual provision293 is also usually made for the former to occur in certain events (often without notice by the owner repossessing the goods). Again, on termination of the agreement, express provision is made requiring the hirer to pay to the owner such a sum as seeks to ensure that the owner is not out of pocket as a result of the termination. Modern hire purchase contracts usually confirm that rentals already due are recoverable294 and then merely add, ‘together with damages for all loss sustained by the owner’. Alternatively, they may provide that the same ‘repudiatory measure’ is recoverable as when the hirer terminates.295 The effectiveness of such payment clauses is considered further below.296

Hirer’s contractual right of termination

7.39  Most hire purchase agreements (unlike conditional sale agreements) give the hirer a contractual right to terminate the agreement by returning the goods and paying a certain sum that seeks to ensure that the owner is not (p. 286) out of pocket should this occur. Historically,297 these so-called ‘minimum payment’ clauses often required the hirer to pay ‘by way of compensation for depreciation’ an amount which (for example) meant the owner received one-half298 or some other fraction299 of the total amount due had the agreement run its course. Today, if the agreement is within the Consumer Credit Act 1974, then it cannot provide for more than half of the total hire purchase price to be payable.300 However, for agreements outside the scope of the Act, a common form of clause requires the hirer to pay an amount that essentially equals the damages he would pay for repudiatory breach.301 As noted below,302 such a clause will withstand challenge as a ‘penalty’ (as it is payable on voluntary termination and not breach) but may be regarded as ‘unfair’ in consumer contracts303 or as giving rise to an ‘unfair relationship’.304

‘Direct collection’

7.40  The practice described above in relation to conditional sale,305 whereby a dealer wishing to give his customers the facility of purchasing his goods by instalments often enters into an arrangement with a financier to the effect that the financier buys the goods from the dealer and then itself enters into an instalment sale agreement with the customer,306 also operates in relation to hire purchase, except that the financier enters into hire purchase agreements with the customer. Again the economic reality is that the financier ‘lends’ the balance of307 the purchase price to the customer (by paying it over to the dealer) and the customer ‘repays’ by rental payments under the hire purchase agreement. However, in law the dealer sells the goods to the financier, who then hires them to the customer under a hire purchase agreement. Therefore the financier is the ‘owner’ as far as the customer is concerned and subject to all the liabilities308 (and regulatory consequences309) (p. 287) that this status brings with it.310 The master agreement between the dealer and the financier normally gives the financier rights of recourse against the dealer should the goods prove defective311 or the hirer default on his obligations.

Consumer credit regulation

7.41  Hire purchase agreements made with individuals312 are usually ‘regulated credit agreements’313 within the consumer credit regulatory regime imposed by the FSMA and the retained provisions of the Consumer Credit Act 1974.314 Although the regime also makes provision for the regulation of pure ‘hire’ agreements,315 it explicitly provides that hire purchase agreements are ‘credit’ and not ‘hire’ agreements, for the purposes of the regime.316 Indeed, in recognition that in effect a hire purchase agreement entails the provision of ‘credit’, the regime calls the owner the ‘creditor’ or ‘lender’ and the hirer the ‘debtor’ or ‘borrower’.317 The original £25,000 financial limit was abolished,318 but is retained for agreements made for ‘business purposes’.319 If the hire purchase agreement is a ‘regulated credit agreement’, the consumer credit regulatory regime imposes a number of obligations on the owner/creditor/lender. These correspond to those imposed on the seller under a conditional sale agreement and reference should be made to the relevant discussion above.320 The regime also confers a number of rights on the hirer (the ‘debtor/borrower’) that cannot be curtailed by the terms of hire purchase agreement.321 The general right to terminate the agreement before it has run its course and the specific (to conditional sale (p. 288) and hire purchase) ‘voluntary termination right’ have also been considered above.322 The protections conferred by the regime when regulated hire purchase agreements are enforced are considered below.323

Unfair relationships

7.42  The discussion above324 on the application of these provisions in the Consumer Credit Act 1974 to conditional sale agreements is equally applicable to hire purchase agreements. Thus all hire purchase agreements made with individuals325 are vulnerable to attack if they are regarded as giving rise to an ‘unfair relationship’.

Finance lease

Finance lease326

7.43  The ‘finance lease’ (sometimes called an ‘equipment lease’) has developed as an alternative to conditional sale and hire purchase, where the goods have a limited useful life and the person taking possession has no interest in obtaining title to the goods as opposed to possession and use during that useful life. In law it is a contract of ‘hire’, that is, a bailment of goods where the bailee or hirer pays a monetary amount (‘rent’) for possession and the right to use them. As in all bailments,327 ownership of the goods is retained by the bailor, who is therefore entitled to have possession of the goods returned to him at the end of the bailment. At common law, a bailee is bound to take reasonable care of the goods328 but the finance lease typically modifies this obligation in order to augment the lessor-financier’s ‘security’. Thus the bailee/lessee typically agrees to keep the goods in good working order and repair329 and he usually also undertakes responsibility for the costs of using the goods, for example paying all taxes and charges associated with their use.330 The bailee/lessee has no right to dispose of the goods.331 Indeed, the finance lease agreement normally contains an express undertaking by the lessee that he will retain possession and not dispose of or otherwise encumber the goods with any interest adverse to the lessor-financier’s title,332 unless it is a head lease in the context of leverage leasing,333 in which case it will permit the financier (the lessee under the head lease) to effect specified sub-leases in restricted circumstances.

‘Operating’ and ‘finance’ leases

(p. 289) 7.44  Hire contracts may take many forms and in commerce are given many names. A major practical (and, historically, accounting) distinction is between so-called ‘operating leases’ and ‘finance leases’.334 ‘Operating leases’ are the familiar short-term hire contracts where goods, which have a reasonably long economic life, are hired out for successive, relatively short, periods. The lessor ‘retains most of the risks and rewards of ownership’ of the goods.335 They are not considered further in this text as they do not perform a security function. ‘Finance leases’ are more sophisticated financing transactions where, in essence, a financier hires the goods out for the duration of their useful life and receives by way of rental payment from the lessee its capital outlay in purchasing336 the goods together with a return on that outlay. This time the lessee ‘has substantially all the risks and rewards associated with the ownership’ of the goods other than title.

Comparison with conditional sale and hire purchase

7.45  In enabling the lessee to have possession and use of the goods for the duration of their useful life, the finance lease performs a similar economic function to a conditional sale or hire purchase contract, all three categories of transaction having the common feature that the retention of the title by the owner has a ‘security’ function that ‘secures’ the periodical payments.337 Indeed, finance leases usually involve similar tripartite arrangements to those in the ‘direct collection’ business,338 with the lessee choosing the goods from a supplier, the supplier selling them to the financier339 and the financier leasing them out to the lessee. However, in law, the finance lease is merely a contract of hire; the goods remain the property of the lessor-financier and can never become the property of the lessee under the hire contract. Should the lessee be given an option to purchase or be obliged to purchase the goods under the hire contract, the contract will be one of hire purchase340 or sale,341 respectively. Nevertheless, as will be noted below,342 the finance lease often gives the lessee the right to receive the benefit of any proceeds of sale of the goods and in that case there is no real economic difference between the three types of transaction.

Advantages of leasing

7.46  If the goods have a limited life in that they have little residual value after a given period, from the economic point of view it makes little difference to the person who wishes to use them whether he obtains possession under a conditional sale, a hire purchase contract or a finance lease.343 Moreover, from the financier’s point of view, all (p. 290) three types of agreement entail the retention of title and hence perform a ‘security’ function without some of the disadvantages of ‘true’ security. However, there are additional advantages that a finance lease has over the other two retention of title transactions. Historically, the major reason344 for the popularity of the finance lease was its favourable taxation treatment, although this advantage has now been eroded.345 In essence, the capital allowance could be claimed by the lessor-financier346 (and hence reflected in a reduction in the rentals it charges) and the rentals are deductible as a revenue expense by the lessee. A second advantage is that there are no specific statutory exceptions to the nemo dat rule in the cases of a hire contract and hence the lessor-financier is less likely to lose title to a third party.347


7.47  The finance lease takes many forms, which are devised according to the goods involved and the commercial (especially cash flow) needs of the lessee. Indeed, it is this flexibility that probably contributes to its continuing popularity. The common feature is that the lessor-financier’s capital outlay in purchasing348 the goods and its finance charges are recovered by way of the rentals paid by the lessee during the minimum ‘primary period’ of the lease. This period therefore corresponds to the anticipated useful life of the goods. Provision is then made for dealing with the goods thereafter and for adjusting the financial position between the parties. As the goods have been ‘paid for’ in the primary period, the lessee may be given the option to rehire them349 (or the lease may automatically continue) at a much lower rental for a further (‘secondary’) period.350 Alternatively, the goods may be sold351 and the proceeds (or most of them) transferred to the lessee.352 If a financier and lessee envisage a long-term relationship, for example if the lessee wishes to meet all his long-term equipment needs by leasing the equipment from a particular financier under a number of finance leases, the two parties may enter into a facultative353 master agreement, which sets out the standard terms on which future finance leases will be made.354

Leveraged leasing355

7.48  The lessor-financier may itself wish to obtain funds (‘leverage’) from other financiers (‘funders’356) to enable it to enter into financial leases.357 These (p. 291) funders will themselves usually wish to be secured in relation to the lessor-financier’s obligations to them and they too may use retention of title devices to achieve this, as an alternative to lending the money to enable the lessor-financier to purchase the goods and taking a charge over the goods themselves and the rentals payable under the finance leases.358 Hence such funders may themselves purchase the goods from the supplier and let them out (either under a lease or hire purchase agreement) to the lessor-financier on terms that it may sub-lease to the ultimate lessee. The head lease or hire purchase agreement, as it involves a retention of title by the funder, will not give rise to a registrable charge,359 although the funder often also takes a charge360 over the sub-lease agreements and the sub-rentals payable under them. Such an arrangement presents problems for the lessor-financier as it then only has a possessory right in the goods (under the head lease or hire purchase agreement). Hence if the head lease or hire purchase agreement is terminated, this right (and the lessor-financier’s entitlement to the sub-rentals) also terminates. However, as the sub-lease will have been permitted under the terms of the head lease or hire purchase agreement, it will bind the funder, who will be entitled to collect the sub-rentals.361 As this right is a contractual right under the sub-lease, which derives from the funder’s status as owner of the goods, it is not a registrable charge.362

Loss of lessor’s title

7.49  The statutory exceptions to the nemo dat rule applicable to conditional sale363 and hire purchase364 agreements, do not apply to hire contracts.365 Hence the lessor-financier’s ‘security’ under a finance lease is less precarious than that of the financier under those other retention of title transactions. However, in leverage leasing,366 the head lease (between the funder and the financier) necessarily permits the financier to effect sub-leases and hence these sub-leases are binding on the funder. As noted above, this may often be advantageous to the funder in that if the head lease is terminated, the sub-lease is still binding on it (as owner of the goods who has permitted them to be sub-leased by its lessee) and the funder has the right to continue to collect the sub-rentals, which right is not a registrable charge.367

Core obligations

7.50  As noted above, the rentals during the ‘primary period’ of a finance lease amortize the lessor-financier’s capital outlay in purchasing the goods and enable it to make a return on that outlay.368 Hence the lessee is generally369 obliged to hire the goods (p. 292) for that minimum period and has no right to terminate during it.370 At the end of the primary period, a number of consequences may be provided for by the contract,371 but crucially the contract cannot provide that title may372 or must373 pass to the lessee; title must be retained by the lessor-financier. Being a bailment where ownership can never pass to the hirer, the lessee is obliged at common law, at his own expense, to return the goods to the lessor-financier374 at the end of the primary period.375 However, the finance lease will often modify this obligation (although confirming that return is at the lessee’s expense). As has also been noted, by the terms of the finance lease, the lessor-financier transfers ‘all the risks and rewards associated with the ownership’ of the goods to the lessee.376 The lessor-financier invariably reserves the right to terminate the lease and recover possession on the occurrence of various specified events,377 including any378 breach by the lessee and certain other events that are prejudicial to the lessor-financier, such as steps leading up to and including the lessee’s insolvency.379 On termination, express provision is made for the lessee to pay to the lessor-financier such a sum as seeks to ensure that the lessor-financier is not out-of-pocket as a result of the termination. The relevant clause usually provides that the lessor-financier may recover the rentals already due but unpaid together with future rentals,380 the future rentals being discounted to reflect their accelerated receipt.381 If the finance lease does not give the lessee the right to keep any proceeds of sale of the goods, then those proceeds (discounted to reflect early receipt) will also be added to the amount recoverable by the lessor. The effectiveness of such a payment clause is considered further below.382 Finance leases are ‘contracts for the hire of goods’383 within the Supply of Goods and Services Act 1982 and hence subject to the terms implied by that Act.384 As in the (p. 293) case of conditional sale385 and hire purchase,386 it is customary for the lessor-financier to include exclusion of liability clauses in the finance lease, giving rise to the usual issues as to their effectiveness.387

Consumer credit regulation

7.51  The consumer credit regulatory regime imposed by the FSMA and the retained provisions of the Consumer Credit Act 1974388 makes special provision for ‘regulated hire agreements’, which are defined389 as agreements390 made with individuals391 for the bailment392 of goods which (1) are not hire purchase agreements393 and (2) are capable of subsisting for more than three months.394 The original £25,000 financial limit has been abolished,395 but is retained for agreements made for ‘business purposes’.396 Hence, the majority of finance leases are still outside the regime either because the lessee is corporate or because the lessee hires the goods for his business and the amounts involved exceed £25,000. If the finance lease is a ‘regulated hire agreement’, the regulatory regime imposes a number of obligations on the lessor-financier (called the ‘owner’ under the regime). A lessor-financier who carries on the business of making such agreements needs to be authorized.397 Advertisements promoting such agreements need to comply with the so-called ‘financial promotion’ regime398 and the form and content of the finance lease agreements themselves also need to satisfy specific requirements.399 However, in a (p. 294) departure from the position in relation to conditional sale400 and hire purchase,401 in the tripartite supplier-financier-customer situation, the supplier is not deemed by the statute to be the agent of the lessor-financier in relation to ‘antecedent negotiations’.402 Thus, whether he is the agent or not (so as, for example, to bind the lessor-financier in respect of any representations they make) must be ascertained according to ordinary common law principles.403 The Consumer Credit Act 1974 also confers a number of rights on the lessee (called the ‘hirer’ under the Act) that cannot be curtailed by the terms of the lease agreement.404 An important protection is the statutory right to terminate405 a hire agreement by notice after eighteen months, before it has run its course.406 However, the typical finance lease407 usually falls within one of the cases where this right is excluded, in particular where the lessee hires goods ‘for the purposes of a business’408 and ‘the goods are selected by him and acquired by the owner for the purposes of the agreement at the request of the hirer’.409 The protections conferred by the regulatory regime when regulated hire agreements are enforced are considered below.410

Not ‘credit’

7.52  Unlike hire purchase agreements,411 hire agreements are not considered ‘credit’ agreements for the purposes of the consumer credit regulatory regime and a separate regulatory regime is provided for those hire agreements that fall within its scope. In particular, neither the protection conferred on ‘protected goods’ in relation to conditional sale and hire purchase412 nor the jurisdiction of the court to reopen ‘unfair relationships’413 apply to hire agreements. The court has a more limited power to provide ‘financial relief’ for the hirer.414

(p. 295) Sale and lease-back/sale and buy-back

‘Sale and lease-back’ and ‘sale and buy-back’

7.53  The legal difference between a transaction that creates a security interest, and one that transfers an absolute interest, has already been noted.415 Yet both transactions result in the obtaining of funds by the owner of the assets and therefore an obvious way to avoid creating a security interest is to transfer (that is, sell) the absolute interest instead. In cases where the seller wishes to retain possession and perhaps recover ownership of the assets at a later stage, in addition to effecting the absolute transfer, the arrangement will confer such rights on him. This gives rise to the so-called ‘sale and lease-back’ or ‘sale and buy-back’ transaction. The debtor ‘sells’ his assets and receives a ‘price’, but the buyer agrees to allow him to retain possession on payment of a ‘rent’ (sale and lease-back) and/or to repurchase the assets at a later stage (sale and buy-back). If the sum total of the payments to be made by the ‘seller’ to the ‘buyer’ equals the ‘price’ plus an amount representing interest on that money, the economic equivalence of that transaction to a loan on the security of the assets is clear. However, neither the original ‘sale’416 nor the retention of title417 in the lease, hire purchase or conditional sale (as the case may be) aspect of the transaction, gives rise to true ‘security’ interests.

Sale or security?

7.54  There is a considerable amount of case law on such arrangements, some of it accepting them at face value418 and some of it recharacterizing them as a security transactions.419 The case law in the latter category has mainly concerned individuals wishing to borrow money on the security of their assets420 who were offered a sale and lease-back421 or sale and buy-back422 transaction instead of a loan secured on those assets. The result of recharacterizing the transaction as one of a secured loan, was that it gave rise to a registrable bill of sale and hence that the transaction was void either as against the borrower’s trustee in bankruptcy423 or as between the parties.424 The courts’ reasoning is usually consistent (p. 296) with the arrangements being regarded as a ‘sham’:425 the ‘true nature’ of the agreement not being reflected in the documents:

So when the transaction is in truth merely a loan transaction, and the lender is to be repaid his loan and to have security upon the goods, it will be unavailing to cloak the reality of the transaction by a sham purchase and hiring.426

This is particularly the case where the buyer, having repossessed the goods on breach of the hire agreement and sold them, was only entitled to keep the amount due to him, accounting for any surplus,427 as this is an indicator of a security rather than a sale transaction.428 Moreover, case law where the issue was whether the transaction was void as between the parties has stressed the fact that one aspect of the Bills of Sale Acts is the protection of borrowers and that this justifies a greater readiness to find that the transaction is really a (secured) loan.429 However, now that there is statutory consumer protection in even the quasi-security context of hire purchase,430 conditional sale431 and leasing,432 there is less incentive to recharacterize such transactions, when part of a sale and lease-back or buy-back arrangements, as secured loans.

True sale

7.55  There is a significant number of cases where the sale and lease-back or sale and buy-back transaction has survived challenged as a secured loan. Early examples of such case law concerned companies wishing to raise money on the basis of their rolling stock.433 In the leading case,434 the company originally intended to borrow the money on the security of that stock. However, on being legally advised that this would be ultra vires, but that a sale and lease-back would not be, the company sold the stock and hired it back under a hire purchase agreement.435 As this was a transaction between two commercial concerns, deliberately structured on legal advice to overcome a legal obstacle to borrowing, the Court of Appeal saw no reason to recharacterize it as anything else:

The parties meant [the transaction] to operate according to its tenor as comprised in the deeds. It was not intended by them as a mere blind or cloak for something behind, it was a transaction substituted for another, but bona fide substituted, and intended to be acted upon according to its purport and apparent effect.436

(p. 297) 7.56  Later case law concerned instances of collusion between a car dealer who had arrangements with a finance company for the hire purchase of his stock by his customers437 and a person already owning a car who wished to raise money.438 In essence, the scheme usually entailed the dealer buying the car and then utilizing the arrangements it had with the finance company and so selling it to the company, which then let the car out on hire purchase to the original owner.439 When the finance company sought to enforce the hire purchase agreement, the original owner (the ‘hirer’ under the hire purchase agreement) resisted enforcement on the basis that the whole transaction was a secured loan and hence void either as an unregistered bill of sale440 or an unregistered charge under the Companies Act.441 In two early decisions the challenge succeeded,442 but since then the Court of Appeal443 has consistently refused to recharacterize the transaction as one of loan, upholding the sale to the finance company and the consequent hire purchase transaction as genuine. As well as the obvious unmeritorious nature of the recharacterization argument,444 a crucial factor has been the lack of knowledge on the part of the finance company that it was letting the vehicle back to the original owner rather than an ordinary customer of the dealer.445 This factor enabled the Court of Appeal to distinguish earlier authorities and clearly it is easier to suggest that the arrangements are a ‘sham’ and that the documentation does not reflect the true nature of the transaction if both parties ‘intend to mask a mere loan’.446 However, in other cases the common intention of the parties to avoid a loan has not been regarded as a factor supportive of recharacterization.447 On the contrary, it is often supportive of a characterization in line with that common intention.

Risks of recharacterization

7.57  The case law on sale and lease-back and sale and buy-back transactions indicates that of all the quasi-security devices, such transactions are the most vulnerable to challenge. However, successful challenges have generally only been in the (p. 298) consumer protection448 context and can be regarded as ‘sham’ cases.449 Where two business undertakings deliberately structure their transaction as a sale and lease-back (or buy-back) and operate the transaction according to its terms, it is most unlikely that the courts will recharacterize the transaction as a secured loan.450 A recent example of recharacterization can be cited, but this was a case of a complex financial arrangements where the nature of the interests created were unclear and the court therefore needed to characterize, rather than recharacterize, the transaction.451 Even in a ‘consumer’ context, in line with the case law on the other quasi-security devices,452 the more traditional sale and lease-back or buy-back transactions are likely to be upheld, absent factors that suggest they are a ‘sham’.453 Thus in finance leasing the prospective lessee sometimes buys the goods from the supplier as principal and sells them on to the lessor-financier, taking them back on a finance lease.454 There is no reason to suppose that such a transaction will not be taken at face value. The ‘collusion’ cases455 might suggest, at least in the consumer context, that such a transaction might be recharacterized as a secured loan where the lessor-financier is aware that the lessee is the original owner. However, as noted above, the fact that a transaction has been deliberately structured to avoid the consequences of secured lending is not, in other contexts, enough to cause recharacterization and it is suggested that this should also be the case in sale and lease-back or buy-back.

C.  Title transfer financial collateral arrangements


Title transfer of financial collateral as alternative to charge

7.58  As an alternative to taking security over various forms of financial collateral (securities, ‘cash’, or credit claims), the parties may enter an arrangement under which the financial collateral is transferred outright from the collateral provider to the collateral taker. In the classic ‘repo’ arrangement the transfer will be in exchange for cash,456 but title transfer arrangements may also be used to provide collateral under a derivatives transaction or to provide ‘margin’ to an individual or central counterparty.457

Title transfer and the FCARs

(p. 299) 7.59  Title transfer arrangements over financial collateral between non-natural persons fall within the Financial Collateral Arrangements (No 2) Regulations 2003 (FCARs)458 that implement the Directive on Financial Collateral Arrangements,459 if the purpose of the arrangement460 is to secure or cover relevant obligations.461 The FCARs are discussed in detail in chapter 3. Their impact on title transfer arrangements is much more limited than on security financial collateral arrangements. Title transfer arrangements have never been registrable;462 the collateral taker’s right of use463 is inherent in the arrangement, as the only obligation is to retransfer financial collateral of the same type; likewise the right of appropriation464 is also inherent, as the obligation to re-transfer will end if the arrangement is terminated for the collateral provider’s default and will be replaced by a requirement to refund any balance after the value of the financial collateral has been netted off against the sums due from the collateral provider; close-off netting is in any event protected under other legislation,465 and many of the insolvency provisions that are disapplied by the FCARs in the case of security financial collateral arrangements had no application to title transfer arrangements.


Repos as alternative to charge

7.60  With investment securities such as bonds and shares, an alternative to mortgaging or charging466 the securities is to use a ‘repo’ or, more fully, a ‘sale and repurchase agreement’.467 In essence,468 the borrower sells the securities to the financier for cash and agrees to repurchase equivalent securities at the original sale price plus a sum that represents the financing charge for the period during which the arrangement has lasted (the ‘repo rate’). Thus although the buyer has legal ownership of the security for the repo term, the seller retains all significant benefits and risks relating to the security [such as] movements in market price.469 Many repos are for short fixed periods, such as overnight; others are for longer fixed periods, and others still may be ‘open-term’ repos under which the arrangement can be extended from day to day, or will remain in force until terminated upon demand.470

Repos and reverse repos

(p. 300) 7.61  Just as a single transaction may be referred to as a ‘sale’ when looked at from the point of view of the seller and as a ‘purchase’ from the buyer’s point of view, so a sale and repurchase is often referred to as a ‘repo’ from the point of view of the original seller (in the example above, the borrower) and as a ‘reverse repo’ when looked at from the point of view of the original buyer (the financier).

Repos and sell/buy-backs

7.62  A distinction is also sometimes drawn between a repo, under which the agreement is for sale and later repurchase at the original price with a separate payment for the financing charge, and a ‘sell/buy-back’ where there is simply an agreement for a sale at one price and for repurchase at a higher price, which includes the sum representing the repo rate. The practical effect is much the same.

Standard forms of repo

7.63  Most repo transactions in the London market are conducted under the terms of the Global Master Repurchase Agreement (‘GMRA’) of the Securities Industry and Financial Markets Association (New York) and the International Capital Market Association (Zurich).471 Repos were originally used primarily for Treasury and similar fixed-income securities, because of their relatively stable values, but they are now also used for equities, and the standard form now has an appropriate annex.472

Master agreements

7.64  It is common for there to be a master agreement between the parties under which a number of transactions can be covered by the same arrangements. If the net exposure of the parties may vary over time, so that one party will sometimes be a net creditor and sometimes a net debtor, the agreement may entitle either party to call for ‘collateral’ to be transferred outright. Thus there may be several transfers in each direction. The master agreement will commonly allow net deficits on one transaction to be set off against net surpluses on another, so reducing each party’s exposure.473

Mechanism on default

7.65  Should the seller default on its repurchase obligation or in some other way,474 or if either party becomes insolvent, the non-defaulting party may serve a notice of ‘early termination’.475 The buyer’s obligation to transfer back equivalent securities will be replaced by an obligation to pay their current market value.476 This and the buyer’s obligations are accelerated so that they become due on the early termination date.477 The seller’s obligation to pay the current value will be set off against the sums that were due from the original seller on repurchase,478 so that depending on the value of the securities at that time a sum will be payable in one direction or the other (‘close-out netting’).

Right of use

(p. 301) 7.66  A particular advantage of the classic form of repo so far described is that the buyer (the financier) becomes outright owner of the investment securities. Its only obligation is to redeliver equivalent securities479 when the original seller (borrower) is to repurchase.480 The financier can thus deal with them as it wishes, for example by itself using them as collateral (whether by way of further repos or true security arrangements).

Substitution of other securities

7.67  The standard agreement also permits the original seller to repurchase securities and replace them with others of the same value. This requires the buyer’s agreement on each occasion.481 Giving an equivalent right under a charge would not prevent it being a fixed charge. However, there seems no reason why a repo agreement should not give the seller the right to substitute according to fixed criteria, so that it is not necessary to obtain the other party’s consent to each substitution. To give such a right under a charge might well result in the charge being only a floating charge.482


7.68  It is usual for the agreement to provide that dividends and similar payments by the issuer that become due during the period of the repo will be passed to the original seller.483 In sell/buy-back arrangements the same effect may be achieved by adjusting the price of the buy-back.484


7.69  The repurchase price is tied to the original sale price, not to the current market value of the investment securities. Thus the financier will want to ensure that the investments are worth sufficient to cover the repurchase price and the financing charge. The original price may therefore represent a degree of ‘over-collateralization’. Conversely, if the value of the securities exceeds the sums due, the borrower is faced with a credit risk in the form that, were the financier to become insolvent, the borrower might not recover the sums that would be due to it after close-out netting. Thus the agreements normally provide for what is called ‘marking to market’. If the value of the investments falls below a certain level, the financier may call for further securities to be transferred to it; if they rise above a certain level, the borrower is entitled to repurchase an appropriate number of securities.486 Failure by either party to comply will be a default that will trigger close-out netting.487

Recharacterization risk

7.70  A repo in many ways performs the same function as a charge.488 The original buyer (the financier) is protected against the original seller’s (‘borrower’s’) failure to return the money advanced in the form of the repurchase price, and to pay the (p. 302) financing charges (the ‘repo rate’), except to the extent that the current value of the investment securities falls short of what is due. The ‘borrower’ stands to recover any net surplus, save if the financier has become insolvent. It is clear that repos are often used as a form of ‘quasi-security’, though they are also used for other purposes.489 Nonetheless because classic repo transactions and sell/buy-backs are structured as outright sales and as outright purchases back, there appears to be no risk that either a repo or a sell/buy-back will be recharacterized as a charge.490

Agency and tri-party repos

7.71  Because the administration of a repo can be burdensome, some parties will delegate it to a third party such as a global custodian. Under the tri-party repo, a bank or system operator administers the repo for both the parties. It has rightly been pointed out that with such arrangements it is important that the buyer’s right to take delivery of the securities from the agent is not restricted, because if it were the arrangement might risk being characterized as a security agreement, not a sale.491

Hold-in-custody repos

7.72  Under this kind of arrangement the investment securities are sold but are kept by the seller in custody for the buyer. This is obviously risky for the buyer492 and we understand that such transactions are not common.

Stock lending

7.73  It is worth contrasting repos to a similar looking transaction, the stock loan,493 under which investment securities are ‘loaned’ to a party who needs them temporarily, for example when it has bought and resold securities and has to deliver them under the resale before it has received them (a ‘short position’). The borrower is obliged to retransfer equivalent securities. Transactions of this kind usually involve the borrower having to give to the lender collateral for the borrower’s obligation to retransfer equivalent securities. This collateral, in the form of cash or securities, is provided on a title transfer basis, so that ownership is transferred to the lender, who must transfer equivalent collateral to the borrower once the borrower’s obligation to transfer equivalent securities is fulfilled. The stock loan itself does not normally perform the function of a loan of money although if the ‘collateral’ provided for the return of the stock is cash (which is very often the case) the stock ‘lender’ will have use of the cash during the period of the stock loan. However, the purpose of the arrangement is to allow the stock borrower use of the securities and the stock lender will receive a fee for its use.494 In Beconwood Securities Pty Ltd v ANZ Banking Group the Federal Court of Australia held that a stock loan agreement should not be recharacterized as a mortgage.495 The principal reasons given were, first, that the title to both the stock lent and the collateral provided by the stock borrower passed unencumbered to the other party; (p. 303) secondly, that when the transaction comes to an end the obligation is not to return the securities initially lent or the collateral actually provided, but merely to return equivalents; and thirdly, that the redelivery obligations are converted into payment obligations, which are set off against one another.496

Title transfer arrangements to provide margin

Title transfer to provide margin in derivatives transactions

7.74  Title transfer arrangements are also commonly used in relation to derivatives transactions to provide collateral (usually variation margin and, more rarely, initial margin497) to the counterparty or to a central counterparty.498 The European Market Infrastructure Regulation (EMIR)499 makes central clearing compulsory for many derivatives trades and requires the posting of both variation and initial margin to the central clearing house.500 It also required posting of variation and initial margin on both sides of an over-the-counter (OTC) derivatives transaction: this was a change from the market practice where initial margin was regularly only posted if a party had concerns about the credit position of its counterparty.501 Regulatory Technical Standards (RTS) were issued under EMIR502 as to the methods by which such collateral must be posted. For example, where the derivatives transaction is on the terms of the ISDA Master Agreement, the parties may enter a Credit Support Annex503 that provides for ‘variation margin’504 in the form of outright transfers of collateral depending on the net exposure of the transferee to the credit risk of the transferor, and for the return of collateral if the exposure reduces.505 If the obligations under the derivatives agreement are satisfied, or if either party defaults, the transfer arrangement will operate in the same way as described earlier for repos, in other words the obligations and the collateral will be netted off.506

(p. 304) D.  Receivables

General principles



7.75  The term ‘receivables’ refers to amounts due to (‘receivable’ by) a business, with the term ‘documentary receivables’ being used to denote negotiable instruments that embody receivables.507 Legally, receivables are ‘choses in action’, that is, rights enforceable by court action.508 Historically, English law has generally used the term ‘book debts’ to denote such amounts and this term occurred in those statutes that required the registration of certain transactions involving ‘book debts’: the Companies and Insolvency Acts.509 As a result, the term ‘book debt’ has acquired a specific meaning, essentially an amount due in the course of a business which is normally entered into the ‘books’ of the business.510 Hence not all ‘receivables’ are ‘book debts’, a distinction that was of relevance when the registrability of a transaction was being considered under the old Companies Acts511 and still is of relevance under the Insolvency Act 1986.512 However, modern commerce,513 influenced by American terminology, tends to use the wider term ‘receivables’ (shortened from ‘accounts receivable’) to refer to all debts owed to a business. The following discussion will adopt that wider term, although when it comes to determining if transactions are registrable by virtue of the Insolvency Act 1986, the question of whether ‘book debts’ (as opposed to receivables) are involved will need to be asked.


7.76  As receivables are choses in action, dealings in them are effected by way of assignment. The assignment may either be an equitable assignment or a statutory (‘legal’) assignment under the Law of Property Act 1925, section 136. An equitable assignment merely requires the assignor to intend to transfer the relevant interest in the receivables to the assignee.514 No special formality or notice to the debtor is required.515 On the other hand, a statutory assignment needs to satisfy the substantive516 and formal requirements of the Law of Property Act 1925, section 136. An important formal requirement is that it must be in writing and ‘express notice in writing’ must be given to the debtor.517 Although usually called a ‘legal’ assignment (in that section 136 states that an assignment within its (p. 305) terms ‘is effectual in law’ and passes ‘the legal right to such debt or thing in action’ and ‘all legal … remedies’), that term is misleading in so far as it may imply that the ‘bona fide legal purchaser’ rule applies, so that a subsequent statutory assignment prevails over a previous equitable one.518 Section 136 explicitly states that the assignment ‘is effectual in law (subject to equities having priority over the right of the assignee)’ and therefore the assignment takes subject to prior equitable assignments (‘equities’). Priority between assignments is determined by the rule in Deale v Hall 519 (and thus is preserved by giving notice to the debtor) and is not dependent on whether the assignment is equitable or ‘legal’ (that is, statutory).520 As will be considered below,521 not giving notice has a number of disadvantages, but nevertheless equitable assignments are normally regarded as satisfactory in receivables financing, unless the assignee wishes to bring an action in his own name (without joining the assignor) for the debt, in which case he usually522 needs to ensure that he has obtained a statutory assignment, which will (unless this has already occurred) entail giving notice in writing to the account-debtor.

Value of receivable

7.77  The receivables of a business constitute a significant—often the most significant—part of its assets. Their economic value will primarily depend on two main factors: the length of time before they become payable and how likely the account-debtors are to fulfil their obligations. The effect of the former factor on value entails a familiar calculation and essentially depends on predicting the movement of interest rates in the future. The effect of the latter is also not difficult to evaluate by those familiar with the relevant market and the categories of customer the business has. A third factor is whether the assignee is legally entitled to the face value of the debt. Thus the account-debtor may have defences or cross-claims that will diminish or extinguish the debt he prima facie owes or, more fundamentally, he may raise the argument that the receivable is not assignable at all. Both these issues will now be considered in turn.

Defences and cross-claims

Defences and cross-claims523

7.78  The general principle is that a debtor should not be prejudiced by an assignment of the debt he owes. This principle was reflected in the old cases on equitable assignment by the principle that the assignee took subject to ‘equities’.524 In relation to statutory assignment, as noted above, the Law of Property Act 1925, section 136 expressly reflects this latter principle by stating that the assignee takes ‘subject to equities having priority over the right of the assignee’.

(p. 306) 7.79  Most obviously, any rights that the debtor has under the contract giving rise to his debt,525 which affects his liability, can be asserted against the assignee. Such rights may not only reduce the amount that the assignee can recover526 but may affect the assignee’s right in other ways.527 In addition, any rights of set-off that the debtor has against the assignor may also be asserted against the assignee,528 at least until he receives notice of the assignment. Such rights of set-off are generally regarded as ‘equities’ even if they are technically not equitable but other categories of rights of set-off. The issue of when such ‘equities’ can be asserted has usually arisen in the context of whether notice has affected such rights and is considered more fully in the discussion of the effect of notice, below.529

Assignability and non-assignment clauses

Assignability and non-assignment clauses

7.80  Although certain choses in action cannot be assigned at all and although some assignments are void on grounds of public policy,530 generally these limitations on assignability do not arise in receivables financing. However, there is one assignability issue that is relevant: what is the effect of a ‘non-assignment clause’ in the contract giving rise to the receivable: that is, a clause prohibiting or restricting the assignment of receivables arising under it?531 As a matter of interpretation, the clause may purport to operate in a number of different ways532 but most usually it purports to preclude an assignee from acquiring any direct rights against the obligor (such as a debtor) from the obligee (such as a creditor).

Reasons for non-assignment clauses533

7.81  There are many reasons why an obligor may not wish his obligee to assign the chose in action, with the result that the obligor has to deal with an assignee rather than his original obligee. The identity of the obligor’s counterparty may be important to him in certain contexts.534 Thus non-assignment clauses are standard practice in building contracts and syndicated loans, where the attitude of the counterparty (p. 307) to performance and enforcement is crucial.535 More generally, performance or payment to another may be less convenient and, despite notice of the assignment, a debtor may mistakenly pay his original creditor and hence not obtain a good discharge.536 If parts of the debt are assigned to multiple assignees or the same debt is assigned to successive assignees, the debtor will be inconvenienced by having to deal with them all rather than one original creditor and again runs the risk of paying twice. Finally, assignment and consequent notice may ‘cut off ’ certain rights of set-off that the debtor would otherwise continue to have against his original creditor.537

7.82  On the other hand, once it is conceded that choses in action can be assigned and that third parties can acquire rights to or in them, the interests of such third parties need to be considered. For this reason, covenants against assignment in leases of land are generally ineffective to preclude the vesting of the lease in an assignee, as such covenants are regarded as contrary to the public policy of not restricting the alienation of property.538 Similarly, if non-assignment clauses are to be effective in rendering receivables non-assignable, then this will undermine receivables financing. Assignees will either have to incur the expense of checking that the receivables they obtain do not arise under agreements with such clauses539 or to take the risk and reflect this in the amount they are prepared to pay for a batch of receivables. For this reason, international conventions with the aim of facilitating receivables financing restrict the effectiveness of non-assignment clauses,540 as does the US Uniform Commercial Code.541 Moreover, the Small Business, Employment and Enterprise Act 2015542 empowers regulations to be made invalidating some non-assignment clauses in certain cases and draft regulations covering (and therefore facilitating) invoice discounting have been made.543

Effect of non-assignment clauses on obligor

7.83  English law recognizes that an obligor may, by the insertion of a non-assignment clause, preclude the transfer of the chose in action to an assignee so as to enable the assignee to exercise rights against him.544 In the context of a building contract that provided that neither party was able to assign the benefits of the contract without the consent of the other, the House of Lords in Linden Gardens Trust Ltd v (p. 308) Lenesta Sludge Disposals Ltd545 confirmed previous case law546 and recognized the effectiveness of such clauses in precluding a valid assignment: ‘an assignment of contractual rights in breach of a prohibition against such assignment is ineffective to vest the contractual rights in the assignee’.547 Thus the debtor remains liable to his original creditor and obtains good discharge by paying him. Moreover, any notice that the purported assignee gives to the debtor will have no effect. In particular, rights of set-off that would have been cut off by notice548 may continue to arise and reduce the value of the debt. In Linden Gardens the court rejected any analogy with covenants against assignment in leases. The justification given was that land is in limited supply and hence it is contrary to public policy to restrict the free market, whereas this is not the case in relation to receivables.549 The distinction has also been explained on the historical basis that leases have always been regarded as ‘part property’ and hence inherently alienable, whereas the common law (as opposed to equity) took the view that choses in action were personal and not assignable.

Construing the non-assignment clause

7.84  Before giving effect to a non-assignment clause, the clause must be construed to determine precisely what it prohibits.550 It is clear that a prohibition on ‘assignment’ covers not only a statutory but also an equitable assignment551 and it may cover the creation of a charge.552 Otherwise, the clause may be drafted to prohibit assignment in certain circumstances, typically without the consent of the debtor.553 Moreover, the rights that arise under a contract are various and hence the prohibition may relate to some rights but not others. Thus initially the parties have rights to performance from one another; after performance the performing party is entitled to the ‘fruits’ of the contract, namely accrued rights of action or rights to payment.554 It follows that where the parties are merely concerned that performance be rendered to each other, a non-assignment clause may merely preclude assignment of the former but not the latter (p. 309) rights.555 For similar reasons, it may be that a non-assignment clause will not be construed so as to prohibit the assignment of sums that have already been paid over by the obligor to the obligee. Indeed some commentators have gone further and suggested that when it comes to the liability to pay a debt, a debtor has no legitimate interest as to the identity of his creditor and hence that a non-assignment clause that seeks to preclude the assignment of pure debts, or a fortiori sums already paid, should not be upheld.556

Contractual rights of assignee

7.85  Although previously there was doubt about the status of the assignment contract as between the assignor and assignee,557 it is now clear that, as between those parties, the contract of assignment is a valid contract, with the consequence that the assignee who does not acquire rights against the obligor as a result of the non-assignment prohibition at least has a right of action for breach of contract against his assignor. In Linden Gardens Lord Browne-Wilkinson agreed (obiter) with that general proposition, adding ‘in the absence of the clearest words [the prohibition] cannot operate to invalidate the contract between the assignor and assignee and even then it may be ineffective on the grounds of public policy’.558 Subsequent dicta have been more categorical that the contract is effective as such559 and this accords with general contractual principles that a third party to a contract (the obligor, in relation to the assignment) usually cannot interfere with the contractual obligations undertaken by the parties to a contract.

Assignor as trustee

7.86  The question then arises whether the assignee can acquire rights in addition to a breach of contract action against the assignor, in particular proprietary rights that will potentially give him priority should the assignor become insolvent. An early Court of Appeal case, Re Turcan,560 held that a non-assignment clause in a policy of insurance did not preclude the insured becoming trustee of the proceeds for another (the trustees of his marriage settlement) by virtue of his covenant to settle after-acquired property. Although it was assumed that the non-assignment clause was effective to preclude the trustees of the settlement claiming the benefit of the policy directly from the insurance company,561 the trustees were held able to claim the proceeds of the policy from the executor of the assured. This decision recognizes that, although in both cases the assignee/beneficiary acquires an equitable interest, there is a conceptual difference between an equitable assignment562 and a (p. 310) declaration of trust.563 There are also practical differences564 that justify the drawing of this distinction in the context of a non-assignment clause. Moreover, whilst the recognition of this distinction is not without controversy,565 it appears to have the support of the Court of Appeal in Barbados Trust Co Ltd v Bank of Zambia,566 where the declaration of trust device was explicitly used in order to circumvent a non-assignment clause.

7.87  Re Turcan was applied in Don King Productions Inc v Warren,567 which concerned a contract between a boxer and his promoter that contained a non-assignment clause. At first instance, Lightman J construed the clause as not precluding a declaration of trust as opposed to an assignment. Hence, when the promoter purported to assign the contract in circumstances where it was the ‘manifest’ intention of the parties to the assignment that he held the contract on trust for the ‘assignee’, this was held to be the effect of the ‘assignment’. The recognition that an ‘assignee’ of a non-assignable chose in action may nevertheless obtain a beneficial interest in it under a trust is of great consequence if the assignor becomes insolvent, as the assignee then obtains priority as equitable owner.568

Special characteristics of the trust

7.88  As noted above, the proposition that a non-assignment clause does not preclude the ‘assignor’ holding the chose in action on trust for his ‘assignee’ is not without difficulty.569 Case law on trusts of choses in action suggests that the trustee ‘can take steps to enforce performance to the beneficiary by the other contracting party’ and ‘if [the trustee] refuses, the beneficiary can sue’.570 Thus the creation of a trust of the benefit of a contract may have an impact on the ‘other contracting party’, the obligor. If performance from him is still outstanding, the obligor may find that his obligee, who is now a trustee having to take directions from a beneficiary, is less accommodating in so far (p. 311) as the exercise of any powers or discretions are concerned.571 Moreover, the obligor may find himself being sued by the beneficiary when the trustee (the obligee) refuses to bring an action against him. Hence the purpose of the non-assignment clause would be defeated in these circumstances by such a declaration of trust. This difficulty was met in Don King by the suggestion that these normal consequences of a trust of a chose in action did not necessarily follow if the chose in action was non-assignable. Relying on case law that trust principles can be adapted in the commercial context,572 Lightman J said that ‘the declaration of trust cannot prejudice the rights of the obligor’ so that the exercise of any judgement as to performance remains with the trustee and ‘the courts will be astute to disallow the use of the procedural shortcut [allowing the beneficiary to sue] in a commercial context where it has no proper place’.573 Thus he recognized that a ‘limited’ trust might arise, limited in the sense that it confers rights on the beneficiary vis-à-vis the trustee but no rights on the beneficiary against the obligor to dictate the terms of performance or to bring an action if the trustee refuses. However, when the possibility of such a ‘limited’ trust arose (obiter) in Barbados Trust Co Ltd v Bank of Zambia,574 it met with less enthusiasm.575

Insolvency of assignor

7.89  The effect of a non-assignment clause in the insolvency of the ‘assignor’ has yet to be determined.576 Clearly the ‘assignee’ has a personal claim against the assignor for breach of contract577 but does he also acquire a proprietary interest that will give him priority over the unsecured creditors of the assignor? If the assignor is found to hold the chose in action on an express or implied trust,578 then it would seem to follow579 that he obtains such priority by virtue of his beneficial interest. The position in the absence of such a trust580 is not settled and it may be that the ‘assignee’ under an assignment in breach of a non-assignment clause will not be regarded as acquiring a proprietary interest so as to obtain such priority. Indeed there are categorical Court of Appeal dicta (in non-insolvency contexts) that the ‘assignee’ only acquires contractual rights.581 However, the effect of such an assignment as between the ‘assignee’ and ‘assignor’ is of no concern to the obligor and there is much to be said for the proposition that the obligor cannot (as a third party to the assignment) interfere with the rights created between the parties to it. (p. 312) Hence, just as the obligor cannot, by the insertion of a non-assignment clause, preclude the ‘assignee’ obtaining contractual rights against the ‘assignor’, it is arguable that he should not be able to preclude the ‘assignee’ from obtaining proprietary rights in the ‘assignor’s’ insolvency.


7.90  Thus it is clear that a non-assignment clause will preclude the ‘assignee’ obtaining any rights against the obligor.583 However, despite some initial doubts,584 it now seems equally clear that such a clause will not preclude the ‘assignee’ obtaining contractual rights against the assignor/obligee585 as a result of a purported assignment and will not preclude a trust of the chose in action arising should the assignor/obligee expressly declare such a trust. The equitable rights under the trust may well be ‘limited’ in the sense explained in Don King, but such limited rights should be sufficient to confer potential priority in the event that the obligee becomes insolvent.

7.91  In the absence of an express declaration of trust by the obligee586 the question arises whether a trust will be implied if the obligee purports to effect an assignment in contravention of a non-assignment clause. This will depend on whether the obligee can be taken to have agreed to hold the benefit of the contract on trust for the ‘assignee’.587 That intention was clearly evident in Re Turcan588 and was held to have been ‘manifest’ in Don King.589 However, case law in the building contract context demonstrates that this intention will not always be found, in which case no trust in favour of the assignee will arise.590 It may be that in the context of the insolvency of the obligee,591 where the competing interest of the obligee’s other creditors are at stake, a court will be less ready to find an intention to create a trust. Clearly, if an assignee wishes to protect himself against the consequences of taking choses in action that are subject to non-assignment clauses, he should require his assignor expressly to undertake to hold such choses in action on trust for him.592 Once such a trust is found, it seems clear that (absent evidence of intention to the contrary) it will cover all the benefits of the contract, both rights to performance and ‘fruits’ of performance.593 When construing the scope of a non-assignment clause this distinction between rights to performance and ‘fruits’ may be relevant in that the clause may preclude assignment of the (p. 313) former but not the latter.594 But if the non-assignment clause covers both, then it would be difficult to justify a finding other than one that the obligee intended to create a trust of both in favour of his ‘assignee’.595

Prior assignments

7.92  Finally, if the assignment predates the contract that contains the non-assignment clause (as may be the case if there is a contract to assign future choses in action596) and then the contracts giving rise to those choses in action incorporate non-assignment clauses, it has been suggested that the non-assignment clause does not render that prior assignment ineffective. Thus, it has been suggested, that when the chose in action comes into existence, it is effectively assigned by virtue of the previous contract to assign. The relevant (obiter)597 authority is Foamcrete (UK) Ltd v Thrust Engineering Ltd,598 where Mummery LJ said that only assignments in breach of and hence subsequent to the contract creating the chose in action were caught by the non-assignment clause. This is difficult to follow because if a non-assignment clause renders the chose in action inherently non-assignable it should not matter when the purported assignment takes place.599 If there is an agreement to assign future debts, an equitable assignment of each debt occurs when it comes into existence. It is clear that for the purpose of priority the assignment dates back to the date of the agreement to assign,600 but if the debt cannot be assigned at all because of the non-assignment clause, then the assignment, albeit ‘dating back’ to the agreement, cannot be effective.

Notice of assignment


7.93  Many forms of receivables financing do not entail the giving of notice to the account-debtors, at least initially.601 This may be because the assignor does not wish his customers to be aware of the financing transaction or because it is simply expensive and impracticable to contact all the account-debtors.602 Without notice, the assignee acquires an equitable interest in the debts,603 which, especially if the right is reinforced by the assignor agreeing to pay the proceeds into a separate bank account, gives him the protection of a secured creditor should the assignor become insolvent. However, not giving notice carries a number of risks and disadvantages, which will now be considered.

Notice and priority

(p. 314) 7.94  First, the assignee who does not give notice may lose his priority as a result of the rule in Dearle v Hall.604 Hence, if notice is not given to the debtor, then anyone with no notice of the assignment who acquires a subsequent interest in the receivable and himself gives notice to the debtor, will obtain priority over the previous assignee.605

Notice and rights of set-off

7.95  Second, although the assignee takes ‘subject to equities’ and hence any rights of set-off that the debtor has against the assignor may generally also be asserted against the assignee,606 notice to the debtor of the assignment curtails some of these rights.607 The general principle allowing set-off against the assignee gives effect to the policy that the debtor should not be prejudiced (in no longer being able to exercise his rights of set-off or, a fortiori, any defences he has to the claim) by an assignment of the debt he owes. However, the countervailing interests of the assignee not to have the value of the chose in action he has acquired on assignment diminished, must also be accommodated. Therefore the law recognizes that by giving notice, the assignee generally ‘freezes’ his rights so that, ‘after notice of an assignment of a chose in action, the debtor cannot by payment or otherwise do anything to take away or diminish the rights of the assignee as they stood at the time of the notice’.608

7.96  The extent to which a debtor can set off claims against an assignee was considered by Templeman J in Business Computers Ltd v Anglo-African Leasing Ltd.609 First, the debtor may exercise equitable set-off as against an assignee, irrespective of whether (or when) the assignor has given notice or not. Hence equitable set-off is available irrespective of whether the debt accrues before or after the notice of assignment where the set-off (for example, as a result of a rebate) arises under existing arrangements between the debtor and assignor.610 However, equitable set-off is only available in relation to cross-claims arising out of the contract giving rise to the debt611 or out of a ‘closely connected’ contract612