Commercial Law and Commercial Transactions - Essay Example

? Commercial Law In the Bank of Credit and Commerce International SA (No. 8) case, the House of Lords upheld the legal effectiveness of charge backs.Their Lordships ruled that a debtor could take a charge over one of its own debts to a creditor, as security for carrying out a mutual obligation (Re Bank of Credit and Commerce International S.A. (No. 8), 1998). Consequently, it is not impossible, theoretically, for a bank to have a charge over the cash deposited by one of its customers and which functions as the security with regard to a loan provided to the customer. This effectively discounted the Court of Appeal’s conceptual impossibility contention that had been supported by it (McCormack, 2002, p. 7). Such reciprocity in indebtedness is common to several commercial transactions and this decision by the House of Lords has provided immense relief to the commercial community. This is due to its capacity to do away with ambiguity and promoting transactions that are of immense benefit. The fact that there are legally valid and effective alternate transactions does not reduce the importance of the aforementioned category of transactions (Re Bank of Credit and Commerce International S.A. (No. 8), 1998). These alternatives cover the contractual rights of set off and rendering the deposit a flawed asset, which the third party in the position of the depositor or depositor cannot withdraw. The court ruled with great insight that the device of a charge back ensured powerful protection to a bank. This was by means of the flawed asset techniques and the contractual set off, and not due to the charge over the asset (Re Bank of Credit and Commerce International S.A. (No. 8), 1998). Their Lordships’ decision in Re Bank of Credit and Commerce International SA (No. 8) brought a few important questions to the fore. First, whether the presence of a charge in a party’s favour in relation to that party’s indebtedness nullifies the reciprocity that is essential for the insolvency set – off to become operative. Second, whether the assets of the company that becomes insolvent are theoretically collected, prior to the set – off becoming operative (Re Bank of Credit and Commerce International S.A. (No. 8), 1998). The ruling of the House of Lords was in the negative, with regard to these questions (Davies, 2011, p. 187). Commercial transactions are always exposed to the risk of insolvency or default. This is mitigated by employing credit derivatives, which create exposure to or hedge the credit risk inherent in debt instruments, like bonds and loans. There is nothing novel about this function, which had been undertaken by debt syndication, cash securitisations, and loan participations. These initiatives had been utilised to control the credit risk of debt instruments. Such credit risk had been managed by the practice of sell – down of the investor of lender’s risk in the debt instrument (Ali, 2004, p. 326). All the same there is a crucial difference between the previous credit risk management strategies and credit derivatives. The latter separate the credit risk of a debt instrument from itself and this risk is transferred to a third party. In addition, the debt instrument is retained or disposed of to another party. This renders credit derivatives, tools of credit risk management that have much greater precision. Lenders and investors are protected against credit risk, due to credit derivatives; and the economic benefit of the debt instrument is not transferred (Ali, 2004, p. 326). Moreover, insurance and reinsurance companies, banks, bond insurers and hedge funds are the chief sellers of credit protection. Credit risk protection is provided by these financial institutions, first, by the sale of protection under credit default swaps to investors or lenders. Second, by the making investment of funds in securities issued under a programme of synthetic securitisation (Ali, 2004, p. 326). Companies of Scotland were not permitted to create a floating charge with regard to the whole or part of their undertakings and property. This was the situation till the year 1961. Lord Hoffmann, while commenting upon the English law, in his judgement in Re Bank of Credit and Commercial International SA (No 8), observed that a charge was fundamentally a security interest that had been generated in a manner that ensured that did not involve the transfer of possession or title to the beneficiary. This was not the situation in Scotland, where the transfer of title or possession was indispensable for the creation of a charge (MacQueen, 2006, p. 4). There is considerable activity with regard to the growth of the various areas of the global financial markets. One of the leading sectors of the global financial markets is none other than that of the credit derivatives. The latter have increased to a tremendous extent, as pointed out by the International Swaps and Derivatives Association. This body has highlighted that fact that at the end of the year 2003, credit derivatives were at the level of US$3.58 trillion. This depicted a 67% increase, in comparison to the amount outstanding at the end of the year 2002 (Ali, 2004, p. 326). In the recent past, a new category of credit derivatives came to the fore, wherein the sellers of credit protection were also borrowers in the context of the debit instruments, for which the protection was being purchased. Thus, this category of credit derivative consists of corporate protection sellers that undertake the credit risk of their own obligations (Ali, 2004, p. 326). The overall economic or commercial appearance of a transaction could be significantly different from its legal depiction under the English law. There are some transactions, which from the commercial perspective appear to be secured credit or financing, but whose legal structure displays a different proprietary effect. The English courts have generally adopted a lenient attitude towards the characterisation of such transactions. An example of this is provided by a recourse receivable sale transaction. The above discussion is the import of the ruling in Lloyds & Scottish Finance Ltd v Cyril Lord Carpet Sales Ltd (Lloyds & Scottish Finance Ltd v Cyril Lord Carpet Sales Ltd , 1992). Another instance is provided by the judgement in Welsh Development Agency v Export Finance Co. Ltd, and relates to the intermediate sale of goods that transpire prior to the onward sale to the ultimate purchaser. This provides the intermediate purchaser with ownership in the goods and receivables, on account of the onward sale (Welsh Development Agency v Export Finance Co. Ltd , 1992). In Don King Productions Ltd v Warren, Lightman J opined that the restriction in question should apply to transactions effected not only in equity but also at law. This could be by means of a declaration of trust or an equitable assignment. In addition, it should endeavour to encompass the interest of the borrower in the assets, irrespective of whether these possess an equitable or legal nature. Moreover, the restriction should apply to transactions relating to a part or the whole of the borrower’s interest in an asset. Furthermore, a restriction upon the assignment of a chose in action should not isolate a declaration of trust by the borrower with regard to the intended person to whom the property or asset is to be conveyed legally (Don King Productions Ltd v Warren , 1998). The contents of a security document, wherein the security had been taken as a floating charge, provides information regarding the limitations imposed upon the freedom of the chargor to deal with its assets. The lender endeavours to impose contractual restrictions on the chargor’s freedom to deal with its assets (McKnight, 2002, p. 193). In such security, the chargor can address the charged assets free of the charge and in the ordinary course of business, till such time as the charge is not crystallised. The courts do not enforce a strict definition of what dealing in the ordinary course of business implies. Thus, any activity that involves the chargor, except for the permanent cessation of its business is deemed to be included in this concept (McKnight, 2002, p. 193). Some instances are disposing of the assets, providing fixed security over the assets, and the disposing of assets in financing transactions involving sale and lease back. These should prove to be latently detrimental to the initial floating chargee. Restrictions should not be in absolute terms, if the charging document incorporates contractual limitations on addressing the assets with a floating charge on them (McKnight, 2002, p. 194). This is due to the fact that a floating charge essentially seeks to allow the borrower to conduct its business by employing its assets for legitimate purposes. Thus, a balance should be struck between protection of the chargee’s security from dissipation due to transactions that are impermissible and the commercial requirements of the chargor (McKnight, 2002, p. 194). Moreover, another example was provided by the assignment of a receivable as payment for goods on a non – recourse basis. This was the subject matter of Re Marwalt Ltd (Re Marwalt Ltd , 1992). However, in Orion Finance Ltd v Crown Financial Management Ltd, the debtor had acknowledged notice of an assignment that was in breach of a prohibition, without any objection. It was held, in this case that the assignment was effective (Orion Finance Ltd v Crown Financial Management Ltd, 1994).. In addition, in Re New Bullas Trading Ltd, the court accepted that there could be a fixed charge over the book debts, along with a floating charge on the debts’ proceeds (Nash & Collier, 2001). However, criticism was levelled against the New Bullas (Re New Bullas Trading Ltd, 1994) on the following grounds. It was contended that debts that were the subject matter of security were realised by payment, which then extinguished them. In instances, where the chargor had been empowered to collect such debts, the chargee could assert his interest over the security as a fixed interest was via the proceeds (Re Keenan Bros Ltd , 1986). Moreover, the chargee establishes that the debt is collected for his account and not that of the chargor, by means of a provision in the contract. In the absence of such contractual control, the fixed security of the charge is rendered devoid of meaning, because the debts will be collected by the chargor for his account (Re Keenan Bros Ltd , 1986). There are several reasons to discount these criticisms of the New Bullas. First, a book debt that is sold instead of being collected possesses value in monetary terms. Second, there are several contexts, in which the proceeds of debts and debts have been deemed to be distinct items of property. These important issues were addressed by Walsh J, in the pioneering case of Re Keenan Bros Ltd, of the Irish Supreme Court (Re Keenan Bros Ltd , 1986). A relationship of debtor and creditor exists between a bank and its customer. Thus, amounts of a company are shown as credit entries, in a chronological manner, in the book debts receivable account. These amounts are owed by the bank to the company and do not constitute debts related to the deed of charge or debenture. They also do not constitute book debts due to the company. The fact that the account was opened to receive the book debts due to the company does not change this situation in any manner. This principle was given credence to in Re Brightlife Ltd by Hoffman J (Re Brightlife Ltd, 1987). In the above case, the judge held that a bank account with a credit balance could not be classified as a book debt, as employed in the context of commercial debentures. The accepted usage was cash at the bank and not debt. Consequently, it would be incorrect from the legal perspective, to describe a credit balance in a bank account as a debt. This line of reasoning was supported to some extent by the House of Lords in Re Bank of Credit and Commerce International SA. In Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd, the court ruled that the assignee had to account for the proceeds of the debts, after being received, to the assignor. This was not prevented by a prohibition in the contract on the assignment of debts (Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd, 1994). It is evident from this that the proceeds of debts and debts are viewed from different perspectives. Referring to Lord Hutton’s ruling in the Northern Ireland Court of appeal in Northern Bank Ltd v Ross, Lord Hoffmann opined that the employment of charge back effectively provides the chargee with security with respect to the cash deposited with it or with regard to the indebtedness that it owes. He also stated that the pertinent restrictions should be incorporated in the charge document, in order to control the conditions under which the deposit is to be held and becomes due for payment (Northern Bank Ltd v Ross , 1990). Notwithstanding the fact that the fundamental limitations and contingencies could be understood from the employment of the terms charge or charge back to define the contract between the lender and the depositor, it would be far more beneficial to specify these conditions explicitly (Northern Bank Ltd v Ross , 1990). In the Ross case, the issue considered was whether money deposited into an account with Allied Irish Banks by the company, prior to its liquidation, was subject to a fixed charge that prevailed over all the debts, including book debts. The debts considered were those that had been previously executed by the company and were made out in favour of the Northern Bank. The House of Lords held that cash at bank was not a part of the book debts and other debts. In addition, it was held that cash at bank denoted the credit balance in a bank account, regardless of whether that account was utilised as a trading account (Northern Bank Ltd v Ross , 1990). The liquidator of a Cayman company requested the court to apply section 426 of the English Insolvency Act that addressed fraudulent and wrongful trading and the avoidance of transactions at undervalue. Although, the English Court was unable to apply the antecedent transaction provisions of the English Insolvency Act, in the absence of an order under section 426, the liquidator emerged successful (Howcroft, 2008, p. 411). The defendants contended that the English law should not be applied to the liquidation of a foreign company, as this could make them liable for acts that were illegal under English law, but not in the place of incorporation of the debtor. It was also argued by the defendants that section 426 of the English Insolvency Act would limit the English Court to apply English procedural law to the insolvency of a foreign company (Howcroft, 2008, p. 411). This was rejected by the court, which opined that the applicable law had to be determined on the basis of procedural as well as substantive law. The court opined that the result anticipated by the defendant could occur only when the courts in both the jurisdictions were of the opinion that the anticipated result was just (Howcroft, 2008, p. 411). However, in the 19th century cases of London & South Western Rly Co v Blackmore (London & South Western Railway Co v Blackmore , 1870) and Lyall v Edwards (Lyall v Edwards , 1861), reliefs had been addressed on the basis of a specific dispute or compromise in a disputed claim. In Bell v Lever Bros Ltd, the court held that the employment relationship between the plaintiff and the defendant could not be construed as a contract uberrimae fidei. It was also held by the court that there is no duty to disclose the unlawful acts of the defendant during negotiations pertaining to the payment of money at the time of termination of their contract (Bell v Lever Brothers Ltd , 1931). The feature of practical reassurance was introduced by the Court of Appeal. However, its opinion in the context of charge backs was not accepted by the House of Lords. This implies that with reference to deposits with banks, it very rare for the emergence of an obligation to register. In Re Charge Card Services Ltd, it was held that the payment by credit card was in lieu of payment by cash. Hence, such payments were an unconditional discharge of the price (Re Charge Card Services Ltd ). This decision was rescinded by the House of Lords in the case Re Bank of Credit and Commerce International SA (Hamilton, 2000, p. 13). The creation of a security interest without transfer of title to the beneficiary is termed a charge in English Law. An example of a chose in action is the entitlement of a depositor to claim the repayment of his deposit with a bank. This is held to be property and consequently it is possible to grant a chose in action to the bank or a third party. An equity of redemption and the related rights would remain with the depositor (Insolvency Law. Bankruptcy and corporate insolvency, 2009). A related notion is that of the equitable principle of marshalling. On occasion, a debtor could have two or more creditors, and one of these creditors could be in a position to enforce a claim against more than one security, while the other is limited to a single security. In such instances, the latter creditor has the equity to insist upon the first creditor to restrict himself to the extent possible, to the proceeds of the security over which the latter creditor does not enjoy any claim (Insolvency Law. Bankruptcy and corporate insolvency, 2009). With respect to a bank’s charge, the difference would be that instead of the beneficiary of a charge having to obtain payment from the debtor, the amount in question would acquire the status of a book entry with the bank’s accounts. This would be the sole difference between a charge given to a bank and a third party (Insolvency Law. Bankruptcy and corporate insolvency, 2009). In such instances, there can be no merger of interests, as title to the deposit would be vested with the depositor, save for the charge over it by the bank. Such bank charge does not necessitate any formal assignment. Therefore, a debtor enjoys a proprietary interest, via a charge over the debt (Insolvency Law. Bankruptcy and corporate insolvency, 2009). In Helstan Securities Ltd v Hertfordshire County Council, it was held that if the parties to a transaction had consented to render the chose inalienable, then assignment of a chose in action cannot be sanctioned by equity or statutory provision (Helstan Securities Ltd v Hertfordshire County Council, 1978). A flawed asset is precisely what such a chose of action constitutes. This term was employed by Hoffman J, in the Re Bank of Credit and Commerce International SA case (Ong, 2008, p. 195). As such the English courts have ruled that methods of obtaining credit or raising finance and placing the financier or creditor in a partially secured position, by providing it with proprietary rights in such assets, cannot be considered to be a grant of security. A lending bank may enjoy netting and a right of set off with respect of the credit balance of its customers. However, this does not connote security, even if supported by contract. Furthermore, the same rule applies to the flawed asset provision, which permits the bank to segregate the deposit from the assets made available to the liquidator, in the event of the depositor declaring insolvency. This holds good, despite the possibility for such banks to exercise charge over the deposit. In such cases the taking of charge constitutes the offer of security (Re Bank of Credit and Commerce International S.A. (No. 8), 1998). References MacQueen , H. L. (2006). Case Comment Floating charges in the House of Lords again. Edinburgh Law Review, 10(1), pp. 4 – 5. Lyall v Edwards , 6 H & N 337, ER 139 (1861). London & South Western Railway Co v Blackmore , LR 4 HL (1870). Bell v Lever Brothers Ltd , UKHL 2 (1931). Helstan Securities Ltd v Hertfordshire County Council, 3 All ER 262 (1978). Re Keenan Bros Ltd , BCLC 242 (1986). Re Brightlife Ltd, Ch 200 (1987). Northern Bank Ltd v Ross , 14 BCC 883 (1990). Lloyds & Scottish Finance Ltd v Cyril Lord Carpet Sales Ltd , BCLC 609 (UK House of Lords 1992). Re Marwalt Ltd , BCC 32 (1992). Welsh Development Agency v Export Finance Co. Ltd , BCLC 148 (1992). Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd, 1 AC 85 (1994). Orion Finance Ltd v Crown Financial Management Ltd, 2 BCLC 607 (1994). Re New Bullas Trading Ltd, 1 BCLC 448 (England and Wales Court of Appeal 1994). Don King Productions Ltd v Warren , 2 Lloyd's Rep 176 (1998). Re Bank of Credit and Commerce International S.A. (No. 8), AC 214 (UK House of Lords 1998). Insolvency Law. Bankruptcy and corporate insolvency. (2009). Retrieved September 10, 2011, from http://www.swarb.co.uk/lisc/Insol19971997.php Ali , P. U. (2004 ). The conundrum of self-referenced credit-linked notes. Journal of International Banking Law and Regulation , 19(9), pp.326 – 330. Davies, P. S. (2011). Interpreting commercial contracts: back to the top. Law Quarterly Review, 127, pp. 185 – 188. Hamilton , G. J. (2000). Invalidation of securities upon insolvency. Federation Press. Howcroft , N. J. (2008). Universal vs. Territorial Models for Cross-Border Insolvency: The Theory, the Practice, and the Reality that Universalism Prevails. University of California Business Law Journal, 8, pp. 368 – 418. McCormack , G. (2002). Security interests in deposit accounts: an Anglo-American perspective. Insolvency Lawyer, pp. 7 – 13. McKnight, A. (2002). Restrictions on dealing with assets in financing documents: their role, meaning and effect. Journal of International Banking Law, 17(7), pp.193 – 204. Nash, L., & Collier, B. (2001, October). Floating Charges May Leave Lenders Adrift. Retrieved September 10, 2011, from http://findarticles.com/p/articles/mi_hb3252/is_5_115/ai_n28868012/ Ong, D. S. (2008). Trusts Law in Australia. Federation Press. Re Charge Card Services Ltd , 3 All ER 289 (1986). Read More