R Bruce Wood, head of asset-based lending, asset and invoice finance at Morton Fraser, scotches some common misconceptions about the difficulty of funding consumer finance companies in Scotland, and the key differences between Scots and English law in this critical area

Whether looking at credit sale agreements – or loan agreements – under employee car ownership schemes or straightforward HP/PCH to consumers, you hear comments like:

  • “The finance company which wants finance from us for its consumer deals is Scottish-registered, and that’s a problem,” or
  • “We can’t fund that finance company by block discounting in Scotland,” or
  • “We can’t do back-to-back funding in Scotland.”

There is no truth in the first two of these, and only a little in the last.

But, admittedly, unnecessary trepidation by assuming the worst is safer business than funders gaily funding finance company business with Scottish consumers without giving thought to the differences between how Scots and English law approach their funding arrangements.

So, let us deal with the misconceptions.  There follows an imaginary conversation with a funder offering finance to a finance company, Financeco, which finances cars for consumers:

Financeco is Scottish-registered, and even though its customers are in England, we can’t accept these deals.
The fact that Financeco is Scottish-registered is irrelevant. Whether you are buying Financeco’s receivables or agreements, or are taking security over them, the relevant law and the ability to take security is not down to the nationality of Financeco.  

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So what is it down to?

The relevant law is the law of Financeco’s agreement with its customer, or possibly also the place where the consumer is.
So, whether you extend facilities to an English Financeco or a Scottish Financeco, your arrangements with Financeco need only comply with English law for consumer agreements entered into by Financeco under English law; however, they will be required to comply with Scots law if they are entered into under Scots law, even if Financeco is English.

So, if the consumer agreements are governed by Scots law we still have a problem as we cannot fund them by block discounting, or other methodology involving the purchase of receivables such as securitisation or warehousing?

No, that is not right either. You can fund agreements entered into under Scots law by block discounting or other receivables-purchase arrangements, but you need to ensure that your funding documentation with Financeco recognises the different Scots law issues.

The key problem is that Scots law does not have a system of ‘equity’ as English law does.  That is important, because the receivables assignments you routinely take under English law, without giving notice to the relevant end users/debtors, are assignments which are valid in equity.

The Scottish rule is that such assignments have no effect until notice of assignment is given to the end users/debtors and, in the funding of finance companies, giving notice of the funder’s interest in the numerous consumer agreements is impracticable.

However there is a solution, namely to ensure that the assigned agreements are held in trust by Financeco for you as funder. And, yes, there are some greater formalities in Scots law around the creation of that trust than the equivalent requirements in English law, but those additional formalities are not insuperable and certainly do not render the funding impracticable.

That is all very well, but our preferred methodology is not to buy receivables or agreements from Financeco when we are funding their consumer agreements, but rather to rely on fixed charges under debentures. And even if the relevant consumer agreements are written by Financeco under English law, we understand that Scottish-registered companies cannot grant debentures, but can only grant floating charges.  

No, that is not right either. The relevant legal system which determines whether and how you can take security over any asset is the law of the place where the asset is.

There is absolutely nothing to stop a Scottish company granting a debenture containing fixed and floating charges in exactly the same way and in exactly the same terms as would be done by an English company, so long as it is understood that the effectiveness of the debenture depends upon where the assets are.

The debenture will constitute fixed charges over assets in England, including receivables arising under English law consumer agreements.

Likewise, even if that debenture is granted by an English company, it will not confer fixed charges over assets in Scotland, and will not be effective except as a floating charge in relation to receivables arising under Scots law consumer receivables.  

We still have a problem, because our usual methodology is to do back-to-back funding, taking security assignments over the consumer agreements between Financeco and its customers. And these are fixed charges, which, as you have said, are ineffective if those agreements are written under Scots law.

Yes, on the face of it this is an area where Scots law gives you a poorer security than English law does.

As explained above, because of principles of equity in English law a funder which takes a security assignment over consumer agreements without giving notice to the end users may still have a fixed charge over these agreements.

In Scotland that is not true and, while the trust route mentioned above may assist you where you are buying receivables, it may not help you where you are trying to take security over receivables.

However the difference between the two legal systems here is more apparent than real.

In English law, a security assignment of receivables, where notice is not given to the end-users, is not a fixed charge unless the funder controls the rental stream from the end-users and, as we know, many funders find it impracticable to do that. What they then end up with is a security assignment re-characterised as a floating charge, and in Scotland you can take a floating charge which has exactly the same effect as a floating charge in English law.

One point to note, however, is that while an English security assignment defaults to a floating charge if the rental stream from the end users is not controlled, a purported security assignment without notice to end users in Scots law does not default to a floating charge, and the floating charge has to be actually taken.

It is advisable, therefore, when taking a security assignment – whether Financeco is English or Scottish – to add to the security assignment a clause worded as a floating charge over any consumer agreements to which Scots law applies.
You will then have covered all the bases.