Infospectrum is seeing an increase in the number of occasions its clients are being asked to pay third parties for goods or services, i.e. to pay a party with whom they have not contracted. Such requests are most commonly made in relation to payment of freight or bunkers. This article explores the underlying motivations as to why a client may be asked to pay a third party and the possible legal ramifications.
Why do such structures exist?
Over and above the obvious question of fraudulent intent/cyber crime, the use of different payment beneficiaries can stem from the management of many issues, whether it be tax, cash flow, asset financing, or even the management or circumvention of sanctions controls.
There are legitimate reasons as to why you as the client may be asked to make a payment to a third party. For example, it may be that the party you have contracted has outsourced the collection of its payments to a standalone collection company. However, in the normal course of the business relationship, you can expect to have been informed of this by your contract partner.
Alternatively, it may be that your contracting party has chosen to sell its invoice to you to a factoring company via a factoring contract, particularly if your contract partner is a small to medium-sized enterprise. Where a factoring company is involved, such a company will have purchased the invoice, amongst others chosen by the seller, in return for an advance payment to the seller of around 70-90% of the invoice balance. The remainder is then paid upon collection minus a small factoring fee based on a percentage of the invoice values. A factoring company has every right to approach you directly for payment since they will have purchased the invoices outright. Consequently, there is no reason for the seller of the invoices to be involved in the collection process other than to notify you that a factoring company will be used, although such notice can also come from the factoring company. Alternatively, there may already be a brief notice of assignment wording on your contract partner’s invoice to that effect. In certain countries, your consent to such assignment may also be required.
You may also be asked to pay a third party because your contracting party has an accounts receivable (A/R) financing facility in place. You are less likely to find out about A/R financing (also known as Invoice Discounting) than factoring because A/R financing is a loan rather than a sale. Such loans tend to be confidential and the contracting party still often remains responsible for collection of the accounts receivables. Specifically, A/R financing is the provision of a loan from a finance company or bank, backed by a pledge of the business assets associated with the accounts receivable to that company — in this case your payment of your contract partner’s invoice.
Not all structures are the same
Both factoring and A/R financing are vanilla structures arising out of the need for a company to manage its cash flow requirements. So why should these financing arrangements give pause for thought when that invoice needs to be paid? In order to answer this, it is important to understand the fundamental difference in law of the two structures. A factoring company will purchase invoices outright, obtaining ownership and title to them. An A/R financing company loans funds upfront secured against future receivables i.e. batches of unpaid invoices. The A/R financing company is then repaid when the invoices are finally paid. What this means for the financing companies is should your contract partner become insolvent, a factoring company cannot file a claim against the bankruptcy estate since it has in effect already been paid. However, an A/R financing company has not yet been paid and can therefore participate in any bankruptcy proceedings. An A/R financing company could be a big player in insolvency proceedings, as was the case with ING Bank which funded OW Bunker before the latter’s collapse in 2014.
Disputes or assignments – knowing your rights
Both the factoring company and the A/R financing company are primarily interested in the collection of funds. Therefore they will have undertaken a certain amount of due diligence to ensure that they are not being assigned receivables likely to be the subject of dispute. Typically, your contract partner will have made representations in the underlying finance facility that the accounts receivable are “payable, without defence, set-off, dispute or counter-claim”. In any assignment between your contract partner and the finance company, your contract partner will retain responsibility to perform the work, and it is only the collection and receipt of the funds that is assigned to the finance company. This means that if any dispute arises under your contract, your pursuit of a claim against your contracting party would continue in the usual manner. However, your legal right to set-off the value of one claim against another, if this applies, may be impacted.
Furthermore, under English law, in most cases the beneficiary of your payment can assign any rights under a contract to a third party on the satisfaction of two conditions, these being:
1. That the assignment is in writing and
2. That you (as the debtor) are given written notice of the assignment (i.e. you don't have to agree with it, but you must be told)
Upon assignment, your new beneficiary (the assignee) may demand your payment, and can sue for it in his own name; equally, you (as the debtor) must respond to these demands, although you may ignore a demand from your original beneficiary (the assignor). Parties to an English law contract may agree restrictions on assignment, for example that rights may not be assigned without your consent, and if the two parties so choose, that consent should not be unreasonably withheld. An assignment which does not comply with the requirements of the law or agreed restrictions will be invalid and you could, in theory, ignore any demand by the assignee, while remaining bound to the assignor.
What you need to know
The use of payment beneficiaries is certainly common, and some aspects of these vehicles could be described as the “norm” in our industry. However, if these vehicles do not have a legitimate function, dealing with them may have exceptionally negative results for the payer/payee if appropriate steps are not taken. With sanctions, there is an expectation that the sender will have undertaken sufficient checks to ensure sanctions compliance before releasing the payment. Without evidence of these checks, the suggestion that the transfer was sent in error won’t cut it. Over and above the reputational damage and impact on banking relationships, non-compliance with sanctions legislation in the UK can result in financial penalties of up to GBP 1m and prosecution of individuals for criminal offences resulting in prison sentences of potentially up to seven years. It is clearly not good enough to say you weren’t aware of your new counterparty’s ultimate beneficial ownership (UBO).
In summary, whatever the reason given for not paying your original contractual party, you need to know your rights. You must also be crystal clear as to the reasons for the change to have been made and the UBO of the new recipient of your funds.
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