– Vinod Kothari
– With edits/updates by Richa Saraf
[Updated as on 08th April, 2020]
Assignment of receivables out of transactions is growing astronomically; though without any numerical evidence, but one can say that the total volume of sale of loans and sale of receivables might be exceeding global trades in goods and services put together. Assignment or transfer of receivables is taking place for variety of purposes – securitisation, loan sales, originate-to-transfer transactions, security interest, transfer of servicing or collection function, sale of distressed loans to loan resolution companies, and so on.
While the global usage of assignment of receivables has become so common, the body of law that defines what can be assigned, what is the impact of restrictions on assignment, what happens upon assignment, etc., is still anchored in 19th Century principles, and in most countries, there may not be a specific law dealing with assignments. This is a pity, given such clear laws dealing with sale of goods.
Before getting into the subject, just a bit of clarity on the jargon. Assignment of debt, assignment receivables, assignment of actionable claims, assignment of choses in action, assignment of things in action, transfer of receivables, sale of receivables, loan sales, etc are all terms that point to the same thing. This article is relevant for each of these. Assignment may lead to securitisation –this article does not deal with the law of securitisation.
Commercial risks in originate-to-transfer model:
This article is on the legal issues of assignment; however, as most assignments take place in context of loan trading or receivables acquisition business, it is important to mention some significant commercial risks of the originate-to-transfer model.
The subprime crisis of 2007-8 brought to focus the risks of what came to be known as the originate-to-distribute model. The word “distribute” pertains to securitisation transactions – a more generic word is “transfer”. There are plenty of commercial transactions today which are originated and sold by the originators to others. Banks/brokers originate loans and sell them; vendors originate leases and sell them; within the world of financial institutions, trading in loans takes place very commonly. Hence, it may sound highly anachronistic to talk of the risks of originate-to-distribute model, but then, some significant risks are as follows:
- The originator extracts the whole or substantially the whole of his equity in the transaction; therefore, originator does not have significant skin-in-the-game. In most cases, originators may also be putting the assets off the balance sheet – hence, originators may not have sufficient stakes, to be vigilant about the transaction.
- The originator’s business model may be non-compliant with several applicable laws. Hence, the assignee’s rights would be subjected to all such counterclaims that the originator would have faced.
- Since originator extracts equity upfront, originator may have business policies aimed at the short-term, compromising the long term.
- After all, the assignee acquires such rights as the originator has, in the originating agreement. Assignee would not have drafted/approved the origination agreement. Hence, if there are any deficiencies, gray areas or weaknesses in the origination agreement, the same will be inherited by the assignee as well.
- If the originator has made any promises, representations or other averments, at the time of doing the transaction, the assignee will be affected thereby. Sometimes, there may be correspondence, mail trails etc which may not have been disclosed to the assignee.
All this highlights the need for the assignee to be extra vigilant.
Meaning of assignment:
While the current level of commercial use of assignment has never been seen in the past, assignment of debt or contractual benefits has been there ever since law of contract has existed, and has almost been the same over the ages.
The word assignment is used in context of incorporeal, that it, intangible assets. Corporeal assets are transferred; incorporeal assets are assigned, as the physical dimension of transfer, meaning change of hands, is not applicable in case of intangible assets. As physical assets may be transferred either for sale, or security, or exchange, or gift, likewise, assignment of incorporeal assets may be done either for sale, or exchange, or gift, or pledge or creation of security interest. If it is a sale, gift or exchange, the assignment will be absolute; if it is merely by way of a security interest, it may be conditional or specific.
Assignment of contract or assignment of benefits under contract:
Users are quite often confused as to whether a contract is being assigned, or benefits under a contract are being assigned. A contract is a bunch of mutual rights and obligations. Assignment of a contract would mean assignee steps in the shoes of the assignor and assumes all the rights and obligations of the assignor. For example:
- X enters into a contract of sale with Y where X is the seller. The contract would obviously provides for rights and obligations of either party. X will have the obligation to deliver what he promised to sell, and to ensure that the subject matter adheres to such specifications, conditions and fitness as is either explicitly agreed upon or implied. X has the right to receive the price. Y has the obligation to pay the price, and the right to receive goods.
o Assignment of the benefits under the contract by X would mean the receivables under the contract, that is, the price for the goods, may be assigned to P.
o Assignment of the contract by X would mean P becomes the counterparty to the contract of sale, which is now a contract between P and Y.
- This is true for most contracts, as any contract would imply a bunch of mutual rights and obligations.
The general position in law is that a contract is assignable only with the consent of the counterparty. This is most logical, because holding otherwise would expose the counterparty to obligations of a party with whom it never dealt. Holding otherwise would land up Y in contract with P, who Y had never selected.
On the contrary, assignment of the benefit of contract, that is, rights arising out of contract, does not at all impact the counterparty, as the counterparty can still enforce his rights, that is, the assignor’s obligations, against the assignor. All assignor transfers is his rights. In the example above, if X transfers the receivable to P, there is no adverse implication for Y.
In Khardah Company Ltd v. Raymon & Co (India) Private Ltd. AIR 1962 SC 1810, the Constitution Bench laid out the principle as follows:
“An assignment of a contract might result by transfer either of the rights or of the obligations thereunder. But there is a well-recognised distinction between these two classes of assignments. As a rule obligations under a contract cannot be assigned except with the consent of the promisee, and when such consent is given, it is really a novation resulting in substitution of liabilities. On the other hand, rights under a contract are assignable unless the contract is personal in its nature or the rights are incapable of assignment either under the law or under an agreement between the parties.”
Similarly, in Indu Kakkar v. Haryana State Industrial Development Corporation Ltd. and Another (1999) 2 SCC 37, a two-judge Bench of the Apex Court held, in reliance upon Khardah Company (supra), that:
“Assignment by act of parties may cause assignment of rights or of liabilities under a contract. As a rule a party to a contract cannot transfer his liabilities under the contract without consent of the other party. This rule applies both at the Common Law and in Equity (vide para 337 of Halsbury’s Laws of England, Fourth Edition, Part 9). Where a contract involves mutual rights and obligations an assignee of a right cannot enforce that right without fulfilling the co- relative obligations.”
Even in a case of assignment of rights simpliciter, an assignment would necessarily require the consent of the other party to the contract if it is of a ‘personal nature’. This is elucidated by learned authors Pollock and Mulla in their commentary on The Indian Contract and Specific Relief Acts (R. Yashod Vardhan, and Chitra Narayan eds., 15th edn., Vol. I) at page 730:
“A contract which is such that the promisor must perform it in person, viz. involving personal considerations or personal skill or qualifications (such as his credit), are by their nature not assignable. The benefit of contract is assignable in ‘cases where it can make no difference to the person on whom the obligation lies to which of two persons he is to discharge it.’ The contractual rights for the payment of money or to building work, for e.g., do not involve personal considerations.”
In Kapilaben vs Ashok Kumar Jayantilal Sheth (2019), the Supreme Court observed as follows:
“10. It is important to note that in the modern context where parties frequently enter into complex commercial transactions, it is perhaps not so convenient to pigeonhole contracts as being either ‘general’ or of ‘personal nature’ or as involving the assignment of purely ‘rights’ or ‘obligations’. It is possible that a contract may involve a bundle of mutual rights and obligations which are intertwined with each other. However, as this Court has held in Indu Kakkar (supra), the same rule as laid down in Khardah Company (supra) and as stated in Section 15(b) of the Specific Relief Act, may be applied to such contracts as well. Where the conferment of a right or benefit is contingent upon, or coupled with, the discharge of a burden or liability, such right or benefit cannot be transferred without the consent of the person to whom the co-extensive burden or liability is owed.
It further has to be seen whether conferment of benefits under a contract is based upon the specific assurance that the co- extensive obligations will be performed only by the parties to the contract and no other persons. It would be inequitable for a promisor to contract out his responsibility to a stranger if it is apparent that the promisee would not have accepted performance of the contract had it been offered by a third party. This is especially important in business relationships where the pre-existing goodwill between parties is often a significant factor influencing their decision to contract with each other. This principle is already enshrined in Section 40 of the Contract Act:
“40. Person by whom promise is to be performed.- If it appears from the nature of the case that it was the intention of the parties to any contract that any promise contained in it should be performed by the promisor himself, such promise must be performed by the promisor. In other cases, the promisor or his representative may employ a competent person to perform it.” It is clear from the above that the promisor ‘may employ a competent person’, or assign the contract to a third party as the case may be, to perform the promise only if the parties did not intend that the promisor himself must perform it. Hence in a case where the contract is of personal nature, the promisor must necessarily show that the promisee was agreeable to performance of the contract by a third person/assignee, so as to claim exemption from the condition specified in Section 40 of the Contract Act. If the promisee’s consent is not obtained, the assignee cannot seek specific performance of the contract. B. Application of the above principles to the present case.”
General rule on assignment of benefits under contract:
The general rule on assignment is:
- Assignment of a contract is permissible only with the consent of the counterparty;
- Assignment of rights of benefits under a contract is permissible without the consent of the counterparty.
If the assignment of the contract is done with the consent of the counterparty, that amounts to a novation- that is, partial re-writing of the terms of the original contract.
Exceptions to the assignability of benefits under a contract:
The rule that the benefits under a contract are assignable, is subject to some important exceptions:
- Contracts involving the credit, skill or personality of the assignor cannot be assigned. For example, a bank agrees to give a loan to X. X cannot assign the right to receive the loan to P, as the loan was based on the credit of X. Likewise, if a tailor agrees to stitch a suit for X, X cannot assign the right to have a suit stitched to Y.
- Contracts of personal service cannot be assigned. For example, if Y agrees to serve the office of X, X cannot assign the service contract to P.
- If the contract expressly prohibits the right of a party to assign his receivables or benefit under a contract, then such receivables/benefit are not assignable, or not assignable without the consent of the counterparty. There have been several rulings on the impact of prohibition under contract on assignability of benefits under, particularly, something a like a debt. More than a century ago, in Re Turcan (1888) 40 Ch.D.5, it was held that if a life insurance policy was not assignable, it did not prevent the insured from declaring himself as a trustee for the assignee. In Barbados Trust Company Ltd Bank of Zambia and Anr  EWCA Civ 148, the House of Lords held that a prohibition on assignment operates only between the assignor and the counterparty to the contract, and not between the assignor and assignee- hence, the contract to assign would still operate as equitable assignment.
Whether receivables can be assigned?
Section 3 of the Transfer of Property Act, 1882 (“TP Act”) defines ‘actionable claim’ as follows:
““actionable claim” means a claim to any debt, other than a debt secured by mortgage of immoveable property or by hypothecation or pledge of moveable property, or to any beneficial interest in moveable property not in the possession, either actual or constructive, of the claimant, which the Civil Courts recognise as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent”
Sections 130-137 of the TP Act contains provisions with regard to assignment of actionable claims and lays down the procedure for assignment of receivables. Section 130 of the TP Act states that:
“(1) The transfer of an actionable claim whether with or without consideration shall be effected only by the execution of an instrument in writing signed by the transferor or his duly authorised agent, shall be complete and effectual upon the execution of such instruments, and thereupon all the rights and remedies of the transferor, whether by way of damages or otherwise, shall vest in the transferee, whether such notice of the transfer as is hereinafter provided be given or not:
PROVIDED that every dealing with the debtor other actionable claim by the debtor or other person from or against whom the transferor would, but for such instrument of transfer as aforesaid, have been entitled to recover or enforce such debt or other actionable claim, shall (save where the debtor or other person is a party to the transfer or has received express notice thereof as hereinafter provided) be valid as against such transfer.
(2) The transferee of an actionable claim may, upon the execution of such instrument of transfer as aforesaid, sue or institute proceedings for the same in his own name without obtaining the transferor’s consent to such suit or proceeding and without making him a party thereto.”
So, the assignment of receivables shall be effected upon execution of an instrument and the transferee shall, on the strength of the instrument, attain lawful rights to recover the claims from the debtor in his own name without any reference to the transferor.
In the case Mulraj Khatau v. Vishwanath Vaidya (1913) 15 BOM LR 9, the Bombay High Court held that an assignment by a debtor when effectuated by a written instrument is governed by Section 130(1) of the TP Act and only thereafter all the rights and remedies are vested in the transferee.
Therefore, it appears from the above, the receivables are assignable in accordance with the provisions of the TP Act.
Principles for assignment of receivables:
For a valid transfer of receivables, the following principles are generally accepted:a) The receivables must exists at the time of assignment;b) Receivables must be identifiable;c) Assignment of rights and not obligations;d) No contractual restriction on transfer;e) There must not be a right of set-off or claims against the assignor. As held by the Apex Court, in ICICI Bank Limited v. Official Liquidator of APS Star Industries Ltd. & Others, “rights under a contract are always assignable unless the contract is personal in its nature or unless the rights are incapable of assignment, either under the law or under an agreement between the parties. A benefit under the contract can always be assigned. That, there is, in law, a clear distinction between assignment of rights under a contract by a party who has performed his obligation thereunder and an assignment of a claim for compensation which one party has against the other for breach of contract.”
The benefits arising out of a contract are assignable from the assignor to the assignee, and in this context, the relevant case is Mulkerrins (formerly Woodward (FC)) v. Pricewaterhouse Coopers  UKHL 41. The House of Lords held that, “The general rule is that the benefit of a contract may be assigned to a third party without the consent of the other contracting party. If this is not desired, it is open to the parties to agree that the benefit of the contract shall not be assignable by one or either of them, either at all or without the consent of the other party.”
Assignment of future benefits under contract vs. assignment of benefits under future contracts:
A contract may give rise to benefits in future- for example, a contract of sale on credit creates a right to receive the sale price at the appointed time. This is an existing debt, though payable in future. There is no doubt as to the assignability of such debt.
A contract may also create future receivables, which either do not exist now, or are contingent, conditional or uncertain right now. For example, if a landlord has let out property to a tenant, the tenant will have rentals to pay in future, but as these rentals are based on continuing performance, they have not become unconditional or non-contingent right now. The rule on assignability of future debt is that future debt is also assignable, though such an assignment would operate when the receivable comes into existence. There is elaborate discussion on assignment of future debt in Vinod Kothari: Securitization: Financial Instrument of the Future.
However, as regards assignability of contracts in future, that is, contracts not yet entered into, it is highly speculative and contingent, and other than as a promise on the part of the assignor to assign benefits of such contracts as may be entered into in future, such an assignment has no relevance.
Assignment of receivables in case of pending litigation: Whether disputed receivables can be assigned?
Another major question that arises is that whether future debt or receivables is assignable. This question must be answered in affirmative keeping in mind the case law of Tailby v. Official Receiver  13 A.C. 523, in which it has been held that all future debts, properties and expectancies are assignable. In the case of Mc Dowell and Co. Ltd. v. District Registrar 2000 (3) ALD 199, the Andhra Pradesh High Court held that “the definition of actionable claim has been extended so as to include such equitable choses in action as debts or beneficial interest in moveable property whether existent, accruing, conditional or contingent.”
Rights of the assignee:
Rights of assignee are no better than those of the assignor, as the assignee steps into the shoes of the assignor. A very old text [Alfred W. Bays American Commercial Law Series, 1920, sec 122] puts it as follows: “The theory of contract being that it is a personal relationship between two or more persons who have chosen each other, assignment of rights thereunder, without the other party’s consent, is permitted, as we have seen, upon the theory that the contractual arrangement is not thereby disturbed. It follows from this, that such assignment cannot be permitted to increase the obligations of the other party thereunder. Therefore, the assignee will take the right as it actually exists, not as it may seem to be; and will take it subject to all adjustments and defenses to which the assignor would have been subject had there been no assignment”. That is to say, the counterparty to the contract cannot be put to a disadvantage by virtue of an assignment, as assignment is merely a transfer of rights that the assignor had.
Assignment of receivables vs. sale of the asset:
Practitioners are sometimes not clear about assignment of receivables, versus sale of the asset from which receivables arise. Take, for instance, the case of a lease of an asset. Assignment of receivables would mean sale of the lease rentals, not the asset. In that case, the leased asset still remains the property of the assignor – that is, the assignor has retained the residual interest in the asset. However, it would be different if the lessor sells the asset that has been leased out.
Assuming that it is contractually possible to sell the leased asset, if X sells the asset to P, there is no need to separately assign the receivables arising out of the lease. The lease rentals flow from the asset- if the asset has been transferred, the receivables automatically flow from the asset.
Whether consent from debtor required? Whether notice to debtor required?
The general rule is if the assignment is silently done between the assignor and assignee, and has not been notified to the debtor, it would nevertheless be good as between the assignor and assignee, but would not be operative against either the debtor or the world at large. Such an assignment is called equitable assignment.
The proviso to Section 130 of the TP Act provides that dealing of debt/actionable claim by the debtor shall be valid as against the transfer between the assignor and the assignee, save where the debtor is a party to the transfer or has received express notice thereof.
Issues pertaining to assignment:
There are host of legal/taxation/accounting issues that pertain to assignment of receivables, and the complete matrix may be indeed very complex. Following is only a brief pointer to the legal issues that may arise:
Legal formalities on assignment:
Legal systems of most countries would lay down what is required to give effect to assignment. For example, sec 136 of the UK Law of Property Act deals with the procedural formalities to give effect to a transfer of a “thing in action”, that is, actionable claims. Section 130 of the TP Act in India deals with assignment of actionable claims. These legal provisions essentially provide that an assignment must be by way of an agreement in writing, and such assignment must be notified to the debtor. Why is notice to the debtor required? The answer is obvious – how is the debtor expected to reconise the rights of the assignee, who he never dealt with, and has not been notified of. The interpretation of this requirement is that if the assignment is silently done between the assignor and assignee, and has not been notified to the debtor, it would nevertheless be good as between the assignor and assignee, but would not be operative against either the debtor or the world at large. Such an assignment is called equitable assignment.
Stamp duty on assignment:
As per Indian Stamp Act and mostly all state stamp acts (such as Maharashtra), a “conveyance” includes every instrument, by which property, whether movable or immovable, or any estate or interest in any property is transferred to, or vested in, any other person, inter vivos, and which is not otherwise specifically provided for by Schedule I. Therefore, the respective stamp act will have to be looked into to determine the stamp duty payable on assignment. For instance, Clause 25(a) of Schedule- I of the Maharashtra Stamp Act shall be applicable on assignment transactions, which provides that stamp duty shall be payable at 3% of the market value of the property.
Implication of inquorate stamp duty:
Section 35 of the Indian Stamp Act, 1899 provides that instruments not duly stamped are inadmissible in evidence and cannot be acted upon for any purpose. The relevant extract is reproduced below for reference:
“35. Instruments not duly stamped inadmissible in evidence, etc.- No instrument chargeable with duty shall be admitted in evidence for any purpose by any person having by law or consent of parties authority to receive evidence, or shall be acted upon, registered or authenticated by any such person or by any public officer, unless such instrument is duly stamped:
Provided that- (a) any such instrument shall be admitted in evidence on payment of the duty with which the same is chargeable, or, in the case of an instrument insufficiently stamped, of the amount required to make up such duty, together with a penalty of five rupees, or, when ten times the amount of the proper duty or deficient portion thereof exceeds five rupees, of a sum equal to ten times such duty or portion.”
In SMS Tea Estates Private Limited vs. Chandmari Tea Company Private Limited, (2011) SCC 66 and Garware Wall Ropes Limited vs. Coastal Marine Constructions and Engineering Limited, (2019) 4 SCC 2019 or in Chilakuri Gangulappa vs. Revenue Divisional Officer, Madanpalle (2001), the Hon’ble Supreme Court of India while holding that an insufficiently stamped instrument cannot be relied upon for any purpose, however, observed that the concerned court has to follow the procedure provided under the Indian Stamp Act, 1899 for impounding the instrument before permitting a party to enforce the said insufficiently stamped instrument.
Initiation of insolvency petition in case of assignment transactions:
Section 5(7) of the Insolvency and Bankruptcy Code defines a “financial creditor” to mean “any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to.”
There have been umpteen cases where the assignee of the debt has initiated insolvency petition against the corporate debtor on occurrence of default, and the same has been admitted by the Adjudicating Authority. However, there have been cases where the petition was challenged on grounds of technical issues, such as non- registration of assignment agreement or inadequate stamp duty. In this regard, it is pertinent to refer to the following rulings to understand what will be the consequences in such a case:
- In Lalan Kumar Singh, Executive Director (under suspension) & shareholder of M/s. GPI Textiles Ltd., vs. M/s. Phoenix ARC Pvt. Ltd., & Anr., the Hon’ble National Company Law Tribunal Appellate Tribunal held that- “The assignment cannot be challenged in the petition under Section 7 and that too by a party who had the knowledge of ‘Assignment Deed’ as back as in the year 2012”. In fact in the said case, the Tribunal relied on a letter written by the ‘Corporate Debtor’, from which it was clear that the ‘Corporate Debtor’ agreed for assignment by HSBC in favour of ‘Phoenix’, and accordingly, held that– “in this background, it is not open to the appellant either to raise allegation of mala fide against the HSBC or to allege that the assignment is illegal.”
- In the case of Edelweiss Asset Reconstruction Co. Ltd. vs. Sejal Glass Ltd., the Corporate Debtor had not contended that the debt does not exist or the default did not occur but had only raised technical defences as to the validity of documents being not duly stamped. Here, the Hon’ble National Company Law Tribunal, Mumbai Bench held that even if the agreements, as alleged, are not admissible as an evidence of debt and default, there are several other documents that show the admission by the corporate debtor of the debt that it owes to the petitioner, and accordingly, the petition was admitted.
- In Edelweiss Asset Reconstruction Company Limited vs. M/s Winsome Yarns Ltd., the issue in hand was w.r.t. the maintainability of the petition as the entitlement of the petitioner to file the petition under Section 7 of the Code as a financial creditor of the corporate debtor, which was solely dependent on the enforceability of assignment agreement. In the said case, the Hon’ble National Company law Tribunal, Chandigarh Bench did not allow the petition, observing as follows:
“In normal circumstances, the presumption of the validity and enforceability goes in favour of the document on record. The onus of proving a document as invalid and unenforceable is heavily on the person who is challenging the said document. Bald allegations without sufficient basis cannot shift the onus from the person questioning the validity to the person placing reliance on a particular document. In the instant case, the respondent-corporate debtor by placing reliance on the above referred documents of the Revenue Authorities whereunder a categorical finding was given that the Assignment Agreement is inadequately stamped and that the petitioner was directed to pay an amount of ₹1,45,85,000/- towards the deficit stamp duty, able to shift the onus to the petitioner.
Once the corporate debtor by placing reliance on the orders of the relevant Revenue Authorities able to show that the Assignment Agreement is unenforceable and the petitioner not is not able to produce any stay order thereof, this Adjudicating Authority has no other option except to reject the petition.”
Off balance sheet treatment following assignment:
One of the most tricky questions for parties to ask is – does the assignment lead to an off-the-balance sheet treatment for the assignor? The answer may not be short, but some quick rules are as follows:
- Assignment is a case of a sale – sale may be a true sale or just a sale. However, for accounting off-balance sheet treatment (also called “de-recognition”), what is required is not a legal sale, but a transfer of risks and rewards. Hence, there may be cases where there is no legal sale, and yet, because of transfer of risks and rewards, the receivables in question may go off the books. Contrary, there may be cases where there has been a legal sale, and yet, off balance sheet treatment is not allowed.
- The accounting off-balance sheet is determined as per accounting rules, contained in IFRS 109 [Ind AS 109] These rules focus on transfer of substantial risks and rewards, or retention of substantial risks and rewards, and put up the next condition where there is no substantial transfer of risks and rewards – whether there has been a surrender of control.
For details of IFRS 9/IndAS 109, see our write-ups here – http://vinodkothari.com/category/corporate-laws/accounts-and-audit/.
IFRS 9 was preceded by IAS 39 – see Vinod Kothari’s article on IAS 39 – see http://vinodkothari.com/ifrs_9/
True sale, which is usually an issue in case of securitisation/direct assignment transactions, has been discussed at length in our write up here – http://vinodkothari.com/2019/01/assignment-of-receivables-in-financing-transactions/
Our write up on GST on assignment of receivables can be viewed here –