Many asset based lenders charge collection fees as part of making available asset based facilities to companies.
What is asset based lending / invoice discounting?
Asset based lending (more particularly, invoice discounting) is a financing transaction where a company (which supplies goods or services) assigns/sells its unpaid invoices, book debts or other receivables to a financier at a discount for immediate cash to use for working capital purposes. The financier charges interest on the amount advanced and the company is also required to pay a variety of fees to the financier on day 1 and in certain other situations. The company almost always retains responsibility for collecting the debts and administering its sales/supply ledger unless and until a “termination event” or “event of default” occurs, whereupon the financier will have a number of rights and remedies available to it under the finance documentation including the right to take over collections of the “financed” invoices/book debts/receivables and to charge a related “collection fee”. A recent decision in the High Court (BHL v Leumi ABL Limited  EWHC 1871) may require asset based financiers to reconsider the approach that they would take in setting the amount of their “collection fee”.
The case concerned a clause in a receivables finance agreement (RFA) made between Leumi ABL Limited (Leumi) and Cobra Beer Limited (Cobra) which allowed Leumi to charge collection fees of up to 15% of sums collected by it. Leumi took over collections following Cobra’s administration (a “termination event” under the RFA) and around the same time one of Cobra’s shareholders, BHL, agreed to indemnify Leumi for any shortfall it suffered under the RFA.
Leumi collected approximately £8,000,000 and applied the full 15% to the collected amount, giving a collection fee of £1,200,000 plus VAT. Leumi had recovered enough to “repay” its principal exposure, but sums were still owing to it and these sums comprised almost entirely the collection fee. Leumi claimed under the BHL indemnity.
BHL challenged the collection fee on 3 grounds:
- Leumi was only entitled to its actual costs of collection;
- the 15% collection fee was a penalty; and
- setting the fee at the 15% maximum allowed was a breach of Leumi’s duty not to exercise its discretion in an arbitrary, capricious or irrational manner
BHL failed on grounds #1 and #2 but succeeded on ground #3.
BHL succeeded on ground #3 because of the so-called “Braganza duty”, i.e. that a contractual discretion must be exercised in a way which is not “arbitrary, capricious or irrational in the public law sense” (Braganza v BP Shipping  1 WLR 1661). The judge held that Leumi had failed to consider properly the correct percentage for the fee. Nor had it demonstrated the rationale it had used to set the fee at 15% maximum. It was suggested that this should have involved Leumi considering, among other things:
- how long the collect-out would take
- how the process of collecting the book could change over time (i.e. later collections would be more difficult to recover)
- who would do the collect-out (i.e. Leumi and/or third parties)
- its internal costs (based on its considerable past experience of collect-outs)
Failure to do this meant that Leumi could not show how it justified charging the 15% to Cobra/BHL. The judge found that 4% was the maximum that should have been applied.
Comment: some good news and some bad news for asset based financiers
On the good side, the Cobra case could be seen as positive for asset based financiers insofar as Leumi’s collection fee was found not to be a penalty. This was because the fee was not expressed to be a payment for breach of contract. It was, by contrast, expressed as an obligation on Cobra to pay an amount if Leumi chose to terminate Cobra’s agency to collect debts and collect-out itself. An asset based financier which uses the second formulation in its finance documents will improve the chances of its “collection fee” being enforceable.
On the negative side, however, the Cobra case has highlighted the wide discretion that many asset based financiers have in their finance documentation to set fee levels and to make other decisions (for example, to adjust the credit limits and funding levels, to set reserves which reduce the amount of finance available and to decide what does or does not count as a receivable “eligible” for funding). While the Leumi case concerned the exercise of a discretion to set a collection fee, it is perhaps not too far of a stretch to say that asset based financiers should also consider exercising these other types of discretions in accordance with the “Braganza duty” – i.e. rationally by reference to objective criteria – to reduce the risk of challenge by a borrower or its insolvency official or even the courts.
Jonathan Porteous, head of Banking & Finance at Stevens & Bolton, comments: “following hot on the heels of the Watchfinder case, which also concerned the exercise of contractual discretion and the “Braganza duty” (see our article on Watchfinder here), the Cobra case is a further example of how the English courts are ever more willing to scrutinise the exercise of discretionary powers in a commercial situation. The result of the Cobra case will be of interest to all those involved in exercising discretions and/or making decisions in all sorts of finance transactions.”