Assignment of rights in the financial industry
Gaby Samir El Hakim, Maha Alkhabbaz and Hesham Bucheeri of NBB explore the critical role of an assignment of rights in the financial industry, highlighting its impact on risk mitigation, secured financing and liquidity enhancement.
An assignment of rights refers to the transfer of certain rights arising from a contract to a third party outside of the contractual relationship. Under such arrangement the party assigning its rights continues to be responsible for the completion of the respective contract, but the benefit of such contract is transferred to the third party.
An assignment of rights may include an assignment of all rights, benefits, interests, title to the monies, proceeds, and all other receivables generated from and in relation to a specified contract.
In the realm of lending, an assignment of rights continues to play a pivotal role in securing interests while extending credit. This legal mechanism enables banks to secure their financing against any possible default by the borrower, by providing the lender with a right to the benefit of the contract, i.e. the contract proceeds and/or other receivables under the contract. In doing so, an assignment of rights allows the lenders to manage risk effectively and to free up liquidity.
LEGAL FRAMEWORK SURROUNDING AN ASSIGNMENT OF RIGHTS
Article 287 of the Law No. 19 of 2001 with respect to the Civil Code in the Kingdom of Bahrain (the “Civil Code”) stipulates that a creditor may assign receivables without the consent of the debtor, “A creditor may assign his right to a third party unless there is a provision in the law or an agreement between the parties that prohibits such assignment, or on account of its nature. The assignment is valid without the consent of the debtor.”
As highlighted by Article 287 above, in principle, a creditor possesses the right to assign their claim to another party. This ‘claim’ essentially represents the creditor’s entitlement to receive something, most commonly a sum of money, from a debtor. This highlights that the focus is on the creditor’s right to dispose of their right, treating it as a form of property. The debtor’s involvement is not a prerequisite for the assignment’s validity. However, it is also key to note that under Article 289 of the Civil Code, an assignment is not effective against a debtor or a third party unless it has been accepted by the debtor or duly notified to him.
Key court judgments issued by the Court of Cassation, such as Case No. 753/2015, have shaped the understanding of these assignments of rights. In this judgment, the Court of Cassation, referencing Articles 287 and 289 of the Civil Code, ruled that “an assignment of rights is concluded by agreement between a creditor assigning a right owed to him by his debtor and the assignee, who takes the place of the former creditor in his relationship with the debtor. The debtor’s consent is not required for the assignment’s formation. However, assignment is not effective against the debtor or third parties until they are formally notified, unless they have explicitly or implicitly accepted it. In such a case, they are bound by it from the time of their acceptance, even if there is no fixed date. If accepted, the debtor is bound from the moment of acceptance, even without a fixed date. Nevertheless, for the assignment to be effective against third parties, the debtor’s acceptance must have a fixed date, as per Article 14 of the Law of Evidence.”
ASSIGNMENT OF DEBT: THE ROLE OF THE LENDER’S CONSENT
Conversely, the assignment of debt, being a situation where a borrower intends to transfer their obligations under a
contract to a third party, requires the lender’s consent.
This is stipulated in Article 301 of the Civil Code, which states that “If an assignment deed is entered into between the principal debtor and the assignee, it shall not be effective towards the creditor unless ratified by the creditor.” This Article 301 underscores the importance of maintaining the integrity of the lender-borrower relationship.
Not obtaining consent from the lender shall result in an assignment being ineffective. Critically, the lender’s silence following notification of the debt assignment is construed as a rejection, rendering the assignment ineffective in relation to them. The necessity of the lender’s consent is further emphasised by judicial precedent; for instance, in Case No. 651/2010, the Court of Cassation ruled that unauthorised assignments which lack lender approval are deemed invalid.
ASSIGNMENT OF RECEIVABLES BY WAY OF SECURITY
An assignment of rights may be by way of a transfer of receivables to the lender bank. In such a case, cash is assigned to the bank directly and is not deposited into an account held by the borrower. Such funds are immediately used for the repayment of the borrower’s facility.
Alternatively, the borrower may provide an assignment by way of security. In doing so, funds are routed to the borrower’s account held with the lender bank, and such an account is then pledged to the lender bank. In this case, the borrower holds responsibility to effect payment of the monthly instalments when due. However, in the event of default, the lender bank has the right to deduct the amount due from the pledged account pursuant to the right of set-off created by way of the assignment agreement and the pledge over the account.
ASSIGNMENT OF RIGHTS IN LIGHT OF REORGANISATION OR BANKRUPTCY
Consideration must also be given as to the impact of reorganisation and bankruptcy on an assignment of rights. In such an event, the appointed trustee must consider the assignment and determine whether it is valid. This is done in light of the trustee’s obligations under the Reorganization and Bankruptcy Law No. 22 of 2018 as amended (the “Reorganization and Bankruptcy Law”), which stipulates that the trustee must perform the acts necessary to protect and manage the bankruptcy estate.
If the trustee deems the assignment to not be in the best interests of the creditors, pursuant to the trustee’s authority under Article 72 of the Reorganization and Bankruptcy Law, such an assignment may be dismissed, and the lender may claim his rights pursuant to the financing documentation signed by the borrower. Article 72 states “(a) The trustee shall petition the court to invalidate any action taken by the debtor or any obligation incurred by the debtor retroactively in the following cases: (1) if the debtor has taken such action or incurred such obligation with the intent to defraud current or future creditors or with the intent to prejudice their ability to obtain their claims. (2) if the debtor did not receive fair consideration for such action or incurred an obligation that does not benefit them.”
IMPACT OF AN ASSIGNMENT OF RIGHTS ON CREDIT RISK MITIGATION
Credit risk is set out in Volume 1 (Conventional Banks) of the Central Bank of Bahrain Rulebook (“CBB Rulebook”) as the potential that a borrower will fail to meet its obligations as per the terms agreed with the bank. Paragraph CA-4 of Volume 1 concerns credit risk mitigation, being the techniques used by banks to mitigate the credit risks they are exposed to.
It is highlighted that the type of security (being tangible or intangible) obtained in relation to a borrowing impacts the view taken on credit risk. Given that an assignment of rights is not eligible for recognition as a collateral instrument under credit mitigation techniques, the bank cannot avail the reduced capital charges.
As we navigate the complexities of an assignment of receivables, our colleague Mr. Ali Ehsan, Group Chief Risk Officer, brings valuable perspective on the treatment of an assignment as a collateral, “In today’s dynamic financial landscape, assignment of rights is not just a tool – it’s a strategic imperative for safeguarding the credit health of organisations whether users or providers of capital. By enabling transfer of rights in carefully governed and well administered manner, assignments can be the cornerstone that unlock significant opportunities for asset monetisation, driving liquidity, and value creation”.
Under the legal regime governing secured transactions in various jurisdictions, could the classification of an assignment change from a capital charge standpoint from a regulatory point of view? This is because these assignments will be registered in a public register and will be deemed to be akin to a tangible security. Such approach would expand the pool of assets which may be granted as tangible security under financing, which would further encourage parties to participate in lending and borrowing and may enhance the presence of complex structured finance transactions within the industry.
THE FUTURE OF THE ASSIGNMENTOF RIGHTS
The assignment of rights represents a vital component of the lending landscape. By grasping the underlying legal principles, bankers can navigate these complexities more effectively.
Looking ahead, technological advancements could play a significant role in enhancing the assignment of rights, making the process more efficient and secure. Technologies such as blockchain have the potential to provide a transparent and tamper-proof record of assigned receivables, reducing disputes and improving enforcement. Similarly, smart contracts could automate the execution of assignments, ensuring seamless transfers of rights upon predefined conditions, such as loan repayments or borrower defaults. If adopted, these innovations could streamline structured finance
transactions and minimise reliance on manual processes.
As financial institutions explore these technologies, regulatory adaptation and ensuring compliance with legal requirements is key to mitigate risks and enhance the overall effectiveness of lending strategies.
Text by:
GABY SAMIR EL HAKIM, group chief legal officer & corporate secretary, National Bank of Bahrain B.S.C.
MAHA ALKHABBAZ, legal counsel, National Bank of Bahrain B.S.C.
HESHAM BUCHEERI, legal counsel, National Bank of Bahrain B.S.C.
