Invoice finance market set for further growth as result of landmark Spectrum Plus ruling

A new survey from Demica amongst leading commercial lawyers predicts further growth for the invoice finance or asset-based lending (ABL) market - be it factoring, invoice discounting or asset-backed securities (ABS) as a result of legislation passed by the House of Lords earlier this year, which has received surprisingly little market commentary. 90% of respondents believed that the ‘National Westminster Bank plc v Spectrum Plus Ltd’ case would lead to banks to lending more frequently through invoice financing.

The decision meant that banks, when providing finance to a company against its book debts, would no longer be top of the pecking order when recovering the company’s assets should it become insolvent. They would hold only a "floating" and not "fixed" charge on these assets, meaning their efforts to receive priority over a company’s assets would be denied in favour of preferential creditors. Millions of pounds’ worth of assets are now being directed away from banks as stalled liquidations are now under review. Some estimates have put the number of cases tied up in this way at around 550.

Demica’s research was carried out across the top 30 commercial law firms in the UK. The lawyers were canvassed for their opinion on a number of areas, such as the ruling’s implications for traditional lending and for asset-based lending. The study most specifically investigated the likely course that banks would take in the light of the Spectrum Plus ruling.

Nineteen out of the thirty respondents estimated that, in the light of increased risk for banks, the continuation of lending policies with pricing the same as before the Spectrum ruling was not feasible. A quarter of respondents estimated that additional security would be sought by banks to bolster guarantee packages. Certain parties estimated that directors – more notably of SME firms, (who by nature have fewer assets and are usually more likely to rely on obtaining lending secured against company book debt) - would have to make further security pledges.

Though it is still possible for banks under Spectrum to levy a fixed charge by the imposition of restrictive conditions on borrowers, in order to gain priority in the case of insolvency, half of the respondents predicted that banks would not take this direction. This procedure relies on assigning company debts used as security to the bank, or on paying all the debts’ proceeds into an account which is blocked/from which the company can not draw funds. A fifth of respondents believed that some banks would attempt to structure a fixed charge, but that this would prove commercially unfeasible, as borrowers would be likely to resent the restrictions this would place on their cash flow and working capital requirements.

Two thirds of respondents deemed that, of all the possible avenues open to banks, the most likely scenario was a complete review of the entire area of risk assessment. This would necessarily lead to a certain revision of the terms of the funding offered and to the tightening of credit policies, creating a somewhat unfavourable climate for borrowers. A total of ninety per cent of respondents held the view that this ruling would create excellent opportunities for the ABL market. Both factoring and invoice discounting are based on the purchase of a customer’s debts by a financier, which represents a change in ownership of the debts, rather than just a grant of security over debts. In the knowledge that no other creditor can lay prior claim to these book debts, invoice financiers can provide higher levels of funding than banks. Those offering factoring and invoice discounting services are set to receive more business as banks are forced to offer more expensive funding. Because of the good security achievable through invoice finance, banks too are increasingly encouraging borrowers to factor or discount their debts through the banks’ own ABL divisions.

Phillip Kerle, CEO, Demica, comments "The Spectrum Plus ruling on 30 June 2005 is likely to be of great importance for lenders, borrowers and asset-based lenders alike. Our study demonstrates that banks will assess the security over book debts that are not operating a blocked account procedure on the basis of floating security (rather than a fixed). Borrowers without significant tangible assets looking to access bank debt are likely to find that it will be more expensive in future, as lenders set their margins accordingly. As the research highlights, other possible avenues are not commercially feasible and are overly restrictive for borrowers. ABL is now set to become the preferred option where funding is required against book debts and is now likely to play a more significant role in the financing of domestic and international business."

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