EUROPEAN COMMISSION Brussels, 29.9.2016 COM(2016) 626 final REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL AND THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE on the question of the effectiveness of an assignment or subrogation of a claim against third parties and the priority of the assigned or subrogated claim over the right of another person



REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL AND THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE on the question of the effectiveness of an assignment or subrogation of a claim against third parties and the priority of the assigned or subrogated claim over the right of another person 1.INTRODUCTION 1.1.Assignment of claims in the perspective of the Capital Markets Union The Capital Market Union Action Plan concluded that despite significant progress in recent decades to develop a single market for capital, there are still many long-standing and deep-rooted obstacles that stand in the way of cross-border investments. One of the obstacles identified results from differences in the national treatment of third party effects of assignment of debt claims that complicates the use of these instruments as cross-border collateral particular when bank loans are mobilised as financial collateral in central bank credit operations or in the context of securitisations, and makes it difficult for investors to price the risk of debt investments. To facilitate cross-border investment, the Capital Markets Union Action Plan foresees that 'the Commission will [...] propose uniform rules to determine with legal certainty which national law shall apply to third party effects of the assignment of claims' and that action will be taken by 2017. This report is the first step in identifying the main problems related to the lack of a uniform rule on the law applicable to the third party effects of assignment and the order of priority of the assigned claim and the possible approaches that could be taken to address those problems. 1.2.The concept of assignment of claims Assignment of claims is a legal mechanism which enables both simple transfers of claims from one person to another and complex financial operations used to finance the business activity of firms, such as financial collateral arrangements, factoring and securitisation. At its basis, it involves the transfer by a creditor ("assignor") of his claim against a debtor to another person ("assignee"). Examples of typical assignment transactions are set out below (point 2.1). With the increasing interconnectivity of national markets, assignment often involves a cross-border element, which can lead to a conflict of applicable laws. Legal certainty as to which law applies to the different relationships involved is paramount for the smooth running of assignment operations. Increased legal certainty leads to increased availability of capital and credit across borders and to more affordable rates - particularly beneficial for small and medium enterprises (SMEs), and in the long run, to the facilitation of cross-border movement of goods, services and capital. 1.3.Existing EU legislation In the European Union, the objective of enhancing legal certainty in the area of assignment of claims has been addressed by harmonising rules on conflict of laws in Regulation (EC) No 593/2008 on the law applicable to contractual obligations (the Rome I Regulation). These rules provide that the relationship between assignor and assignee under a voluntary assignment or contractual subrogation of a claim against the debtor shall be governed by the law that applies to the contract of assignment.. The harmonised rules also aim at protecting the assigned debtor by ensuring that he does not owe the assignee more than he owed the creditor/assignor. Consequently, the law governing the claim to which the assignment relates, which is the only law which the debtor can reasonably expect to apply, will also govern the relationship between the assignee and the debtor, the assignability of the claim, the conditions under which the assignment can be invoked against the debtor and the question whether the debtor's obligations have been discharged. However, there is an important element missing in the existing regulation, which concerns the question which law governs the effectiveness of an assignment against third parties. This question is crucial to ensure legal certainty in cross-border assignment operations. This Report fulfils the legal obligation under Article 27(2) of the Rome I Regulation which requests the Commission to submit a report on the question of the effectiveness of an assignment or subrogation of a claim against third parties and the priority of the assigned or subrogated claim over a right of another person. 1.4.Securities and claims transactions The Capital Markets Union Action Plan points out, besides the uncertainty in the area of assignment of claims, to the similar uncertainty existing in the context of cross-border securities transactions. Indeed, both securities and claims are frequently the subject of similar financial transactions, such as collateralisation. Sector specific legislation containing conflict of laws rules has been adopted in the field of securities law with a view to reduce the systemic risk inherent in payment and securities settlement systems, to limit the credit risk in financial transactions through the provision of cash, financial instruments and credit claims as collateral, or to enforce proprietary rights in the event of the reorganisation and winding up of credit institutions. These specific conflict rules apply in the EU Member States and point to the law of the State where the register, relevant account or centralised deposit system is located. These rules have, however, been implemented or are being applied differently in the Member States. This leads to legal uncertainty and additional costs which may create obstacles for the smooth running of financial operations in the internal market. Also in the area of securities a general approach to the issue of conflict of laws has so far not been established. Neither has the substantive law on securities been harmonised so far at EU level, notwithstanding the recent development of EU legislation in the area of financial market infrastructure, including European Markets Infrastructure Regulation (EMIR), Central Securities Depositories Regulation (CSDR) and MiFID II/MiFIR and notwithstanding ongoing work for several years. In the light of the similar objectives which may be pursued by claims and securities transactions, it may be useful to coordinate any work on the conflict rules regarding both types of transactions. This is even more so since the distinction between a "claim" and a "security" is not always clear in practice. 1.5.International instruments The conflict of laws problems in the context of claims and securities transactions has been the subject of work at the international level. A United Nations Convention on the assignment of receivables in international trade has been established in 2001. It has not entered into force so far. Its principles have been incorporated in the 2007 UNCITRAL legislative guide on secured transactions. A 2006 Hague Convention on the law applicable to certain rights in respect of securities held with an intermediary also has not entered into force so far. 1.6.External study and consultations

A study examining the question of the effectiveness of an assignment or subrogation of a claim against third parties and the priority of the assigned claim over the right of another person was carried out for the European Commission (hereinafter “the study”). The study based its findings on statistical, empirical and legal data from twelve European Union jurisdictions representing a range of legal traditions, as well as six economically important non-Member States. 2.importance of assignment in international trade and on capital markets 2.1.Examples of assignment transactions Historically assignment took place in relation to a single claim, which was transferred from the creditor to one or several subsequent assignees. Example 1: Outright transfer of a single claim The creditor/assignor C assigns his claim against the debtor to assignee A. A may notify the debtor of the assignment, for instance when this is required by the national law of C's place of habitual residence. A then re-assigns the same claim to assignee B. B may decide not to notify the assignment, for instance because this is not required by the law of the underlying claim where such a notification or registration is not necessary to render the assignment effective. C subsequently becomes insolvent and his insolvency administrator tries to ascertain whether B is the valid owner of the claim.. In recent times, assignment transactions have evolved to include assignment of claims in bulk and assignment of both present and future claims. Such transactions have become widely used by businesses in order to obtain capital and credit to finance their business operations. Example 2: Factoring An SME supplier C wishes to assign the bulk of his current and future claims against clients in several Member States to factor A, which in return for a discount against the purchase price is ready to agree to provide cash flow finance, collect the debts and accept the risk of bad debts. To propose an interesting discount to C, A would need to know that the assignment will be effective against third parties in the event of C's insolvency. A may also be worried that while under the law of the assignment, which governs the proprietary effects between A and C, all claims are assignable, it may be that under the law governing some claims included in the assignment bulk assignments are prohibited. Legal certainty as to the law governing the effectiveness of the assignment against third parties and the priority of an assignment against other competing assignments has become crucially important in particular in credit transactions involving SMEs which are often unable to obtain finance across borders or are forced to accept unfavourable terms unless they can offer security, often in the form of claims against their debtors. Example 3: Assignment as security An SME C wants to utilise to the maximum extent possible the value of its claims against the buyers of its products to obtain secured credit from both assignees A and B, using the same assets as security. In order to extend credit to C, A and B would need to know the priority of their security rights in the same asset. C may also fraudulently assign the same claims to A and B without their knowledge. In the event of C's insolvency, the insolvency administrator would need to ascertain the order of priority between A and B. A complex mechanism of obtaining cost-effective credit is securitisation. Securitisation is a financing technique by which homogeneous income-generating assets (often claims) − which on their own may be difficult to trade − are pooled and sold to a specially created third party, which uses them as collateral to issue securities and sell them in financial markets. Example 4: Securitisation A large retail chain C assigns its receivables arising from the use by customers of its in-house credit card to a special-purpose vehicle (A). A then issues debt securities to investors in the capital markets. These debt securities are secured by the income stream flowing from the credit card receivables that have been transferred to A. As payments are made under the receivables, A will use the proceeds it receives to make payments on the debt securities. With increased cross-border investment, securities such as bonds are often assigned as collateral to secure credit from investors. The holding chain between investors and issuers is complex: securities can be held through multiple tiers of intermediaries, potentially located in different countries, as may also be the case with investors. This makes it difficult to assess who owns what, with possible serious consequences for financial stability. 3.problems 3.1.Current divergence of conflict rules in the Member States The substantive rules applicable to assignment in the Member States differ greatly. For example, there are different notice requirements for the effectiveness of assignments, different priority rules, different rules applying to assignment of future claims, as well as different limitations on the assignability of claims. In the absence of harmonisation of these substantive rules, private international law solutions are extremely important in resolving conflicts of laws. However, in determining the law applicable to third-party aspects of assignment there are several different approaches in the States analysed in the study. The law of the contract between assignor and assignee governs all proprietary aspects of assignment in The Netherlands. This solution favours party autonomy, but it bears the risk that creditors of the assignor can be defrauded. In order to correct such abuses, recourse may be made to the general principle fraus omnia corrumpit or to the public policy exception. As to the question of priority in the case of competing assignments, the law governing the second assignment decides upon the protection of good faith second acquirers. This approach has gained some support in other Member States, such as Germany. It is also found in Switzerland. The law of the assignor's habitual residence determines the third-party aspects of assignment in Belgian law. Some Italian scholars support the introduction of the law of the assignor's habitual residence for bulk assignments and assignments of future claims. In Luxembourg, in the specific sector of securitisation, the law applicable to the third-party aspects of the assignment shall be the law of the country in which the assignor is established. Similarly, under U.S. law, the perfection of most assignments is governed by the law of the assignor's location. The law of the underlying claim assigned is favoured in several Member States, such as Spain and Poland. In the absence of a statutory provision, case law and doctrine support this solution in the UK, Germany and Italy. This approach is also found in Australia, Canada, Japan and the Russian Federation. Other solutions present in the Member States are the lex rei sitae (Czech Republic and Sweden) and the law of the habitual residence of the debtor (France). In other Member States, for example Finland, there is no clear rule.

3.2.Legal uncertainty The absence of a uniform conflict of law rule creates several main areas of legal uncertainty. The heterogeneity, ambiguity or absence of conflict of laws solutions in respect of third-party effects of assignment can lead to contradictory results. For instance, in Example 3 above, A may think that his priority is determined by the law of the State of C's habitual residence, while B relies on the law of the assignment contract with A. Each believes that their assignment is effective and that it has priority over the rights of the other. Often, they will not be aware of each other's rights but will rely on checks for the absence of other assignees performed in accordance with the law they presume applicable, i.e. check on the basis of disclosure requirements which may protect potential assignees under the law of one Member State but not under the law of another Member State. In respect of claims under future contracts, one may not easily determine at the time of assignment the law governing the claim assigned. In Example 2, A would not be able to determine in advance the laws of the underlying claims and, faced with the risk of having to comply with yet unknown rules, A may either refuse to finance C or charge a considerably higher premium than he would otherwise. In addition to the lack of regulation, those aspects of assignment already regulated give rise to certain uncertainties, in particular insofar as financial instruments traded on financial markets are concerned. For instance, it is not clear what is the exact scope of Article 14 of Regulation 593/2008 (Rome I). In effect, whereas traditional 'securities' (e.g. shares or bonds) are commonly regarded as not covered by this provision, rights in securities which are traded [electronically] on some capital markets are believed to be rather included in this conflict-of-laws rule. Legal uncertainty in establishing the effects of assignment against third parties and the order of priority arises most urgently in the event of an insolvency of the assignor. Thus, even if Article 14 of the Rome I Regulation, clarifies the applicable law between the parties, in the event of an insolvency a third law will very often come into play in determining the effectiveness of assignments and their order of priority: the law applicable to the insolvency proceedings against the assignor. Regulation 2015/848 on insolvency proceedings (recast) (the Insolvency Regulation (recast)) lays down the conflict rules applicable in insolvency proceedings. As a general rule, insolvency proceedings are opened in the State where the centre of main interest of the assignor is located at the time of the opening of the proceedings. By way of derogation from this rule, where the debtor has an establishment in another Member State, secondary proceedings can also be opened in that other Member State but only in respect of assets situated there. The law of the State where insolvency proceedings are opened (lex concursus) determines, among others, the assets which form part of the insolvent estate, the rules governing the distribution of proceeds from the realisation of assets, the ranking of claims and the rules relating to the voidness, voidability or unenforceability of legal acts detrimental to the general body of creditors. The Regulation clarifies where assets such as registered shares in companies, book entry securities as well as cash held in accounts are considered to be situated for the purposes of determining the scope of secondary proceedings. Furthermore, where insolvency proceedings are opened in another Member State than that where assets are located, third parties' rights in rem and reservation of title are protected. The law applicable to the effects of assignment on third parties may therefore, in the case of insolvency proceedings opened against the assignor, be determined by the Insolvency Regulation (recast). Insolvency is indeed a situation where ownership questions between competing right holders become particularly important. Consequently, future harmonised rules on third-party aspects of assignment will need to be carefully aligned with the existing acquis in the area of insolvency. 3.3.Practical problems and high legal costs The empirical data collected by the study shows that 47% of the stakeholders consulted encounter practical problems in securing the effectiveness of an assignment against third parties. Unlike marketable securities which are generally recorded in electronic accounts, credit claims are evidenced only by a credit agreement. As a result, there is higher risk that the same credit claim might be posted as collateral to more than one collateral taker without the actual knowledge of the latter collateral takers that the credit claim was already pledged in favour of a different person. In addition, the lack of harmonised conflict of laws rules increases the number of substantive laws potentially applicable to the provision of credit claims as collateral, which might make it more difficult to fulfil the eligibility criteria of the Eurosystem. Furthermore, the average legal costs for cross-border transactions involving assignments, an important proportion of which stem from the need to carry out due diligence in respect of several legal systems, are in many cases very high and can amount to several hundreds of thousands of euros. For example, one factoring business reported legal costs ranging from £350,000 to £1 million per transaction. 4.possible approaches 4.1.General considerations The study shows that, as also set forth in the Capital Markets Union Action Plan, a harmonised conflict of law rule governing the third-party aspects of assignment is needed in order to ensure legal certainty and a balancing of the interests of all parties concerned in a cross-border assignment. Such a rule would also support cross-border trade, in particular by reducing legal costs and due diligence, and facilitating the availability of capital and credit at affordable rates for SMEs. The study also shows that a single connecting factor may not be appropriate for all types of assignment operations; a combination of connecting factors which would accommodate the interests of various stakeholders may be more appropriate. However, since sector-specific rules carry the risk of inherent complexity and characterisation problems, their use should be limited as much as possible. Among all possible connecting factors, the law of the contract of assignment, the law of the assignor's habitual residence and that of the law of the claim assigned have been supported by a majority of stakeholders as well as a significant number of Member States. Some connected matters could also benefit from further clarification, such as the scope of Article 14 of the Rome I Regulation. In the light of this, three possible approaches have emerged. 4.2.The law of the contract between assignor and assignee Currently, the proprietary aspects of assignment between the assignor and assignee are governed by the law of the contract of assignment. This approach would subject all proprietary aspects of assignment – including the effectiveness of an assigned or subrogated claim against third-parties and the question of priority between the assignee and competing right holders - to the law chosen by the assignor and assignee for their contract of assignment. However, to prevent any possible prejudice to third parties, this choice should be limited, in what concerns the effects of the assignment, to either the law of the country in which the assignor has his habitual residence or the law governing the assigned or subrogated claim.