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Collection Fees under Scrutiny

There has been much debate and comment amongst invoice financiers and others following the recent landmark decision of the High Court in BHL v Leumi ABL Ltd [2017] EWHC 1871 (QB), but we have to point out that the decision did not come as a surprise to everyone.

As long ago as spring 2012 we published an article in our Briefing under the title “Danger in Discretionary Charges” which commented upon a recent case which we had settled in which a discretionary collection charge on termination had been challenged as unreasonable. The article stated amongst other things: –

“From a drafting perspective it is arguable that the Financier is in a stronger position in levying these sorts of charges upon a termination event if it has an absolute entitlement to do so and there is no reference either to a discretionary power or use of words such as “up to” a specific percentage, which can itself be construed as involving the exercise of a discretion.

Also, from a drafting perspective there is an argument for carefully considering the removal of any reference to the specific purpose of the charge, such as “ to cover our additional costs”, because again this opens up room for argument as to whether the charge can be justified in the light of the stated purpose…

Of course to the extent that clients or their lawyers consider these matters in the pre-take on negotiating process an absolute power to charge without any reference to a purpose justifying the charge may be commercially unattractive and the subject of resistance, but this has to be balanced against the mischief of a serious challenge in litigation”.

Fast forward 5 years and the risk we had foreseen was the basis of the unfortunate decision for Leumi as invoice discounter at the end of a lengthy trial (8 days of hearing) and no doubt extremely expensive legal battle.

The case came on before the London Mercantile judge, HHJ Waksman QC. He is a judge of who, by our own experience has a great deal of experience in invoice finance matters. He has a deserved reputation for a no – nonsense commercial approach and for a clear grasp of the practicalities of all aspects of asset based lending.

Much has already been written about the Leumi case, some of it well-informed and some less so, so we will not go into much detail on the facts and will concentrate on the key takeaways for invoice financiers.

Facts

BHL was indemnifier of the obligations of the well-known beer brand Cobra Beer Limited to Leumi under a confidential invoice discounting facility which ran up to £18 M. The Service Fee was 0.15% of each receivable with a Discount Charge of 1.5% above base, both of which were subject to increase in the event of Leumi being entitled to disclose its interest in the receivables to debtors.

The minimum period was 24 months and Cobra was to act as Leumi’s collection agent.

The Receivables Finance Agreement (“RFA”) was comprehensive and contained extensive charging provisions including: –

(1) an obligation to pay all costs and expenses that Leumi might incur “including its own administrative and other costs” in any way relating to collecting receivables (“the Disbursements clause”); and

(2) “if Leumi requires the Client to repurchase any Receivables and the Client fails to do so within 7 days of such demand, Leumi will be entitled to charge the Client an additional collection fee at up to 15% of amounts collected by Leumi thereafter. This collection fee is in addition to any other fee payable by the Client to Leumi under this Agreement. The Client expressly acknowledges that such fee constitutes a fair and reasonable pre-estimate of Leumi’s likely costs and expenses in providing such service to the Client” (“the Collection Fee clause.”)

Leumi’s collection efforts

Just over 12 months after the start of the RFA Cobra went into administration, so Leumi took over the collection of the receivables and almost immediately indicated that it would be charging a collection fee of 15%. At this stage there was £10.5 M worth of receivables outstanding, and about £8.1 M was then collected (in fact about £7 M was collected within the first 4 months)

The collection process involved Leumi hiring Cobra’s two main credit controllers and using the services of a third-party collection company and experienced solicitors. This resulted in further costs and fees which were charged separately as disbursements under the Disbursements clause of the RFA and which were not in dispute in the action.

Leumi claimed to be entitled to charge an additional collection fee of approximately £1.2 M on the basis of a straight 15% of amounts collected.

The judge took the following view of the proper meaning of the Collection Fee clause:

“I consider that the provision allows Leumi to charge a fee which is meant to represent or capture or estimate in some way its future costs and expenses in respect of the collection. The language suggests that the fee is to be charged or can be charged in advance of the incurring of the costs and there is obviously a margin of flexibility given to Leumi since by definition it cannot know in advance precisely what those costs will be”.

Limits on exercise of discretion

The key point in the case was that since the contractual provision relating to the collection fee was expressed to confer a discretion upon Leumi, as a matter of law the discretion had to be exercised subject to certain constraints and in accordance with certain principles.

The judge explained the position at paragraph 40 of his judgement: –

“Since this provision gives Leumi a power to set in advance a percentage fee, which will apply to all later recoveries, there has to be some qualification thereto, otherwise it could be exercised oppressively or abusively. In my judgment, this is a case where (whether as a matter of construction or the implication of a term) a discretion such as this must be exercised in a way which is not arbitrary, capricious or irrational in the public law sense. See the Supreme Court decision in Braganza v BP Shipping [2015] 1 WLR 1661 at paragraphs 27-31, 52-53 and 102-103. For ease of reference I shall refer to these limitations on the exercise of the discretion as ” the Braganza Duty “. The fulfilment of that duty will entail a proper process for the decision in question including taking into account the material points and not taking into account irrelevant considerations. It would also entail not reaching an outcome which was outside what any reasonable decision-maker could decide, regardless of the process adopted. However, the duty does not mean that the Court can substitute what it thinks would have been a reasonable decision”.

Evidence about the exercise of the discretion

It became clear from the evidence that, contrary to its advanced case, in reality Leumi had, as a matter of practice, always charged the maximum wherever a provision gave a fee which could be “up to” a particular percentage. The judge found that there had been no attempt at calculating an appropriate percentage based on the likely collectable receivables as against what Cobra owed at the time or having regard to the likely cost of any collect out.

In this regard the judge was particularly critical of Leumi’s approach: –

“It is not as if Leumi was inexperienced in collect-out situations. Mr Couzins himself had been involved in 100-150 collections in the course of his career, and Mr Hird had been involved in 200-300 overall, and in the 8 years at Leumi, he had overseen some 50 collect-outs. So Leumi must in truth have had a considerable amount of data about how much collect outs can and do cost over a range of cases-none of that was put into evidence at all and there is no suggestion that in fixing 15% Mr Couzins or anyone else at Leumi had regard to previous collect-out experience”.

Factors which ought to have been taken into account

The judge pointed out that amongst other things the fact that the discount charge had been increased in order to take account of Leumi’s costs and expenses of the collection going forward ought to have featured in an assessment of the appropriate percentage to apply as a collection charge.

The Judge summarised the other deficiencies in the approach taken by Leumi as follows: –

“(1) There was no attempt to calculate likely costs and expenses and no attempt to use data from previous collect-out experience;

(2) There was no consideration of the extent to which any collection process was likely to be materially carried out by third parties especially in the later stages where the collections would become more difficult and if so, whether those expenses would be charged separately, as indeed they were here;

(3) There was no consideration given as to whether a short delay in setting the charge would give Leumi an important breathing space in which to form a more informed view as to the proper percentage to be applied”.

(4) Much was made of the general perception that this was going to be a difficult collection and the suggestion that the fact of Cobra’s going into administration would heighten this because some debtors who would normally pay might be encouraged not to; but all of this was in very general terms and cannot in any way remove the need to undertake a process by which some sensible estimate of costs could be reached by reference to how much Leumi needed to raise in the collections process (by reference to the monies outstanding to it), how long it thought the process might then take and in the light of all of that what its own justifiable internal costs might be.”

Expert Evidence

In order to come to a determination on the main issue it was necessary for the court to consider detailed expert evidence from external accountants on both sides relating to 2 further issues:

(1) what were Leumi’s actual internal costs expended in the collection process; and

(2) what internal costs could reasonably have been anticipated by Leumi had it exercised its discretion properly?

Actual costs

Surprisingly, no actual records of time spent internally by Leumi were made contemporaneously even in note form. The judge heard expert evidence as to actual internal costs: –

(1) BHL suggested an approach based on the hourly rates implicit in the salaries of Management Staff who were actually engaged in the process of collections;

(2) Leumi’s expert suggested an “opportunity cost” approach based on the notional contribution to profit of each relevant emloyee, which generated a much higher hourly rate.

The judge preferred BHL’s approach and concluded that a generous figure for actual costs was only £33,260 – this compared to the £1.2 M collection fee claimed by Leumi.

Estimated costs

As an alternative, the judge sought to analyse the highest percentage fee which Leumi could have charged if it had exercised its discretion lawfully and properly.

Again, the judge was particularly critical of Leumi’s case in this regard: –

“The exercise here is to determine the highest percentage fee which Leumi could have charged without being in breach of its Braganza Duty .

This can only be done by reference to the materials before me even if other materials exist which might have proved useful. Thus I cannot be assisted by potentially highly relevant information about the costs and timings of previous collect out operations known to Leumi because this has not been provided. Moreover, to the extent that Leumi contend that any cost estimate must err on the side of generosity because of the uncertainty going forward, I cannot take much note of that since Leumi deprived itself of the data from those previous collections which would have reduced much of the uncertainty, in my view.

It is also important, again, to note that whatever may have been the difficulties perceived by Leumi about the Cobra ledger at the time, Leumi was not entitled simply to look at those in the round and then leap immediately to 15% or some other high percentage. Its Braganza Duty required it to attempt to translate all of that into a rational estimate of its internal costs going forward.”

After hearing from the experts the judge rejected Leumi’s evidence that it would have been reasonable and appropriate for it to predict a 3 year recovery process yielding virtually nil as “absurd”, and agreed with BHL’s expert that implicit salary costs for the likely period of collections was the correct approach.

On this basis the judge came to a figure of £212,000 as the reasonable collection costs which Leumi should have estimated if it had exercised its discretion properly, or about 3% of the outstanding amount. The judge then adjusted this to err on the side of caution and give Leumi the benefit of the doubt to 4% on collections of about £8.1 M, producing a figure of £320,000.

Mistake

One of the unusual features of the Leumi case was that BHL had in fact already paid £950,000 of the collection fee. Because Leumi had then threatened to bring proceedings for what it claimed was the outstanding balance of the collection fee, the proceedings were in fact instituted by BHL in an attempt to recover amounts already paid.

Whatever the rights and wrongs of the arguments on the discretionary nature of the collection charge, Leumi in addition took the position that it disputed BHL’s right to recover anything already paid on the basis that as a matter of law the payments were made under a mistake of law and were therefore not recoverable.

The judge gave very little credence to this argument, the result was that Leumi was required to repay the £950,000 already paid by BHL subject to the deduction of the 4% collection fee which it was in fact entitled to charge.

Penalty clause

BHL argued in the alternative that the Collection Fee clause was a penalty and unenforceable. Because the judge agreed with BHL on the central issue in the case relating to the exercise of Leumi’s discretion in applying the collection charge it was not necessary for him to decide this point, but he would have decided it in favour of Leumi for the following reasons: –

“(1) First, on a proper construction of [the Collection Fee clause], I consider that Cobra’s obligation to pay the collection fee was a primary and not secondary obligation. It is not akin to a sum payable instead of damages, in my view. Cobra had a choice whether to purchase the ledger or not and the power to charge the collection fee arose if it did not. The fact that Cobra may have been unable to purchase the ledger makes no difference;

(2) Even if Cobra’s obligation was secondary, it is not a fixed sum or even a particular formula but a fee to be arrived at in the exercise of a discretion tempered by the application of the Braganza Duty as I have concluded above. It is not a penal or extortionate provision. It does have a high ceiling and in theory it could lead to a high collection fee but that does not render paragraph 2 penal in my judgment. Moreover, Leumi had a clear legitimate and commercial interest in being compensated for its internal costs of the collect-out, and the process of being able to make an estimate and charge the fee at the outset is commercially legitimate in my view;

(3) Moreover, Cobra was a large commercial entity and negotiated the RFA on an arms-length basis even if its terms were standard”.

Permission to appeal

Permission to appeal this judgement was refused by the Court of Appeal on the basis that the judge was clearly correct and that there was no arguable case to the contrary.

Comment

In our view the result of this case came as no surprise, and it is highly regrettable that it was fought to a conclusion which has resulted in a reported decision which is bound to be relied upon against invoice financiers going forward.

At the end of the day in addition to fully recovering as disbursements the significant sums expended on credit controllers, a debt collection agency and solicitors in the collection process, the stark fact is that Leumi was seeking to rely on a contractual clause in the RFA to entitle it to recover roughly £1.2 M in relation to actual internal costs which the judge assessed at just over £33 K.

It is too early to say what effect this case will have in practice, but we have a number of thoughts at this stage.

Can retrospective claims be brought for repayment of fees?

This case has unsurprisingly caught the attention of insolvency practitioners and others who have an interest in the amount of fees levied by invoice financiers on termination or distress situations.

It is not yet clear whether there will be an avalanche of claims by insolvency practitioners or former clients relating to fees which have already been paid, but there are a number of obstacles which such claims would have to overcome: –

  • each claim would have to consider the specific provisions of the RFA concerned, and could not simply rely on the analysis of the RFA in the Leumi case;
  • payments or claims which had been disputed and compromised or settled would be more difficult to reopen; and
  • the Limitation Act usually precludes claims going back more than 6 years.

Should Collection Fee clauses in RFAs be reviewed?

Leumi’s problems arose primarily because the Collection Fee clause gave it a discretion on charging, and as we pointed out in our 2012 article referred to above modern authority clearly establishes that a contractual discretion has to be applied properly and within the ambit of certain considerations: in essence it must be applied rationally and not arbitrarily, which necessarily involves a proper process for decision making.

The position would have been very different if the relevant part of the Collection Fee clause had merely specified a set fee of 15% rather than a charge “up to 15%”, since the application of a fixed charge would not normally involve the exercise of a discretion.

In our view invoice financiers should therefore give serious consideration to reviewing clauses in RFAs dealing with collection fees and the like, and removing any discretionary element required by deleting words such as “up to” in such clauses.

However, that is not the end of the matter because unless carefully drafted a clause may still fall foul of the law on penalties. This did not play a significant part in the Leumi case because the judge in effect held that Leumi’s room for manoeuvre in applying the collection fee was limited by its obligation to apply its discretion lawfully and not arbitrarily – if not for this the court would have had to consider the penalty argument in much more detail. The important point for an invoice financier is to ensure that the collection fee and other termination provisions as a whole in any RFA do not impose charges which are manifestly excessive or extortionate, and avoid any suggestion of double recovery.

What about the ABFA Code and the Ombudsman?

The Guidance to the ABFA Code for Members has this to say about termination charges: –

“3.2.6 Where Members’ agreements require fees to be paid in the event of a client ceasing to trade, any fees payable should be reasonable and justifiable. Members should be able to demonstrate that the fees charged are clearly defined within the agreement and might relate to areas such as costs incurred relating to the recovery of indebtedness, and outstanding contract periods.”

Members are therefore under a duty to ensure that RFAs comply with these principles, and disaffected clients are entitled to take complaints to the Ombudsman, which decides disputes on the basis of what it considers to be “fair and reasonable” rather than in accordance with the strict letter of the law.

It is therefore likely that the Leumi case will lead to a number of referrals to the Ombudsman.

What approach should be taken where a discretion is to be exercised?

Where a significant collection fee is to be charged and a contractual discretion is involved, invoice financiers would do well to take account of the judge’s various comments on the correct approach to be adopted: –

  • accurate records of internal time spent by all personnel involved in the collection process should be kept and be capable of being justified;
  • a proper decision-making process must be carried out, which involves consideration being given to a delay in taking the decision as to the level of charges to be applied;
  • any assessment should take into account evidence of the experience of previous workouts wherever possible.

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