following post is contributed by Soma
Bagaria, who is a Legal Advisor at Vinod Kothari & Company in Kolkata.
She can be reached at firstname.lastname@example.org)
has been a constant conflict of whether the substance or form shall dominate
while determining the nature of a transaction. There are two schools of thought
on this: one which gives dominance to substance over form and the other which
prefers the dominance of intention that is expressed rather than that not
expressed, i.e. prefers the form over substance.
transaction goes for determination, while respecting the intention of the
parties set out in the documents, it shall be preferable to probe into the
substance of the transaction rather than the plain label and language used so
as to decipher what actually the transaction is all about. As has been said by
many, language as an indicator is good but cannot be a determinant.
the case of Hallmark Cards Incorporated
v. Yun Choy Limited and the Standard Chartered Bank (Hong Kong) Limited
(an insolvency law matter), where the document in question was the Receivables
Purchase Agreement (“RPA”), has given
supremacy to the form over substance and held a transaction as a sale even
though, as discussed hereunder, the elements of a sale were absent.
of the Liquidator of the Company (Yun Choy Limited)
argued that (a) the transaction amounted to a lending secured by a charge on
the book debts of the Company; (b) since the charge is not registered, the same
is invalid; (c) the transaction amounted to a general assignment of book debts
and hence void by reason of non-registration under the applicable bankruptcy
laws of Hong Kong.
substance of the RPA arguing that even though the transaction was expressed as
a sale and purchase of the debts due from the Company’s customers, in substance
it was an assignment by way of security creating a fixed charge over the book
non-repayment of debt by a customer. Hence, in absence of transfer of risk, being
an essential ingredient of sale, the transaction cannot be a sale.
could require the Company to purchase all the outstanding debts and sum of the
funds in use;
Company who could recover full value of its book debts, i.e., if the payment by
the Company’s customers to the Bank exceeds the sums debited in the factoring
account, the credit balance would be payable to the Company;
recover the balance from the Company;
purchase of a debt.
therefore, argued that the elements set out in the case of In re George
Inglefield Ltd., were
satisfied in the transaction, and hence, the same would not amount to a sale
but a mortgage. George Inglefield case has set out clear differences
between a true sale and a mortgage:
Seller is not entitled to get
back the asset sold by returning the money to the purchaser.
Mortgagor is entitled, until
foreclosed, to get back the asset by returning the money to the mortgagee.
Account of profit
Purchaser does not have to
account the seller of any profit realized by sale of the asset purchased from
Any amount realized in excess
of the amount sufficient to repay the mortgagee shall be accounted back to
Right to receive the shortfall
Purchaser cannot recover from
seller any amount which upon resale of the purchased property was
insufficient to recoup the money paid to seller.
A mortgagee is entitled to
recover from the mortgagee the difference between the amount from sale of
asset and the amount due from mortgagor, if the amount from the sale of asset
is insufficient to meet such amount due.
could be validly argued that the principles of a true sale transaction (as
discussed below) were missing, and looking at the substance it may not appear
as a true sale.
of the Bank (i.e. the Standard Chartered Bank)
Bank argued that:
the credit balance in the factoring account did not amount to an equity of
debt for the purchase price to be fixed by the amount to be collected by the
famous cases of Welsh Development Agency v. Export Finance Co Ltd and
Orion Finance Ltd v. Crown Financial Management Ltd.
even though the same apparently looked like a financing transaction but was
documented as a sale, setting out the following principles of determination:
at as a whole and its substantial effect shall be seen.
whole of the language that a substance can be ascertained.
term in the agreement cannot be discarded unless there can be found within the
agreement other language and stipulations which necessarily deprive such term
of its primary significance.
of book debts, rather than a charge, even though under the purchaser of the
debts is given recourse against the vendor in the event of default in payment
of the debt by the debtor.
debts, and not a charge, even though the purchaser can recover the shortfall if
the debtor fails to pay the debt in full.
the documents taken as a whole compel a different conclusion, the transaction
which they embody should be categorized in conformity with the intention which
the parties have expressed in them.
of the Hong Kong High Court
was held to be a sale.
of the decision
Hong Kong Court did not give any basis for its decision and neither did it
discuss the parameters of a sale transaction. This case is a clear case of a
form over substance ruling.
looking at some of the factors of a sale, it cannot be said that the
transaction was a sale
normally refused to go by the label of the contract rather than looking into
the nature of the agreement. One important aspect to be seen, which was
elaborated in the case of Major’s
Furniture Mart v. Castle Credit Corp,
is whether the risks have been retained by the seller. In this case the Court
had said that it shall be seen whether the nature of recourse is such that the
legal rights and economic consequences of the agreement bear a greater similarity
to a financing or a sale transaction.
preferred a substance over form approach, which is different from the form over
substance which the UK Courts have preferred.
presence of a repurchase agreement has the effect of being treated as a secured
of the transaction to satisfy the determinants for a true sale transaction
recourse against the seller
transferred by the seller to the buyer, thereby eliminating a possibility of
any recourse against the seller. This is primarily a negative attribute and may
not in itself be a determinant factor as recourse is like a warranty given by
the seller on the quality of the assets sold.
the Hong Kong Court gave the Bank a recourse against the Company, in spite of
which the transaction was upheld as a sale. The Hong Kong High Court accepted
the Bank’s contention that even though there may be recourse against the
seller, a transaction could be sale.
of residual interest by the seller
have control on profits of the buyer that arise after the sale. This was also
clearly highlighted in the George
Inglefield case by the liquidator of the Company. As has been stated, the
rewards shall also stand transferred along with the risk in a sale transaction.
is not ascertained or fixed, it cannot be said to be a sale transaction. This
factor makes the transaction move closer to a financing transaction.
of the UK Courts and those following the UK principles to accept the language
of the contract as the primary indicator of substance continues. The ruling
does not help resolving the substance v. form conflict, which still continues
as an unresolved debate.
– Soma Bagaria