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Protection from counterparty insolvency in the FinTech industry

Taylor Wessing has recently refreshed its Safeguarding Your Business guide providing advice to clients as to how to proactively or reactively protect themselves from counterparty insolvency. In this article, I will briefly highlight some of the areas of the guide relevant to the FinTech industry.

September 2016

While no-one knows what the future holds for our economy as a result of the Brexit vote, there is no doubt that it has caused uncertainty which will continue until there is greater clarity about our exit from the EU and the timetable for that.

With uncertainty comes economic instability and now, more than ever, is the time when businesses need to take proactive steps to protect themselves against the financial difficulty that their counterparties may be in.

The nature of the fast-growing FinTech market means that many operators are branching into new areas at great speed. As with any fast growing market, however, there may be financial failure of various parties; clients should be anticipating this and working out how they will deal with it. In particular, we are seeing issues in FinTech around:

  • contractual terms to mitigate counterparty insolvency risk;
  • arrangements to protect third party funds on an insolvency process; and
  • security to maximise recovery.

Contractual terms to mitigate counterparty insolvency risk

What do your contractual terms provide for if your supplier, customer, borrower etc is in financial difficulty or goes into an insolvency process? Unfortunately, the return to unsecured creditors, where a company or individual goes into an insolvency process, is normally negligible and often nothing at all. Do not assume that standard terms will give adequate protection on a counterparty's insolvency process or can adequately deal with your contractual relationships.

So what can you do to improve your position on counterparty insolvency? A creditor has various options, which may or may not be appropriate in the circumstances. These include retaining title in goods supplied, taking security for debt owed (which I talk about below), asserting a lien over goods held, taking money on account or just tightening credit terms and keeping a closer eye on unpaid debts.

Some of these options are more appropriate than others, but elevating your status above that of an unsecured creditor not only increases your chances of recovery on an insolvency process, it also puts you in a stronger negotiating position.

We acted for a client whose lien over product not only resulted in it being paid in full, but also enabled it to secure a contract to continue to supply and service the company in administration on a much more profitable basis going forward.

Arrangements to protect third party funds on an insolvency process

We have acted for various clients hosting platforms introducing investors to entrepreneurs where investment money passes through the platform. What happens to third party monies on the insolvency process of either the entrepreneur or the investor?

Where one party suffers from the insolvency process of another, that party will look for other areas of recovery and that will include platform hosts, particularly if they have received and passed on money that has subsequently been lost.

Those handling other parties' money need (and need to be seen to have) terms that clearly set out what happens to that money on an insolvency process of one of its counterparties and how the money is held before that.

Usually that would involve the use of a trust to properly segregate the money and ensure it can be returned to the party who owns it. This will become even more pertinent as regulation in this sector increases. The last thing platform hosts will want is allegations of regulatory breach and/or mishandling of customers' money.

Security to maximise recovery

If you take security in respect of debts owed or money lent, then you will improve your prospects of recovering on a counterparty's insolvency process. Security requires proper legal documentation and registration and may not be appropriate in all circumstances, but it certainly should be considered, particularly if you are lending money.

However, taking security does not simply improve recovery prospects. It also enables you to be served with the intention by your borrower to go into an insolvency process and allows you to take more control of the insolvency process and choose your own insolvency practitioners, if that is what you want to do.

In addition, security enforcement can be used to take control of a business and potentially bring it into the ownership of the secured lender. Again, security should not be discounted without consideration of the benefits and control it gives.

We have recently acted for a client who used its security to ensure the transition of a branded distribution business to an appropriate party, rather than that which the retiring owner had in mind.

Summary

Ideally, you should not wait for a counterparty's insolvency process before realising what protection or lack of protection you have. The FinTech industry is moving quickly. Those who can best protect themselves against the financial failures of others will have the best chance of maximising their offering in this area.

If you have any questions on this article please contact us.

Protection from counterparty insolvency in the FinTech industry
Neil Smyth


Neil looks at ways to mitigate fallout from counterparty insolvence..

"You should not wait for a counterparty's insolvency process before realising what protection or lack of protection you have…those who can best protect themselves against the financial failures of others will have the best chance of maximising their offering in this area."