The common types of assets taken by lenders in Tanzania as collateral in corporate finance transactions include the financed commodities, landed properties, other physical assets such as motor vehicles, plant and equipment. However, contractual rights while considered risky, can also be taken as security in a corporate finance transaction. To create security over rights to receive payment, and other rights stipulated in a contract can be appealing to lenders and has become an important factor in structuring many asset finance or commodity transactions. These rights are generally choses in action that is, personal rights of a property that can only be claimed or enforced by action, and not by taking physical possession.
Creating security over contractual rights is commonly done through assignment by way of security of the said rights, benefits, and or interests in a contract from the person assigning the rights (the “assignor”) to the person being assigned the rights (the “assignee”). Contractual rights that can be the subject to assignment by way of security include rights to receivables, insurance policies, sale and purchase agreements, rights relating to investments, and credit balances.
Contractual rights can further be secured by way of charge, thus, creating proprietary interests over the rights, benefits, and interests of the person creating the charge (the “Chargor”) in a contract in favour of the person receiving the charge (“the Chargee”). The charge grants the Chargee the right to take possession of and take benefit from the interest in the rights if the Chargor defaults on the secured obligations as stipulated in the deed of charge and the underlying facility agreement.
The charge will serve as an encumbrance on the Chargor’s rights within a contract but does not transfer ownership to the Chargee and the ability to exercise contractual rights remains with the Chargor albeit the exercise of all or some of the referenced contractual rights could be subject to approval or prior notification to the Chargee.
A non-typical scenario where contractual rights can be taken as security is a commodities finance transaction, Oil being the financed commodity where both the Lender and the Borrower are foreign entities from separate jurisdictions with no commercial presence in Tanzania, but the financed Oil is for supply and is stored in comingled storage tanks in Tanzania.
In this particular scenario the borrower’s obligations cannot be secured by executing a debenture considering debentures can only be perfected if the borrower is an entity incorporated in Tanzania. Further to that, the borrower cannot execute a charge or pledge the financed Oil as security to the Lender since the financed Oil is comingled with the Oil owned by other parties. Independent security interests cannot exist in goods which are commingled since the identity of the original goods is lost. Contractual rights however can be taken as security.
Contractual rights to be taken as security for the financed Oil in comingled storage arise from the storage Agreement executed between the borrower (as the owner of the Oil in storage) and the storer. While the Oil is in storage, title to the Oil is vested to the storer. The storage agreement will entitle the Borrower to hold space in the storage tanks, to be able to inject and withdraw the Oil to and from the tanks. The storage agreement may also contain certain guarantees relating to the storage of the Oil issued by the Storer to the Borrower; the tank receipts issued by the Storer; insurance policies of the Storer and the Borrower; and letters of credit or local purchase orders issued to the borrower by its customers purporting to acquire the Oil. All these agreements confer certain rights to the borrower and it is these rights that can be charged and assigned in favour of the Lender.
When purporting to assign contractual rights by way of security a due diligence should be conducted on the contracts to check provisions restraining the parties from assigning their rights to third parties, and to ensure that appropriate consents to assignment are obtained from counterparties if necessary.
By Kenneth Ulaya - Advocate
Note: This is not a legal opinion, and the contents hereof are not meant to be relied upon by any recipient unless our written consent is sought and explicitly obtained in writing.
