This is one of a series of articles we at Morton Fraser are producing to guide our clients through the wholesale change proposed in Scots law in relation to security over goods, intellectual property and shares, on the one hand, and invoice finance or the purchase of receivables, on the other. For a general introduction to what the Bill covers, see here. The Bill is slated to move through the Scottish Parliament this session, so, while detail may change during that passage and statutory instruments will be required before it can become effective law, it is now timely to start preparing for the new regime. This article is concerned with the how the changes proposed by the Bill will interact with Scots insolvency law.
Summary of some of the Key Points of the Bill
- For the first time ever a new form of fixed security over goods, intellectual property and financial instruments (including shares in Scottish companies) is to be introduced on the current Bill passing through the Scottish Parliament - the Statutory Pledge
- The Statutory Pledge can be over future as well as currently owned property as long as the future property fits the description in the pledge
- It takes effect as a fixed security on registration in the new Register of Statutory Pledges or, in the case of future property, on the later of that registration and the asset being owned by the provider. If the pledge is granted by a company or LLP it needs to be registered at Companies House within 21 days of its date irrespective of when it is registered in the Register of Statutory Pledges
- The Statutory Pledge is a fixed security, unlike a floating charge, it ranks on the provider's insolvency ahead of the preferred debts, the portion reserved for unsecured creditors, and the administrator's expenses
- The ability to grant Statutory Pledges is not restricted to corporate entities. Consumers, sole traders and partnerships can also grant a Statutory Pledge. There are some limitations on the property which consumers can pledge; these limitations also apply to sole traders but not in respect of their business assets
- On insolvency of the provider:
- the pledge is effective over the property pledged provided it comes into the ownership of the provider before the onset of the insolvency.
- there can be more than one pledge over the same property, in which case they rank in order of registration in the Register of Statutory Pledges, though the creditors can amend this by written agreement
- in competition with creditors doing diligence on the pledged property, the pledge ranks first if created before the diligence is executed but only for sums already advanced before that execution or which the creditor was bound to advance
Assignation of claims
- The Bill introduces a formal process for assigning debts, referred to as "claims" (but basically this covers the right to performance of an obligation, hence a debt, a sub-hire agreement or a bank account will all be captured).
- The assignation can be over existing claims as well as future claims, provided they are adequately described so they can be identified as falling within the relevant description given in the Bill. Therefore, it is competent to assign a claim which at the time the assignation is given is not held by the assignor (and indeed the claim may not exist at that time). That's an important clarification of an area of doubt in Scots law.
- The claim (or debt) is transferred either by the intimation of the claim (giving of notice) to the debtor, as in current practice, or, under the new regime, registration of the assignation document with the new Register of Assignations ("ROA"). In respect of future claims, the assignment comes into effect on the later of the claim coming into existence and registration with the ROA.
- Where the assignation in question is a security assignation, it is treated as being a fixed security on registration at the ROA and there is no time limit for registration albeit if the assignation is granted by an LLP or company it still needs to be registered at Companies House within 21 days of its date, irrespective of when it is registered in the ROA.
- If notice hasn't been given to the debtor, then such debtor paying the assignor in good faith is protected by the Bill and is discharged of his obligation to pay the assignee.
- Provided the claim is appropriately identified in the assignation and the claim is in existence at the point of insolvency, then registration in the ROA gives the creditor priority over an insolvency practitioner appointed to the assignor without the need for intimation or notice, which is a big divergence from the current law
The purpose of this article is to examine the interaction of the new Statutory Pledges and Assignation of Claims regimes with Scots insolvency laws.
Statutory Pledges - Ranking in an insolvency
Once registered in accordance with provisions in the Bill, a Statutory Pledge will constitute a fixed security under Scots law. Accordingly, in common with all other fixed charges, in an insolvency of the grantor, it will rank in priority to any floating charge and will not be subject to the claims of preferential creditors or the effect of the prescribed part.
Competition between Statutory Pledges
It will be possible for two or more Statutory Pledges to be granted over the same assets. In such circumstances, the Statutory Pledge with the earlier date of creation will have priority (s64(1)(a) of the Bill).
Competition between Statutory Pledge and a right in security (other than a Statutory Pledge)
Where the asset is secured by a Statutory Pledge and also by a different fixed right in security, then the security with the earlier date of creation will have priority (s.64(1)(b) of the Bill). An example of such a right in security would be a common law pledge in hands of a pawnbroker.
However, where the security in question is one which arises by operation of law then that security will have priority regardless of date of creation (s,64(4) of the Bill) (landlord's hypothec and liens are two examples of securities that arises by operation of law in Scotland).
Agreement as to ranking (s64(6))
Creditors may agree in writing that the ranking of Statutory Pledges with other Statutory Pledges or with any other security right should be determined in a manner other than that set out in s.64. Accordingly, creditors are free to agree how their securities will rank.
Such an agreement however has effect only among the parties to the agreement and is not registrable (s.64(7)).
This is in contrast to the position with ranking agreements in respect of floating charges and standard securities. Such ranking agreements are registered as a matter of course because lack of registration would mean that the ranking agreement would not be binding on a liquidator or administrator.
So what is the effect of insolvency on the terms of a ranking agreement under s.64(6) of the Bill? S.64(7) states that such an agreement has effect only on the parties to the agreement (and their successors). Accordingly, if the debtor is not a party to the agreement, then the ranking provisions cannot bind any future liquidator/administrator/trustee in bankruptcy. That would therefore mean that the higher-ranking creditor would be exposed to the risk of the insolvency of the lower ranking creditor.
Assignation of claims - insolvency issues
For insolvency professionals the proposed regime for assignations of claims is primarily relevant in respect of the question of ascertaining whether title to a claim has transferred from the assignor to the assignee (and thus whether the benefit of that claim sits within the insolvent estate). The draft Bill contains one innovation that is likely to be of particular interest to insolvency professionals. That is the ability of a party to assign a claim that has not yet come into existence, to the effect that when the claim later comes into existence, ownership of the claim would transfer to the assignee at that later point. (Draft Bill, ss 1(5) and 3(2)(a))
This part of the article addresses that issue.
Under the current law, for title to transfer, any such assignation would require to be intimated to the debtor when the claim came into existence (it being logically impossible to intimate at any earlier point), with title transferring only at the point of intimation. Under the regime proposed in the Bill, registration in the Register of Assignations ("RoA") and intimation would both constitute alternative valid methods of transferring ownership of a claim. Accordingly, because registration of the assignation of such a claim can occur prior to the claim coming into existence (with title passing immediately the claim comes into existence) the question arises as to what happens in the event of the assignor falling into insolvency in the period between (i) RoA registration; and (ii) the claim coming into existence? In short, would such a claim fall into the insolvent estate of the assignor, or would it be the property of the assignee?
The relevant parts of the Bill are:-
"5 Assignation of claims: insolvency
(1) Subsection (2) applies where, after an assignation document is granted, the assignor becomes insolvent.
(2) The assignation is ineffective as regards any claim which, though identified by the assignation document as a claim assigned, is not held by the assignor before the assignor becomes insolvent.
(8) Subsection (2) does not apply as regards a claim in respect of income from property in so far as that claim— (a) is not attributable to anything agreed to by, or done by, the assignor after the assignor became insolvent, and (b) relates to the use of property in existence at the time the assignor became insolvent."
The general rule therefore (in para 5(2)) is that such an assignation is not effective against an insolvency practitioner.
However that general rule will not apply where the claim relates to "income from property". But that disapplication of the general rule only applies to the extent that the claim is not attributable to anything done by the assignor (or agreed to by the assignor) after the insolvency. And the disapplication of the general rule is only relevant where the claim relates to use of property that exists at the time of the assignor's insolvency.
Or to put it another way, an assignation is effective against an insolvency practitioner if the following are all true in respect of the claim:-
(i) the claim relates to "income from property";
(ii) the claim is attributable to anything done by (or agreed by) the assignor prior to insolvency; and
(iii) the relevant property referred to in (i) existed at the point of insolvency.
So what would all of this mean in practice? In particular what does it mean in the factoring and discounting industry?
Let us imagine a receivables finance agreement ("RFA") entered into on January 1 that states that all customer contracts and related rights notified to the lender are assigned to the lender. The lender immediately registers the assignation contained in the RFA in the RoA.
The company goes into liquidation on June 1, by which time it has notified the lender of the existence of new customer contracts. What is the position of the lender in respect of the rights under those customer contracts?
For the purposes of our analysis we can (simplistically for the purposes of this analysis) divide those rights into (a) invoices issued prior to June 1 (in respect of work done prior to that date); and (b) uninvoiced WIP existing at June 1.
It will be obvious that it must be the intention that title to the invoices at (a) will rest with the lender. And this must mean that in respect of such invoices, the "general rule" set out above will not apply to such invoices. Therefore, the three necessary "conditions" to disapply the general rule:-
(i) the claim relates to "income from property"; and
(ii) the claim is attributable to anything done by (or agreed by) the assignor prior to insolvency; and
(iii) the relevant property existed at the point of insolvency;
must all be true in respect of invoices issued prior to the insolvency in respect of work done prior to the insolvency. To satisfy the conditions, the claim must relate to income from property that exists at the point of the insolvency. In this case, what is meant by the "property"?
In the Discussion Paper, three examples are used to illustrate and explain this particular point:- (i) rentals from leases of heritable property; (ii) royalties from a book; and (iii) a chauffeur's income from using a car for driving. In each case it can be seen that the income is related to an item of "property" (i.e. heritable property, book or car) but it is doubtful for reasons explained further below that the reference to "property" can really be restricted to something tangible like a building or a book or derived from the use of a car.
It is important to realise that what the draft provisions are trying to catch are a multitude of different situations where a claim can arise (including where work is done (e.g. the chauffeur driving) and where a claim arises simply because of the passage of time without work being specifically done (e.g. the rental income under a lease).
And the three examples given in the Discussion Paper are useful in identifying how the draft provisions seek to deal with the different ways in which claims can come into being. While the rental income and the book royalties are clearly derived from "property" (the heritable property and book respectively) for the chauffeur it is his skill and time that is being paid for - it is not really "the car" that is key (albeit it is obviously an essential point of chauffeur services). The reason it is necessary to be clear that it is not the car that is the "property" in the chauffeur example will become clearer when you consider the next paragraph.
Compare the situation of someone who makes a living from conducting "Jack the Ripper" walking tours (and then charging for them only after they have been carried out). Here there is no "property" analogous to the car (unless one is prepared to argue that shoe leather is the property) involved but that surely cannot therefore mean that invoices issued by the walking tour guide prior to insolvency on June 1 for tours conducted prior to that date would not be the property of the lender. There could be no valid policy reason for treating the chauffeur and guide's invoices differently. Indeed to do so would mean that all invoices issued in respect of the provision of pure services (e.g. manpower) would run the risk of being excluded in the event of an insolvency. That cannot be the correct outcome and so we must establish what is meant by "property" in those "supply of services only" cases.
So in the case of the walking tour guide, what is the "property" that allows his invoices to satisfy conditions (i) and (iii)? The answer must be that the WIP that is created by carrying out the walking tour is the relevant "property" for this purpose. And so in the chauffeur example it is not the car that is important, rather it is the WIP. And it will be apparent of course that with the rentals and the book royalties there is no WIP (which is why the reference to "property" in the draft Bill is necessary).
Looking now at the question of the uninvoiced WIP at June 1? We have assumed that the assignation in the RFA is an assignation of all rights of the company under the customer contracts and would therefore be apt to catch WIP. Are the three "conditions" applicable in respect of the uninvoiced WIP?
The WIP is attributable to work done by the assignor prior to the insolvency and so condition (ii) is met. Equally the WIP exists at the point of insolvency so condition (iii) is also met. Is condition (i) met? To satisfy condition (i) we need to decide whether this is the assignation of a claim that relates to "income from property". Once we accept that the WIP is the property it is clear that condition (i) is satisfied.
But an assignation will only escape the effect of the general rule to the extent that the WIP exists at the point of insolvency. Therefore, any invoice that is issued post-insolvency, but which is in respect of WIP that spans both pre- and post-insolvency periods will fall to be apportioned between the insolvency practitioner and the lender on a time basis, with the insolvent estate getting the benefit only of the post-insolvency element of the invoiced WIP.
It will be obvious then that any dispute between a lender and insolvency practitioner could well be around the issue of establishing when WIP is created. From the lender's point of view that requires that the company keeps accurate records and that the lender has access to the records.
In the context of insolvency, the introduction of Statutory Pledges and the assignation of claims regime do not appear to create any particular conceptual difficulties. Of course, the intention behind the changes is to create a regime that is more fit for purpose in the modern commercial world and to allow borrowers access to funding that might have been denied them because of existing limits in Scots law as regards the ability to assign future rights or grant fixed security over moveable property. In insolvency however, the other side of the equation is that the assets available to satisfy unsecured creditor claims will necessarily be diminished.
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