Why is this important to asset and invoice financiers? - The Key issues (and to securitisation providers, technology financier, real estate financiers and project financiers too)
1. What Stage are we at?
The Bill has been prepared by the Scottish Law Commission. Consultation by the Scottish Government as to the desirability of the Bill is now underway with stakeholders. As the Bill is a complex piece of legislation in a difficult area and not in itself a vote-winner for MSPs, it is vital that the asset and invoice finance industries help emphasise how important the reform is to improving the availability of finance for businesses in Scotland. I gave evidence to this effect, with Scottish Law Commission colleagues, at a recent public session of the Scottish Parliament's Economy, Energy and Fair Work Committee. That Committee has now asked Ministers to confirm when progress on this will be made. So pressure is mounting for the Bill to be brought forward and there is a chance it may feature in the next Parliamentary session, but that pressure requires to be maintained.
Scots law in this area is simply not fit for purpose. It is out of date - the only existing statutory framework dates from 1862 - and has not adapted to the needs of today's business. Small, unincorporated businesses who cannot grant floating charges are particularly prejudiced in raising finance compared to their counterparts in England. Few countries in the developed world present a less business-friendly approach to the raising of finance than Scotland does.
2. What are the problems that the Bill is designed to solve?
I'll look at this in three sections: what problems are currently faced specifically by asset financiers (including motor financiers); ditto for invoice financiers; then more general problems affecting all forms of finance.
2.1 Asset Finance Issues
- There's no such thing as a chattel mortgage (or bill of sale) in Scotland and no equivalent. So, a fixed charge on chattels (called "corporeal moveables" in Scots law) is impossible without the lender taking and keeping possession of the chattel, as in, for example, pawnbroking.
- Because of a specialty in the Sale of Goods Act, a sale and hire purchase back transaction is open to challenge in Scots law. If successfully challenged the consequence is that the finance remains a legally enforceable debt but title in the sold asset does not leave the seller and reach the finance company. This means that refinancing an asset which the potential borrower already owns is fraught with difficulty. The non-existence of a chattel mortgage alternative works as a double-whammy.
- A security assignment (called a security assignation in Scots law) has no effect unless and until notice (called "intimation" in Scots law) is given to the debtor in the assigned obligation. The financier holding the unintimated assignment has no security and loses out to an insolvency practitioner appointed to the assignor. There is no default to a floating charge in any circumstances. This means that, for example, the funding of contract hire companies where there may be hundreds of sub-hire agreements entered into month by month and where the giving of notice is a practical impossibility can only really be done by floating and not by fixed charge lending.
- Compounding the previous issue is uncertainty about how formal the notice or intimation has to be and whether an acknowledgment from the debtor is required. Admittedly, in recent years the courts have been more relaxed about this than what is required by the 1862 legislation but some nervousness remains.
2.2 Invoice Finance Issues (and for Securitisations too)
- It remains unsettled in Scots law whether it's competent to assign a debt before it exists. So, whole turnover agreements which include Scottish debts have to provide for some form of corroborative assignment (assignation) when debts are notified to the invoice financier on their being added to the sales ledger.
- The same requirement for notice (intimation) to the debtor applies to an absolute assignment of a debt to the invoice financier as it does in relation to security assignments as explained above. Scots law does not have the concepts of legal and equitable assignments and in England invoice financiers rely on equitable assignments to protect their title against other creditor of, and an insolvency practitioner appointed to, their invoice finance client. In Scots law the invoice financier has no title to the debt until notice is given to the debtor.
- The same issues as to what is required to evidence a valid notice to the debtor also apply. There is therefore some nervousness in factoring about the validity of a sticker on an invoice, though again the courts have been more relaxed here of late.
- Invoice financiers seek to circumvent the difficulty by relying on a trust created in the invoice finance agreement whereby the client undertakes to hold purchased debts (once they exist and have been purchased) on trust for the invoice financier until the debtor pays or the invoice financier gets good title to them (by giving notice). This form of trust has been blessed by the courts (in relation to debt purchases but not security). However, this was in a case where the trust was governed by English law and Scots law requires more formality at least to transfer the debts into the trust than English law does. Thus, the transfer of debts into the trust has to be intimated to the beneficiary of the trust (the invoice financier) and that intimation can only be given as and when the debts in question come into existence and have been purchased - in other words, again when the debts are notified to the invoice financier.
- Because of issues which surround the creation of the trust in relation to each purchased debt, invoice financiers invariably take floating charges from the client. Only companies and LLPs though can grant floating charges.
2.3 Other Problems - applicable to finance more generally
- Crown Preference: the UK Government is re-introducing Crown preference in insolvency. This has led to irritation in England, but the situation is much worse in Scotland because of the above difficulties in taking fixed security over moveables and the inevitable reliance on floating charges which will rank behind Crown preference on insolvency. (Debts, rights under agreements such as sub-hire agreements, company shares, intellectual property rights etc are classed in Scots law as incorporeal moveable property - the equivalent of choses in action or intangible property in English law.) The Bill will solve this.
- Shares: a share pledge is in law a security assignation. The equivalent here of giving notice to the debtor is that, for there to be any security over the shares, the creditor/assignee (or its nominee) has to be registered as the member on the register of members. Many creditors baulk at the consequences of that.
- Intellectual property rights: again the form of security is a security assignation and here the equivalent of giving notice to the debtor is for the creditor/assignee to be registered as proprietor on the patent or trade mark etc register. Again the creditor may be wary of the consequences as obligations follow entry on the register. The position is further complicated here because there is only a single UK patent and trade mark register (ignoring EU registers), so how do you distinguish a patent or trade mark to which Scots law properly should apply from another one?
- Any security over any other form of incorporeal moveable property faces some similar issue. For example, a security over a bank account needs intimation to the bank with issues thereafter for control of the account, or the assignation of rents in real estate financing which is a security assignation requiring the giving of notice to the affected tenants.
3. Does the Bill solve all these issues and, if so, how?
It does - at a stroke. There are consequences of course but they are not arduous. It brings Scots law in this area into the 21st Century and actually improves it beyond the current English law position (which is itself not without its challenges).
The Bill establishes a new register, the Register of Moveable Transactions ("RMT"), which will be administered by the Registers of Scotland (in other words, the same place as the Land Register of Scotland). It will be an electronic on-line register. Registration of a document in the Register will be cheap - a few Pounds it's assumed - as will be the cost of searching it. The Bill sets up the RMT in part 3 of the Bill, where the detail of the proposed logistics are to be found. There are in effect two new Registers within the RMT, the Register of Assignations and the Register of Statutory Pledges. I now turn to the two separate issues behind the creation of the separate Registers as provided for in parts 1 and 2 of the Bill.
3.1 Assignation of Claims
This is where the Bill solves the issues facing invoice financiers, as well as such things as the asset financier's problem with security over, say, sub-hire agreements. Don't be put off by the word "claim" which is used in the Bill - it simply means the right to the performance of an obligation, hence a debt, a sub-hire agreement or a bank account.
A document assigning such a claim - whether absolute or in security - can be registered in the RMT. So an invoice financier's debt purchase agreement can be so registered, as can be the asset financier's security assignation of sub-hire agreements. The assignation of future debts (or claims) is confirmed to be competent and, provided what it being assigned is adequately described so that it can be identified as falling within the relevant description, will be effective (for example, all debts due to X by its customers; or all sub-hire agreements the subject matter of which are the vehicles supplied by asset financier to the assignor on hire purchase agreements). Registration gives the creditor priority over an insolvency practitioner appointed to the assignor without any need for intimation or notice. Where the assignation in question is a security assignation, it is treated as being a fixed security.
Invoice financiers will no longer need to rely on a trust and may not bother with floating charges. Anxieties, if there are any, about confidential invoice discounting with partnerships and sole traders will vanish. And what goes for invoice financing, also applies to securitisations (though of course here the overall security package may remain all-encompassing).
Of course debtors paying the assignor in good faith have to be protected, so it's still the case that if notice hasn't been given to the debtor, he is discharged of his obligation if he pays the assignor rather than the assignee when he had no reason to do otherwise. But that's no different from the position in England following the old case of Dearle v Hall which dealt with the priority of sequential good faith debtor notices. Also, it's clarified that there's no formality required for the giving of notice to the debtor; as long as it's clear in its description of the situation, it will be treated as a valid notice. The Scottish Law Commission's explanation makes specific reference to the factor's sticker on invoices in this regard.
This simple new procedure will help other finance areas as well, for example technology finance, real estate financing backed by leases where the problems with the assignation of rents disappear, and project or construction finance where collateral warranties need to be assigned.
3.2 Statutory Pledges
These new forms of security - the equivalent of a charge over the like property in England - fall into two categories.
First, a statutory pledge can now be created over corporeal moveables (chattels). So, if there is any doubt about a sale and hire purchase back transaction, a cautionary supplemental statutory pledge can be taken over any right the seller may continue to have in the chattel and clears any issues upon its being registered in the RMT. Or a simple loan can be advanced by way of refinancing and secured by a statutory pledge over the chattel in question, which could be a van or a car fleet or a machine tool or anything else you care to think about as long as it's not heritable (i.e. land or buildings). Again, this will be a fixed security created upon registration.
Secondly, the same statutory pledge can now be created over certain types of incorporeal moveables, for the moment limited to company shares (financial instruments not being bills of exchange and the like) and intellectual property rights (though the categories can be increased by statutory instrument).
Again, in both cases, future assets not yet owned by the granter of the pledge can be included in the pledge, provided the identification is clear. Registration in the RMT completes the effectiveness of the security.
4. Some new issues
- The RMT will be a public register (as is the Land Register in Scotland). Anyone can search it for a fee. Not only will creditors do this as a matter of course, but so for example will motor traders to ensure a part exchange vehicle isn't the subject of security in the RMT.
- Because it's public, invoice financiers buying debtor books and others taking security over multiple assets, corporeal or incorporeal, will probably want to keep commercial detail off the Register. Accordingly, debt purchase agreements, for example, will probably in future be accompanied by a separate short assignation document, so that only this latter document will be registered rather than the debt purchase agreement itself. Admittedly, this is a downside in that one more document is required, but that's a small price to pay for the huge benefit of the new arrangements.
- The new legislation is to be facilitative rather than exclusionary. So, if someone wants to take an assignation and give notice to the debtor rather than register in the RMT, they can still do so. It's thought this will largely be used in private, domestic transactions rather than in business lending, but it could still be used for example with a security assignation over a single agreement, such as a power purchase agreement.
- The new arrangements apply to consumers as they do to businesses, subject to some exceptions, for example, a consumer is not to be able to grant a charge over future assets and there are monetary de minimis limits on what property can be charged by consumers. This could be one of the - hopefully few - political obstacles to the Bill. While the Bill makes perfect sense in relation to consumers and the protections should be the province of compliance legislation through the FCA rather than Scots civil law, politicians may still hesitate (as they have in England with reform of the Bill of Sale legislation). So, this position may change as the Bill progresses. The simple fact is that the Bill is desperately needed for business, particularly small business, in Scotland and the loss of its application to consumers might be a mistake but also a small price to pay for improving the position for business.
- The Scottish Parliament has no remit in relation to company law, so cannot with this or any other Bill amend the law relating to registration of charges at Companies House. Security assignations and statutory pledges may, therefore, trigger the need for dual registration, both in the RMT and the relevant Register of Charges. Again, while this may be a pain, it's not a big imposition and it's hoped that there may be an electronic solution to this between the Keeper of the RMT and Companies House.
- The RMT will be kept by reference to the assignor or pledgor; it will not be classified by the property affected, so searches will be done by person. It follows that care will be required when registering to ensure adequate and correct information is lodged. There will be no penalty for failing to remove an entry from the Register, so there may be historic information recorded. But then that's the case with the Register of Charges at Companies House as well - and the same imperative will lead to the Register being updated, namely, the borrower's requirement to assure a new creditor that a proposed transaction will give rise to a clear search when put through.
- There is a cost to setting up the Register. The Keeper of the Registers and the Scottish Government need reassured that the cost will quickly be amortised by the volume of registration and search dues. It's vital therefore that the affected finance industries lend their support to the Bill and do what they can to be reassuring about the level of usage. Those of us who have worked with the Scottish Law Commission on this Bill over the last eight or so years have no doubt whatever that it will be very frequently used.
Please feel free to contact me with any queries.
The content of this webpage is for information only and is not intended to be construed as legal advice and should not be treated as a substitute for specific advice. Morton Fraser LLP accepts no responsibility for the content of any third party website to which this webpage refers. Morton Fraser LLP is authorised and regulated by the Financial Conduct Authority.