Key differences between Scottish and English security
Beverley Wood and Laura Purves of law firm Morton Fraser identify some key issues for funders to think about when considering entering into asset finance transactions in Scotland.
In Scotland, there is no direct equivalent to the fixed security interests over moveable assets which can be granted under English law. The only fixed security interests generally recognised by Scots law are: a standard security which is taken over land or heritable property (real estate) in Scotland; a pledge of shares which has been properly created by transfer of the pledged shares to the pledgee; a pledge of assets which involves the transfer of possession to the security holder (but is clearly impracticable if those assets are required for the generation of income); and an assignation which has been intimated (notice has been given) to all relevant third parties. Therefore, generally in Scotland the most commonly taken security tends to be the standard security over heritable property, or an all assets floating charge.
The lack of ability to take fixed security in Scotland creates different issues for both asset and invoice financiers. Scots law in this area is not fit for purpose, but a significant change is on the horizon.
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Sale and hire purchase back in Scotland
In a sale and hire purchase back, a typical transaction involves equipment being sold to the funder by the customer, to then be hired back to the customer by the funder under a hire purchase agreement. In this way, the customer receives payment for the sale of the equipment but can continue to use it and repay the funder by way of instalments under the hire purchase agreement.
When is Scots law relevant?
The key consideration in respect of a transfer of title to goods is not whether the hirer is Scottish or the finance agreement is governed by Scots law, but the law of the place where the goods are at the time title passes (together with any further restrictions introduced by the governing law chosen by the parties). Therefore, if a funder acquires goods from a hirer and the goods are in Scotland at the time, then the issue of any conditions which require to be fulfilled for the passing of title in those goods to the funder is a matter for Scots law, as well as the law of the relevant sale contract if different.
What is the issue with sale and hire purchase back?
The Sale of Goods Act 1979 (the "Act") contains the basic rules which govern sale of goods and provides that title to goods on sale passes when the parties intend it to. There is an exception in Scotland which means that this provision of the Act does not apply to a sale intended to operate by way of security. It is therefore likely that the old Scots common law still applies to these transactions, meaning that delivery of the goods is required for title to pass. There is case law to the effect that a sale followed by hire purchase back is (or at least can be) a sale by way of security, meaning there is a risk that, without delivery, title does not pass to the funder, which could leave the transaction at risk of challenge.
So, can it still be done?
The risk of sale and hire purchase back transactions being successfully challenged (most likely by an administrator in the insolvency of the relevant company), resulting in the funder's title to the equipment being void and the funder becoming an unsecured lender, understandably creates a degree of caution amongst funders when approaching this type of transaction in Scotland.
However, this does not mean it cannot be done in any circumstances, and where genuine characteristics of a sale can be established rather than the characteristics of a security, some funders in the market appear willing to take the risk. However, it does require funders to give thought to the potential risk involved. The risk may be alleviated to a large extent if the customer's credit covenant, taken with any available guarantee or other security (a chattels mortgage in England or floating charge in Scotland) is undoubted, so that the goods themselves are not an essential part of the security package.
There are also other valid reasons why sale and hire purchase back may be a perfectly reasonable approach, such as avoiding the possibility of being a deemed importer of the goods into the UK. The key is to ensure the circumstances of any given transaction are considered in light of the Scottish legal background.
Is sale and leaseback any less risky?
With a sale followed by a leaseback, title to the goods never reverts to the hirer as, unlike hire purchase, there is no option for the hirer to purchase. It, therefore, looks far less like a sale operating by way of security.
Where the lease is a finance lease, whilst all of the economic benefits of the reversion of the ownership do pass to the lessee if he gets, for example, 95 per cent or more of the sale proceeds, that is still 95 per cent not 100 per cent. It is therefore still materially different from the situation where there is a reversion of the title.
Invoice finance in Scotland
Any funder offering invoice finance facilities in the UK whose borrowers have (or may in the future have) debtors with a Scottish connection should be aware of the different rules applicable to invoice finance in Scotland.
Scots law is less user-friendly to invoice financiers than English law, and the following is a brief, high level guide to some of the key issues to consider in invoice finance transactions which involve Scottish debts or debtors.
When is Scots law relevant?
The issue is not whether the seller of the debts (the "Customer") is Scottish or English, but whether (i) the debts are governed by Scots law, or (because of a stray case in the Court of Session ("Ticketus")) (ii) the debtor is in Scotland. Scots law is undoubtedly less user-friendly to invoice financiers than English law.
How do I assign Scottish debts?
In English law, if there is an agreement to buy and sell a debt and the buyer pays the purchase price then equity will provide that the purchaser has an equitable assignment of the debt. However, there is no equity in Scots law, so in Scotland there must be an actual assignment (which we call assignation, but there is nothing in the difference).
What about debts that are not yet in existence?
It is not settled in Scots law whether an assignment of a debt which does not exist yet is competent and so because of the risk, steps have to be taken to back up any initial assignment of debts, present and future, with an assignment of future debts once they have come into existence.
Do you need to give notice to the debtor? How?
The Publicity Principle: this is the principle that two parties should not be able to effect secret transfers of property which affected third parties don't know about. In contrast, equity can allow this in English law. So, the Publicity Principle tells us that the buyer has no title to the debt in a challenge by third parties (which include the administrator or liquidator of the client) until notice is given to the debtor of the assignment (referred to in Scotland as "intimation".)
It is probably the case that notice cannot be validly given before the debt exists. So, letters in advance to a debtor with whom the Customer has a continuing relationship do not do much good. A notice is needed each time, though a sticker on the invoice stating that the debt has been assigned to the invoice financier is regarded as sufficient.
What if I can’t give notice?
Often, notice is not an option from a commercial perspective, particularly in confidential arrangements. Normally, in such circumstances, a Customer in England declares in the invoice finance agreement that debts which have not vested in the invoice financier are held in trust for the buyer by the Customer as trustee of the trust. The same approach can be taken under Scots law in relation to Scottish debts, but Scots law likes a bit more formality in creating this trust, so it is important that the invoice finance agreement contains the required Scottish provisions.
It is common for invoice financiers to take security from the Customer to bolster their position and render pointless any challenge to the trust mechanics.
As it is not practicable to take a fixed charge on debts in Scotland, the floating charge is usually the only form of security which is viable. This is unless the invoice financier wants to take a security over the client's land and buildings or the client has assets in England which lend themselves to being charged by way of fixed charge.
There is hope on the horizon as the Moveable Transactions (Scotland) Bill was included in the legislative programme for 2021/22 announced by the Scottish Government and, if approved, it will fundamentally reform the law in Scotland in this area.
Following a merger in February 2013 with Macdonalds (established in Glasgow in 1614), Morton Fraser can lay claim to being the oldest law firm in Scotland. Laura Purves is a senior solicitor and Bev Wood is a partner with Morton Fraser.