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Once enacted, Insolvency Practitioners (IPs) may begin to see real changes in certain aspects of the management of formal insolvency processes in Scotland. This insight sets out a high-level summary of the potential impact of the Bill for IPs if enacted in its present form.
The Bill, as presently drafted, proposes two key reforms to the way in which owners of moveable property can grant security over it or transfer ownership of it in favour of a third party. These changes are intended to make it easier for individuals and companies to raise finance.
At present, if a lender wishes to take fixed security over moveable property in Scotland, they have two options:
(a) The borrower can grant a possessory pledge by physically delivering the charged property to the lender; or
(b) The borrower can enter into an assignation, under which ownership of the asset is transferred to the lender and written notification (known as intimation) is sent to all contractual counterparties.
These options are cumbersome, legally complex and in many cases commercially unviable.
The Bill proposes two changes. Firstly, it introduces a new form of fixed security over both corporeal and incorporeal moveable property (for incorporeal property, this is presently restricted to intellectual property) which will not require transfer of ownership or delivery of assets to the lender. This is known as the statutory pledge.
Secondly, it modernises the operation of assignations by allowing assignation of future claims; allowing electronic intimation of assignations and enabling registration in a statutory register as an alternative to intimation.
It is anticipated that these proposals will present a significant increase in the scope for lenders to take fixed security over assets of corporate borrowers and security over moveable assets owned by individuals. In a restructuring scenario this could well mean that new or alternative sources of funds may become available (depending on the nature of the business) to support a refinance where the existing lending and security structure is no longer tenable.
If the statutory pledge, once available, has been used to secure lending by either an individual or a corporate borrower then the realisations of the pledged assets will not be available for distribution to unsecured creditors (whether by way of the prescribed part or otherwise) or floating charge holders unless there is a surplus. This will inevitably lead to lower returns to any creditor without the benefit of a fixed charge in any formal insolvency proceedings.
The rebalancing of the proportion of assets subject to fixed charge security rather than floating charges may also limit the ability of insolvency officeholders to recover their fees and expenses.
Fixed charge security takes priority to the officeholder’s remuneration, disbursements and expenses in the statutory scheme setting out the waterfall of distributions on a formal insolvency process. While IPs already make these assessments at the outset of an appointment, once the Bill is enacted they will need to be alert to the potential for more extensive fixed charge security on the likelihood of their fees being paid at the end of the process.
IPs will need to extend their pre-appointment and pre-distribution due diligence to include the electronic searches of the new of Statutory Pledges and Assignations Neither register is definitive. Accordingly, these searches will be needed in addition to the investigative steps officeholders presently take in order to satisfy themselves as to the existence and validity (or otherwise) of any pledges or assignations.
Registration in the new register will be a pre-requisite for a validly created statutory pledge (but not for a possessory pledge).
A statutory pledge becomes effective when the property subject to it is identifiable and becomes the debtor’s property and the pledge has been registered in the Register of Statutory Pledges. There is potential for dispute here about when the clock begins ticking for registering the document at Companies House as there is currently no guidance about the interplay between the 21 day requirement for registration at Companies House and the new registration provisions set out in the Bill. This uncertainty will need to be addressed as part of any advice an IP obtains on the validity of fixed security for the purposes of making a distribution. It is hoped that further guidance or amendments will follow before the Bill is enacted.
There is nothing in the Bill to prevent a debtor granting multiples statutory pledges over the same assets. The general rule that priority depends upon date of creation can be changed by agreement between the parties. However, a ranking agreement relating to statutory pledges (unlike those which relate to floating charges and standard securities) will not be registrable.
Any ranking agreement relating to multiple statutory pledges is, according to the Bill in its current form, has effect only as between the parties and their successors. There is a real risk for creditors that a ranking agreement will not be binding on the borrower (and any insolvency officeholder subsequently appointed over or in respect of the borrower) if the borrower is not a party to the agreement. If these provisions remain in the final form of the Act, IPs will need to take great care to determine the correct position before making any distribution.
The most recent consultation on the terms of the draft Bill closed on 6 September 2022, and we are awaiting the Scottish Government’s review of the responses it has received.
We do not yet know when the Bill will become law or what changes will be made before it does. For now, IPs just need to be aware of the proposals and the potential impact on the way in which both corporate and individual insolvency processes in Scotland are managed.
If you would like further information or advice about the issues discussed in this insight, please contact a member of TLT’s Restructuring & Insolvency team.
Contributor: Tessa Durham
This publication is intended for general guidance and represents our understanding of the relevant law and practice as at January 2023. Specific advice should be sought for specific cases. For more information see our terms & conditions.
05 January 2023