“Effectually executed diligence” and MacMillan v T Leith Developments Ltd [2017] CSIH 17

The floating charge is a statutory creation in Scotland — the law is currently found in Companies Act 1985, ss 462–466. The charge was introduced initially (in 1961 in Scotland) to give debtor companies the opportunity to raise finance by granting a non possessory security to creditors — where generally Scots law prohibits the grant of express non possessory securities.

One of the most complicated issues that arises in the law of floating charges is the question of competition between a floating charge and a third party creditor.

So, for example, a floating charge holder Bank A has a priority over most creditors because on the occurrence of certain events the charge attaches (because a company is wound up (attachment is under s 463 of the Companies Act 1985) or goes into receivership (attachment is under s 53 (7) of the Insolvency Act 1986) or the administrator of a company notifies that there will be insufficient available to pay off creditors para 115 of Schedule B1, to the INsolvency Act 1986).

However, under s 464, Companies Act 1985 the charge will be subject to third party secured creditors where (a) the third party creditor has an involuntary security such as landlord’s hypothec or lien; or (b) the third party creditor has a voluntary real right in security (eg pledge or standard security) created before the floating charge was created (irrespective of whether the charge contains a negative pledge clause); or (c ) the third party creditor has a voluntary real right in security (such as a pledge or standard security) made a real right before the floating charge attaches (provided that the floating charge does not contain a negative pledge clause).

The charge is also subject to priorities for preferential creditors (unpaid employees and others protected by Insolvency Act 1986, Sch 6) and the prescribed part (a ring fenced sum for the general body of unsecured creditors created under s 176A of the Insolvency Act 1986).

Generally though — aside from the prescribed part — unsecured creditors have no priority over the floating charge. However, in law generally it is possible for an unsecured creditor to make him or herself secured by executing a judgment against assets belonging to the debtor. In Scots law this is known as diligence. In Scots law diligence includes arrestment — which involves seizing the incorporeal assets of the debtor (such as bank accounts); attachment — which involves the creditor seizing the corporeal moveable assets of the debtor (goods); adjudication (a little used diligence allowing the creditor to seize the immoveable property of the debtor (land and buildings); and inhibition — which is a diligence which prohibits the debtor from dealing with his or her immoveable property.

While generally diligence would give the creditor priority in the insolvency of the debtor (subject to rules striking down certain diligences carried out in the sixty days prior to insolvency — now found in s 24 of the Bankruptcy (Scotland) ACt 2016, applied to corporate insolvencies by INsolvency Act 1985, s 185) when the issue of a competition between floating charges and diligence arose in Lord Advocate v Royal Bank 1977 SC 155 despite the legislation in Companies Act 1985, s 463 and Insolvency Act 1986 s 55(3) providing that the charge attached subject to “effectually executed diligence” it was held that the vast majority of diligences would give no priority to the third party creditor — unless he or she had “completed” the diligence by either selling the property or having the debtor’s asset transferred to the third party creditor. The case attracted much criticism from academic commentators (for examples see Sim at 1984 SLT (News) 25 and my own article at 2000 JR 325) but remained the law until Friday when MacMillan v T Leith Developments Ltd [2017] CSIH 17 (a five judge decision in the Court of Session) unanimously overturned the case of Lord Advocate v RBS 1977 SC 155.

The following is a brief note summarising the grounds for the decision in MacMillan pending an article that myself and my PhD student Alisdair MacPherson are working on examining the decision.

MacMillan involved a competition between an inhibition and a floating charge and held that an inhibition is effectually executed diligence. The case overturned Lord Advocate v Royal Bank because:

(a) The interpretation given to “effectually executed diligence” in the context of arrestment (and attachment) largely deprived the expression of having any legal effect. (para 57 per Lord President Carloway and para 90, per Lord Drummond Young)

(b) The expression “effectually executed diligence” relates to the 60 day rule set out in s 24 of the Bankruptcy (Scotland) Act 2016 (and its predecessor provisions). (para 58, per Lord President Carloway and paras 94–97 and 100–101, Per Lord Drummond Young)

(c ) The suggested interpretation in (b) was endorsed by the promoter of the bill when the floating charge was originally introduced, and so is supported by application of Pepper v Hart. (para 59 per Lord President Carloway and paras 98–99, per Lord Drummond Young)

(d) The decision in Lord Advocate v Royal Bank appears to take an inaccurate view of the law of arrestment, and relies on case law which did not directly relate to the orthodox application of the law of arrestment (paras 84–88, per Lord Drummond Young)

(e) The case creates a circle of priorities where there is an assignation, an arrestment that predates intimation of the assignation, and a floating charge which postdates the intimation of the assignation. (paras 92–93, per Lord Drummond Young)

(f) The decision in Lord Advocate v Royal Bank ran counter to the true nature of the floating charge in giving the debtor freedom to deal with assets before attachment of the floating charge — which means that assets are free to be attached by creditors too (para 89, per Lord Drummond Young)

The next two grounds are specific statutory interpretation issues — in addition to the Pepper v Hart issue identified as factor (c ).

(g) The re-enactment of the provisions relating to effectually executed diligence after the decision in Lord Advocate v Royal Bank did not serve as parliamentary endorsement of the earlier Inner House decision — Barras v Aberdeen Steam Trawling and Fishing Co, [1933] AC 402 is only an aid to construction and not conclusive and does not apply to consolidation statutes (Haigh v Charles W Ireland Ltd 1974 SC (HL) 1, at 40 per Lord Diplock endorsed). (See para 65 per Lord President Carloway and paras 104–109, per Lord Drummond Young)

(h) While Lord Advocate v Royal Bank has represented settled practice for 40 years, and the courts will generally be slow to reverse a decision where practice has been settled (see, for example, R (on the application of N) v Lewisham LBC, [2015] AC 1259). IN the view of Lord Drummond Young it is necessary to distinguish between adversarial and non adversarial processes (per Lord Drummond Young at paras 111–112) and as Lord Advocate v Royal Bank related to non adversarial processes the settled practice rule did not apply to restrict the court in overturning the case. (See paras 66–68 per Lord President Carloway and paras 110–114, per Lord Drummond Young).

The arguments (a) to (f) in MacMillan largely replicate the criticisms in the articles on Lord Advocate v RBS (including those of Sim and myself). Commentators had suggested in addition the following (although this does not appear as a factor directly referenced in the judgment). The reversal of Lord Advocate v RBS also serves to address this problem and ensure the floating charge operates in a way more consistent with the general law.

(i) The decision in Lord Advocate v Royal Bank seems contrary to Forth and Clyde Construction Co Ltd v Trinity Timber & Plywood Co Ltd 1984 SC 1 which held that a floating charge attached subject to a statutory hypothesis — which provides that the charge attaches as if it is the default type of security applicable to the particular property to which it attaches, hence for incorporeal moveable property the charge attaches as if it is an intimated assignation in security. In the general law an arrestment made before the intimation of an assignation will mean the arrester will take priority over an assignee and therefore the approach taken by Lord Advocate v RBS was inconsistent with the general approach to competitions between diligence and fixed securities.