In determining whether a security interest has been validly created in accordance with the requirements of Scots law, the key considerations are whether the security transaction has been carried out publicly or in secret and whether the requirements of legal validity have been met and, unlike under English law, the concept of equity is irrelevant.
The absence of equity in Scots law means that the intention of the parties is irrelevant; the creditor either has a valid security or nothing at all. Scots law recognises five main types of security which can be taken over moveable assets: pledge, assignation, lien, hypothec (which is rarely used) and the floating charge.
In deciding what security to take, lenders need to consider several factors including the type and location of the asset to be secured and the requirements of each security against the other possible options. The key issues with each security are set out below.
- The pledge is the delivery of an asset in security to a creditor.
- The creditor takes (and retains) possession of the asset.
- Ownership of the asset remains with the debtor.
- The creditor has a right to sell the asset on an event of default by the debtor.
- Unsuitable for assets which cannot be delivered and are required by the borrower in order to generate income to repay the underlying debt.
- Can be adapted for use with assets in an independent warehouse e.g. whisky stocks.
Assignation in Security
- Suitable for transferring the borrower’s rights to incorporeal moveable property such as book debts and IP rights to a lender.
- Any such assignation must be intimated otherwise the assignation will be ineffective.
- Impractical where numerous debts are being financed and notice requires to be given to a large number of debtors.
- Creditor retains the possession of an asset until an underlying debt or obligation is repaid or performed in full.
- A lien can protect an unsecured creditor seeking repayment because fixed or floating charge holders will be unable to enforce their charges and realise the secured assets whilst they are subject to a lien.
- The lien can only be exercised when the creditor already has possession of the asset.
- A floating charge can secure all of the assets of a company or LLP or can be limited to specific assets.
- The borrower will also be free to dispose of and acquire assets until such time as the floating charge has crystallised. If the charge covers all assets, the assets charged by the floating charge therefore change throughout the duration of the security.
- If contained within a Debenture, the floating charge should cover all of the borrower’s Scottish assets, whether or not separate fixed charges have also been granted over those assets.
- Floating charge holders are paid out after fixed charge holders, preferential creditors and the prescribed part (a maximum sum of £600,000 which is ring-fenced for unsecured creditors).
- Crystallises into a fixed charge on the occurrence of a limited number of insolvency events (unlike in England where this can occur by contract).