In Scotland, there are six basic forms of security:
- a standard security
- a floating charge
- a lien
- a hypothec
- an assignation in security
- a pledge
The standard security is the only method by which a fixed legal charge can be created over property assets in Scotland. It is governed by statute, namely, the Conveyancing and Feudal Reform (Scotland) Act 1970. The 1970 Act not only stipulates the required form of the security, but also sets in place standard conditions with which the customer will require to comply (unless varied by the bank). In addition, the 1970 Act contains the remedies available to a lender which arise in the event of default by the customer. These cannot be varied and are:
- power to sell the property
- power to enter into possession of the property
- power to carry out any necessary repairs
- power to apply for a decree of foreclosure (remedy by which debtor forfeits ownership of property to security holder).
In order to exercise any of the statutory remedies, the lender would take preliminary steps, namely:
- serving up a calling up notice
- serving of a notice of default, or
- application to the Sheriff Court (under section 24 of the 1970 Act).
The 1970 Act also sets out in detail the required form of calling up notice, valid methods of service of these and the powers which can thereafter be exercised. In the event of a failure to comply with a calling up notice, the lender is entitled to enter into possession and lease the property for any period not exceeding seven years. The lender may apply for a court order in the event that the customer does not cooperate in this regard. If the lender intends to exercise its statutory power to sell the property due to customer default, it will also be required to have first served a calling up notice on the customer to that effect. If the customer fails to comply with the calling up notice (that is, to pay in full the debt owed) the lender then has the right to sell the property.
The power of sale must be exercised in accordance sections 25 and 27 of the 1970 Act. The lender has a statutory duty to firstly advertise the property and achieve the “best price” that can reasonably be obtained on sale.
Where residential property is involved, the terms of the 1970 Act have been altered by the Mortgage Rights (Scotland) Act 2001 and Home Owner and Debtor Protection (Scotland) Act 2010 which imposes additional requirements on the part of the lender and also, by including a requirement for court authorisation before remedies are exercised, meaning that a court action will be required in almost all cases with a residential element.
Often a customer may have also granted pari passu (equally) or postponed standard securities over the property to assist their finances. Where the lender is a prior ranking charge holder, it will be entitled to sell the asset without the consent of the other secured lenders, unless it has agreed to consult with them in advance in terms of any ranking agreement regulating the priority of the charges. The proceeds of sale will be held by the selling creditor in trust for those having an interest. On receipt of the proceeds of sale, they require to be applied in terms of section 27 of the 1970 Act in the following order of priority:
- the expenses of the sale;
- sums due under the prior ranking standard securities being redeemed;
- sums due under any postponed securities (as ranked if appropriate per a ranking agreement); and thereafter;
- any surplus is then paid to the customer.
Floating charges may be granted by limited companies and limited liability partnerships (LLP), but not by individuals or conventional partnerships. The charge floats over all (or any part) of the assets (including moveable property) held from time to time by the company, until the winding up or appointment of a receiver in respect of the company, at which point the charge fixes (crystallises) and the creditor gains a real right to the assets held by the company at that time.
In terms of the Companies Act 2006, floating charges must be registered in the register of charges at Companies House within 21 days of their creation. When registered the charge is deemed to have been created as the date of its execution. Currently, there is no requirement to register floating charges in the property registers. Although provision has been made for such registration in the Bankruptcy and Diligence (Scotland) Act 2007, the relevant sections are not yet in force and it is uncertain if or when they will come into force.
A lien is a right to retain moveable property pending payment of a debt or satisfaction of an obligation. (For example a hotel may retain a guest’s luggage until the bill has been paid).
A hypothec is similar to a lien except that the creditor does not take possession of the property instead it merely acquires a preferential right to have its debt paid out of the proceeds of the property. The best known example of a hypothec is the landlord’s hypothec which is now of decreasing relevance. The Bankruptcy and Diligence (Scotland) Act 2007 has effectively confined landlords hypothec to commercial leases and, by abolishing the main method of enforcing the hypothec (sequestration for rent), has led to a lack of clarity as to how the hypothec may now be enforced.
Assignation in Security
An assignation in security can be used for providing security over incorporeal moveable property. The assignee holds the property in security for a debt owed by the assignor (known as a “cedent”). When the debt is repaid the assignee will assign the property back to the cedent (known as “retrocession”) or can realise the property if the debt is not repaid. Assignations in security are becoming increasingly rare as, in practice, if incorporeals are to be the subject of a security, it will usually be a floating charge. The most common examples are assignations of book debts (i.e. a debt that may appear on the books of a business) or assignations of rents (where a leased property is subject to a standard security and the creditor also requests an assignation of rents in security of the debt).
A pledge is a security over corporeal movables whereby goods are transferred to the creditor and returned on payment of the debt.
Where there are multiple securities, there are rules as regards ranking:
- Generally a fixed security will have priority over a floating charge (this will always be the case where the fixed security arises by operation of law- e.g. a lien or hypothec)
- Where a fixed security is created as a real right prior to crystallisation of the floating charge, it will have priority.*
- Multiple floating charges will rank according to their dates of registration.*
- Where there is a ranking agreement that will regulate the ranking of the securities.
- Where the charges contain ranking clauses these will apply except that pre-existing securities will not be affected by clauses in subsequent securities unless they also contain such a clause.
* Rules 2 and 3 are subject to rules 4 and 5.