Background

The law in relation to landlord's hypothec underwent significant changes on 1 April 2008 when the Bankruptcy and Diligence (Scotland) Act 2007 abolished sequestration for rent and instead provided that the hypothec was to rank as a security in an insolvency procedure.

Since 1 April 2008 certain issues have arisen out of ambiguities in the legislation. These issues have become apparent particularly in administrations. This note looks at:

  • The nature of the hypothec
  • The priority of the hypothec in relation to a floating charge;
  • The rent covered by the hypothec;
  • The goods covered by the hypothec; and
  • Dealing with goods subject to the hypothec.

Nature of the hypothec

The Landlord's hypothec is a security arising by operation of law . On a tenant entering an insolvency procedure the hypothec provides the landlord with security over goods on the premises, to the extent that those goods are owned by the tenant. Therefore, if the goods are subject to Retention of Title or if title has already passed to a third party in terms of the Sale of Goods Act 1979, they will not be subject to the hypothec. The security is for unpaid rent only. Any claim for dilapidations or other costs will not be covered by the hypothec.

Priority of the hypothec in relation to the floating charge

Prior to 1 April 2008 there was conflicting case law as to whether the landlord's hypothec ranked ahead of the floating charge. However, the general view taken by solicitors and academics was that the landlord's hypothec did rank ahead of a floating charge. Albeit that this priority was of no value if goods had been removed from the premises prior to the landlord raising sequestration for rent proceedings.

Whilst there is no case law on the matter to date, it is our view that post 1 April 2008 the Landlord's hypothec ranks ahead of the floating charge in respect of goods on the premises at the date of administration.

Arrears of rent due as at date of appointment of the administrator

All rent which has fallen due at the date of the appointment of an administrator will be secured by the landlord's hypothec. Whether rent has fallen due is determined by the date on which the payment was due to be made in terms of the lease. Therefore, even if rent that has not been paid relates to a period of occupation after the date of administration, it will be due pre-appointment if the lease required it to be paid in advance and the date the payment was due was pre-appointment. It is therefore important to know the date on which rent fell due.

Rent falling due after the date of appointment

Unfortunately, the legislation is unclear as to whether the hypothec is security for rent that falls due post appointment. Under the old law the hypothec would cover rent due up to the date that the landlord raised sequestration for rent proceedings to enforce the security. However, sequestration for rent has now been abolished and the new legislation does not make it clear what if any limits apply to what rent the hypothec covers. The new legislation states that, the hypothec is to rank in the insolvency process and that it is security for "rent due and unpaid only". On a straightforward reading that would seem to cover all rent that falls due, whether pre or post appointment (while the lease remains in existence). It might be argued that the Scottish Parliament only intended that the hypothec should be security for any rent that had fallen due pre-appointment. However, the terms of the legislation do not support this. The point will not be clear until a ruling has been made by the courts.

Ways to deal with the uncertainty as to the sum secured

There would appear to be two ways to deal with the uncertainty surrounding the sum secured by the hypothec. The first would be to seek directions from the court under paragraph 63 of schedule B1 of the Insolvency Act. The likely outcome of such an action is unclear. The second option would be to seek to reach a commercial settlement with landlords where the issue arises.

Goods covered by the hypothec

It was noted in the first section that, on a tenant entering an insolvency procedure, the hypothec provides the landlord with security over goods on the premises, to the extent that those goods are owned by the tenant. The question has been raised as to whether the hypothec covers only goods on the premises as at the date of the insolvency procedure or whether it would cover goods subsequently brought onto the premises by the administrator. Again the legislation is unclear on this point.

What is clear is that the goods will not be subject to the hypothec if they are not owned by the tenant. Therefore, if title to the goods brought onto the premises has been obtained in the name of the administrators as principals, rather than the company in administration, then the goods should not be caught by the hypothec. Accordingly, if the administrators are looking to purchase further stock to sell from stores in Scotland they should consider carefully the terms on which they do this.

One other scenario in multi-sited insolvencies would be where goods purchased by the company prior to the administration are moved into a Scottish store post-administration in order that they can be sold. Where these goods are subject to Retention of Title they will not be caught by the hypothec. However, if the company has title to the goods, then, on a straightforward reading of the legislation, such goods would appear to be caught by the hypothec. As with rental arrears, this point will not be clear until a ruling has been given by the Courts.

Sale of goods covered by the hypothec

The position with the sale of goods subject to a hypothec is very similar to the position regarding the sale of goods subject to retention of title (ROT) clauses. As with ROT, where the administrator has become aware that there will be a claim, the goods subject to a hypothec should not be sold without consent of (i) the landlord or (ii) the court per paragraph 71 of Schedule B1 of the Insolvency Act 1986. If goods are sold without such consent then it is prudent to ensure that (i) an inventory has been kept of what has been sold and at what price and (ii) the sale proceeds are retained in a marked account so that the landlord cannot complain to have suffered any loss as a result of the sale.

An administrator must also consider what costs of sale can be deducted if he sells goods subject to the hypothec. The legislation is silent on the issue of what amount the landlord is entitled to on the sale of the goods subject to the hypothec. It is not certain whether it would be the purchase price, sale price, or independently assessed market value. There is also no guidance in the legislation as to what costs, if any, can be deducted where the administrator has dealt with the sale. In general, when administrators deal with the sale of secured assets they will agree in advance with the secured creditor what level of their time cost will be paid. In the event that agreement cannot be met though the general position is that it will only be the disbursements and not the administrator's time cost that will be deductible. There is no authority on this point in relation to the hypothec. However, we would not expect the administrators to be in any better position than they are with other securities. It therefore seems likely that it will be the actual proceeds of the sale that will be payable to the landlord. Obviously a different figure could be agreed by way of a commercial settlement.

Conclusions

The uncertainty in relation to landlord's hypothec clearly requires issues of risk management to be assessed by IPs. In our view there if the sums involved are significant and agreement with the landlord cannot be reached the administrator should seek directions from the Court.