A significant decision issued last week by a five judge bench of the Inner House has reversed a 40 year old decision on the meaning of 'effectually executed diligence' in a receivership.
Section 60 of the Insolvency Act 1986 provides that in a receivership, all persons who have 'effectually executed diligence' on any part of the property of the company which is subject to the charge by which the receiver is appointed have priority over the holder of the floating charge.
In 1977, in the case of Lord Advocate v Royal Bank of Scotland ('Lord Advocate'), the Inner House determined that an arrestment, not followed by a furthcoming, was not 'effectually executed diligence' and therefore the arrester did not have priority in competition with the floating charge holder. In subsequent cases it was generally accepted (although never expressly determined) that the reasoning in Lord Advocate also applied to inhibitions which post-dated the creation of the floating charge.
Although the decision in Lord Advocate has been the subject of much academic criticism over the years it has never, until now, been the subject of judicial reconsideration. The case of MacMillan v T Leith Developments Ltd (in receivership and liquidation) provided a five judge bench of the Inner House of the Court of Session with the opportunity to revisit the decision and consider afresh the meaning of 'effectually executed diligence' and the question of the competition between a floating charge holder and an inhibiting creditor in a receivership.
MacMillan v T Leith Developments Ltd (in receivership and liquidation)  CSIH 23
The case concerned the rights of an inhibiting creditor (MacMillan) in the receivership of T Leith Developments Ltd. The inhibition post-dated a floating charge which had been granted by the company in favour of Clydesdale Bank, but as at the date of receivership the whole debt due to the Bank was debt which had been incurred post-inhibition. The question which then arose was whether the inhibition provided MacMillan with a priority over the debt due to the Bank.
In order to determine this question, MacMillan raised proceedings seeking a declarator that the inhibition was an 'effectually executed diligence' and that the receiver was obliged, when distributing the sale proceeds of the company's assets, to pay the sums to him before making payment of any balance to the Bank. MacMillan also argued that even if the inhibition was not an 'effectually executed diligence', it nevertheless provided him with a priority over the Bank's post-inhibition debt.
At first instance, the commercial judge felt bound to follow the decision in Lord Advocate and rejected the argument that MacMillan had an 'effectually executed diligence' in terms of the Insolvency Act. However, he also went on to hold that a diligence could nevertheless be effective against a floating charge holder even it was not categorised as 'effectually executed diligence'. This was because an inhibition had the effect (as the law then stood) of creating a preference over post-inhibition debts. As such, the judge held that MacMillan was entitled to payment of his debt in priority to the Bank.
The decision was appealed to the Inner House where the court had to consider three key issues:
- Whether Lord Advocate was correctly decided as regards the meaning of 'effectually executed diligence' and whether it applied to inhibitions;
- If Lord Advocate was not correctly decided, whether it was nevertheless appropriate for the court to overrule it; and
- Whether, in a competition between a floating charger holder and an inhibitor, the inhibition creates a preference over post-inhibition debts.
The Lord Advocate decision
As will have been clear from the opening paragraph of this article, the Inner House held that Lord Advocate had been wrongly decided. Giving the words 'effectually executed diligence' their ordinary, legal meaning simply meant that the diligence had to have proceeded upon a proper warrant and been properly executed. This was said by the court to be a 'practical and realistic' interpretation, coinciding with what a Scots lawyer and those working in the field of debt recovery would understand an effectually executed diligence to be. Both arrestments and inhibitions were therefore held to be 'effectually executed diligence' in terms of the Insolvency Act.
Was it appropriate to overrule Lord Advocate?
Having determined that Lord Advocate was wrongly decided, the court then had to decide whether it was nevertheless appropriate to now overrule what was described as 'such a significant authoritative precedent'. In this regard, the court had two considerations. Firstly, the principle that where Parliament re-enacts a statutory provision which has been the subject of judicial interpretation, the court should infer that it intended it to have the same judicially determined meaning (known as 'the Barras principle'). Their second consideration was the settled nature of the law and practice following Lord Advocate.
The first consideration arose for reason that Lord Advocate concerned the interpretation of a provision in an Act from 1972 which eventually became Section 60 of the Insolvency Act. Although the Inner House recognised the Barras principle, it also recognised that it was not one of absolute application in ascertaining the intention of Parliament; it would be a question of circumstances in each case. In this case, the court determined that the legislative history of the Insolvency Act was such that it would not be appropriate to assume that Parliament intended to endorse Lord Advocate when it re-enacted the provision of the 1972 Act.
As regards the second consideration, it was argued for the receiver that Lord Advocate had been applied 'day in and day out' given the large number of receiverships since 1977 and that the consequences of Lord Advocate being wrongly decided would be striking. Every receivership would be deemed to have proceeded on the basis of an error of law and money would have gone to the wrong persons, which could result in a flood of litigation.
However, although the Inner House recognised that there will have been many cases in which the floating charge holder will have prevailed over an inhibiting or arresting creditor, it also doubted the extent to which this type of consideration should be regarded as of importance when a larger court re-examines the reasoning of a smaller bench. The court concluded that 'It would be odd indeed if this court considered that Lord Advocate had been wrongly decided as a matter of law, but declined to overrule it because of subsequent practice'.
Does the inhibition create a preference over post-inhibition debts?
Finally, the court considered that having already determined that an inhibiting creditor falls into the category of a person having 'effectually executed diligence', it followed that any post-inhibition indebtedness was struck at by the inhibition with the effect that the inhibitor was entitled to rank in any distribution as if those debts had not been incurred.
To use the words of the commercial judge, this case has arisen 'in the twilight of the era of receivership'. Indeed, since the effective abolition of the appointment of receivers by the Enterprise Act 2002, the number of receiverships have fallen considerably, with only five receivership appointments in Scotland in 2015-16 and only five appointments as at the end of the third quarter of 2016-17.
As such, the low number of receiverships, coupled with the abolition in 2009 of the preference given to inhibitors in insolvency proceedings, means that the decision in this case is unlikely to be applicable in many situations arising in the future. Nevertheless, this remains a significant decision of a five judge bench of the Inner House, putting to bed years of academic doubt and criticism directed at the decision in Lord Advocate, as well as providing a fresh consideration of the Barras and 'settled practice' principles of statutory interpretation.