Moveable transactions – Scotland v England Round 2 – taking security over chattels

Key Points

• As things stand, Scots law is at a disadvantage when it comes to taking security over chattels.
• The new Scottish statutory pledge will go a long way towards addressing this.
• Could this give Scotland the edge whilst also providing further impetus for reform in England?

Abstract

Scottish moveable transactions law is currently outdated and much less useful in practice than the law in England and Wales. The Moveable Transactions (Scotland) Act 2023 will bring Scots law up to date when it comes into force and will arguably move it ahead of the law south of the border. This article tests whether or not that is the case when taking security over chattels.

Introduction

The Moveable Transactions (Scotland) Act 2023 was recently passed by the Scottish Parliament and is expected to come into force in the second half of 2024. It radically reforms the Scottish law of assignation (assignment) of receivables and other “claims” and introduces a new “statutory pledge” over corporeal (tangible) moveables (broadly, chattels) and intellectual property. A new Register of Assignations and Register of Statutory Pledges are to be introduced, to be maintained by Registers of Scotland and with electronic registration of an assignation or pledge document in the relevant register assigning the claim or creating the statutory pledge. Registration will be an alternative to the existing methods of assigning claims by giving notice of (“intimating”) the assignation and of taking fixed security by taking possession of the “chattel” or transferring the intellectual property - which will continue, with some modernisation.

Details of the Scottish reforms and the potential opportunities arising from them can be found in the previous articles by Hamish Patrick in the February 2018 edition of this Journal (with the then Scottish Law Commissioner, Dr Andrew Steven, (2018) 2 JIBFL 71) and in the June 2022 edition of this Journal ((2022) 6 JIBFL 389). 

This is the second in a series of articles comparing the effects of the 2023 Act with the position under English law. The first article ((2023) 9 JIBFL 603) looked at assigning receivables. This article looks at taking security over chattels.

As things stand, English law is very much in the lead when it comes to taking security over chattels. In 1897, the law in Scotland regarding security over corporeal moveable property was described as being “beset with difficulties” by the writers Gloag and Irvine in their authoritative book published that year. Other than the introduction of floating charges in 1961, not much has changed. Besides the floating charge (and leaving to one side aircraft and ships), the only “true” security that can be taken over corporeal moveable property under Scots law is the ancient security of “pledge”. All of this contrasts unfavourably with the position in England where chattel mortgages, security bills of sale and fixed charges may be used over chattels without the need for delivery of the property to the creditor. In addition, equity does not exist in Scots law - there are no equitable charges or mortgages. However, the cavalry is coming in the form of the new Scottish statutory pledge.

Taking security over chattels

In this context, chattels or, in Scotland, corporeal moveable property encompasses things with a physical (tangible) form that are moveable, such as trading stock, equipment or machinery.  The main forms of security taken over corporeal moveable property in Scotland are:

• Floating charges
• Pledges

When the 2023 Act comes into force, it will also become possible to take statutory pledges over corporeal moveable property.

The main forms of security taken over chattels in England are:

• Charges (fixed and floating)
• Chattel mortgages
• Security bills of sale
• Pledges

Charges

In England, companies and limited liability partnerships (LLPs) have the ability to grant fixed charges over their chattels. Fixed charges attach immediately to the relevant property provided it is capable of being specifically identified. In addition, fixed charges can cover both present and future property and multiple fixed charges can be granted over the same property. Statutory pledges operate in much the same way. A statutory pledge is created over property which is identifiable from the document constituting the statutory pledge when it is registered in the Register of Statutory Pledges (section 48 of the 2023 Act). That constitutive document can be in electronic form. A statutory pledge can catch both present and future property (sections 45 and 48 of the 2023 Act).

In England, the security holder has to have sufficient control of the property subject to the fixed charge. If the security holder does not have sufficient control, the charge will be floating and not fixed Worthington (2023). This is important given the priority that the holder of a fixed charge has, in terms of priority of distributions to creditors on insolvency, over the holder of a floating charge.

The position in Scotland is similar although the mechanism for ensuring that the security holder has sufficient control over the property subject to the statutory pledge is arguably more straightforward. Under section 51 of the 2023 Act, if the security provider transfers property subject to a statutory pledge to a third party, that property remains subject to the statutory pledge unless the prior written consent of the security holder has been obtained. In this regard, the consent must have been granted within 14 days before the transfer and whether to grant or withhold consent must remain at the discretion of the security holder, meaning that the security holder cannot agree in advance to give its consent. The practical consequence of section 51 of the 2023 Act is that, like the English fixed charge, statutory pledges may not generally be used to secure fluctuating categories of assets such as trading stock – it simply wouldn't be practical for the security provider to have to obtain consent to the disposal of each item of stock. However, if a statutory pledge were taken over trading stock, it would remain a fixed security over that stock unless and until extinguished by consent or the acquiescence or good faith provisions mentioned below - raising interesting priority questions when compared with a re-characterised English fixed charge over stock.

A statutory pledge cannot be re-characterised as a floating charge. Instead, if a security holder allows the security provider to deal with the property subject to a statutory pledge (or any part of it) other than by means of granting consent as envisaged above, the statutory pledge will be extinguished (section 52 of the 2023 Act). In this scenario, English law may have the edge, at least in relation to companies and LLPs (and subject to the point above on trading stock). However, in practice, security holders taking statutory pledges from companies or LLPs in Scotland are also likely to take a back-up all assets floating charge which will give the security provider the same level of protection as it would have had if a fixed charge were to be re-characterised as a floating charge.

As mentioned above, property over which a statutory pledge has been granted will transfer subject to that statutory pledge unless the requirements of section 51 are complied with. There are also provisions in the 2023 Act (sections 53 to 55) that protect good faith purchasers and extinguish the statutory pledge.

Floating charges operate in much the same way north and south of the border. In particular, only certain entities can grant floating charges, most importantly companies and LLPs. They can cover all or part of the security provider's assets. In England, they typically cover the security provider's trading stock or fluctuating assets. In Scotland, they are usually granted over all of the security provider's assets and undertaking and, less commonly, over specified assets or categories of assets. As the name suggests, they float or hover above the secured assets until they crystallise.

Chattel Mortgages

In England, a legal mortgage over a chattel involves the transfer of legal title to the chattel to the security holder, subject to the proviso that title will be transferred back to the security provider when the debt is repaid. As with a fixed charge, the property must be identifiable and the security holder would need to be satisfied that the security provider had title to it. In theory, a similar approach could be taken in Scotland, operating as a “functional security” where there is no subordinate real right in the property, but instead ownership is used for security purposes. However, there is a catch. Section 62(4) of the Sale of Goods Act 1979 states that “the provisions of this Act about contracts of sale do not apply to a transaction in the form of a contract of sale which is intended to operate by way of mortgage, pledge, charge, or other security.” What that means is that, if a transaction triggers section 62(4), Scottish common law will apply, with the result that delivery is necessary for ownership to pass. This can lead to goods being delivered to the security holder and immediately re-delivered. It isn't clear whether or not this form of transient delivery works. In any event, the statutory pledge would get round the need for such transactional gymnastics and, as an added bonus, title would remain with the security provider ensuring that the security holder was not exposed to any of the administrative and legal consequences potentially attached to taking ownership of the property. For this reason, the statutory pledge arguably trumps the chattel mortgage.

Security Bills of Sale

In England, it is possible for individuals and unincorporated businesses to grant a non-possessory security over their chattels provided that it complies with the Bills of Sale Acts 1878 to 1891. The requirements laid down in the Bills of Sale Acts are complex and have been the subject of considerable debate, most recently in connection with the Goods Mortgages Bill proposed by the Law Commission (the landing page for this project can be found here) but ultimately shelved by the UK Government in 2018. The requirement for the security provider's property to be listed in the documents effectively prevents individuals from creating security over property they may acquire in the future and from creating a floating charge over their moveable property. The position is also complicated by the fact that, unlike in Scotland, partnerships in England do not have separate legal personality.

In Scotland, it will not be possible for individuals to grant statutory pledges unless:

• the individual is acting in the course of:
  • the individual’s business (meaning that sole traders will be able to grant statutory pledges);
  • the activities of a charity of which the individual is a trustee; or
  • the activities of an unincorporated association (other than a charity) of which the individual is a member; and
• the encumbered property is a “permitted asset”.

An asset is a “permitted asset” if:

• it is (as applicable):
  • used, or to be used, wholly or mainly, for the purposes of the individual’s business;
  • an asset of the charity; or
  • owned by the individual on behalf of, or jointly with the other members of, the association; and
• it has a value exceeding £3,000 at the time the statutory pledge is entered into (arguably preventing statutory pledges over future assets).

The Scottish Government has the ability to vary both the minimum value mentioned above and the types of property that can be permitted assets (section 46 of the 2023 Act). It is also worth flagging here that the good faith safeguards for purchasers of property subject to a statutory pledge mentioned above will apply to statutory pledges granted by sole traders. This is in contrast to the position with bills of sale which give no protection to purchasers who unwittingly buy goods subject to bills of sale.

On the plus side, as Scottish partnerships have separate legal personality, they can grant statutory pledges in their own right.

In relation to sole traders and partnerships, Scotland appears to have the edge.

Pledges

In both England and Scotland, a traditional pledge requires delivery of the property to the secured creditor. Ownership remains with the security provider (unless and until the security is enforced). Physical delivery is problematic for a variety of reasons. Parting with possession of the property means that the security provider cannot use it for their business. A pledge also leaves the lender with responsibility for holding the property for the duration of the loan. In practice, in Scotland, a pledge is typically used over property that is held by an independent third party, for example, whisky stored in a commercial warehouse. In that scenario, there is no physical delivery. Instead, the third party warehouse keeper/custodian is notified of the pledge and instructed to hold the property for the security holder, analogously to English attornment (although in the case of attornment, the custodian is required to acknowledge to the security holder that the property is being held to their order). This is described as “constructive” rather than “actual” (physical) delivery of the pledged property to the security holder. Whilst there is case law from the nineteenth century that casts some doubt on the validity of constructive delivery in Scotland, this is largely ignored in practice. The 2023 Act will remove this uncertainty by making it clear that delivery can be achieved by instructing a third party that has custody of the property to hold it to the order of the security holder (section 44(1) of the 2023 Act). The upshot of this is that the position in England and Scotland regarding possessory pledges is broadly similar. Given its other advantages, the likelihood, in Scotland, is that the statutory pledge will sound the death knell for the possessory pledge, in particular, in the context of taking security over whisky.

Ships and aircraft

It is not possible to create a statutory pledge over:

• an aircraft in respect of which it is competent to register a mortgage in the Register of Aircraft Mortgages kept by the Civil Aviation Authority;
• an aircraft object (as defined in regulation 5 of the International Interests in Aircraft Equipment (Cape Town Convention) Regulations 2015 (S.I. 2015/912)); or
• a ship (or a share in a ship) in respect of which it is competent to register a mortgage in the register of British ships maintained for the United Kingdom under section 8 of the Merchant Shipping Act 1995.

(Section 47 of the 2023 Act)

The point here is that security over these assets is covered by the relevant UK wide security regimes. However, it will be possible for a statutory pledge to be granted over smaller vessels such as yachts that are not registered in the UK Ship Register. Equitable security is possible in England over aircraft, ships and other vessels, retaining English advantages for registrable aircraft and ships, but not other vessels.

Registration Requirements

A charge (including a mortgage) by a company or LLP over a chattel should be registered at Companies House under Part 25 of the Companies Act 2006. Part 25 applies north and south of the border. Failure to register within the 21 day period results in the charge becoming void against a liquidator, administrator or any creditor of the company or LLP. Section 859A(7) of the Companies Act 2006 states that “charge” does not include a “pledge”. The prudent view here is that “pledge” in this context refers to a possessory pledge and does not include a non-possessory pledge such as a statutory pledge and that, as a result, any statutory pledge granted by a company or LLP should be registered in the Register of Statutory Pledges and at Companies House.

Conclusion

Currently, England is very much ahead of Scotland when it comes to taking security over chattels. However, help is at hand from the 2023 Act. As can be seen, the statutory pledge will in most cases put Scotland on an equal footing with the position in England and, in some cases (particularly for sole traders and partnerships), arguably ahead. In particular, the Scottish reforms adopt a straightforward approach to taking security over corporeal moveable property and add certainty to the law in relation to (non-statutory) pledges. They might even provide fresh impetus to bring back the currently shelved Goods Mortgages Bill in England?

This article was first published in the December issue of the Butterworths Journal of International Banking and Financial Law. To learn more, you can also read our previous article, Moveable transactions: Scotland v England: Round 1 – assigning receivables. Andrew Kinnes and Hamish Patrick are Banking and Finance Partners at Shepherd and Wedderburn LLP. Both sat on the Advisory Group to the Scottish Law Commission’s Moveable Transactions Project from which the 2023 Act derives and remain actively involved in implementation of the 2023 Act.

References

Sarah Worthington, Fixed and floating charges: still favouring absolutism over multi-factored nuance (2023) 9 JIBFL 583 for a discussion of this point post Re Avanti Communications Ltd (in admin) [2023] EWHC 940 (Ch).