Protection of purchasers is brought into sharp relief

It is over 10 years since the House of Lords decision in the case of Sharp v Thomson (1997 SC (HL) 44)  threw a judicial cat amongst the pigeons of property and insolvency law in Scotland. The House of Lords, overturning decisions of both the Outer and Inner Houses of the Court of Session, decided that ownership of a property passed unencumbered by, in this case, a crystallised floating charge, even though the disposition of that property (which had been delivered before the floating charge crystallised) had not yet been registered in the Property Register.

18 December 2007

It is over 10 years since the House of Lords decision in the case of Sharp v Thomson (1997 SC (HL) 44)  threw a judicial cat amongst the pigeons of property and insolvency law in Scotland. The House of Lords, overturning decisions of both the Outer and Inner Houses of the Court of Session, decided that ownership of a property passed unencumbered by, in this case, a crystallised floating charge, even though the disposition of that property (which had been delivered before the floating charge crystallised) had not yet been registered in the Property Register.

Crystallisation of the floating charge
Steven and Carole Thomson bought a flat in Whinhill Road in Aberdeen from Albyn Construction Ltd in 1989 and although they paid the price in June that year, for some reason the disposition wasn't delivered until 14 months later on 9 August 1990, which meant that although the Thomsons were in possession, ownership of and title to the flat remained with Albyn. 

On 10 August, Mr Sharp and Mr Souter were appointed as joint receivers to Albyn, by virtue of a floating charge over Albyn's whole "property and undertaking". A floating charge in effect "floats" over the assets of the company without actually encumbering any of them with a real right, until such time as it crystallises or attaches to the assets, by the action of the creditor under the floating charge, when it attaches to whatever property of the company is subject to the charge, at which point it affects such property as though it was a fixed security over the property to which it has attached. The effect of the appointment of the receivers was to crystallise the floating charge at that date.

Had the charge attached?
Was the flat part of the property and undertaking of Albyn at the time the receivers were appointed? The disposition that was delivered to the Thomsons on 9 August was not registered in the Sasine Property Register until 21 August, by which time the floating charge had crystallised. The issue for the courts to determine was therefore whether or not the flat was part of the "property then subject to the charge" on 10 August, when the receivers were appointed.

The lower courts confirmed that the floating charge had attached to the flat, so that although the Thomsons had registered their title and acquired a real right of ownership, their ownership was burdened by the undischarged floating charge.  However, in the final appeal to the House of Lords, these decisions were reversed, and their lordships decided that the floating charge had not attached to the flat, and that the Thomsons owned the flat free of the charge.

What amounts to property subject to the charge?
Although this final decision was obviously good news for the Thomsons, it posed problems for insolvency and property practitioners, the traditional view being that in such situations, where there were competing entitlements to ownership, the winner of the "race to the registers" would be the preferred owner. The practice had arisen amongst property lawyers, of obtaining a trust declaration from a seller, to cover the period from the date of delivery of the disposition, when the price would typically be paid over, until the effective recording or registration of the disposition in the Property Register, when the purchaser obtained a real right of ownership.  Such trust declarations contained in the disposition would, it was hoped, place the property being disponed outside the property interests of the seller and thus defeat any creditors' rights. Some took the view that with the House of Lords decision, this practice was no longer necessary.

However, the basis for the House of Lords decision is at best unclear and it became the subject of much debate and deliberation. It seemed that there could be two interpretations of the outcome – on a broad view it could mean that there is a stage in the transactional process in a sale where the purchaser would acquire an interest in the property, which is some way short of the legal entitlement given by the real right of ownership, but which nonetheless imbues the purchaser with some protection – a form of "beneficial interest" in the property. The implications of this interpretation of the decision would have significant impact on established property law principles, and introduce English property law concepts into the law of Scotland, but there was nothing to indicate at what precise point in the proceedings such an interest would arise.

On the other hand, there could be a much narrower reading of the decision, namely that while the title to the property still remained in the name of the company at the time of crystallisation of the charge, it no longer formed part of its "property and undertaking" in terms of the floating charges legislation, limiting the effect of the decision to floating charges only.

Enter the cavalry in the form of the Scottish Law Commission
Given the doubt and uncertainty generated by this decision, not to mention the potential for destabilisation of Scottish property law, the Scottish Ministers asked the Scottish Law Commission to review the decision, and in its Discussion Paper (Number 114) published in July 2001, the Commission recommended that the approach which had been taken by the House of Lords should be rejected, and replaced by specific legislative protections for purchasers.

Subsequent events have mitigated the difficulties in this decision
Since the publication of its Discussion Paper on the topic, a number of the recommendations made by the Commission have been overtaken by events:

  • The Enterprise Act 2002 provides that floating charges (other than those already in existence at the time, or certain limited exceptions) would no longer be enforceable by receivership. Over time, therefore, receivership is becoming less and less common, with administration becoming the more typical approach.
  • The House of Lords decision in 2004 in the case of Burnett's Trustee v Grainger 2004 SC (HL) 19, which concerned not dissimilar circumstances, but involved a trustee in sequestration, and which, although initially decided in the lower courts in terms of the broader application of Sharp v Thomson, subsequently determined that the narrower application – that Sharp applied to floating charges only – was the correct one. 
  • The protections for purchasers against the sequestration of an individual seller now contained in the Bankruptcy and Diligence etc (Scotland) Act 2007, which provide a purchaser with a safe 28 day period from delivery of the disposition in which to complete title, during which any trustee in sequestration is prevented from completing title, and improved protection for good faith purchasers.

Current recommendations of the Commission
The Report on Sharp v Thomson published by the Commission this month takes account of these events, and while there is now a general view that the threat of subversion of the Scottish legal system has receded, there are nonetheless some sensible and useful changes that can be made to the legal system to provide effective protections for purchasers against the effects of a seller's insolvency, particularly where the seller is a company, by improving transparency in the procedures and giving a purchaser adequate notice of the true position.  The Report includes a draft Attachment of Floating Charges etc (Scotland) Bill which would implement most of the proposals in the Report.

The principal recommendations in the Report are:

Immediate requirement to register a resolution for voluntary winding up
A Scottish company that decides on a voluntary liquidation currently has a period of 15 days to forward of a copy of a resolution for its voluntary winding up to the Registrar of Companies for Scotland and the Accountant in Bankruptcy. So even although the liquidation takes effect from the date of the resolution, that fact is potentially concealed from public record for up to 15 days after the event. The Commission recommends that this time limit should be replaced by an obligation on the company to forward the resolution as soon as it has been passed.  The terminology used is "forthwith" which while it connotes a degree of urgency may not contain sufficient precision for some in the profession.

Immediate requirement to register a petition for winding up
A petition for the winding up of a company by a court in Scotland already required to be notified "forthwith", but this requirement rests with the company, which may have little incentive to do so.  Accordingly the Commission recommends that this duty should rest with the clerk of court, who should notify to the Accountant in Bankruptcy and to the Registrar of Companies for Scotland.

Repeal of liquidators' ability to race pre-emptively to the register
Section 25 of the Titles to Land Consolidation (Scotland) Act 1868 provides for completion of title by company liquidators without any authorisation from the court, giving a liquidator the ability to complete its title to heritable property immediately.  Although not much used in practice, it could provide a liquidator with the same kind of advantage formerly enjoyed by trustees in sequestration, who are now to be handicapped by the 28 day rule contained in the Bankruptcy and Diligence Act. Instead of introducing a similar arrangement for liquidators, the Commission recommends a straightforward repeal of the section.

"No attachment without registration" principle to apply to floating charges
A floating charge may crystallise without any publicity, there being a requirement to register the instrument of appointment under the charge within seven days.  The view of the Commission is that there should be no attachment without registration, and they recommend that Sections 53(6) and 54(5) of the Insolvency Act 1986 should be amended so that, for a floating charge that has been registered in the Register of Floating Charges (to be introduced under the provisions of the Bankruptcy and Diligence Act), the appointment of the receiver (or joint receivers) takes effect at the time that a notice of attachment is registered in the Register of Floating Charges, and that such registration will signify acceptance of office. The "no attachment without registration" principle should apply to attachment by liquidation as well.

Floating Charges to attach upon registration in the Register of Floating Charges
When the proposed Register of Floating Charges is introduced, the time of attachment is to be the time of registration in the Register of Floating Charges, and this should apply to administration under the Enterprise Act 2002 as well, although there should continue to be a requirement to register with the Registrar of Companies.

Floating charges granted by LLPs
The proposals concerning floating charges granted by companies should also be applied to floating charges granted by limited liability partnerships, as well as by European economic interest groupings and by industrial and provident societies

Non UK Companies
The Commission recommends that for the purposes of Scottish internal law, there should be a simple legislative provision that in any case not covered by its other recommendations, a floating charge, being a charge registered in the Register of Floating Charges, should not attach until a notice of attachment has been registered in that register. This would cover floating charges granted by non UK companies, and help to improve transactional security when dealing with those entities.

What happens now?
The draft Bill attached to the Report is mercifully short and deals with the principal issues highlighted in the Report, although some of the issues and recommendations could be implemented, if that is to happen, by secondary legislation. Given that the nature of the recommendations of the Commission synchronise well and interact with the approach taken in the Bankruptcy and Diligence Act, much of which is due to come into force in the near future, it would seem likely that Scottish Ministers may well consider introduction of this Bill, and therefore a filling in of any gaps in current and prospective legislative provisions, as an easy win.  There are as yet no indications of when, or if, the Scottish Parliament will find a slot for introduction and parliamentary scrutiny of this Bill. If or when it is introduced to Parliament, it will follow the usual route of parliamentary analysis and debate.
The Scottish Law Commission Report is available from the website of the SLC at:

Dorothy Boyd
Ann Stewart