Section 60(1)(b) of the Insolvency Act 1986 provides that any person who has "effectually executed diligence" over any part of the company's property subject to a floating charge shall be paid in priority to the floating charge holder. The exact meaning of "effectually executed diligence" has been the subject of some controversial case law, especially in relation to arrestments.
The Bankruptcy and Diligence (Scotland) Bill proposes a number of reforms to the law of arrestments which will inform the correct interpretation of section 60(1)(b) going forward.
The position to Date
The case of Lord Advocate v Royal Bank of Scotland in 1977 seemed to provide a straightforward answer to the question of when an arrestment would be regarded as effectually executed diligence. The Court reasoned that there were two stages to arrestment, service of the schedule of arrestment and action of furthcoming. An action of furthcoming required to be raised in cases where the debtor was not prepared to agree to the funds being released to the arresting creditor. The Court reasoned that where an arrestment had been served but not "completed" by an action of furthcoming it could not be regarded as an effectually executed diligence. This decision was helpful for Receivers who would otherwise have had to consider winding the company up within 60 days of the arrestment having been executed in order for it to be cut down under section 185 of the 1986 Act.
The issue was further refined in the case of Iona Hotels in 1991 when the Court was asked to consider a situation in which the floating charge was granted after the arrestment had been served. In that case the Court held that the arrestment prevailed over the floating charge, not because it was effectually executed diligence, but because the arrestment had rendered the property in question litigious and had restricted the debtor's power to grant a security over that asset. To add to the mix, a number of leading academics criticised both decisions, arguing that an arrestment which is served prior to crystallisation of a floating charge should be regarded as effectually executed diligence and that to focus instead on the date of registration of the charge was illogical.
The Proposed Reforms
The Bill proposes a number of reforms to the law on arrestment, including provision for arrested funds to be released automatically 14 weeks after service of the arrestment i.e. without the need to raise an action of furthcoming. The automatic release provisions will only apply where the arrestment is in execution of a decree or document of debt. They will not apply in relation to arrestments on the dependence. Moreover, if the debtor gives notice of objection to the funds being released or if the arrestment is recalled or if the funds become the subject of an action of multiplepoinding, automatic release will not occur.
The implication of this reform is that an arrestment is effectually executed once the schedule of arrestment has been served. The automatic release provisions mean that in many cases no further step need be taken by the creditor to "complete" the diligence. This challenges the rationale of Lord Advocate v Royal Bank of Scotland, which has long been doubted by academics. However, it will not be until another case comes before the court that any pronouncement to the contrary will be made. These reforms may encourage arresting creditors to litigate this issue afresh.
The story doesn't end there. Section 61 of the 1986 Act deals with the Receiver's power to sell property subject to, amongst other things, "effectual diligence executed". The Bill inserts a new section 61(1)(B) which provides:-
"For the purposes of sub-section (1) above, an arrestment is an effectual diligence only where it is executed before the floating charge… attaches to the property…"
With this provision, the Bill makes clear that the key event determining priority between a floating charge and an arrestment should be the date of crystallisation and not the date of registration of the floating charge.
It should, however, be noted that the position in relation to inhibitions is different and we will look at that in the next bulletin.
The proposed reforms make for a persuasive case that arrestments should in future prevail over floating charges where the arrestments have been served pre-crystallisation. However, to obtain an authoritive pronouncement to the contrary would require parties to got to the expense of raising a court action. Receivership has largely been abolished for post-Enterprise Act charges but there remain many floating charges in existence which pre-date the Enterprise Act and there are of course, the various carve-outs set out at sections 72B-72G of 1986 Act. It is therefore entirely possible that the point will arise in the future. Rather than deal with some of these difficult issues before the Courts, where the arrestment has been executed within 60 days, it may be prudent to simply proceed to wind the company up to enable the arrestment to be struck down by section 185.