Key Points:
- Moveable transactions law in Scotland is changing with the introduction of a statutory pledge.
- The new legislation imposes restrictions on individuals and unincorporated organisations pledging their assets.
- Consumers will not be able to grant the new statutory pledge and sole traders, charity trustees and members of clubs and societies will only be able to pledge “permitted assets”.
- These restrictions will present a challenge for lenders when deciding whether to take a statutory pledge from an individual or unincorporated organisation.
Abstract
Soon it will be possible to grant a statutory pledge over Scottish moveable property under the Moveable Transactions (Scotland) Act 2023.
Companies and other incorporated bodies will be able to pledge their assets, but section 46 of the new Act restricts individuals and unincorporated organisations from doing so unless acting as a sole trader, a charity trustee or a member of a club or society.
Introduction
A new type of security interest for moveable property in Scotland, called a “statutory pledge”, is being introduced by the Moveable Transactions (Scotland) Act 2023. The legislation creating the framework for this new security interest received Royal Assent last June and is expected to come into force in the second half of this year.
This article is the third in a series of articles considering the effects of the new Act. The first article looked at assigning receivables, the second article compared the new Scottish statutory pledge with the options for taking security over chattels under English law, and this article considers the restrictions on a statutory pledge being provided by an individual or unincorporated organisation.
The statutory pledge is a major step forward for moveable transactions law in Scotland. Until now, taking fixed security over Scottish moveable property has often been impractical because possession or ownership of the security subjects typically needs to be conferred upon the creditor in order to create a valid security interest.
The new legislation will allow a statutory pledge to be created by registration without any requirement for the pledged asset to be delivered to the security-holder. This new form of non-possessory fixed security should enable greater use of Scottish moveable property as collateral in secured finance transactions.
While aiming to deliver improved access to finance through reform of moveable transactions law, the new Act also seeks to ensure individual consumers are adequately protected from the risks of providing fixed security over their assets.
Who can grant a statutory pledge?
When Part 2 of the Moveable Transactions (Scotland) Act 2023 comes into force, companies, limited liability partnerships (LLPs) and other incorporated legal entities will be able to create statutory pledges. However, section 46 of the Act imposes restrictions on individuals and unincorporated organisations pledging their assets.
Under section 46, an individual can only grant a statutory pledge if they are acting in the course of:
- their business;
- the activities of a charity of which they are a trustee; or
- the activities of an unincorporated association of which they are a member.
This means that a statutory pledge cannot be granted by a natural person who is acting as a consumer, but a sole trader, charity trustee or member of a club or society can provide a statutory pledge.
What assets can be pledged as security by an individual?
The new statutory pledge can be granted over moveable property in Scotland. Moveable property includes both tangible assets (called “corporeal property”) such as goods and also certain intangible assets (called “incorporeal property”) such as intellectual property. Separate specialist regimes apply to the creation of security over corporeal property consisting of an aircraft or ship.
Where the provider of the statutory pledge is an individual, section 46 restricts the type of assets that can be pledged to “permitted assets” only.
To be a permitted asset, the encumbered property must satisfy conditions relating to: (1) its use or ownership; and also, for corporeal property only, (2) its monetary value.
Use/ownership condition
An individual can only create a statutory pledge over an asset if:
- it is used, or to be used, wholly or mainly for the purposes of their business; or
- it is an asset of the charity of which they are a trustee; or
- it is owned by them on behalf of an unincorporated association of which they are a member or owned by them jointly with the other members of that association.
Value condition
Where the encumbered property is corporeal property, it must be worth more than £3,000 when the statutory pledge is granted.
The point in time when the monetary value of an asset must be assessed is “immediately before the document under which it will become encumbered property is granted”. Any valuation report obtained by the secured creditor in respect of encumbered property should therefore be certified as of a date as close as possible to the date when the pledge document is granted (i.e. delivered to the pledgee).
Where the encumbered property comprises a collection of assets, it may be necessary to consider whether every asset individually has a value in excess of £3,000.
The requirement that corporeal property must have a value in excess of £3,000 immediately before the pledge document is granted precludes certain types of future assets from being pledged by sole traders, charity trustees and members of clubs and societies.
Identifying whether an individual is acting in the course of business
A statutory pledge can only be granted by an individual acting in the course of either a business or the activities of a charity or other unincorporated association. In all other circumstances, a statutory pledge by a natural person is void and creates no effective security. It is therefore important to know when an individual is acting in the course of business.
There is no direct authority on the question of when an individual is acting in the course of business for the purposes of the Act. However, it is likely that, firstly, there must be a business carried on by the provider of the pledge and, secondly, a connection must exist between the grant of the statutory pledge and that business.
The fact that the encumbered property is used in a business carried on by the provider is probably not a sufficient connection if the obligations secured by the pledge are unrelated to that business. For example, a sole trader who pledges plant and machinery to secure a loan to cover a child’s university fees is unlikely to be treated as providing a statutory pledge in the course of business.
Demonstrating that a sole trader is acting in the course of business
Unlike the regulatory regimes for consumer credit and mortgage lending, a “business purposes declaration” signed by the provider of a statutory pledge does not create a rebuttable presumption that the individual is acting in the course of business for the purposes of section 46. The Act contains no “safe harbour” provisions deeming particular categories of statutory pledge to be granted in the course of business.
To guard against the risk of a statutory pledge by a sole trader being ineffective, a secured creditor should obtain adequate evidence that the security-provider is acting in the course of business. That evidence may include, for example, an application form signed by the individual disclosing the purpose of any finance to be secured by the pledge or a copy of the individual’s business plan.
Evidence of the security-provider’s business may be required in any enforcement proceedings and should therefore be retained by the secured creditor for the full duration of the statutory pledge.
While a business purposes declaration does not create a rebuttable presumption for the purposes of section 46, any such declaration could be an important piece of evidence in any dispute as to the competence of the individual to grant the pledge.
What is a business?
Except where an individual is acting as a charity trustee or a member of a club or society, section 46 states that a statutory pledge can only be granted by an individual if they are acting in the course of business. To satisfy the requirement for a business, it is likely that the individual must be carrying on activities involving a commercial element and with a degree of continuity.
That raises the question of whether a statutory pledge can be created for a business which does not yet exist, for example, a business intended to be carried on in the future by the provider of the statutory pledge.
There is not yet any direct authority on section 46, but interpreting the words “in the course of” widely to include any business intended to be carried on by the provider of the statutory pledge seems to achieve a more sensible outcome than a narrow interpretation requiring a pre-existing business.
By contrast with section 46, the business purposes exemption under the consumer credit regime provides greater legal certainty by explicitly exempting loans over £25,000 taken out for the purposes of a business carried on, or intended to be carried on, by an individual.
Many trades, professions and crafts carried on by individuals will be readily recognisable as a business, but it may be harder to identify whether activities constitute a business if the individual is acting purely as an investor or managing family assets or the activities are not carried on for profit.
In the course of whose business?
Where an individual grants a statutory pledge in the course of business, section 46 requires that it must be in the course of “the individual’s business”.
Assessing whether a pledge is provided in the course of an individual’s business will often be a straightforward exercise, particularly if a sole trader pledges assets used to carry on their business as security for a loan to finance that business.
The assessment will be less straightforward if a pledge supports a business carried on by someone other than the provider, for example, where:
- a sole trader pledges their business assets to secure a guarantee of another person’s liabilities;
- a statutory pledge is created over partnership assets held in the name of an individual partner to secure the debts of a Scottish firm; or
- a shareholder borrows money to invest in their company’s business and provides a statutory pledge as security for that loan.
What happens if the provider of a statutory pledge dies?
On the death of a sole trader who has granted a statutory pledge, the encumbered property vests in their executor and then devolves according to their Will or the rules of intestate succession. In general, a statutory pledge remains enforceable against any personal representative of the original provider and any successors in title (although good faith acquirers can take encumbered property free of the pledge in certain cases).
The interaction between section 46 and the interpretation provisions in section 113 of the Act is not free from difficulty. The former states that it “… is not competent for an individual to be the provider of a statutory pledge unless…” they are acting in the course of business, as a charity trustee or as a member of a club or society. The latter defines “provider” as including or consisting of “… any successor in title, or representative, of a provider …”.
Read together, one could interpret sections 46 and 113 as saying that it is not competent for an individual to be a successor in title to, or a representative of, the provider of a statutory pledge unless that individual is acting in the course of business, as a charity trustee or as a member of a club or society – in other words, where a sole trader who has provided a statutory pledge dies, their pledged assets cannot vest in another individual unless the latter is acting as a sole trader. That interpretation would produce such an odd outcome that it surely cannot have been the intention of the statutory draftsperson.
A similar challenge arises when interpreting the interaction between sections 66 and 113 as to whether a court order is required after the death of a sole trader to enforce a statutory pledge granted by them. Section 66 requires a court order as a pre-condition for enforcing a pledge if the provider is a sole trader and enforcement is against property used for business purposes. It is unclear whether that requirement applies once the provider has died and the pledged assets have vested in an executor or been transferred to a beneficiary of the deceased’s estate.
Can a high net worth (HNW) individual create a statutory pledge?
As a statutory pledge cannot be granted by an individual unless they are acting in the course of business, the activities of a charity or the activities of another unincorporated association, a HNW individual cannot grant a statutory pledge in their own name to support borrowing purely for investment purposes.
Where assets are held for a HNW individual in the name of a company (e.g. a family office or private investment vehicle), it is competent for that company to create a statutory pledge over those assets.
The underlying policy behind the restrictions in section 46 is to provide adequate protection for consumers against the risks of providing fixed security over essential household items. Arguably that policy aim could be delivered while still allowing HNW individuals to pledge investments held in their own name. Regulatory regimes for financial services often allow HNW individuals to opt out of receiving the benefit of protections and remedies for consumers, for example, there is a HNW exemption under the consumer credit regime. It is unfortunate that the new Act limits the benefits of the statutory pledge to those HNW individuals who choose to set up a corporate vehicle to hold their investments.
Can a trust create a statutory pledge?
If the trustees of a charitable trust are individuals, section 46 permits the trustees to create a statutory pledge in the course of the activities of that charity over any asset of the charity, except that if the asset is corporeal property it must be worth more than £3,000 when the statutory pledge is granted.
There is no equivalent provision in the Act giving general authority for individual trustees of a non-charitable trust, such as a pension scheme, to create a statutory pledge. Where a non-charitable trust carries on a business, it is unclear whether the individual trustees could create a statutory pledge in reliance on the provisions of section 46 which permit sole traders to pledge business assets.
Where a trust (whether or not charitable) is established with a sole corporate trustee, the restrictions in section 46 do not apply. The corporate trustee can create a statutory pledge in the manner permitted by the trust’s constitution.
Can a partnership create a statutory pledge?
A partnership established under Scots law has separate legal personality from its partners. As such, the restrictions under section 46 on individuals creating statutory pledges do not apply where the provider of the pledge is a Scottish partnership.
Where, however, a statutory pledge is created over partnership assets held in the name of a partner who is an individual, that individual is treated as the provider (even if the pledge secures obligations owing by a Scottish partnership) and the restrictions under section 46 will accordingly apply.
Partnerships established in England and Wales do not have separate personality, and so each underlying partner will typically be treated as a provider of a statutory pledge in respect of partnership assets they hold. If those partners are individuals, then the restrictions under section 46 will apply.
Conclusion
The introduction of this new form of non-possessory fixed security is a welcome and much-needed improvement to Scots law and will allow greater use of moveable property as collateral in secured finance transactions in Scotland.
Determining whether a statutory pledge can be taken from an individual or unincorporated organisation is not without its challenges. Lenders will need to develop new processes to successfully navigate the restrictions in section 46, including identifying when an individual is acting in the course of business and retaining documentary evidence of business purposes for any subsequent enforcement proceedings.
This article was first published in the December issue of the Butterworths Journal of International Banking and Financial Law. Peter Alderdice is our Banking and Finance director – contact Peter via email at peter.alderdice@shepwedd.com and visit our Moveable Transactions Reform in Scotland page to learn more.