The Scottish Parliament is debating the Moveable Transactions (Scotland) Bill which aims to introduce a new type of security interest for moveable property in Scotland, called a “statutory pledge”.
As the draft legislation enters Stage 2 of the parliamentary process this month, one of the key issues in the spotlight is how best to ensure that the proposed reforms deliver improved access to finance for sole traders, while at the same time providing the enhanced protection for individual consumers that the Minister undertook to provide following discussions at Stage 1.
In this article, Peter Alderdice considers potential models for achieving the Scottish Government’s stated policy aim of allowing sole traders to grant the proposed new security, but stopping consumers from doing so.
A “bright line” between sole traders and consumers?
In implementing their policy, the Scottish Government faces the challenge of coming up with a legal test that distinguishes between sole traders and consumers. That is easier said than done, because the same person can be both a sole trader and a consumer.
By way of illustration, an individual taking out credit to purchase power tools for their joinery business would ordinarily be regarded as transacting for business purposes, but if they buy a lawnmower on credit from the same hardware store for their home garden that would be treated as a consumer transaction.
Sometimes a security arrangement will clearly be a business transaction, but other times determining the nature of the arrangement can be more nuanced. For example, a person who provides a guarantee to cover their spouse’s business debts is typically considered to be acting as a consumer, even though the obligations being guaranteed are business debts.
The legal test in the Bill to distinguish between sole traders and consumers in the context of a security arrangement needs to be unambiguous – a bright-line rule – providing a high degree of legal certainty.
Any doubt as to when individuals are eligible to grant a statutory pledge creates legal risk for lenders and could reduce their willingness to accept the new security from sole traders – or potentially lead to unnecessary costs and delays in verifying eligibility.
Model 1: purpose of the pledge
One model that the legislation could adopt to determine whether an individual is eligible to grant a statutory pledge is to consider the purpose for which that individual is entering into the security arrangement.
Under this model, a security-provider would be eligible to grant a statutory pledge if, in entering into the security arrangement, they are acting wholly or predominantly for the purposes of a business carried on by them.
A similar test is already found in the consumer credit regime. Under that regime, credit agreements above a monetary threshold (£25,000) that are entered into for business purposes are exempt from regulation.
In order to enhance legal certainty when relying on the business purposes exemption under the consumer credit regime, there is a standard form of declaration that lenders can ask borrowers to sign. If signed, such a declaration creates a rebuttable evidential presumption that the credit agreement is entered into for business purposes. In any enforcement action, a court will therefore treat the credit agreement as exempt from regulation, unless contrary evidence is presented.
To avoid an unscrupulous lender requesting a business purposes declaration for a consumer loan, a lender cannot rely on a business purposes declaration under the consumer credit regime if the lender knows or ought to know that the borrower is not entering into the credit agreement for business purposes.
A business purposes test with a self-declaration could be adopted as a model for determining eligibility to grant a statutory pledge. Such a model would ensure that a statutory pledge could only be granted by a sole trader when acting as such. Although one potential criticism of this model is that it might not prevent a sole trader from pledging essential household items as security for business loans.
Model 2: type of encumbered property
A second model that could be used by the Bill to determine eligibility for granting a statutory pledge, is to consider the type of property being encumbered by the security.
Under this model, an individual could only competently grant a statutory pledge over certain categories of asset. There are various methods by which those categories could be identified in the Bill, for example, by way of:
- a generic description of permissible (or proscribed) assets, e.g. any property used (or not used) wholly or predominantly for business purposes;
- a list of specific assets that may be pledged (a ‘white’ list) or not be pledged (a ‘black’ list); or
- a minimum monetary value of property below which an asset may not be pledged.
Each of those methods of categorisation has its own advantages and disadvantages. For instance, trying to apply a generic description of permissible or proscribed assets in a real-world scenario is fraught with uncertainty. Conversely, creating detailed lists of essential household items may lead to the law quickly becoming out of date.
Depending on the method of categorisation, a self-declaration by the security-provider as to the type of property being encumbered could be a helpful way to enhance legal certainty.
The Bill as introduced contained such a value limit and provision for that to be modified, along with provision for types of property to be specified as unpledgeable and a prohibition on pledges by consumers of most future assets.
Model 3: nature of the secured obligations
A third model that the parliamentary drafters might consider is to focus on the nature of the obligations secured by the statutory pledge.
Under this model, the Bill could provide that a statutory pledge cannot secure liabilities in respect of lending to consumers.
The concept of consumer lending could be defined by reference to existing regulatory classifications under financial services legislation, for example:
- regulated mortgage contracts;
- other regulated home finance arrangements (e.g. home reversion plans, home purchase plans, and sale and rent back agreements);
- consumer buy-to-let mortgage contracts;
- regulated credit agreements; and
- regulated consumer hire agreements.
Liabilities arising under guarantees and indemnities in respect of any of those contracts or agreements could also be excluded.
Admittedly, this model does not focus directly on the essential household items which government policy seeks to protect. Though, the policy also appears to be driven by concerns that the statutory pledge proposals might have the unintended consequence of creating a new form of high-cost credit in Scotland. Banning the use of the statutory pledge as security for consumer lending would arguably achieve that policy goal. It would also have the benefit of being a relatively simple rule.
While this model would not prevent a person pledging essential household items as security for a business loan, typically an individual could only do so under the existing regimes either for their own business loan or after receiving independent legal advice.
Model 4: a combination
A further alternative would be to combine elements from one or more of the three models described above, such that:
- a person could only grant a statutory pledge if they are acting for business purposes;
- certain essential household items could not be encumbered by a statutory pledge; and/or
- liabilities for consumer lending could not be secured by a statutory pledge.
Combining multiple elements might achieve the very highest level of consumer protection, but potentially at the cost of increased complexity.
Whatever legal test is adopted to distinguish between sole traders and consumers, it should strike an appropriate balance between good consumer protection, on the one hand, and good access to finance for sole traders, on the other.
Not a consumer or a sole trader?
Finally, those drafting the Stage 2 amendments to the Bill will need to pay due regard to individuals who are neither consumers nor sole traders, e.g.
- High net worth individuals are typically not treated as consumers in the context of lending and security because they are better able to protect their own interests. Arguably the Bill should allow such individuals to pledge assets held in their own name, rather than restricting the benefits of the statutory pledge to high net worth individuals who choose to set up a corporate vehicle to hold their assets.
- Unincorporated associations and trusts may be operated by individuals acting in a professional capacity, but they will often not be carrying on a “business” in the narrow sense of the word, particularly if the organisation is a not-for-profit or charity. It would however seem odd to treat such professionals as consumers in the context of a policy aimed at protecting essential household items.
- Partnerships established in Scotland have separate legal personality, but those formed in other parts of the United Kingdom (and in various overseas jurisdictions) do not. One would expect partners of firms established outside Scotland who transact partnership business in Scotland in their own individual names to enjoy at least the same benefits under the Bill as sole traders will.
Shepherd and Wedderburn has been heavily involved in moveable transactions law reform in Scotland for many years. For more information on the Moveable Transactions (Scotland) Bill, please contact Peter Alderdice or visit our webpage here.