In Scotland, the law around the ability to raise debt by using moveable property as security is particularly archaic, making it difficult to use such assets as collateral.
In 2017, the Scottish Law Commission proposed a much sought-after reform to the law regarding moveable property in Scotland by proposing the Moveable Transactions (Scotland) Bill.
So, why is this relevant? In Scotland, the law around the ability to raise debt by using moveable property as security, for example, security over cars, plant and machinery (corporeal moveable property) as well as legal claims, intellectual property and shares held in a company (incorporeal moveable property), is particularly archaic, making it difficult to use such assets as collateral and therefore not evolving with modern business needs. With the presence of sectors such as technology and science becoming increasingly prevalent, a borrower’s main asset on offer to a creditor as security will most likely be incorporeal moveable property: raising debt on that basis needs to become more readily accessible.
Given the effect of the current pandemic and the ongoing pressures of Brexit, the Scottish government has announced that its planned Moveable Transactions (Scotland) Bill would not go ahead this parliamentary session. This article will look at why it is important that pressure is maintained on pursing the Bill, by looking at the current problems facing security over incorporeal moveable property – in particular shares held in a Scottish company - and how the Bill seeks to modernise and clarify that law.
There are two main problems with current law:
- Where moveable property is used for security, it must be held outright by the creditor which would mean that the particular asset cannot be used by the borrower and it may impose obligations on the creditor: an unattractive prospect to both parties.
- Incorporeal moveable property is transferred by a process called ‘assignation’ and it is a legal requirement for the person who owes the obligation to be ‘intimated’ of such assignation, which can be a cumbersome exercise.
This significantly impacts the ability of certain businesses to raise finance as most types of financing based on moveable property has undesirable consequences and is subject to uncertainty. Due to differences in interpretation of the law, lenders commonly require floating charges from their borrowers. However, small unincorporated businesses, such as sole traders, cannot grant floating charges and are therefore prejudiced compared to counterparts in other jurisdictions. A more business-friendly solution is therefore desirable.
Turning to taking security over shares in a Scottish company, where the shares in a particular company are valuable, this can be a significant form of security for lenders. This form of security is of a possessory nature, and it is that possessory nature which is the root cause of the issues we explore further below, which will hugely benefit from a reform in legislation.
One of the key characteristics of this type of security is that the shareholder must transfer the shares it holds in a particular Scottish company to the lender as security for the repayment of a debt, in contrast to the position in England, for example, where the lender would hold such shares on an equitable basis – a concept which does not exist in Scotland.
In order to effect the transfer, the register of members of the relevant company would be updated to show the creditor as the registered holder and share certificates issued in its name. If the borrower defaults under the loan agreement, the creditor would then be able to exercise its rights as owner of the shares. Whilst the share pledge documents would be drafted such that the relevant shareholder can exercise their usual rights to vote and take dividends (prior to any enforcement action), the creditor would be listed as the registered holder of the shares. As you would expect, this comes with some undesirable consequences:
- If the share pledge documentation is not suitably drafted, there is a risk that the company whose shares are pledged could be considered a subsidiary of the creditor who has taken the share security; it is unlikely that a creditor would want to be considered its parent company which could have accounting, tax and legal implications.
- The new Person with Significant Control (PSC) regime has not been drafted with the peculiarities of Scottish share pledges in mind and therefore it is not clear whether a creditor who has taken security over Scottish shares should be listed on the PSC register or not, in contrast to the position in England where they do not. If it is listed on the PSC register, this could result in the creditor having various liabilities which are again unwelcome. This particular point is often the subject of a lengthy discussion which could add to the legal costs.
- The issue of liabilities under a defined benefit pension scheme poses another risk to secured creditors. The Box Clever Appeal Court decision reminded us that the registered shareholder of a company that has ‘control’ over that company faces uncertainty that even a carefully worded share pledge would be sufficient to avoid them from being liable for contributions.
For these reasons, some lenders in Scotland have taken the view not to take share security as a matter of course – or at least, not to have the shares transferred to them and run the risk of relying on security which could be void against a liquidator - and are therefore forced to rely on security over other assets.
In order to fix these issues and create certainty around the issue of ownership and control, the solution under the Bill is to create a new electronic Register of Statutory Pledges. This would serve as a proxy for actual delivery of the relevant assets to the creditor; the security would be registered in a new public register and avoid the need to physically transfer the shares to the secured creditor, allowing the relevant shares to remain in the name of the shareholder who would have full control over the relevant shares. The shares would continue to be encumbered if it is transferred without the consent of the secured creditor, differentiating it from a floating charge where the charged assets can be disposed of/ dealt with in the ordinary course of business.
In addition, future assets not currently owned by the pledgor could, under the proposals, be included in the pledge and registered on the register which would alleviate the need for any supplementary pledge which would be required under current law. Another fix. It should be noted, however, that the proposals are to build on the current law: a creditor can still opt for the traditional route if that is their preference.
As mentioned, the Bill will not go ahead this parliamentary session. With the running costs thought to be low and the demand high, pressure needs to be maintained on pursuing the Bill in order to give certainty around the law in this area to better protect both creditors and borrowers, adapt to the requirements of evolving businesses today and ultimately modernise the law by displacing the antiquated nature of Scots law in this area. Meantime, particular attention needs to be paid to the drafting of share pledge documentation in order to mitigate the risks highlighted above.
1 Granada UK Rental & Retail Limited and others v The Pensions Regulator and another  EWCA Civ 1032