Property: When the debtor defaults

In December 2021 the Scottish Law Commission published its second Discussion Paper on Heritable Securities, exploring default and the exercise of remedies under a standard security. This article sets out the key questions asked in the paper, on which comment is invited until 1 April 2022.

Background

The availability of finance secured on heritable property is essential to the economy, facilitating home ownership and growth in the agricultural and commercial property sectors. Figures from UK Finance show that, in 2020, mortgages allowed approximately 300,000 first-time buyers to purchase a home in the UK. In 2020-21, Registers of Scotland counted 108,139 mortgage transactions registered here alone.

The Scottish Law Commission project

The Commission is conducting a major review of the law in this area, the first since the introduction of the Conveyancing and Feudal Reform (Scotland) Act 1970. The project, which began in 2018, will consult on potential reforms to the law over a series of three discussion papers. The first, published in 2019 (Scot Law Com DP No 168), sought views on pre-default issues, including creation and assignation of standard securities. The current paper (Scot Law Com DP No 173) looks at default and the exercise of a standard security post-default, as set out in more detail below. A third paper, due for publication in early 2023, will deal with two complex, technical issues: sub-security arrangements and security over non-monetary obligations. The results of consultation on all three papers will be drawn together in a final report and draft bill, anticipated in 2025.

Overview of the current paper

DP No 173 is made up of 15 substantive chapters, with 69 consultation questions on default, the procedural aspects of enforcement and the remedies available under a standard security. The overall aim is to streamline the process of exercising a security while maintaining an appropriate balance between the interests of the parties.

Ranking

A preliminary issue is how standard securities should rank where more than one has been granted over the same property. Under s 13 of the 1970 Act, a subsequent security holder is able to restrict the priority of an earlier “all sums” security by giving notice. In practice, parties often seek to avoid this outcome. The paper consults on reform, asking if this rule should be retained, and about the legal effect of writing and registration in relation to ranking agreements.

Default

The definition of “default” within the 1970 Act is complex and has given rise to a series of reported cases, most memorably the decision of the Supreme Court in Royal Bank of Scotland plc v Wilson [2010] UKSC 50. The Commission suggests a more straightforward approach in future legislation. Consultees are asked whether the security holder should be entitled to exercise the security: (i) where there is a failure to perform the secured obligation; or (ii) in other circumstances as agreed between the parties to the security arrangement. The paper also seeks views on whether further instances of default (such as insolvency) should be set out in statute.

Notices

Under the 1970 Act, exercise of a standard security may (or sometimes must) be preceded by service of one of two forms of notice: a calling-up notice or a notice of default. The Commission explores a more streamlined procedure to avoid the questions which arise at present about when these forms are used and how they are served. The paper suggests replacing the current options with a new “default notice”, service of which will be mandatory in every case. Consideration is given to the form and content of the default notice and the methods by which it may be served. The paper also considers the length of time for which an expired default notice should be viewed as providing a valid basis for exercising the security, particularly if the default which led to the notice is later remedied.

Court orders

The circumstances in which a security holder requires a court order to exercise remedies under a standard security are complex, turning on multiple factors such as the nature of default and the notice procedure used. The Commission consults on a simplified regime under which a court order would not be required for the exercise of a security other than in specific situations, including cases where the enhanced debtor protection measures apply, or where ejection of occupants is necessary. It also seeks views on connected matters such as the prescriptive period that should apply to any order obtained.

Enhanced debtor protection measures

When the security subjects are used to any extent for residential purposes, the law places additional requirements on security holders during the enforcement process in order to protect the interests of debtors and certain residents of the property. The regime is complex, with significant amendments made to the 1970 Act by the Home Owner and Debtor Protection (Scotland) Act 2010.

The paper reviews the policy background to these amendments, and suggests that the imposition of the enhanced protection measures in every case where the subjects are used “to any extent for residential purposes” gives the regime a broader scope than was intended by Parliament. Views are sought on a revised approach, in which the measures will generally apply only where the debtor is a natural person and the security subjects are a dwellinghouse. Specific questions are asked about whether and how the measures should apply to buy-to-let properties, and in security arrangements where the debtor and the owner of the security subjects are different persons.

The substance of the enhanced protections can be roughly divided into two key measures: compliance by the security holder with a number of pre-action requirements aimed at resolving default without the need to exercise the security; and the need to obtain a court order, granted only where it is reasonable in all circumstances of the case, before any remedy can be used. The Commission seeks views on whether changes to the content of these measures are required.

Remedies

The following remedies are available under a standard security following default: ejection of the debtor or other occupants; entry into possession of the security subjects; grant and administration of leases of the security subjects, including collection of rents; sale of the security subjects; and foreclosure. Views are sought about whether any changes or additions are required to this selection of remedies, such as the introduction of a form of receivership similar to that available under the Law of Property Act 1925 in England & Wales. The paper also asks about restrictions on the choice between remedies, particularly where more than one security is held in the same property, and considers how the proceeds of any remedy should be applied.

Ejection

A security holder who wishes to sell or let the security subjects will normally require vacant possession. If the occupants do not flit voluntarily, a court decree will be required to dispossess them. The law here is complex, stemming from common law and legislation predating the 1970 Act. The Commission suggests that provision should be made in any new legislation for decree of ejection sought under a standard security. Separately, the paper seeks to clarify the law on eviction of private residential tenants by security holders. It also considers the security holder’s duty of care in relation to moveables left in the property after decree of ejection has been executed.

Possession

Under the current law, a security holder “in lawful possession” of the security subjects may exercise various powers of management and maintenance in relation to the property. However, there is a lack of clarity over what is required for “lawful possession”: is it sufficient for a security holder to change the locks as a prelude to sale, or is a longer-term interest in the property, usually as the landlord of a sitting tenant, required? The Commission seeks views on a simplified approach to possession and explores the security holder’s rights and liabilities once in possession, including in relation to outstanding costs incurred by the owner.

Rents and leases

In some circumstances, a security holder may prefer to generate revenue from the security subjects in the form of rental income rather than the proceeds of sale. The paper asks whether any change is needed to the current rule whereby a lease of up to seven years’ duration can be granted by a security holder before the authorisation of the court is required, and seeks to clarify the extent to which a security holder may claim arrears of rent accrued prior to it taking possession as the landlord of the property.

Sale

The Commission reviews the process of sale by a security holder, asking how the duty under s 25 of the 1970 Act to obtain the best price for the property could be clarified in new legislation. It also considers protection for purchasers obtaining title from a security holder, aiming to update the existing provision for good faith buyers set out in s 41 of the Conveyancing (Scotland) Act 1924.

The paper separately asks whether any reform is required to the seldom-used foreclosure process.

Expenses

The costs incurred in the process of exercising a security can be considerable. The extent to which the security holder can recover these costs from the debtor under the 1970 Act is disputed. The Commission asks whether the debtor’s liability for expenses should be limited to those “reasonably incurred”, and whether litigation costs should be restricted to those awarded by the court or agreed between the parties.

Responding to the consultation

Anyone interested in responding to the discussion paper may wish to register for a Commission webinar, in which members of the project team will go through the key issues in the paper in more detail. Information on the webinars (and links to the discussion papers) can be found at www.scotlawcom.gov.uk. The consultation is open until 1 April 2022.