Security reform: the final piece

The Scottish Law Commission has published its third Discussion Paper on Heritable Securities, exploring issues around non-monetary securities and sub-securities. This article sets out the key points raised and questions asked in the paper, on which comment is invited until 29 September 2023.

Project outline to date

The Commission project on heritable securities, which started in 2018, is the first broad review of the law in this area since the Conveyancing and Feudal Reform (Scotland) Act 1970. The first discussion paper in the project (Scot Law Com DP No 168, 2019) addressed a number of pre-default issues, including the creation and assignation of standard securities. The second discussion paper (Scot Law Com DP No 173, 2021) sought views on default and post-default issues, including the process of exercising a security to enforce payment of the underlying debt. Building on earlier work, the third and final discussion paper focuses on two areas of particular difficulty in the current law, namely securities in respect of non-monetary obligations, and sub-security arrangements.

Overview of the current paper

The latest discussion paper is made up of six substantive chapters. The first four chapters cover non-monetary securities and proposals for a new mechanism to protect obligations to transfer land, and include 15 consultation questions. The latter two chapters focus on sub-security arrangements and include three consultation questions.

Securing non-monetary obligations

The 1970 Act permits standard securities to be taken in respect of obligations ad facta praestanda (non-monetary obligations). However, there is confusion as to how securities of this kind operate, and particularly how they can be exercised to enforce performance of the relevant obligation.

Some commentators suggest that what such a security actually secures is a substitutionary financial obligation, such as payment of damages for non-performance of the non-monetary obligation. This is in keeping with the law in comparator jurisdictions considered by the project, and the paper discusses two options for reform along these lines. Option 1 is that security in respect of non-monetary obligations ceases to be possible under new legislation. Substitutionary financial claims in relation to non-monetary obligations could continue to be secured. Option 2 is that security in respect of non-monetary obligations continues to be possible, but with legislation providing that the security holder is entitled only to damages for non-performance of such an obligation. Consultees are asked which of these options is preferred.

The paper also asks whether any issues will arise in relation to ranking of non-monetary securities if one of these options for reform is adopted.

Protecting obligations to transfer land

Non-monetary securities are often taken to protect obligations to transfer land, such as those contained in an option agreement, against a competing grant by the land owner. In such cases, the purpose of taking security is to give a form of third party effect to the secured obligation by making it visible on the Land Register. This publicity will, in some circumstances, allow for a transfer of land in breach of the obligation to be reduced by the creditor under the so-called rule against offside goals. In this context, the financial remedies normally made available by a standard security are not sufficient to meet the needs of the creditor. Rather, what is sought is protection of title.

The paper asks whether a bespoke mechanism should be introduced to protect the priority of obligations to transfer land, as is possible in English law through use of a restriction and in German law by way of the Vormerkung. The paper suggests this could be most appropriately achieved through a new form of notice – referred to in the paper as a “conditional advance notice” – based on the current advance notice system.

Advance notices are designed to protect the priority of deeds due for imminent delivery in implement of a contractual obligation. In contrast, conditional advance notices would protect the priority of deeds due for delivery typically months or years after an obligation had been agreed, and generally only where conditions agreed between the parties had been fulfilled. As such, the design of conditional advance notices would require various points of difference to the advance notice scheme.

For example, the length of the “protected period” for conditional advance notices would have to be significantly longer than that of advance notices, and voluntary extension of this period may need to be permitted. The paper seeks consultees’ input on this and other essential elements of the proposed new scheme, such as the content of a conditional advance notice, who may apply for such a notice to be entered on the Land Register, and whether it should be possible to transfer the right to the notice to an assignee of the claim protected by the notice.

Another important feature of the new scheme considered in the paper is the effect of a conditional advance notice. During the protected period, an advance notice protects the priority of a deed against both voluntary and involuntary competing deeds. It also protects against inhibitions and insolvency events having a similar effect. So, an advance notice guards against the risk that a competing deed might be granted and also the risk that the granter might become insolvent, at least where the granter is a natural person. The paper seeks consultees’ views on whether a conditional advance notice should provide this kind of dual-pronged protection. It also asks whether a conditional advance notice should protect not only the deed, but performance of the obligation to deliver the deed, against competing voluntary deeds.

The paper notes that a scheme based on the advance notice system is not the only possible mechanism for protecting obligations to transfer land, and briefly outlines three alternative options for reform: modifying standard securities legislation to ensure performance of obligations to transfer land, creating a new form of personal real burden for this purpose, and introducing a “personal charge” which could operate as a future or conditional inhibition. Views are sought on whether any of these mechanisms should be explored further in preference to a conditional advance notice scheme.

Sub-securities

Under the 1970 Act, it is competent to take a standard security over another standard security, commonly referred to as a secondary security, “piggyback” security or sub-security. In practice, such arrangements may be encountered in relation to securitisations and debt warehousing transactions, among other examples. The question of how such securities operate, and particularly how they may be exercised, has never been fully resolved. The paper seeks views on how the law in this area should be clarified.

A key difficulty with taking a secondary security over an existing standard security is that the primary security has no market value independent of the claim it secures. This makes it difficult or impossible for the primary security to be sold or otherwise used to realise funds for the secondary creditor. The paper suggests that allowing for security to be taken over a real right with no independent financial value is conceptually incoherent. It tentatively proposes that the competence of standard securities over standard securities should be discontinued in any new legislation, and asks for the views of consultees on this issue.

The paper then considers whether it should be possible for a standard security to be assigned in security, an arrangement which is not competent under the 1970 Act. The Moveable Transactions (Scotland) Act 2023 places on a statutory footing the general principle that accessory security rights follow the claim to payment which they secure. In other words, where a claim to payment is assigned, the assignee is also entitled to acquire any right in security held in respect of that claim. This principle operates regardless of whether the claim is assigned outright, or assigned for the purposes of security.

The paper emphasises that this principle will apply equally where a claim is secured by a standard security. An assignee of that claim, including an assignee in security, is also entitled to an assignation of the standard security. The paper considers whether such an assignation could appropriately be characterised as an “assignation in security”. It also addresses the question of how such an assignation may operate where the standard security is for all sums due or to become due. Views are sought on whether it should be possible to assign in security a standard security and, if so, what consequences should flow from this.

Next steps

Consultation on the discussion paper runs until 29 September 2023. The Commission eagerly awaits responses to help it improve this complex area of law. The results of consultation on all three discussion papers will be drawn together in a final report and draft bill, anticipated in 2025.