LAWS08131 Rights in Security and Cautionary Obligations, Study Guides, Projects, Research of Law

Download LAWS08131 Rights in Security and Cautionary Obligations and more Study Guides, Projects, Research Law in PDF only on Docsity! Rights in Security and Cautionary Obligations 1.1. Introduction to Rights in Security 1.2. Categorisation of Securities 1.3. Characteristics of Personal and Real Securities 1.4. Rationale for Securities 1.5. Cautionary Obligations – General 1.6. Cautionary Obligations – Caution Compared with other Concepts 1.7. Cautionary Obligations – Caution and Improper Caution 1.8. Questions of Liability in Cautionary Obligations 1.9. Rights of the Cautioner 1.10. Termination of Cautionary Obligations 1.11. Bankruptcy Issues 1.12. Rule Against Double Ranking 6. Section Six – Rights in Security and Cautionary Obligations Note – The pre-seen question will likely be on the second part of the course, detailed in the notes below.  These notes relate to various rights of security, including personal and judicial securities as well as cautionary obligations. Then is considered insolvency. All of the content here has coherence and fits together well.  The reading for this part of the course can be found in three textbooks o MacNeil Ch. 8,10 and 11 o Davidson and MacGregor Ch.5 (although content on cautions is more detailed) o Property, Trusts and Succession (but only on asset securities)  Also useful may be o LD Crerar, The law of banking in Scotland (2nd edn, 2007) ch 11 o G L Gretton, “The Concept of Security” in D J Cusine (ed) A Scots Conveyancing Miscellany (1987), pp 126-151 (see the e-reading box on the class website) o W M Gloag & J M Irvine Rights in Security (1897) o D L Carey Miller with D Irvine Corporeal Moveables in Scots Law (2nd ed, 2005) chapter 11 o D J Cusine and R Rennie, Standard Securities (2nd ed, 2002) o AJM Steven, Pledge and Lien (2008) o M Higgins, The enforcement of heritable securities (2010) 6.1 Introduction to Rights in Security  Rights and security arise in the following situation. There is a debtor and a creditor. The debtor owes the creditor money. What happens if the debtor does not pay? There are a number of reasons that the debtor will not pay – perhaps they will not pay or perhaps they cannot pay. o In both the ‘won’t pay’ and ‘can’t pay’ situations the creditor has a problem. They have a right to payment but they cannot obtain the value thereof. How, then does the creditor manage to obtain payment? o There have been described ‘spurs to payment’. These are various steps which are taken to require the debtor to pay and at which stage the debtor might pay:  Ex proprio motu obligation  The request of the creditor  The lawyer’s letter from the individual  The court or the initiation of court action  Decree requiring payment from the debtor – a judicial pronouncement o After a decree has been obtained, the creditor has various options  Diligence, by which various assets of the creditors are seized in order to satisfy the debt which is due. Diligence is individualistic  Insolvency, by which all creditors together share together in the assets of the debtor. The assets are divided and shared based on the debt which is due. Insolvency is communal. o The illusion of limited liability in small companies – banks lending to small limited liability companies will generally require a personal guarantee from that company particularly where a security cannot be granted over hired equipment.  The bank, being conscious of the lack of collateral in the situation, requires a personal guarantee over the assets of the cautioner. This allows the bank in practice to bypass the corporate veil. o In the family context – e.g. where one family member is required to provide a guarantee for the obligation for another o In groups of companies where subsidiaries are set up for particular purposes and to ring fence assets, banks lending to one of the subsidiaries may require caution from other subsidiaries o Certain court actions (e.g. confirmation) require the giving of a bond of caution where the insurance company will be the cautioner o Third party pledge is not a cautionary obligation but is often treated as such. Alf and Bert are cohabitants and co-own a house – Alf runs a business and the business borrows money from a bank which seeks security.  Alf could grant a security for his ½ pro indiviso share of the house. However, the bank will in practice require security from both Alf and Bert.  Thus Bert has not incurred personal liability (and so this is not a cautionary obligation) on an asset. Two very important cases here are Hewitt v Williamson and Smith v Bank of Scotland. Smith confirmed that third party pledge is treated as a cautionary obligation in particular situations. o Quasi-cautionary obligations are those situations where there is an obligation comparable to caution – e.g. being a member of a partnership or an indorser on a bill of exchange. 6.6 Cautionary Obligations – Caution Compared with other Concepts  Sometimes caution is confused with other concepts, note the following: o 1. Guarantees in contracts are not cautionary obligations – e.g. they are not ancillary or parasitic obligations o 2. Representation of credit-worthiness by bank are not undertakings of obligation – they are simply representations from third parties o 3. Letters of comfort is a letter from a bank which confirms the existence of funds in an account to pay a particular balance o 4. Indemnity agreements are not cautionary obligations as the creditor does not have two personal rights 6.7 Cautionary Obligations – Caution and Improper Caution  In proper caution the caution is effected explicitly. It is guaranteed that a sum will be paid provided that a particular condition is fulfilled. Reference is generally made to the principal obligation and the principal obligant.  In improper caution the cautioner is a signatory to the contract and it is unclear ex facie whether or not the cautioner has undertaken to pay or provide caution.  In proper caution, some protections are afforded to the cautioner: o 1. ? o 2. Discussion previously required the creditor to have diligence by the creditor against the principal obligant before enforce the cautionary obligation. This common law rule was removed by the Mercantile Law Amendment (Scotland) Act 1856 (unless expressly contracted into).  The position is now joint and several liability. Each debtor can now generally be sued for the totality of the debt. Externally, joint and several liability allows debtors to recover from other debtors  In cautionary obligations, the principal obligant’s notional liability is 100% and thus the cautioner may sue the principal obligant for up to 100% of the debt if that cautioner is required to pay (their right of relief).  This right of relief means that potentially the cautioner will not receive back what they have paid under the caution. This is particularly so if the principal obligant goes bankrupt. 6.8 Cautionary Obligations – Creation  Are cautionary obligations contracts or promises? This is dependent upon the structure of the cautionary obligation. A cautionary obligation can be structured as a contract, but it is equally possible to structure the obligation as a purely unilateral one (e.g. I will pay x person if x debt of x person is not repaid)  Recall the rules of formal validity under the Requirements of Writing (Scotland) Act 1995 ss.1-2 that gratuitous unilateral obligations must always be in writing where they are made outside the course of business.  Can cautioners escape liability? The general contractual grounds of defence can be pled and thus in particular cases this is possible (where C is creditor, X is a would-be cautioner and D is debtor). o 1. C induces X to enter cautionary obligation.  Possible to escape liability o 2. C misrepresents position to X, but X knows real position.  Not possible to escape liability o 3. X gives cautionary obligation to C without awareness of D’s financial position (thinking D is solvent).  Not possible to escape liability – there is no misrepresentation and the cautioner has been wilfully blind o 4. As 3, but X asks C about D’s position.  If the bank is asked, they may come under a duty to disclose the true position. There is a good discussion on this in the SME on Cautionary Obligations paragraph 895 et seq.  The Greenshields case makes clear that if the creditor is asked about the financial position of D they are required to make full disclosure. o 5. As 3, but C becomes aware that X completely misunderstands D’s position.  See para 898 SME on Cautionary Obligation o 6. D claims finances are fine and X grants caution in favour of C. D is insolvent. X objects to the enforcement of the caution.  In Young v Clydesdale Bank the court took a relatively unsympathetic approach – the misrepresentation was by the principal obligant and not by the creditor with whom the contract was constituted.  However, this position has been successively modified by decisions of Supreme Courts. The first decision here is Barclay’s Bank v O’Brian.  Here Husband (H) and Wife (W) signed a mortgage to secure debts of H’s business. W signed relying on H’s assurances (cost and duration). The mortgage was enforced. W attempted to escape liability.  The court was confronted with English case law which took the same view as Young v Clydesdale. But it took an opposite view.  The court held in this case that the mortgage could be struck down – the creditor had constructive notice that this could be a case where the guarantor could be induced to contract by way of misrepresentation.  The court mentioned other situations where third party inducement could be construed in relation to the bank – e.g. between parent and child and same sex partners.  However, if an individual was advised to take independent advice and proceeded to offer a third party pledge (or guarantee) they would notionally continue to be liable thereupon. Recall – We discussed last time the notion of third party pledge – not strictly a kind of cautionary obligation but relevant in that in third party pledge involves one person guaranteeing the debt of another. Hewatt affirmed that third party pledge was to be treated as a cautionary obligation. Note – Barclay’s Bank v O’Brian is not the law in Scotland. However, they have an impact on the way that Scottish law develops. Do not, in an exam, recount the facts of Barclays Bank or Ettridge as these are not good law in Scotland.  This case led to a change in bank practice. The organisation which deals with lending in relation to lending on land and buildings is the Council of Mortgage Lending.  The CML prepares standards with which a solicitor preparing a standard security must apply. During this litigation, the CML modified guidance to state that where an individual granting a security and the beneficiary of the security were different people, the grantor should be advised to take independent advice.  (Continued from above) In Smith v Bank of Scotland there was a house co-owned by husband and wife. The wife was induced to sign an all sums standard security securing H’s debt due to H’s misrepresentation. This was a security over co-owned property. W did not get independent advice nor was she advised to get independent advice. The Bank was unaware. W sought reduction of the security. o In the Inner House, the position in Young was followed. The case reached the House of Lords. The judgement of Lord Jauncey is particularly odd – he noted the disagreement of the other judges but refused to dissent. o It was held by the court: Note – The Law Society of Scotland provides that a file can be destroyed after a certain number of years, including a letter which advises the client to get independent advice. This letter should not be destroyed. It should be kept. Smith situations arise after the file destruction period. This is much more common than the case law would suggest. 6.9 Questions of Liability in Cautionary Obligations  Who can the creditor sue in the event of default? Liability of the cautioner and principal obligant is in solidum. There is a right of relief owed by the principal obligant to the cautioner. Recall that the principal obligant is liable 100% and the cautioner 0%.  Generally, the cautioner is liable to pay the extent of the principal debt (i.e. the debt owed by the principal obligant). Caution is an accessory obligation. But this can be a complicated issue – what is the nature of the debt guaranteed: o If the sum is fixed – it is capped. o If the sum is fluctuating – it can vary, but will be fixed with notice to the creditor. Upon the serving of notice, Clayton’s Case is introduced. Money going in will pay off the debt, while money going out will not be covered by the cautionary obligation.  It is much more common that, rather than guarantee everything, the cautioner will limit their liability. The limit can legally take one of two forms: o 1. The cautioner will limit the whole debt subject to a cap o 2. The cautioner will pay only part of the debt What does the difference matter? Say there is a security in favour of the creditor for £50,000 and a caution of £50,000, then the creditor has a secured debt of £100,000. However, if the caution is proportional then they may pay less because they may be a lower relevant proportion of the debt. Recall – We examined material on the limitation of liability. It was explained that liability can be limited in one of two ways – either by providing that they will be liabile for the totality of the debt subject to a cap or for a proportion of the debt. Thus if there is a debt of £1000 and the cautioner sets a cap of £500, in the case that the debtor becomes insolvent then the cautioner will pay the balance of the debt due. The cautioner guarantees the totality of the debt less that which the debtor has paid. But if the cautioner only guarantees ½ of the debt, then they may only be liable for up to £500 (in a caution of ½ of £1000).  If a question is clear on whether or not a proportion or full limit is guaranteed, it is necessary only to consider what is actually the case. If the deed is silent (see para. 913 SME). There would seem to be some presumptions, summarised in Veitch v National Bank: o If the debt is fixed, then it appears that the presumption is that the cautioner will be liable for the full amount of the debt up to a cap. o If the debt fluctuates, then the cautioner would seem to be presumed to be liable for a proportion thereof. It is in the interest of creditors for the cautioner to guarantee a fixed amount of the debt and vice versa for cautioners. 6.10 Rights of the Cautioner  What rights are held by the cautioner?  1. A right of relief against the principal obligant. This may be rendered practically worthless in the event of bankruptcy. If the cautioner pays before the principal obligant becomes bankrupt, they are in a stronger position as they may rank in insolvency of the obligant.  2. When the cautioner has paid, the creditor is to receive the benefit of securities (beneficium cedentarum actionum). The cautioner is entitled to: o 1. An assignation of the debt owed to the creditor by the debtor  In certain cases there may be provisions within a contract which make that contract easier to enforce. A registration for execution clause for example allows the carrying out of summary diligence, something which might not be present in a cautioner- debtor relationship. o 2. Any securities held by the creditor over assets of the principal obligant  If the creditors decide to sue the cautioner for the sum, then the cautioner can take benefit of the security. If they have partially paid the creditor, then they are entitled to a partial assignation of the security.  3. Division meant that when there were multiple cautioners, the creditor was entitled only to a portion of the debt allocated pro-rata. Can contract into expressly. No longer automatic post 1856.  4. Discussion required the creditor to enforce debt against principal obligant before they pursued the cautioner. Can contract into expressly. No longer automatic post 1856  5. If the debt has been paid in full, the cautioner has the right to rank in the bankruptcy of the principal obligant 6.11 Termination of Cautionary Obligations  Cautionary obligations can be extinguished: o 1. Grounds of essential validity o 2. Express discharge o 3. The accessory principal – e.g. where the principal obligation is discharged the cautionary obligation will be discharged. There are other particular situations which arise which cause the end of the cautionary obligation. These are farmed as rights held by the cautioner against the creditor. See in particular the following: o 4. It is possible to have the discharge of a cautionary obligation where there is a material alteration in the nature of the underlying contract. If the debtor and creditor reach an agreement which materially alters the nature of the debt between them, the cautionary obligation can be extinguished.  A simple example would be where the debtor and creditor agree that the debt due will increase. In such a situation where further advances are not envisaged the cautionary obligation is ended.  However, where there is a possibility of more money being paid which is envisaged in the original contract, the cautioner cannot plead the invaidity of the caution (see e.g. Bank of Sotland v MacLeod)  One of the difficult situations in practice which arises is where the principal obligation which is guaranteed is an overdraft. The overdraft could, potentially, be fluid in terms of debts and credits.  There is therefore the potential that the cautioner may be in the position where an increase in the overdraft limit may be an alternation which is materially prejudicial. This will be dependent on the wording of i) the overdraft or ii) what the creditor initially agreed to guarantee. o 5. Giving time – this takes place where the creditor agrees that payment can be delayed (but to a particular time) (an effective novation). If the creditor states that they are never going to claim payment from the principal obligant, this will not discharge liability.  However, if the creditor postpones payment for two years, the cautioner will escape liability. The rationale for this would seem to be in the latter position the creditor is not prejudiced. o 6. Giving up security – if the creditor has a right in security over the assets of the principal obligant, then the discharge of this security will release the cautioner from their obligation. o 7. Discharging co-cautioner – if the creditor has a right(s) against another co-cautioner(s) and discharges the co-cautioner(s). 6.12 Bankruptcy Issues  See SME “Cautionary Obligations” para. 913 and 952.  What if the cautioner agrees to pay £200 and the debtor becomes insolvent with debts of £1000 with a dividend of 50p SEE SLIDEs 6.13 Rule Against Double Ranking It is not possible to rank for the same debt twice on the insolvency. If a creditor obtains £500 from insolvency, the cautioner cannot claim in the insolvency(?) This is derived from MacKinnon’s Trs v Bank of Scotland