Cautionary Obligations

Question 1

What is a cautionary obligation?

Answer 1

“Cautionry is an accessory (parasitic - it’s existence depends on there being another debt) obligation (voluntarily undertaken either a contract or a promise) or engagement as surety for another, that the principal obligant shall pay the debt or perform the act for which he has engaged, otherwise the cautioner shall pay the debt or fulfil the obligation.” Gloag and Irvine.

Caution (noun); cautionry (noun); cautionary (adjective). A owes money to B, and C guarantees to B that debt will be paid. C is cautioner (guarantor). English term: “surety/ship.” A is principal obligant (debtor). B is the creditor.

NB most documents do not use the Scottish terminology. In English jargon it is called guarantee or surety. The person who gives the guarantee in Scotland (cautioner) in England is called the guarantor.

[[NB English terminology is often used in Scotland. In England a cautionary obligation is called a surety / guarantee. The person who grants the guarantee is called the guarantor in England.]]

Question 2

Who is included in a cautionary obligation?

Answer 2

Cautionary obligations are a three party relationship
⁃ 1) Creditor
⁃ 2) Debtor (principal obligant[ The courts tend to use the term principal obligant rather than debtor because, from the purpose of the creditor, both the principal obligant and the cautioner are both debtors.] (PO))
⁃ 3) Cautioner

So we have

(1) the principal obligant (the original debtor)
(2) cautioner (person who gives the guarantee (they owe the second obligation to —)
(3) creditor (has two personal rights)

Question 3

What are the key elements of a cautionary obligation?

Answer 3

The key elements:
⁃ Accessory obligation
⁃ Three party relationship (principal obligant[ Principal obligant shall pay the debt to the creditor.], cautioner[ If the principal obligation doesn’t pay the debt then the cautioner will pay the debt.], creditor[ The person owed the debt.])

Question 4

What personal rights does the creditor have?

Answer 4

The creditor has two personal rights:
They hold a personal right against the PO and an accessory right against the cautioner.
⁃ In the event that the debtor defaults, then the creditor will have a second right against the cautioner. In certain circumstances the cautioner signs up to something which effectively means that they are equally liable with the principal obligant from the perspective of the creditor.
⁃ The cautioner will typically have granted a unilateral obligation saying that they will agree to make a payment to the creditor in the event of default by the PO.
⁃ If the cautionary obligation is constitute as a unilateral obligation then under the RWSA 1995 it will have to be in writing.
⁃ However if the cautioner is getting something for the grant of the obligation or they are granting it in the course of a business then it does not need to be in writing (again see RWSA).

Question 5

What happens if the principle obligant doesn’t pay?

Answer 5

⁃ If the PO doesn’t pay and the cautioner does pay, the cautioner has a right of relief against the PO (a right to sue the PO for the sum that they’ve paid.
⁃ If there are two or more cautioners and one ends up paying the whole amount then the one who paid has a right of relief agains the other cautioners on the basis of joint and several liability.

Question 6

What are some examples of cautionary obligations in practice?

Answer 6

⁃ 1. In some (small) limited liability companies the creditors will use cautionary obligations from directors of the company that if the company doesn’t pay the debts due, the directors will pay the debts due. The shareholders in these companies are usually the director. But as a bank lending to a small limited liability company you would look at their assets since a lot of business operate without actually owning assets, i.e. by leasing equipment. (If they hire it and go bust it means the bank can’t take their equipment). So this is a lack of available collateral to insure the business, they will ask for a guarantee over the directors assets e.g. private dwelling house, the bank thus goes behind the veil but trying to get directors and shareholders by requiring them to grant cautionary obligations.
⁃ 2. Family (e.g. where one person in a family is wanting to borrow money the creditor may want someone to grant a cautionary obligation from another member of the family.)
⁃ 3. Groups of companies (where companies create subsidiaries to ring fence liability. Creditors are aware of this and will often ask the parent company to grant a cautionary obligation to support loans taken by the subsidiaries.) The subsidiaries are often set up to make the most of limited liability by “ring fencing” the assets to ensure there is a limited pool available to the creditors. The bank might then request for a guarantee over the companies in the group (which may be worth more money)
⁃ 4. Insurance companies in relation to executries (if you don’t have a will and you want to appoint an executor-dative, they can only be appointed if they give caution to the court. This involves getting the insurance company to underwrite the risk that there is going to be somebody who comes along who is between entitled to be the executor and can administer the estate).
- Where it is an intestate succession, the court requires you to provide a bondifcation, an underwriting of the executry, this tends to get provided by insurance companies who assume the risk. It is structured as a cautionary obligation to underwrite the process.

Question 7

What is a third party pledge?

Answer 7

⁃ This is a bit like a cautionary obligation but isn’t quite is where you have a “third party pledge”. This is where the creditor is granted a security over an asset belonging to a third party.
- This can occur where a husband and wife own a house in common. The husband owns a small business and borrows money for it. The bank ask for a security over his house. But since the house is owned by both the husband and wife, the bank require both the husband and wife to grant a standard security over their half share. The wife is effectively granting a real right over an asset which is owned by somebody else. The wife/cohabitant must sign up as well. The wife does not incur any personal liability. It is not a cautionary obligation in the strict sense as the bank has no personal right agains the wife, but her share in the house is potentially at risk. She has granted a security for a debt that is not hers, against a third party.
⁃ This is not a cautionary obligation in the strict sense because the wife is not personally liable in the event that the husband doesn’t pay - what the creditors can do is sell her share of the property. The court’s refer to this as a third party pledge. Although it isn’t a cautionary obligation, the courts have held that the general rules of cautionary obligations do apply[ However it hasn’t been that the totality of rules apply - merely the rules which apply where cautioners attempt to escape liability. (see point below)].
⁃ The general rules which apply are those which involve the cautioner attempting to escape liability.

The key cases are:

Hewitt v Williamson, and Smith v BoS 1997 (confirms that third party pledge is treated as a cautionary obligation in certain situations)

Question 8

Hewitt v Williamson

Answer 8

??

Question 9

Smith v BoS 1997

Answer 9

Mrs Smith granted a standard security over her 1/2 share of her house and so did Mr Smith. It was Mr Smith’s business that was liable. Wife induced to sign standard security securing Husband’s debt due to H’s misrepresentation. Security over co-owned property. W did not get independent advice. Bank unaware. W seeks reduction of security. [ Not lectured on here]

Question 10

What is a quasi-caution?

Answer 10

1. Every partner is liable for the firm (Partnership Act 1890)
2. If you sign the bill, you become liable on it. So every endorser of the Bill of Exchange, by signing it, is guaranteeing payment. This is quasi-cautioner.

Question 11

What is improper caution?

Answer 11

Improper caution occurs where by looking at the document you can’t tell if it is a cautionary obligation or not. It looks like a normal contract. The cautioner and principal obligant purport to bind themselves as joint borrowers.

Question 12

What is proper caution?

Answer 12

Proper caution: where a caution is done “properly”, where true situation is stated in the document so that the cautioner is expressly stating that they are a cautioner and will pay in the event of default by the PO. It is framed as a security. “I am guaranteeing to pay X sum where A is unable to pay”.

Question 13

Can the cautioner act gratuitously or onerously?

Answer 13

Either

Question 14

What is the difference between proper/improper caution?

Answer 14

In proper caution you are entitled to discussion and division (protections)

Question 15

What is division?

Answer 15

??

Question 16

What is discussion?

Answer 16

⁃ Discussion was a form of protection that the cautioner got. It was a protection whereby the cautioner would only become obliged to make payment in the event that the creditor had taken all necessary steps in order to enforce the debt. (All necessary steps included going to court and doing diligence - only after diligence if the debt still wasn’t paid then the cautioner could be sued). This rule was abolished as a default rule in 1856 however it is open to the parties to contract into. [In practice, creditors do not want the cautioner to contract into it so it only happens very rarely.]

⁃ This means that in effect in both improper and proper caution where discussion has not been contract into joint and several liability operates (the creditor can thus choose who to sue.) The creditor should choose to sue the PO first but they don’t need to do anything beyond this; if the PO is insolvent then they can immediately raise an action against the cautioner. Although either the PO or cautioner can be sued the pro liability is that the PO is 100% liable and the cautioner 0% liable so the cautioner can sue the PO for the full payment (the right to relief which has been mentioned above).

Question 17

How does joint and severally liability work?

Answer 17

In joint and several liability, each debtor can potentially be sued for the totality of the debt. Each debtor can be sued for the total. So from the perspective of a third party who wants to sue, they have lots of choice (e.g to choose the party with the most money).

• However it also has an internal aspect, which is that those parties have agreed between themselves that one person will be liable up to a certain percentage and someone else will not be liable to a lower extent.
• e.g. Mortgage 50%/50% liability where no express term to the contrary.

Question 18

How does joint and several liability apply in cautionry obligations?

Answer 18

• In cautionary obligations, the joint and several liability of the principal 100%, the cautioners liability is 0%. So if the cautioner is sued, they are entitled to acquire all of the money sued from the principal obligant. From the perspective of the creditor, they do not care (can sue cautioner even where they are 0% liable). But in terms of joint and several liability they are equally liable to the extent.
• See MacNeil, para 8.14-8.23
• The cautioner has the “right of relief” — repayment of the sum that the cautioner has ultimately paid.
• If the principal obligant goes solvent however the cautioner may have a right of relief worth nothing.

Question 19

How does caution differ from guarantees?

Answer 19

“Guarantee” also means express contractual warranty eg of quality of goods.
⁃ This is not a cautionary obligation because it is not accessory - it is an undertaking made by one party to contract to another party
- It tends to be an express term agreed by the parties (not a parasitic obligation)

Question 20

How does caution differ from representations of creditworthiness?

Answer 20

e.g. bank reference. If negligent may give rise to liability in delict (but not on the basis of cautionary obligation). (Cf Hedley Byrne & Co v Heller [1964] AC465.) The letter will usually be nondescript and not commit to the future (“person has money in account and has an income” — merely a representation of a current factual situation). This is not a cautionary obligation, just a representation from a third party which is persuading the second party to enter into a contract with A,

Question 21

How does caution differ from comfort letters?

Answer 21

Where a bank writes a letter stating that the debtor usually pays - the bank is not undertaking that they are going to pay in the event of default by the debtor.

Kleinwort Benson v Malaysian Mining Corp [1989] 1 All ER 785. This is another representation to a factual situation.

Question 22

How does caution differ from Indemnity?

Answer 22

This is typically an undertaking by one contracting party to another contracting party that they will make payment in the event that they suffer loss. It states that a certain sum will be payable in the event of a breach. This doesn’t mean that they directly owe the third party the money - it is the equivalent of having the agreement between the PO and the cautioner. A provision to make a payment in a certain situation.

Question 23

What is a quasi-caution?

Answer 23

1) Endorsers of negotiable instruments
⁃ If you are a signatory on a bill of exchange then your signature incurs your liability. This means that you are effectively guaranteeing the debt to the ultimate holder. Thus you are acting as a quasi-caution - the holder can sue you in the event that the drawee doesn’t pay.

2) Partners for their firm[ NB if you are talking about the entity you are talking about the “firm”. The “partnership” is the agreement between the partners.]
⁃ By becoming a partner of the firm you are guaranteeing the debts of the firm. So you are guaranteeing that in the event that the firm does not pay, you as a partner can be sued.

Question 24

Is a cautionary obligation a contract of a promise?

Answer 24

There are two types of voluntary obligation in Scots Law: Promise, and contract. The question is, is a cautionary obligation a contract or a promise? The answer is that it depends on how it is structures. Because it depends it means that the is it important is a particular issue when it comes to formal validity. You can structure a cautionary obligation as a contract (between cautioner and principal obligant). It is equally possible to structure it purely as a promise (unilateral) where it looks like the cautioner is simply saying “I will pay X where Y happens”.

Question 25

Do cautionary obligations have to be signed?

Answer 25

The Requirements of Writing (Scotland) Act 1995, ss 1 and 2 applies. So no need to be signed where it is a contract. If it is a promise it does need to be signed, unless it is made in the course of a business. In practice they are always signed (unlikely to rely upon an oral undertaking).

Question 26

What are the rules of essential validity which apply to cautionary obligations?

Answer 26

The usual rules of essential validity for constitution of voluntary obligations apply. Remember the key relationship is between the debtor and the cautioner. Voluntary obligations can be struck down where there is (1) error (2) force/fear (3) misrepresentation.

Question 27

Can cautioners escape liability on the ground of misrepresentation/fraud/undue influence by the principal obligant?

Answer 27

The starting point

There is copious case law. To understand it the following terms are necessary: ⁃	C = creditor ⁃	D = debtor ⁃	X = cautioner

See 5 scenarios below

Question 28

C induces X to enter cautionary obligation as a result of C’s misrepresentation

Answer 28

The security can be struck down (voidable). Since the cautioner has been induced by an operative misrepresentation and would not have entered into it but for that assurance. This is a typical application of the general law of misrepresentation; since X has only entered into the agreement due to the misrepresentation by C the security is voidable.

Question 29

C misrepresents position to X, but X knows the real position and X enters cautionary obligation

Answer 29

Since X has not been induced to enter the obligation (since they are aware of the real facts) the security cannot be struck down.

Question 30

Royal Bank v Greenshields 1914

Answer 30

Two parties entered into cautionary obligations with the creditor. One knew that the representation from the creditor was wrong but the other party didn’t. So for one the security was struck down (an application of scenario 1), for the other the cautionary obligation was not struck down (an application of scenario 2)
- Makes clear that if a creditor is asked they are under a duty to make full disclosure. This case also touches on situation (5).

Question 31

X gives cautionary obligation to C without awareness of D’s financial position (thinking D is solvent) (most common situation).

Answer 31

⁃ If X is uncurious and asks no questions as to D’s financial position then the cautionary obligation cannot be struck down since the C has no obligation to reveal to D the true financial position unless X asks questions (see 4 below)
- The cautioner cannot escape liability because there has been no misrepresentation, the cautioner has not investigated, merely made assumptions.

Question 32

X gives cautionary obligation to C without awareness of D’s financial position (thinking D is solvent) (most common situation) but X asks C about D’s position

Answer 32

⁃ If X asks then C must answer frankly and honestly. If C lies or only reveals part of the information this is a misrepresentation and thus the security can be struck down.

• The banks silence is potentially problematic (the way the bank operates). If the bank is asked they might come under a duty to disclose the true position. Silence ordinarily does not matter in this context. It might mean the bank has a duty to explain the situation further.
• Good discussion in SME Cautionary Obligations para 895 onwards.

Question 33

X gives cautionary obligation to C without awareness of D’s financial position (thinking D is solvent) (most common situation) but C becomes aware that X completely misunderstands D’s position.

Answer 33

⁃ In this scenario C is under a duty to put them right and explain the true situation. If they do not then the obligation can be struck down.
- See para 898 SME Encyclopaedia

Question 34

D claims finances are fine and X grants caution in favour of C. D is insolvent — Can cautioners escape liability?

Answer 34

⁃ Nothing to do with the creditor itself.

• Typically where D misrepresents to X, the courts held that since D was not a party to the cautionary obligation (it was between C and X) the creditor couldn’t be held liable for D’s lies and thus the security could not be struck down (Young v Clydesdale Bank (1889)).
• X has the duty to satisfy him or herself as to D’s financial position.
• SO in this situation the person incurring the debt (d) will say everything is fine to their cohabitant/partner. The security will be made and registered, then bank will enforce security as business failed to pay the rent. At this stage the partner/cohabitant will say “I wouldn’t have signed that if I had known…”. The default position in Scotland is in Young v Clydesdale Bank (1889). In this situation, the court basically said to the cautioner: “tough”. “The obligation you have is an obligation with the creditor, the creditor did not make you sign it or make any misrepresentation, it was the principal obligant, who is not a party to the contract.

Question 35

How did things change in England?

Answer 35

This was the law in Scotland and England until the 1980s. Then a series of cases went through the courts, culminating in the ENGLISH case of Barclay’s Bank v O’Brien [1994] [the English changes were rejected by the Scottish courts.]:

Question 36

Barclay’s Bank v O’Brien [1994]

Answer 36

⁃ There was a third party pledge situation (see above). A husband and wife signed mortgage documentation to secure debts owed by the husband for the husband’s business. The husband told his wife that everything was going to be okay and that it would only be temporary (assurances). However the husband’s business was ‘screwed’ and it was for a much longer period than anticipated and therefore the bank started to enforce the mortgage. The wife’s defence to the sale of the property was that her husband had induced her to sign this and the bank should have known that the husband was misrepresenting her into signing and thus the bank should be held responsible.
- The husband confirmed under oath that they made a misrepresentation.
- The court held that the bank was liable and that the security could be struck down and it was unenforceable on the basis that 1) the bank has constructive notice (e.g. That this is the potential situation where a principal obligant might dupe the other into signing) that potentially there may be an issue of undue influence in the relationship and 2) there was no financial advantage to the wife. In England the court’s expanded the notion of constructive notice to cohabiting parties, civil partnership, parent and child etc.
⁃ One aspect of these cases is that the husband has an interest in saying that he misrepresented his wife (whereas in most cases of misrepresentation you would deny it) because it meant that the security could be struck down and thus he could keep the house.
- So the court said there are certain relationships where parties may have pressure on the other to sign. The bank then bears responsibility where this undue misrepresentation is made and you lose your right to enforce the mortgage. If however, you said to spouse, go and get independent advice, you have ensured you are trying to get them to consider this outwith the pressure of the familiar relationship.

Question 37

The question which then arose - how would this case affect the law in Scotland?

Answer 37

Husband and Wife sign mortgage to secure debts of H’s business. W signed relying on H’s assurances (cost and duration). Mortgage enforced. W tries to escape liability. What was decided?

Question 38

**Smith v BoS 1997

Answer 38

Wife induced to sign standard security securing Husband’s debt due to H’s misrepresentation. Security over co-owned property. W did not get independent advice. Bank unaware. W seeks reduction of security. What was decided?]
⁃ Two separate actions. Smith and Mumford
⁃ 1) In Smith the agreement was that the property was coowned by husband and wife and the husband duped the wife into signing the standard security agreement
⁃ 2) In Mumford, if you are a spouse who is not the owner of property you have occupancy rights in the property. Those occupancy rights are protected provided you don’t agree to waive them. (So if there is a security granted over the house by the husband, if the wife doesn’t agree then the bank couldn’t sell the property without any purchaser buying subject to the wife’s occupancy rights). In Mumford, rather than getting the wife to sign the standard security itself the husband got her to sign the matrimonial homes consent form saying that she agreed to waive her occupancy rights in relation to the standard security.
⁃ Held: the effect in both cases is that the wife, by signing, is effectively agreeing to the sale of the property and her eviction from the property in the event that the husband defaults on the debts he owes to the bank. So while she is not personally liable for the debts it was an instance of third party pledge under which the wife has agreed that the asset she is living in can be sold for the payment of someone else’s debts.
⁃ Ultimately it was this case which went to the HL. The HL established that the husband had misrepresented the position to the wife (the principal obligant had misrepresented the position to the cautioner.) The cautioner is attempting to escape liability on the basis of the PO’s misrepresentation. The bank was not a party to this misrepresentation and did not know about it. In Smith and Mumford, the documentation had been sent to the wife to sign (whereas in the Barclay’s Bank case the wife was invited into the bank to sign the documentation).
⁃ The principle speech given in the decision is that of Lord Clyde. He gave a number of interesting comments. He stated that he wished to reach the result that was reached in Barclay’s Bank (that the security can be struck down) but is going to reach it for different reasons (to fit in with Scots law).
⁃ He stressed the general principles of Scots law that:
⁃ 1) cautioners generally have to look after themselves
⁃ 2) however the general rule is subject to the duty of good faith, whereby if a creditor was in bad faith then the caution could be challenged.
⁃ But Lord Clyde’s reasoning is strange - he doesn’t rely on any contractual cases at all - only property law ‘offside goals’ cases. And in these cases there isn’t a duty of good faith, bad faith is simply punished. So Lord Clyde takes these cases from a different area and tries to establish a general principle of good faith (a bit of sleight of hand). And since there is a general law of good faith, we don’t therefore need to follow the argument about constructive notice as in England (the basis of the decision in Barclay’s Bank). Lord Clyde suggests that if the cautioner gets independent advice and still signs the cautionary obligation then it is hard to say that the creditor is not in good faith in these circumstances. [“The creditor is in good faith unless the circumstances are such as to lead a reasonable man to believe that owing to the personal relationship between the debtor and the proposed cautioner, the latter’s consent may not be fully informed or freely given.”] The reference in this quote to “personal relationships” echoes the Barclay’s Bank decision and has been interpreted as referring to relationships of marriage, civil partnership, cohabitation or of elderly parent and child.
⁃ Lord Clyde also stated “All that is required of [the creditor] is that he should take reasonable steps to secure that in relation to the proposed contract he acts throughout in good faith. So far as the substance of those steps is concerned it seems to me that it would be sufficient for the creditor to warn the potential cautioner of the consequences of entering into the proposed cautionary obligation and to advise him or her to take independent advice.” So from the perspective of the creditor, the transaction will not be struck down if they tell the cautioner to go and see a solicitor.

⁃ Despite the decision in Smith, it wasn’t entirely clear whether every breach of good faith could trigger a standard security / third party pledge being struck down? The first case which clarified the law here:
⁃ Braithwaite v BoS 1999

Question 39

Braithwaite v BoS 1999

Answer 39

⁃ This was actually a case on share ownership where the spouse agreed to grant a security over her shares for her husbands overdraft. It was argued that because the spouse had not been told to take independent advice before granting the pledge of the shares in favour of the bank, this was sufficient to strike down the security because it was a general breach of the duty of good faith.
⁃ However, the court disagreed. The court held that by looking at Smith and Barclay’s together, it was clear that one thing they have in common was that the principal obligant is alleged to have duped the cautioner into granting the security. Therefore it is a pre-requisite in order to strike down a third party pledge in Scots law that there is 1) an actionable wrong as well as 2) a breach of good faith. So there must be misrepresentation/undue influence/facility and circumvention between the PO and the cautioner and a breach of the duty of good faith.

Question 40

RBS v Etridge

Answer 40

[English case** complicated]

⁃ The wife agreed to guarantee the husband’s business debts. The wife was asked to take independent advice but the lender did not take any steps other than telling her to go away and get this advice. The wife argued that the advice she received was inadequate. It was held that if the lender is asking someone to get independent advice, it has to make sure that they are getting good advice:
⁃ SO the lender must make sure that there is a:
⁃ Face to face meeting
⁃ The wife is happy for the solicitor to act
⁃ The solicitor must explain the document
⁃ The solicitor must explain the consequences and the risks
⁃ In doing this the solicitor has to detail the financial risks based on the financial information that the creditor gives to the solicitor (if the husband doesn’t agree then the bank can’t comply with this requirement and the wife won’t be able to grant the valid security).
⁃ The solicitor must stress to the wife that she is not bound to proceed

Question 41

What was the impact of etridge in England?

Answer 41

⁃ The cautioner has a ‘double barrelled gun’ - one for the creditor, one for the solicitor.
⁃ 1. The cautioner could argue that the cautioner didn’t comply with the Etridge requirements then they could escape liability.
⁃ 2. If the advice is poor advice then the spouse can sue the solicitor. In this case the wife would lose the property but she may be able to sue the solicitor for the value of the loss.

Question 42

Ahmed v Clydesdale Bank

Answer 42

[As with Barclay’s there started being various cases in the Scottish courts where people were wondering if the Etridge requirements were necessary in Scotland.]

⁃ The cautioner wife had granted a security which covered their own debts (in addition to the husband’s business debts.) The court held that if you’ve granted a security for your own debts then this isn’t a third party pledge and thus you cannot escape liability.

Question 43

**RBS v Wilson 2003

Answer 43

(Wilson was ultimately appealed to the Supreme Court on a different issue. It remains good law on this point)
⁃ This case ended up in the Supreme Court. However for our purposes we are interested in the Inner House decision with the leading judgement by Lord Gill.
⁃ In this case, at the time the standard security was initially granted Mr and Mrs Wilson signed an all sums standard security. This is a standard security not just for the original loan but also for any subsequent loan that is entered into. So the wife agreed to cover her debts, her husband’s current debts and any future debts that both incurred. Ultimately the bank tries to enforce the security. The wife argued that she was duped - she didn’t realise her husband’s business was in such a dire financial position and it had been misrepresented to her. The court held that:
⁃ 1) There was no actionable wrong here between the PO and the cautioner look up why?
⁃ 2) The bank had followed the general advice of the council of mortgage lenders and asked both parties to take independent advice. The fact that any independent advice may have been poor was not the bank’s fault - the Etridge test was rejected (the bank couldn’t enquire to make sure that the independent advice reaches a particular standard).
⁃ 3) The cautioners did not act gratuitously and in all earlier cases where a cautioner was able to strike down the obligation they had acted gratuitously. In this case the cautioner got a benefit from entering the security because there was an initial loan in relation to the property which was her indebtedness as much as her husbands indebtedness. [In addition, normally the wife will have an interest indirect but nonetheless significant in the success of her husband’s business.][ Not too important but an interesting point suggesting that in any case like this the wife may receive some indirect benefit]
⁃ Lord Gill implied in para 24 that Smith v BoS was wrongly decided even on its own fact (read para 24!)
⁃ **Read Wilson. The important paragraphs are 24, 29[ Stressing the Braithwaite test of good faith.], 31[ Rejection of the Etridge point.], 32.

**VERY IMPORTANT SUMMARY***

Question 44

Where does Scots law stand now?

Answer 44

The following factors seem to be derived from the cases:
⁃ As a result of RBS v Wilson, where does Scots law stand now? The following factors seem to be derived from the cases:
⁃ a) Can it be shown that the relationship between the debtor (principal obligant) and the cautioner was such that the cautioner’s consent to the grant of security ?
⁃ Which relationships may be covered? Note that English cases may be persuasive in Scotland in this context (including h+w, hetero/homosexual cohabitants etc etc).

⁃ (b) Can the cautioner demonstrate that the debtor had “committed an actionable wrong” against the cautioner; AND has the cautioner relied on that actionable wrong when granting the third party security?
⁃ What actionable wrongs are covered?
⁃ (Undue influence, misrepresentation, facility and circumvention) Silence on behalf of the debtor is not sufficient to commit an actionable wrong unless the debtor is obliged to comment. (RBS v Wilson)

⁃ (c) Did the cautioner rely on that actionable wrong when granting the third party security?

⁃ (d) Did the cautioner grant the third party security gratuitously (ie did the cautioner get nothing in return)?
⁃ See in this context particularly the decision of Lord Justice-Clerk Gill in Royal Bank of Scotland plc v Wilson (that if you’re granting a security over debts you own too then it’s not gratuitous and also the suggestion that even if there is no direct interest you might have an indirect interest in the business doing well.) note the rejection of the developments in English law in Royal Bank of Scotland plc v Etridge (no 2) [2002] 2 AC 773 where the House of Lords set down detailed compulsory guidelines for the creditor to follow to ensure that it was satisfied that the cautioner was independently advised.

⁃ (e) Did the creditor warn the cautioner of the consequences of granting the third party security and advise the cautioner to take independent legal advice?
⁃ See Royal Bank of Scotland plc v Wilson and note the rejection of the developments in English law in Royal Bank of Scotland plc v Etridge (no 2) [2002] 2 AC 773 where the House of Lords set down detailed compulsory guidelines for the creditor to follow to ensure that it was satisfied that the cautioner was independently advised.

Question 45

***Cooper v BoS [2014]

Answer 45

There were zero cases which applied Smith until Cooper v Bank of Scotland [2014] CSOH 16 – the first time Smith has been applied since it was decided. [ This was in the 2014 lecture but not in 2013 so must look this up!!!!.] (The reason seems to be that this is because the banks have always requested the cautioner to get independent advice - if the bank does this it is sufficient to protect their position.)

case comment from Shoosmiths — the first time Smith has been applied since it was decided.

After a lengthy period of silence, a new case in the Court of Session reminds lenders that a high degree of care is required where a wife is granting a security on account of her husband’s debts. We examine what lessons might be learned.
In the case of Smith -v- Bank of Scotland 1997 SC (HL) 111, the courts extended the English legal position which they had formulated in the case of Barclays Bank plc -v- O’Brien into Scotland. Thus, where a spouse was granting a security for his or her spouse’s business debts, the court imposed a duty on creditors to warn a potential cautioner (the Scots term for a person granting a Guarantee or security on another’s debts) of the consequences of entering into the proposed arrangements and to advise him or her to take independent advice.
Following Smith, there were a series of cases litigated in the Court of Session which further defined the parameters of the principle - so, for example, the cautioner required to prove an actionable wrong by his/her spouse in order to have a remedy (Braithwaite -v- Bank of Scotland 1999 SLT 25); the lender may infer from the involvement of solicitors on the cautioner’s behalf that proper advice was being given and did not require to involve itself in the content of that advice nor any potential conflicts of interest on the part of the solicitors (Forsyth -v- Royal Bank of Scotland plc2000 SLT 1295); that the principle in Smith was not retrospective (Clydesdale Bank plc -v- Black2002 SC 555).
For a number of years, however, this area of law had gone quiet, apparently settled.
However, the question of whether security given by a wife for her husband’s debts can be challenged has been raised again in the recent case of Cooper -v- Bank of Scotland plc, in which Lord Tyre issued his opinion on 30 January 2014. Whilst the outcome turns primarily on the facts, it is a judgment of which lenders in Scotland will wish to take note.
Facts
In this action Mrs Cooper’s husband had gone into business with their son, bottling and selling water from an artesian well on a property they owned. Mr & Mrs Cooper held a mortgage with the defenders, secured by an all sums security. The defenders also advanced overdraft facilities to the husband’s business and deemed those liabilities to be covered by the security.
The business began to fail and personal guarantees were sought. Mr Cooper signed a personal guarantee, whilst Mrs Cooper did not (and it appears that this was never pressed). At some point, Mr Cooper arranged a remortgage with Halifax plc. The mortgage lending was paid off and the Bank’s security was discharged.
At some later point, the Bank discovered that the security had been discharged without payment of the guarantee obligation having been made. Their solicitors sent out a fresh security for execution with a covering letter explaining that “this replaces the similar document signed by you in 2002” and this was duly executed and registered.
Ultimately, the Bank called up the security and this action was raised by Mrs Cooper, claiming that she was unaware of the Guarantee and of the security, had never taken advice on it and (whilst it was established that she had signed the security) that she had been presented only with the signing page, had not known what she was signing and had never been advised to gain legal advice. The court found in fact that Mr Cooper had misled her as to the nature of the second security, claiming that it was a remortgage to shorten the term of their secured loan.
Legal position
The court analysed the law as it was developed by Smith and some of the subsequent cases referred to above. The court identified that the elements which required to be in place in order for a security of this nature to be challenged were:-
1. the security required to be gratuitous on the part of the cautioner
2. there must be proof of an actionable wrong by the husband on the wife
3. that the lender had not been in good faith, within the meaning of Smith
4. there must be a causal link between the lenders’ failures and the execution of the security
In relation to (1), it was accepted by the Bank that the security was gratuitous in that Mrs Cooper derived no benefit from it. In relation to element (2), the court was satisfied on the evidence of Mr Cooper that he had committed an actionable wrong against his wife through his concealment of the true position.
The court also held that the requirement of good faith had not been met by the Bank. They had failed to make any attempt to bring to Mrs Cooper’s attention the consequences for her of signing the security, nor advised her to take legal advice. The security had arrived with a cover letter “in bland terms” which conveyed the impression that the fresh security was a mere formality. The requirement at (3), above, was therefore held to have been satisfied.
The court also held that there was a causal link between these factors and the signing of the security. The court accepted the pursuer’s evidence that had she known the true position she would not have signed. The requirement at (4) was therefore satisfied.
The court therefore granted the orders sought by the pursuer.
Conclusions
With hindsight, it is perhaps easy to see what went wrong here - there having been a previous security discharged in error, the lender’s solicitors appear to have treated the granting of the fresh security as a mere formality. It appears they did not therefore take the care that might have been expected had this been “new” security.
It is clear that the courts expect lenders to have the same degree of care at every stage in the life cycle of a business lend - whether it be a brand new security or a replacement of existing security. It is a matter of which lenders (and the solicitors who act for them) will take note.