Rights in security

Question 1

Best Fertilizers of Arizona Inc v Burns

Answer 1

1. “The note is the cow and the mortgage the tail. The cow can survive without the tail, but the tail cannot survive without the cow”
2. The debt can exist without the right in security, but the right in security cannot exist without the debt

Question 2

Albatown Ltd v Credential Group Ltd

Answer 2

1. Albatown acquired a piece of land from FSL
2. FSL had acquired that land from Credential Group
3. The contract between FSL and Credential Group was secured by a standard security (a type of security right which you grant over land)
4. Albatown sought a declarator that the security right had been extinguished (they wanted to get rid of it)
5. In the contract between FSL and Credential Group, it was stipulated that the underlying debt (and therefore the security right) was not enforceable after 2 years
6. 2 years had passed, so the right in security was extinguished
7. The court agreed
8. The security right could not exist without the underlying obligation

Question 3

Smith v Bank of Scotland

Answer 3

1. Although caution is not a contract of utmost good faith, it “required perfect fairness of presentation by the creditor”
2. “…it is well settled that a creditor is under no duty to an intended cautioner to give information as to the debtor’s state of indebtedness and he is entitled to assume that the cautioner has informed himself as to the matters material to the obligation which he is about to undertake” (per Lord Jauncey)
3. “In the context of cautionary obligations it is well settled that as a general rule the cautioner is expected to look to his own interest and to make such inquiries as he considers necessary or appropriate” (per Lord Clyde)

Question 4

Royal Bank of Scotland v Greenshields

Answer 4

1. The creditor
   i. Must disclose to the intending cautioner circumstances which are known to the creditor but are unlikely to be known to the cautioner
   ii. If the creditor discloses information, he must not mislead the intending cautioner
   iii. If the creditor becomes aware that the prospective cautioner completely misunderstands A’s position

Question 5

Young v Clydesdale Bank

Answer 5

1. Originally, the law, both in England and Scotland, did not provide the cautioner with a remedy against the creditor for misrepresentation by the creditor

Question 6

Barclays Bank v O’Brien

Answer 6

1. A husband and wife signed a mortgage to secure the debts of the husband’s business
2. The wife signed relying on the husband’s assurances (cost and duration)
3. The mortgage was enforced
4. The wife tried to escape liability
5. The court ordered the bank to pay the couple’s costs

Question 7

Smith v Bank of Scotland

Answer 7

1. A man ran a partnership with another individual
2. The partnership wanted a loan, but the bank was not satisfied with the financial situation of the partnership and they therefore required security over the house of one of the men
3. The house was co-owned by his wife
4. The wife had no involvement with the partnership but agreed to become a cautioner in addition to her husband
5. She did not get any independent advice
6. The partnership went insolvent
7. The bank wanted to enforce the right in security against the house, which meant that the wife would suffer as well
8. The wife said that she was induced to provide security by her husband
9. She thought her assets would not have been included
10. Her husband probably lied to her
11. The Bank of Scotland could not claim against the wife
12. Following Barclays Bank v O’Brien, the House of Lords wanted to ensure that the same law applied throughout the UK
13. But Barclays Bank was decided on the basis of constructive notice, which forms no part of Scots law
14. Therefore, their Lordships developed the law of good faith and imposed on the creditor an obligation to act in good faith
15. This obligation arises where “the circumstances of the case 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”
16. If the duty arises, “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”

Question 8

Royal Bank of Scotland v Wilson

Answer 8

1. The facts of the case were similar to Smith
2. Two brothers both shared their houses with their wives
3. They both had agreements with their wives that they would guarantee the debts of the other against the bank
4. So no matter what the debt was, if one of the Wilson brothers owed anything to the Royal Bank of Scotland, then the respective wives were also cautioners for that obligation
5. The brothers decided to start a partnership and took out a loan from the Royal Bank of Scotland
6. This meant that, automatically, their wives were cautioners
7. The partnership went insolvent and they failed to pay their debt
8. Even though a partnership in Scotland has a separate legal personality, if the partnership fails to pay the debt the creditor can go after the personal funds of the partners
9. The partners also failed to pay which meant that the cautionary obligations of the wives were triggered
10. They argued that they had been misrepresented by their husbands about the extent of their obligations and the financial state of their partnership
11. The wives relied on Smith v Bank of Scotland
12. In this case, however, the court refused to reduce the cautionary obligation
13. There were two reasons for this
14. Two additional requirements were added to those of Smith
    i. The husbands and wives guaranteed each other, so it was not gratuitous
    ii. There must be an actionable wrong by the principal debtor (it must have been a misrepresentation from the principal debtor to the cautioner)

Question 9

Braithwaite v BoS

Answer 9

1. The creditor is not required to warn or advise the cautioner if the creditor knows that the cautioner already has independent legal advice

Question 10

Requirements for a cautionary agreement to be set aside

Answer 10

1. 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 “may not be fully informed or freely given”?
2. 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?
3. Did the cautioner grant the third party security gratuitously (did the cautioner get nothing in return)?
4. Did the creditor warn the cautioner of the consequences of granting the third party security and advise the cautioner to take independent legal advice?

Question 11

Royal Bank of Scotland plc v Etridge (no 2)

Answer 11

1. 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 12

Bullough v Royal Bank of Scotland

Answer 12

1. The creditor cannot seek to examine the content of the independent legal advice because it is a privileged communication that is kept confidential

Question 13

Veitch v National Bank of Scotland

Answer 13

1. Veitch was a cautioner for a man called Rutherford, who died and became insolvent (his debts were higher than his assets)
2. The overall amount of the debt was £5,855 to the bank, which was the creditor in that case
3. The principal debtor passed away and the bank was able to recover £3,903
4. This left £1,902 to be recovered by the creditor
5. This went against the cautioner, Mr Veitch
6. The cautionary obligation of Mr Veitch was limited to £1,500
7. It was interpreted as a guarantee for a part of the debt (situation 2: the cautioner guarantees only £X of whatever the full debt is (so not a limit))
8. The remaining debt was more than the guarantee of the cautioner
9. The bank wanted to receive the full cautionary obligation
10. Mr Veitch argued that the bank already recovered 2/3 of their debts, so it would be unfair for them to demand the full extent of his cautionary obligation
11. What they would be allowed to require was 2/3 of what he guaranteed, because the overall debt that they were able to recover was also 2/3
12. The court agreed with this argument
13. The reasoning for this was that if Mr Veitch had fulfilled his cautionary obligation before the debtor went bankrupt, he would have been able to rank on the debtor’s estate for £1,500
14. However, the creditor was already ranked on the estate, which meant that Mr Veitch could not be ranked anymore, and the court held that in cases like these, there should be something like a hypothetical
15. The bank was able to recover £1,000 (2/3 of £1,500)

Question 14

Mackinnon’s Trs v Bank of Scotland 1915 SC 411

Answer 14

1. It was held that the cautioner was entitled to rank in the principal debtor’s bankruptcy because the cautioner had paid before the bankruptcy

Question 15

Bank of Scotland v MacLeod

Answer 15

1. Further advances to the principal debtor are not a sufficient alteration if they were in contemplation at the time of the cautionary obligation

Question 16

Armour v Thyssen

Answer 16

1. The defendant supplied steel to a manufacturing company under a contract which contained a retention of title clause
2. The contract was governed by German law
3. The plaintiffs, who had been appointed as receivers, brought proceedings against the supplier seeking a declaration that property in the steel had passed to the company, despite the fact that payment had not been made
4. The suppliers argued that the retention of title clause, which was valid under German law, was effective to prevent title passing, either because the steel in question had been in Germany when the contract had been entered into so that German law was the lex situs, or because the passing of title was governed by German law as the proper law of the contract
5. The receivers agreed that the passing of property was governed by the lex situs, but argued that, once the goods reached Scotland, Scots law governed the question and that the retention of title clause was ineffective under Scots law
6. The House considered a retention of title clause in the context of whether a stock of steel was held as a security
7. It was held that clauses which provide that title to goods supplied does not pass to a buyer until monies on all account have been paid are effective to retain title
8. The decision was made despite the fact that such clauses do in a sense give the seller security for unpaid debts

Question 17

Sharp v Thomson

Answer 17

1. This case concerned whether a flat sold by a company (Albyn Construction) was still part of its assets when a floating charge held by the Bank of Scotland crystallised
2. Although the disposition (transfer deed) for the flat had been delivered to the buyers (the Thomsons), it had not yet been registered, meaning legal title remained with Albyn under Scottish law
3. The issue was whether the flat fell within the company’s “property and undertaking” for the purpose of the floating charge
4. The House of Lords held it did not, reasoning that Albyn had effectively divested its beneficial interest once the disposition was delivered, even though it wasn’t registered
5. This case limited what counts as company assets under floating charges in Scotland, but was later narrowed in scope by Burnett’s Trustee v Grainger

Question 18

AIB Finance Ltd v Bank of Scotland

Answer 18

1. AIB Finance had a floating charge over Lothian Cars Ltd’s assets, which included a negative pledge clause: a term stating that the company would not create any subsequent security that would rank ahead of or equal to the floating charge
2. On the same day that the floating charge was executed, the company also granted a standard security (a fixed charge over property) to the Bank of Scotland
3. However, the standard security was registered after the execution of the floating charge
4. The court ruled that although both securities were signed on the same day, the floating charge took priority, because under the law, the floating charge is effective upon execution, whereas a standard security is only created upon registration
5. Therefore, the standard security breached the negative pledge clause and could not outrank the floating charge
6. This case confirmed that a negative pledge clause in a floating charge is enforceable in Scots law and can be used to defeat a subsequently created security if it conflicts with that clause

Question 19

Tay Valley Joinery Ltd v CF Financial Services Ltd

Answer 19

1. Tay Valley Joinery Ltd had granted a floating charge over its entire property and undertaking
2. It later entered into an invoice discounting agreement with CF Financial Services Ltd, under which present and future book debts were declared to be held in trust for CF
3. The issue was whether these book debts, held in trust, could still fall within the scope of the company’s floating charge
4. The Court of Session held they could not
5. Since the debts were held in trust, they were not part of the company’s general patrimony and were therefore excluded from the floating charge
6. This case confirmed that assets held in trust by a company are not subject to floating charges, reinforcing the principle that company security rights do not extend to trust property