Recently it has become increasingly common that solicitors acting for Landlords in Scotland on insolvency of a tenant are using the Landlord's right of hypothec as an argument to obtain a higher ranking in the insolvency proceedings (winding up, receivership, administration and CVAs) in relation to any arrears of rent, using it as leverage to negotiate a better settlement for their client.

What is the Landlord's right of hypothec?

The hypothec provides the landlord with security over the moveable effects of a tenant owned by the tenant and brought onto the leased premises (subject to limited exceptions). This is a similar right to distress in England and Wales.

Historically, the manner of enforcing hypothec was by court action for sequestration of rent. This enforcement method was abolished by the Bankruptcy and Diligence (Scotland) Act 2007 ("BAD"), and, instead, hypothec has become a right in security arising by operation of law. The effect in Scotland is that the Landlord's hypothec claim ranks ahead of floating charge holders.

What sum is secured by the Hypothec?

The legislation says that it is security for "rent due and unpaid only" for so long as it remains unpaid. Accordingly, the general consensus appears to be (although BAD is unclear):

  • all rent due at the commencement of insolvency proceedings would be secured by the hypothec (including any advance payment)
  • there is divided opinion on whether rent falling due after such commencement is secured or whether it, for example, should be treated as an administration expense

Until there is a ruling on this by the courts we can only guess what the legislators had in mind when BAD was drafted.

What is subject to the Hypothec?

The hypothec attaches to the moveable effects (goods) of the tenant on the leased premises. BAD is unclear on whether this is the goods on the leased premises on the date of the insolvency procedure or whether it covers goods subsequently brought on to the leased premises.

An administrator (for example) who wishes to continue to stock and trade from leased premises in Scotland needs to consider strategies for mitigating this potential liability and think about the terms on which they do so.

Selling goods subject to the hypothec?

Goods on Scottish leased premises should not be sold without either the consent of the Landlord or the court (paragraph 71 of Schedule B1 of the Insolvency Act 1986). If goods are sold inadvertently without such consent then it would be sensible for any IP to take legal advice on a mitigation strategy but also to do, amongst other things, the following:

  • record what moveables have been sold
  • record the sale price (and any evidence indicating the sale to be at open market value) and
  • keep the sale proceeds separate from the floating charge fund "pot" and earmark those proceeds as subject to the hypothec.

Conclusion

Until the law is tested in this area any IP would be well advised to:

  • treat any Scottish leasehold property differently from property in England and Wales
  • take advice on mitigation measures e.g. negotiations with Landlords and strategic lease renunciations
  • If the amounts are substantial consider seeking directions from court (made under paragraph 63 of Schedule B1 of the Insolvency Act) to clarify the position as to what sums are actually secured by the hypothec.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 14/09/2009.