UK: Court Orders Developers To Discharge Security When Option Terminated, Despite Alleged Breach By Security Granter

The Inner House has refused an appeal against a commercial judge's order that developers discharge a standard security granted in terms of an option agreement that had been lawfully terminated.

Background

In 2010, the owners of land in North Lanarkshire (the pursuers) entered into an option agreement with developers (the defenders). Pursuant to the option agreement, the defenders were granted an option to purchase the land (or parcels of it) in exchange for £135,000.

To secure performance of the obligations undertaken by the pursuers in terms of the option agreement, the pursuers were required to grant a standard security over the land. The pursuers were to ensure that the land was allocated for residential development on the local plan. The option agreement also provided that if by a particular long-stop date not more than 10 acres were allocated either party could "walk away" from the deal.

The parcels that were allocated for residential development were then to be sold by the defenders (the defenders were to receive a share of the sale proceeds). The terms of the option agreement allowed either party to terminate the agreement if the allocated parcels were not sold to third party developers by the defenders by a particular date. The security granted was to be discharged upon the earlier to occur of (i) the expiry of the option period or (ii) the termination of the option agreement.

Since no sales had been concluded by the longstop date, on 30 September 2015, the pursuers terminated the option agreement by serving a valid notice and asked the defenders to discharge the standard security. This request was refused and the defenders counterclaimed for £5 million in respect of "losses suffered as a result of alleged breaches of express and implied terms" of the Option Agreement.

Commercial judge's reasoning

In the first instance, the commercial judge ordered the defenders to deliver an executed discharge; his reasoning for this being twofold. Firstly, only the primary obligation of the pursuers (i.e. to convey the land if the option was exercised) was covered by the security as the option agreement provided that the security should be restricted to the parts of the land that were allocated for residential development. Second, as there was no interdependency between (i) the obligations which were said to have been breached by the pursuers and (ii) the defenders' obligation to discharge the standard security, the defenders could not seek to rely on a right of retention or a right to withhold performance, which would be the typical remedies for breach on contract under Scots law. The commercial judge held that the security should be discharged because it "was securing an option which had not been, and could never be exercised".

Decision of the Inner House

The Inner House upheld the decision of the commercial judge. It was said that a right to withhold performance for breach by the owners could not be used to pressure performance of an obligation (even if it was reciprocal) where it was no longer extant as a result of that termination. It was concluded that the construction of the option agreement was such that the security had to be discharged once it ceased to be possible to exercise the option to purchase, either because the option period had expired or the option agreement was lawfully terminated.

Comment

This decision provides a useful guidance on enforcing obligations to discharge security granted in terms of an option agreement. It also highlights the importance of ensuring that the documents clearly set out which obligations are covered by the security, limiting any scope for dispute over interpretation as to which obligations have been secured. It remains to be seen if the judgment will also give rise to a general obligation on chargees to discharge security or if it will be interpreted as simply relating to the interpretation of this particular arrangement.a

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