Inner House overrules ‘wrongly decided’ case on arrestment as diligence

The Inner House of the Court of Session held that the court in the 1977 case Lord Advocate v Royal Bank of Scotland, which ruled that arrestment was not an “effectually executed diligence” in terms of what is now section 60(1)(b) of the Insolvency Act 1986, “did not correctly interpret the words” and should not be followed.

The instant case of MacMillan v T Leith (Developments) Ltd considered whether the words “effectually executed diligence” encompassed an inhibition, as opposed to an arrestment, but the court considered such a diligence was applicable to an inhibition by analogy. The case also concerned whether, in a competition between a floating charge holder and an inhibitor, the charge provided security for debts incurred after the recording of the inhibition.

The Lord President, Lord Carloway, sitting with Lord Menzies, Lord Brodie, Lord Drummond Young and Lord Malcolm heard that the housebuilder defenders, who purchased and developed plots of land at Ayr Road in Glasgow, granted a floating charge to a bank in 2000.

The pursuer and his late wife bought one of the plots in 2005 and the defenders built a house on the land, but after taking entry in 2006 the couple raised proceedings against the defenders seeking damages for breach of contract arising from the construction of the property, and registered a notice and letters of inhibition on the dependence.

Decree by default was granted in 2010 and receivers were appointed by the bank in 2011.

It was agreed that the whole of the debt due to the bank as at the date of the receivership was incurred after the inhibition.

The pursuer sought declarator that the inhibition was an “effectually executed diligence” and that, when distributing the proceeds of sale of the defenders’ assets, the sums due under the sheriff court decree fell to be paid prior to any distribution of the balance to the bank.

In any event, the pursuer maintained that his inhibition provided him with a “priority” over the debt due to the bank.

The Commercial Judge traced the history of floating charges back to the Companies (Floating Charges) (Scotland) Act 1961, section 1(2)(a) of which provided that the security then took effect subject to the rights of any person who had “effectually executed diligence on the property”.

The Companies (Floating Charges and Receivers) (Scotland) Act 1972, which introduced receivership, re-enacted section 1(2)(a) of the 1961 Act, while section 15(2)(a) provided that the receiver’s powers were subject to the rights of those who had “effectually executed diligence” on the property and section 20(1) gave such a person a priority in the distribution of ingathered funds along with those with a prior heritable security.

The Companies Act 1985 re-enacted the 1972 Act as sections 463(1)(a), 471(2)(a) and 476(1)(b), with the latter two sections becoming in turn sections 55(3)(a) and 60(1)(b) of the Insolvency Act 1986.

Section 55(3)(a) of the Insolvency Act 1986 provides that the powers of a receiver over the property of a company which is subject to a floating charge are “subject to the rights of any person who has effectually executed diligence on all or any part of the property” prior to the receiver’s appointment, while section 60(1)(b) provides that the moneys ingathered by the receiver should be distributed to the holder of the floating charge in satisfaction of the debt secured by the charge subject to the rights of “all persons who have effectually executed diligence on any part of the property”.

The Commercial Judge considered that he was bound by Lord Advocate v Royal Bank of Scotland to repel the pursuer’s first plea-in-law that he had an effectually executed diligence and was entitled to a declarator to that effect, but noted that in terms of the applicable common law inhibition conferred a priority over post-inhibition advances made by a fixed security holder and therefore the same must apply to advances made by a floating charge holder.

The defenders appealed the decision on the second point and the pursuer cross-appealed on the first, and the judges unanimously refused the defenders’ appeal and allowed the pursuer’s cross-appeal.

In his opinion the Lord President said: “Not only the Scots lawyer, but also any person working in the field of debt recovery, including those customarily appointed as receivers or liquidators, would clearly understand the word ‘diligence’ to encompass an ‘inhibition’. It is the diligence executed in respect of the heritable property of a debtor, even if it creates no real right and would require an adjudication to provide the creditor with a heritable title. Its practical effect, as creating a preference by exclusion, is considerable, especially upon bankruptcy or liquidation.”

In Lord Advocate v Royal Bank of Scotland the majority held that an arrestment was not “diligence effectually executed on the property of the debtor company” because arrestment did not create a “real right” in the property, as the crystallisation of the floating charge “effectively superseded the arrestment and would win out in any competition”.

Lord Carloway said: “Arrestment is a diligence. The adjective ‘effectually’ qualifies ‘executed’, rather than ‘diligence’. All that ‘effectually executed’ means is that the arrestment is properly laid and, quantum valeat, not ultimately struck down by a liquidation within 60 days. Had Lord Advocate v Royal Bank of Scotland come before the present court, the temptation to give the words their ordinary, legal meaning would have been irresistible.”

The three words under consideration did not appear in the least ambiguous and upon this basis alone, it had to be accepted that Lord Advocate v Royal Bank of Scotland was “wrongly decided”.

“The problem with the reasoning of the majority and the Lord Ordinary in Lord Advocate v Royal Bank of Scotland is that it effectively drives a coach-and-four through the common law of diligence in circumstances in which the statutory wording was…intended to be a saving provision designed to achieve the opposite effect,” Lord Carloway added.

He considered that it would not be appropriate to assume from the legislative history of the Insolvency Act 1986 that Parliament intended to endorse Lord Advocate v Royal Bank of Scotland when it re-enacted the terms of the 1972 Act, as the provision had not been reviewed and the extent to which it had been applied in practice was “neither a matter of agreement nor one of certainty”.

The Lord President said: “There is no ambiguity in the provision. In these circumstances, settled practice cannot convert the ordinary legal meaning of the words used into something conveying a different sense. It would be odd indeed if this court considered that Lord Advocate v Royal Bank of Scotland had been wrongly decided as a matter of law, but declined to overrule it because of subsequent practice.”