A note on a quirk arising from the reform of the law of inhibitions

The law of diligence in Scotland has been substantially altered with the coming into force of Parts 5 and 10 of the Bankruptcy and Diligence etc (Scotland) Act 2007 on 22nd April 2009.

The provisions were brought into The Bankruptcy and Diligence etc. (Scotland) Act 2007 (Commencement No. 4, Savings and Transitionals) Order 2009 (SSI 2009 no 67). Article 3 brings into force the provisions on inhibitions (Part 5) and arrestment (Part 10). I will post something about the arrestment reforms in a later post but initially wished to post something on the inhibition reforms.

The reforms to the law of inhibitions are substantial. Prior to the 2007 Act an inhibition was a freeze diligence, one which prevented the inhibited debtor from transacting with his or her property. But in addition an inhibition also conferred a priority of sorts in ranking. This was because the debtor was prohibited from incurring further debts – and any debts subsequently incurred in breach of this could not prejudice the ranking of the inhibiting creditor. The rules were based on Bell's Canons of Ranking found in Volume II, p 413 of his Commentaries on the law of Scotland (and were discussed in some detail in Professor Gretton's excellent The law of Inhibition and Adjudication (2nd edn), ch 7).

The rules of ranking were comlex to operate, albeit a fertile ground for examination questions. A brief example may explain the complexity. 

 If Alf was the debtor with heritable assets of £15,000 and he owed £10,000 to Bert and £20,000 to Carol if Alf was to become bankrupt at this point Bert would receive £5,000, Carol £10,000. If Bert inhibited Alf at this point and Alf incurred a further debt subsequent to that inhibition by borrowing £20,000 from Donna the ranking would be complicated. In order to determine the payment to be received by each creditor hypothetical rounds of ranking were required. The first hypothetical round ignores the existence of the inhibition.  IN this round Bert would receive £3,000 Carol and Donna £6,000 each. In hypothetical round 2 the inhibition is given effect and the post inhibition creditor's sum is reduced by a figure drawn back to the inhibitor. The pre-inhibition creditor, Carol, is unaffected and receives £6,000. The inhibitor, Bert, receives the amount he would have received if the post-inhibition debts did not exist (ie £5,000 – the figure he would have received if Bert and Carol had been the only creditors). The difference between the amount Bert receives and the figure he would have received in hypothetical round 1 is £2,000 which is drawn back from the amount Donna would have received in round 1.  The final figures then see Carol receive £6,000; Bert £5,000 and Donna £4,000.

Alas, for teachers of diligence such complexities are no more as s 154 of the 2007 Act removes the preference in ranking of an inhibition. The other effects of inhibitions remain.

Before Part 5 of the 2007 Act came into force an inhibition had two principal effects.  It was a prohibition on the debtor granting voluntary deeds affecting heritable property (specifically dispositions or standard securities).  Additionally, where the debtor incurred debts subsequent to the inhibition the inhibitor had a preference in ranking in competition with post-inhibition creditors. As explained this second effect has been abolished by the 2007 Act. An inhibition will no longer confer a preference in ranking in insolvency or on distribution of the proceeds of sale where a creditor enforces a standard security. 

However, under s 160 of the 2007 Act inhibitions continue to prevent conveyances of, or the grant of rights affecting, heritable property.  Where an inhibition is breached the inhibiting creditor has the right to reduce the conveyance or grant.  The creditor’s right to reduce the conveyance or grant which breached the inhibition will prescribe 20 years after the breach (s 161 of the 2007 Act).

The removal of the general preference over post-inhibition debts but preservation of the rule prohibiting the conveyance of, or grant of security over, heritable property creates an interesting problem.

In the example above assume that Donna had loaned Alf money and Alf had granted Donna a standard security. Bert could under s 160 of the 2007 Act reduce the security. The inhibition has been breached.

However, what would the position be if Donna simply loaned the money and then carried out another diligence to enforce her claim for payment? If she adjudged the property on the basis of this loan Donna suddenly acquires a first ranked (judicial) security ensuring her payment of the full equity in the house of £15,000. It appears that Bert as inhibitor can do nothing about it.

Now, this problem may be unlikely to arise given the relatively rare use of adjudiciations – however, it is an option that appears not to be addressed in the legislation and one which may be made easier by the proposed introduction of land attachments (although whether land attachements will be implemented by the current Scottish government seems unlikely).