Shirley Li‑Ting

What is a landlord’s hypothec?

Landlord’s hypothec is an unusual security right that applies by operation of law in Scotland. It does not need to be referred to in the lease or any other contract to apply. It creates a fixed security for arrears of rent over the tenant’s moveable property located on the leased premises.

Whilst the security right technically exists as soon as there are arrears, since the enactment of the Bankruptcy and Diligence etc (Scotland) Act 2007 (BAD Act), there is arguably no ability for landlords to enforce the security - a security right with no ‘teeth’.

This can create a tension between the company (and its supervisor) and the landlord claiming the hypothec given that a CVA cannot affect the right of a secured creditor to enforce its security, except with its consent (section 4(3), Insolvency Act).

A further difficulty is that although the landlord is allowed to rank when the tenant is subject to an insolvency procedure (including CVAs), there is no statutory ranking mechanism for CVAs and instead the BAD Act provides that the hypothec “ranks accordingly” which is not very helpful.

Given this, much of what occurs in Scotland when dealing with landlord’s hypothec arises from convention and practice rather than from black letter law.

What is an arrestment?

Arrestment is a Scottish debt recovery remedy. The closest English equivalent is a third party debt order. Arrestment is frequently used by commercial landlords to recover arrears due under a registered lease as, if the lease is drafted appropriately, there is no need to go to court to secure authority to serve an arrestment.

Arrestment involves messengers at arms or sheriff officers (similar to bailiffs) serving an arrestment on a third party that owes a debt or a liability to account to the tenant. If the arrestment is successful, it obliges the third party to account to the landlord instead of the tenant, up to either the value of the third party’s liability or the arrears (whichever is lower). The most common third party arrested by a landlord is the tenant’s bank.

What is the effect of landlord’s hypothec and arrestments on the implementation of a CVA and vice versa?

Given the very nature of landlord’s hypothec and arrestments and the potential difficulties mentioned in relation to the enforceability of hypothec, how are they treated in relation to a tenant who ends up in a CVA?

Are both remedies treated as secured rights and therefore the rights of a landlord to enforce hypothec and arrestment cannot be affected by the CVA?

Or do they automatically fall and therefore the relevant rent arrears are treated as unsecured claims when the CVA is implemented?

Or are the landlord’s rights merely restricted depending on the treatment of rent arrears in terms of the CVA?

Can the above be determined by robust drafting of the CVA alone or by statute? Or both?

Given the material impact on a landlord’s rights, it is equally important that both businesses proposing CVAs (tenants) and landlords consider the potential impact of hypothec and arrestments.

We have advised on the above in relation to recent high profile retail CVAs, if you would like to discuss the above any further, please get in touch with Shirley Li-Ting and Iain Penman.