Debt finance

Some of the key areas affecting the giving of guarantees and security are as follows.

Capacity

It is important to check the constitutional documents of a company giving a guarantee or security to ensure it has an express or ancillary power to do so and there are no restrictions on the directors' powers that would be preventative. Under Scots law, directors have a general duty to promote the success of the company for the benefit of its members as whole; as such, they will need to be able to show that adequate corporate benefit is derived from the company giving the guarantee or security. This is often more difficult in the case of upstream or cross-stream guarantees or security provided by a subsidiary to its parent or sister company. The safe approach is often to have the members of the company approve the giving of the guarantee or security by resolution.

Insolvency

Guarantees and security may be at risk of being set aside under Scottish insolvency laws if the guarantee or security was granted by a company with a certain period of time prior to the onset of insolvency. This would be the case if the company giving the guarantee or security received considerably less consideration, and as such, the transaction was at an undervalue. For such a transaction to be set aside, certain statutory criteria would have to be met, including that the guarantee or security was given within six months (or two years for connected parties) of the onset of insolvency of the affected party. Guarantees and security may also be challenged on other grounds relating to insolvency. Note that where a guarantee is given to a related company, the circumstances in which it can be set aside are far wider and, in particular, there is no requirement in these circumstances that the chargor was insolvent at the time the guarantee was given.

Financial assistance

It is unlawful for a public company to provide financial assistance for the purchase of its own (or of its holding company's) shares. The prohibition against financial assistance for private companies was abolished on 1 October 2008. Financial assistance in this context would include giving a guarantee or security in connection with the share purchase.

Common forms of guarantees

Guarantees can take a number of forms.

A particular distinction worth remembering is between a performance guarantee and a payment guarantee:

• A performance guarantee is a term used to describe both performance bonds (in the context of trade finance) and ‘see to it’ guarantees (in other contexts).
  • A performance bond describes a financial undertaking used to protect a buyer against the failure of a supplier to deliver goods or perform services in accordance with the terms of a contract. The issuer of the bond undertakes to pay to the buyer a sum of money if the seller fails to deliver the goods or perform the contracted services on time or in accordance with the terms of the contract.
  • A ‘see to it’ guarantee is a promise by the guarantor to see to it that the primary obligor fulfils its obligations under the primary contract. If the primary obligor fails to fulfil its obligations under the primary contract, the guarantor will be in breach of its obligations under the guarantee.
• A payment guarantee is narrower in scope than a performance guarantee as it only covers the payment of money rather than other contractual obligations.

Common forms of security

The law of Scotland differs greatly from that in England and Wales in relation to the forms of security which can be taken over assets located in Scotland. Scots law does not recognize a distinction between equitable and legal charges. In general, Scottish security can be taken over a much more limited range of assets than is the case in England and Wales and there is no overarching security document which would replicate an English debenture. The main forms of security available in Scotland are as follows.

Standard security

This is the equivalent of an English legal mortgage and relates to security over heritable or feuhold property (the equivalent of freehold under English law) and leasehold property for a term of more than 20 years. Standard securities follow a statutory form.

Floating charges

A floating charge is a charge over all of the assets of a company and, unlike the position in England, the floating charge is a separate legal document in Scotland covering all of the assets of a company that are held at the time of enforcement, subject to the priority of certain fixed charges and of certain other preferred debts (included a ‘prescribed part’ which is made available for unsecured creditors). A floating charge is usually enforced by way of appointment of an administrator.

Assignations in security

This is a form of security which can be created over incorporeal moveable assets in Scotland and is the equivalent of an English law assignment. However, because there is no concept of equitable security in Scotland, any assignation in security must be intimated (effectively notified to the counter party) in order for the security to be treated as valid.

Pledges

A pledge is a fixed security over corporeal moveable property. In order to perfect a pledge, the chargee, or its nominee, must have possession of the actual asset. For that reason the only form of pledge which is common to see in Scotland is a pledge over shares. In order to perfect a pledge over shares, the shares in the relevant company must be transferred to the chargee, or its nominee. This is often an issue for banks out with Scotland even though the Companies Act does largely address the various concerns that are raised in relation to this, for example, by making it clear that where shares are only held by way of security, the registered shareholder does not need to treat the relevant company as part of its overall group for various purposes including tax. It should be noted that, in addition to this, the introduction of the person with significant control regime in the UK has led to an (ongoing) debate amongst lawyers in Scotland as to whether a bank which holds shares in a company by way of security should be treated as a person of significant control in relation to that company. The view that the firm takes at present is that this is not the case. However, other firms in the market disagree.

Giving or taking guarantees

To be probative (ie admissible in court without further evidence), a guarantee needs to be in writing and signed by the guarantor.

Guarantees and other securities can be signed on a unilateral basis (ie unlike the case of English law, there is no requirement under Scots law that a guarantee should be given for consideration (although see above for other conditions).

Additionally, there is a risk that a guarantee may be set aside if it was procured by undue influence by a borrower or lender. A party being provided with a guarantee should be alive to this issue and take steps to avoid claims of undue influence by, for example, requiring the guarantor to take separate legal advice (note, this is a significant issue if the guarantor is an individual, particularly if they are a spouse of the borrower).

Giving or taking security

Some funders take the view that rather than intimate the assignation and security of a contract or write themselves up as registered members pursuant to a share pledge, they will maintain an 'unintimated' or 'unregistered' position up until such a time as they require to enforce the relevant security. This is occasionally seen in the Scottish market although DLA Piper advise against taking this approach as, if the 'intimation' occurs only at the time of enforcement, then there is a greater risk that this may be set aside as someone taking security following the onset of insolvency.

Once granted, security needs to be properly perfected before it is valid against third parties. Perfection formalities can range from having the secured asset delivered to the security holder, registration of the security and notice being given to third parties. Most charges created by a Scottish company must be registered at Companies House within 21 days of its creation. Failure to register within this time means that the charge will be void against the liquidator, administrator or any creditor of the company and the money secured by the charge becomes immediately payable.

There are no notarization requirements for security documents under Scots law.

Like guarantees, for a period after a new security interest has been granted (known as the hardening period), it is at risk of being set aside in certain circumstances under insolvency laws. Reviewable transactions include those conducted at an undervalue, preferences and invalid floating charges.