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This Practice Note considers the position on interdict and interim interdict in Scotland. For guidance on:

  1. some other forms of relief in Scottish civil litigation, see Practice Notes: Retention and rescission in Scottish civil litigation and Specific implement and interim specific implement in Scottish civil litigation

  2. other aspects of Scottish civil litigation, see: Preliminary and ongoing considerations in Scottish civil litigation—overview and Starting and progressing a civil claim in Scottish civil litigation—overview, which, in turn, link through to detailed guidance on specific aspects of dispute resolution in Scotland

  3. other key areas of Scottish law and procedure, see our Scotland toolkit, and

  4. the closest equivalent procedure in England and Wales, see: Interim and final injunctions—overview, Freezing injunctions—overview and Search orders—overview which, as well as giving an overview of these different types of injunctions, link through to more detailed guidance on various aspects of such injunctions in England and Wales

Key:

  1. CCA 1981—Contempt of Court Act 1981

  2. CSA 1988—Court of Session Act 1988

  3. CR(S)A 2014—Courts Reform (Scotland) Act 2014

  4. LR(MP)(S)A 1940—Law Reform (Miscellaneous Provisions) (Scotland) Act 1940

  5. SC(S)A 1907—Sheriff Courts (Scotland) Act 1907

Interdict—nature and scope

Interdict is a remedy granted by the court ‘against a wrong which is in the course of being committed or where there is reasonable ground for apprehending that a wrong is intended to be committed’ (Inverurie Magistrates v Sorrie).

Interdicts are personal in nature, directed purely against the party who is said to have violated or threatened the pursuer's rights (Bankier Distillery v Young Collieries).

The essential nature of interdict is that it is a preventative proceeding which looks to the future and, therefore, it will not be awarded against a completed act in the absence of any threat of repetition (Crooke v Scots Pictorial Publishing 1906 13 SLT 232 (not reported by LexisNexis®)).

It can still be ordered, however, even if some positive action is required to comply (Hampden Park v Dow).

Following the introduction of several statutory interdicts, the remedy now covers a wide scope of behaviour within a variety of areas, including:

  1. personal relationships

  2. industrial relations

  3. contract law, and

  4. property law

Interim interdict—nature and scope

A pursuer may also seek an interim interdict under section 47 of the Court of Session Act 1988 (CSA 1988) or, in the Sheriff Court, under section 84 of the Courts Reform (Scotland ) Act 2014.

In comparison with a permanent interdict, which can remain in force for an indefinite period of time, interim interdict provides a provisional remedy.

Where the conditions of grant are satisfied (see further below), interim interdict will be granted immediately by the court to preserve the status quo or prevent a temporary or imminent wrong, pending a final decision of the dispute.

Interim interdict may be sought at any stage of a process for permanent interdict, either alone or together with other remedies. However, if there is undue delay in bringing the application, the court may refuse it (Ayala v Dowell (1893) 1 SLT 374 (not reported by LexisNexis®)).

An application may be considered by the court either before or after the writ has been served on the defender. If a defender anticipates that an interim interdict may be sought against him, he can lodge a caveat with the court to ensure he is notified of any court hearing (Chapter 5 Court of Session Rules; Act of Sederunt (Sheriff Court Caveat Rules) 2006, SSI 198/2006).

In order for interim interdict to be awarded, the pursuer must show a prima facie case and the court must be satisfied that the balance of convenience falls in favour of granting the order (Scottish Milk Marketing Board v Paris).

The defender can, at any time after notice of the order, lodge a motion to recall the interim interdict. The interim interdict will subsist until it is recalled by the court.

Court’s discretion to grant interdict

As Lord Deas explained in Kelso School Board v Hunter 1874 2 R 228 at 232 (not reported by LexisNexis®):

‘interdict is an extraordinary remedy, not to be given except for cogent reasons, and even then not as a matter of right, but only in the exercise of sound judicial discretion’.

Accordingly, interdict and/or interim interdict will only be awarded on strong evidence of a wrong or of reasonable apprehension that such a wrong is intended.

For example, in a case of trespass, it must be shown that there has been actual trespass or a clear threat to trespass. A mere allegation by a party that another had no right to enter their land is not enough (Hays Trs v Young 1887 14 SLR 282 (not reported by LexisNexis®)).

Further, where an alternative legal process is available to remedy the wrong, such as a statutory appeal, interdict will not usually be available.

Bringing a competent claim for interdict

Jurisdiction

Proceedings for interdict and/or interim interdict can be brought in either the sheriff court or the Court of Session. If proceedings are brought in the sheriff court, it will be in the sheriff court where the defender is resident or where it is alleged that the wrong is being committed or...

Read More > Produced in partnership with Jim Cormack QC of Pinsent Masons LLP 29th Jul

This Practice Note considers the position on final orders for specific implement and interim orders for specific implement in Scotland. For guidance on:

  1. some other forms of relief in Scottish civil litigation, see Practice Notes: Retention and rescission in Scottish civil litigation and Interdict and interim interdict in Scottish civil litigation

  2. other key areas of Scottish law and procedure, see our Scotland toolkit, and

  3. the closest equivalent in England and Wales, see Practice Note: Equitable remedies in contractual disputes

Key:

  1. CR(S)A 2014—Courts Reform (Scotland) Act 2014

  2. LR(MP)(S)A 1940—Law Reform (Miscellaneous Provisions) (Scotland) Act 1940

Specific implement—nature and scope

Specific implement is a remedy granted by the court to compel a party to perform a non-monetary obligation (White and Carter (Councils) v McGregor and AMA (New Town) Ltd v Law).

It is the appropriate remedy when a positive act of performance other than the payment of money is sought, such as the delivery of goods or the rendering of services.

Under Scots law, and except against the Crown, specific implement is generally available to a creditor in relation to a non-monetary obligation as a matter of right in appropriate cases, ‘subject to a residual discretion vested in the court to refuse a remedy in exceptional circumstances where injustice would otherwise arise’ (William Beardmore & Co v Barry and Highland and Universal Properties Ltd v Safeway Properties Ltd).

In AMA (New Town) Limited v Law, the Inner House held that a pursuer could only be compelled to resort to damages if implement was impossible or, in exceptional circumstances, disproportionate or unreasonable.

This trend has been made very clear in a number of cases concerning 'keep open’ clauses (Highland and Universal Properties Ltd v Safeway Properties Ltd and Retail Parks Investments v Royal Bank of Scotland).

Interim order for specific implement—nature and scope

Although interdict is available on an interim basis, subject to the creditor showing a prima facie case and on an assessment of the balance of convenience between the parties, the existence of a power to make an interim order for specific implement of non-monetary obligations was only recently put beyond doubt by the CR(S)A 2014 (Church Commissioners for England v Abbey National plc and Clifford Finance Limited v Hughes 2000 SLT (Sh Crt) 19 (not reported by LexisNexis®)).

CR(S)A 2014, s 88 confers an express power on sheriffs to make such orders along with the power to grant orders regarding the interim possession of any property to which the proceedings relate.

CR(S)A 2014, s 90 concerns similar provision as regards the Court of Session.

Court’s discretion to order specific implement

Specific implement, whether final or interim, is governed by a number of principles to avoid arbitrary enforcement.

Accordingly, the court retains an overall discretion to refuse to grant an order for permanent and/or interim specific implement where:

  1. the decree sought is not sufficiently precise

  2. performance would be of a highly personal nature

  3. enforcement would cause exceptional hardship or injustice

  4. replacement performance is readily available

  5. performance of the...

Read More > Produced in partnership with Jim Cormack QC of Pinsent Masons LLP 29th Jul

Prescription

The starting point for any legal advisor in considering raising an action is ascertaining the timeframe within which any claim(s) must be brought. In Scotland, this is covered by the Prescription and Limitation (Scotland) Act 1973, which deals with the ‘prescription of obligations’ (as opposed to the ‘limitation of actions’ in England and Wales).

General principles

Before considering any timeframe within which a claim in respect of an obligation ought to be brought, it is necessary first to consider the type of obligation in question and consequently, the section of the 1973 Act to which such an obligation relates. In general terms, claims relating to the administration of pension schemes may well fall within the Prescription and Limitation (Scotland) Act 1973, s 6 although of course, potential issues can range from professional negligence claims against scheme administrators to liability for contingent debt.

The types of obligations covered by section 6 are found in Schedule 1 of the Prescription and Limitation (Scotland) Act 1973. For present purposes, they include ‘any obligation arising from, or by reason of any breach of contract’.

Section 6 provides that an obligation will be extinguished if, after a continuous period of five years:

  1. no claim has been brought in respect of it, or

  2. no relevant acknowledgement of the subsistence of the obligation has been made

The clock will start ticking on a claim on the date on which the obligation becomes enforceable. Again, such a date very much depends on the individual circumstances of the case.

When a ‘relevant acknowledgement’ of an obligation has been made remains a debatable area in Scots law. There must have been:

  1. ‘performance… towards implement’ of an obligation, or

  2. an ‘unequivocal written admission clearly acknowledging that the obligation still subsists’

See: Furtunato's Judicial Factor v Fortunato 1981 SLT 277 (not available in Lexis®Library).

The exception to the normal time rules is where a party refrained from making a claim by reason of fraud or error on the part of the person who was responsible.

In practical terms, one issue can give rise to a number of prescriptive dates which legal advisers should be aware of when advising.

Example

Facts:

  1. The trustees of X Ltd have lost confidence in their current advisers and are tendering for legal advice, including from your firm

  2. As part of the tender process, you identify a number of issues with the administration of the scheme, including the wording of a resolution in 1995 which, among other things, purported to equalise the normal retirement date to 65

  3. In January 2009, your firm is appointed to act for the trustees and is immediately instructed to consider the equalisation point

  4. In May 2014, you report back to the trustees—there is good and bad news! While the 1995 resolution effectively equalised the scheme, the same resolution was a bit of a cut and paste job from another scheme and has inadvertently given unreduced benefits to members who retire early

  5. The scheme has always been administered on the basis of reduced benefits on early retirement

There are two possible courses of action for the trustees:

  1. Option 1—take the view that the potential liability is relatively small and ‘hope the problem goes away’—if any member realises the issue (which seems unlikely), the trustees will pay up on an ad hoc basis:

    1. May 2019 is the last date on which X Ltd can bring a claim against its previous advisors in respect of the defective resolution

    2. There is a potentially indefinite period of time for members and their beneficiaries to bring a claim against the trustees

  2. Option 2—write to all affected members as soon as possible (eg in July 2009) to advise them of the error and thereafter apply to the Court of Session for rectification of the resolution:

    1. May 2019 is still the last date on which X Ltd can bring a claim against its previous advisors in respect of the defective resolution

    2. July 2019 is the last date on which a member or their beneficiaries can bring a claim against the trustees

Where the potential liability is relatively small, trustees may be tempted to base their decision on how to proceed on economic grounds. However, this approach could expose them to an indefinite period of liability. Trustees also have a fiduciary duty to administer a scheme properly, ie in accordance with the law, particularly where they become aware of a problem.

How the Scottish courts deal with pension schemes

Today's standards of scheme administration do not mirror those of twenty or thirty years ago. In times past, there was little or no distinction between actuarial and legal advice. A more relaxed approach to the need for precision prevailed. At the very least, this has left a legacy of uncertainty for those currently involved in scheme administration.

The good news for those involved in schemes north of the border is that, unlike its equivalent in England and Wales, the Court of Session is generally taking an increasingly pragmatic and commercial approach to uncertainties or inadequacies in scheme administration in the context of:

  1. the definition of ‘deed’

  2. rectification

  3. constructive interpretation

  4. compliance with amendment formalities, and

  5. ‘Bigger picture’ approach to pension schemes

Definition of ‘deed’

The leading case on what can constitute a deed in Scotland is Low & Bonar v Mercer.

Low & Bonar v Mercer—the facts

Following on from Barber v Guardian Royal Exchange Group, Low & Bonar took steps to implement age equalisation in their scheme, which involved various meetings and communications between the company and scheme actuaries. At a meeting of the board of directors of the company on 18 February 1991, it was agreed that the scheme be equalised. The chairman subsequently stated that it would be necessary to ensure communication of the change to members. Five months later in July, the board of directors of the trustees met. Having referenced the previous meeting, minutes of that meeting recorded that the board ‘resolved that the changes be implemented and the Rules amended accordingly...’.

Thereafter, announcements were sent to members advising them of the proposed change.

As is often the case, years later, during routine scheme diligence, a question arose as to whether equalisation had been effective where the scheme amendment power stated:

'The Principal Employer may at any time and from time to time with the consent of the Trustees by deed (emphasis added) alter any of the trusts, powers or provisions of this Deed…'

No definition of either ‘deed’ or ‘Deed’ was included in the scheme rules.

Arguments made by the pursuer and defender

For the pursuer (claimant), it was argued that:

  1. the minutes were simply a record of what was discussed at the meeting

  2. in order to protect members, strict formalities regarding amendment were incorporated into the scheme, and

  3. a board minute was not sufficient to constitute the ‘deed’ envisaged in those provisions

By contrast, the defender (defendant) argued that:

  1. as there was no definition of ‘deed’ in the scheme rules, a degree of flexibility could be afforded in its interpretation

  2. this was particularly the case under Scots law which, unlike English law, has no technical definition of the term

  3. a ‘deed’ would merely require to be in writing and have some degree of formality

The court’s decision

The court held that the minutes of the meeting could be considered to be a ‘deed’ in terms of the amendment powers. It agreed that:

  1. the term did not have any technical meaning in Scotland, and

  2. the only two required characteristics were that:

    1. it should have some degree of formality, and

    2. it must demonstrate an intention to create a legal relation

The minutes, the court said, did both.

Of more general significance is the comment of the court with regards to the administration of pensions schemes:

  1. pension schemes are ‘essentially contractual’ in nature and therefore any approach to interpretation should be a ‘commercially sensible’ one.

  2. pension scheme administration was often conducted ‘without elaborate legal advice’ and therefore ‘it is inappropriate that an over-legalistic approach should be taken to the niceties of the wording that is used: the practical effect of what is done is important’

Provided that the exercise of a power, in this case a power of amendment, has been properly recorded, there was no need, the court said, for it to be ‘unduly technical or restrictive in considering the niceties of its manner of exercise’.

Wider impact of the case

For those involved in providing contentious pensions advice in Scotland, the Low & Bonar decision is of some significance.

In many cases, schemes are administered according to certain assumptions for years if not decades, notwithstanding the fact that such administration may not necessarily be supported by watertight documentation.

The court may be prepared to take a pragmatic approach to legal issues on scheme administration provided that:

  1. all parties involved (for example, members, trustees and the employer(s)) were aware of the decision at the time, and

  2. it is adequately recorded

Rectification

As those involved in scheme administration are all too often aware, there are occasions where it becomes apparent that the language contained in a document, eg a deed of amendment, does not accurately reflect what parties thought it ought to at the time of drafting. Such errors often only come to light during the course of due diligence prior to a sale, consolidation of a Trust Deed and Rules or the appointment of new advisers.

General principles

Common to all UK jurisdictions is the assumption that a signed document is taken to be an accurate reflection of what parties to the document intended it to say, thus giving all involved legal certainty and protection. As a general rule, it will therefore be difficult to depart from what is typically seen as an end to all matters previously under discussion.

It may, however, be appropriate to revisit such wording where it would be ‘truly a disgrace to any system of jurisprudence if there was no way available of rectifying what would be otherwise a gross injustice’ (see Krupp v Menzies (1907) 15 SLT 36).

That being said, the court will not intervene where, at the time of drafting the document, parties simply did not turn their mind to a particular issue.

For the practitioner, rectification ought to be used:

  1. where the wording of a document is wrong, and

  2. perhaps more importantly, where parties are, broadly speaking, in agreement as to what the new wording should be

In such cases, a party or parties are asking the court to replace existing wording with an alternative version. This is to be distinguished from constructive interpretation.

Legislative framework

In Scotland, rectification is a statutory remedy under the Law Reform (Miscellaneous Provisions) (Scotland) Act 1985 (the Law Reform Act), with no common law equivalent.

An application is made to the Court of Session by way of Petition or (if in the Commercial court) Summons. If rectified, a document will have effect as if it had always been so rectified.

The Law Reform (Miscellaneous Provisions) (Scotland) Act 1985, s 8 provides:

(1) 'where (a) the document intended to express or to give effect to an agreement fails to express accurately the common intention of the parties to the agreement at the date when it was made; or (b) a document intended to create, transfer vary or renounce a right… fails to express accurately the intention of the grantor of the document at the date when it was executed'; then

(2) 'the court shall be entitled to have regard to all relevant evidence, whether written or oral'

The statutory provision is similar to the English definition of rectification found in case law:

'if, by looking at what the parties said or wrote to each other in coming to their agreement and then comparing it with the contract they signed, it can be predicated with certainty what their contract was, and that it is by common mistake wrongly expressed in the document, the document can be rectified, but nothing less will suffice"

(Chartbrook v Persimmon Homes [2009] 4 All ER 677)

Requirements for successful rectification

There are a number of hurdles to overcome for anyone seeking rectification of a document:

  1. Has there been prior agreement between parties?

    This ties in to another issue, ie that the reference point is the position of the parties at the time the document was made. Sadly, one cannot simply rely on the fact that a scheme was administered in a certain way for years following an amendment if there was no agreement before the amendment that the changes were to take place. The test is one of the balance of probabilities.

    In practice, the court will expect a party seeking rectification to produce documentation such as member communications, minutes of meetings and instructions to actuaries.

  2. Common intention?

    Whether there was a common intention between parties as to the substance of the document immediately prior to its signing will be determined objectively by the court. Written communications between parties are therefore of significance. Any ‘private, uncommunicated subjective understanding’ will be irrelevant.

    Those involved should again look at member announcements, employer and trustee minutes and any actuarial involvement, including valuations.

  3. What is the problem with the document?

    Rectification can be sought in the case of a variety of different errors or careless drafting. Examples include errors of expression of a party's intention or errors of omission.

Constructive interpretation

An application to the court for ‘constructive interpretation’ of a document has some similarities to one for rectification insofar as both are the result of wording that has broadly speaking ‘gone wrong’.

General principles

Unlike rectification, however, the wording of a document in a case of constructive interpretation is ambiguous (as opposed to wrong), with parties in disagreement as to what each intended at the time of signing. To this extent, parties do not necessarily need to provide the court with precise alternative wording.

Constructive interpretation has evolved through case law. The most notable case is one which will be familiar to practitioners both north and south of the Border: Chartbrook v Persimmon Homes [2009] 4 All ER 677. The case summarises the position as follows:

'we do not easily accept that people have made linguistic mistakes, particularly in formal documents…but… in some cases the context and background [drive] the court to the conclusion that 'something must have gone wrong with the language'. In such a case, the law [does] not require a court to attribute to parties an intention which a reasonable person would not have understood them to have'.

Commercial context

In determining how a document ought to be interpreted, the courts will look not at the prior agreement of parties to the agreement (as they would in the case of rectification) but at the commercial context in which a document was signed. The starting point is to look at:

  1. the ordinary meaning of the language

  2. as interpreted by a reasonable commercial person who would be ‘hostile to the technical interpretations and undue emphasis on niceties of language’ (Mannai v Eagle Star Life Assurance [1995] 1 WLR 1508)

So how should the commercial context within which a document was signed be illustrated, particularly where, contrary to rectification, the parties' prior intentions cannot be affirmed?

Take for example, a rule amendment purporting to equalise normal retirement age to 65 which, due to an error of drafting, excluded a certain category of member, eg deferred members. In many cases, the error in drafting is simply a result of decades of less than perfect scheme amendment, resulting in a patchwork of deeds and rules (in such an example, there is of course some cross-over between rectification and constructive interpretation).

In establishing the commercial context of the rule, one may bring to the court's attention, for example:

  1. actuarial reports and minutes of meetings discussing the Barber decision, its implications, and various options for equalisation (eg equalising...

Read More > Produced in partnership with Frances Ennis of Bellwether Green 29th Jul

The statutory framework

Generally, the legislative framework which applies to private sector occupational pension schemes governed by Scots law is the same as that which applies to the rest of the UK. In particular, the following legislation apply north as well as south of the border:

  1. the Pension Schemes Act 1993 (PSA 1993)

  2. the Pensions Act 1995 (PA 1995)

  3. the Pensions Act 2004 (PeA 2004)

The core trust law on which most private sector schemes are based is different, with Scotland having its own separate trust legislation and case law.

The Scottish judicial system is, however, completely separate so that English decisions on pensions cases are not binding in Scotland, but may provide assistance.

Differences in a number of other areas of law can impact on pensions law and practice.

Application of legislation, guidance and other policy in Scotland

When giving advice in respect of Scottish pension schemes, care must be taken to check that any legislation or other documentation referred to is actually applicable. There will be times where it is unclear, or questionable, whether certain pieces of guidance, policy or even legislation apply in Scotland.

Public sector pensions and outsourcing

In respect of work involving the public sector and outsourcing, while the broad principles are the same, there are a number of differences which need to be considered.

Most Scottish public sector outsourcings will require the Local Government Pension Scheme (LGPS) (or broadly equivalent) pension provision for any employees transferring under the outsourcing contract, although occasionally they will involve one of the other public sector schemes, such as the Principal Civil Service Pension Scheme.

The Local Government Pension Scheme (LGPS)

Scotland has its own set of regulations dealing with the Scottish LGPS. Although these broadly mirror the corresponding provisions of the regulations which apply in England and Wales, they are not identical.

Care should be taken when dealing with Scottish public sector matters that reference is made to the correct underlying legislation, and that legislative references are not out of date.

The importance of getting these points right was seen in the Court of Session decision in City of Edinburgh Council v University of Glasgow. There it was held that a quirk in the Local Government Pension Scheme (Scotland) Regulations 1998, SI 1998/366 (which was corrected in subsequent regulations), combined with the absence of any admission agreement, meant that the local authority had no power to serve an exit debt on the withdrawing employer.

Fair Deal

As practitioners will be aware, in order to protect the pension expectations of employees who TUPE transfer from the public to the private sector, the Government set standards for the pension benefits which the new employer must provide. These are sometimes referred to as ‘TUPE Plus’ requirements as they are in addition to the TUPE requirements. Over the years, these standards have gradually become more and more onerous, so that now the new employer must take on substantial financial obligations and risks.

These additional obligations apply in the same way in Scotland as in the rest of the UK, but it can sometimes be more difficult to establish whether a particular transaction or body is caught by the Treasury's ‘Fair Deal for Staff Pensions’.

Best Value—Scottish equivalent

Some practitioners may not be aware that although New Fair Deal (and its predecessor, Fair Deal) applies in Scotland, the Best Value Direction does not—that applies only to English and Welsh local authorities. However, the Scottish equivalent on Best Value is the Statutory Guidance to Local Authorities on Contracting. This Guidance was first issued in 2003 and was updated in 2006. Our understanding is that it remains in place irrespective of the fact that the English equivalent has been removed. Practitioners should:

  1. familiarise themselves with the Guidance when entering into commercial negotiations on Scottish local authority outsourcing contracts which contain pension provisions, and

  2. consider the pension risks and liabilities which may attach to a contractor or local authority as a result of compliance with the Guidance

The Guidance in relation to pension provision for new joiners seems to suggest that the contractor should avoid creating a two-tier workforce. The terms of the Guidance with respect to new joiners are unfortunately slightly ambiguous and could be interpreted as requiring LGPS/broadly comparable benefit provision for new joiners as well as employees transferring originally from the outsourcing local authority. Therefore, care must be taken to discuss this at length with the contracting authority as it is the authority which has responsibility for ensuring compliance with the Guidance. The outsourcing authority will have to decide the required pension provision for new joiners—the authority's policy to date in relation to pension provision for new joiners should always be checked on an outsourcing contract in order to ensure that it follows any policy it has in place for the sake of consistency.

Given the withdrawal of the two-tier workforce code in England, it is possible that the Guidance could be updated or indeed withdrawn altogether in future.

Other Scottish legislation

There are other areas in which Scotland has its own legislation.

For example, the Electricity (Protected Persons) (Scotland) Pension Regulations 1990, SI 1990/510 apply to protect certain members and former members of the pension schemes operated by the former South of Scotland Electricity Board and North of Scotland Hydro-Electric Boards before their privatisation.

There is one significant difference to the equivalent regulations applicable in England and Wales: the Scottish regulations provide that members will lose their 'protected person' status if they do not elect to transfer their accrued rights to the relevant scheme which they have joined for future service within two years of joining that scheme. This distinction must be made clear to all parties, as it has potentially significant consequences if Scottish members are not properly notified of their options.

Pensions on divorce—the Scottish position

Where Scottish divorce proceedings are involved, it is important for practitioners to have an understanding of the different way in which pension rights are valued and given effect to.

In Scotland, pensions are valued by obtaining a cash equivalent transfer value (CETV) of the fund as at the relevant date, being the date of separation (although there may be scope for the parties to agree to a different valuation date), which is then apportioned to the period of the marriage.

Only the value of the pension rights built up during the period of the marriage/civil partnership are taken into account, and the specific calculation is contained in reg 4 of the Divorce etc (Pensions) (Scotland) Regulations 2000, SI 2000/112.

That apportioned CETV is then treated as being equivalent to liquid assets, and no discount is applied even though the pension can only be accessed on retirement. Although pensions can be shared or offset in the same way as in England and Wales, there is no requirement for the spouse to seek a pension share.

Where a pension sharing order is made, the court may simply specify an amount to be transferred to the spouse rather than a percentage of value as in England. In Scotland, pension sharing is also possible by means of an agreement between the parties to the marriage.

The Pension Protection Fund and section 75 debts—meaning of insolvency event

Insolvency law is another area in which there are differences between the jurisdictions. It is therefore important for practitioners to be aware of what does, and does not, constitute an insolvency event for the purposes of pensions legislation in a Scottish context. This will most commonly be an issue when determining whether a section 75 debt, or a PPF assessment period, has been triggered.

PeA 2004, s 121 makes clear where additional or alternative procedures and events are considered to be insolvency events for Scottish employers for the purposes of that section.

Other practical differences between the jurisdictions

Regardless of the type of work being undertaken, there are some fundamental differences between Scots and English law, which will come to the fore in relation to:

  1. the structure of documentation, and

  2. approaches taken to the interpretation and application of certain principles following Scottish precedents

The structure of documentation governed by Scots law

It is important for practitioners in the rest of the UK to understand that under Scots law the word ‘deed’ does not have any specific or technical meaning. The key point to be aware of is that the requirements under English law for a document to constitute a deed are not applicable when dealing with documents governed by Scots law.

This was highlighted in the case of Low & Bonar v Mercer where the court held that written minutes were sufficient to amount to a deed.

As a result of the different requirements for formal validity of documents, the way in which signing dockets are structured and attestation clauses drafted on documents stated to be subject to Scots law is different from those governed by English law, and care must be taken not to apply English ...

Read More > Produced in partnership with Cameron McCulloch of Pinsent Masons 29th Jul

The rules regarding execution of documents governed by the laws of Scotland are contained in:

  1. the Requirements of Writing (Scotland) Act 1995 (RW(S)A 1995), and

  2. the Legal Writings (Counterparts and Delivery) (Scotland) Act 2015 (LW(CD)(S)A 2015)

This Practice Note considers both the traditional method of execution and execution by counterpart under Scots law.

Contracts or obligations that must be in writing

In Scotland, the general rule is that writing is not required to create a contract or a unilateral obligation or a trust.

Writing is required for the following exceptions to that general rule:

  1. contracts or unilateral obligations to create, transfer, vary or end a real right in land (excluding tenancies or rights of occupation for less than a year and private residential tenancies)

  2. creating, transferring, varying or ending a real right in land

  3. an agreement between adjoining owners to vary their mutual boundary

  4. a gratuitous unilateral obligation (other than one in the course of business) and

  5. a person making a will or becoming trustee of their own property

The remainder of this Practice Note relates to what is required for execution of documents for such excepted categories where a hard copy physical document, is to be signed. See also, Practice Note: Virtual execution under Scots law.

Valid execution is by subscription

Valid execution is achieved by the party (in the case of a unilateral document) or the parties (to a multi-party document) subscribing the document—which means signing at the end of the last page of the main body of the document. RW(S)A 1995 refers to the person signing a document as the ‘granter’.

Where a testamentary document consists of more than one sheet, valid execution is achieved if, as well as having been subscribed by the granter, it is signed by the granter on every sheet. In practice, a testamentary document is subscribed on every page.

Not all of the signatures are required to appear on the same page. It is sufficient for the signature of one granter to be added on the last page of the main body of the document and the other signatures to be added on the subsequent page or pages.

Signatures by natural persons must be either the full name set out in the document, the surname preceded at least by one forename or initials or by the signer’s ‘usual method of signing’ (although noting that this final method will not satisfy the requirements of RW(S)A 1995, s 3 and allow the signature to be self-proving). Execution by non-natural persons, such as companies, limited partnerships or unincorporated associations, is achieved by subscription by the required number of directors, members, authorised officers or other authorised signatories. There is no requirement for the signature to be the normal signature of the person adding it.

Where a document does not relate to land, annexations to it do not have to be signed provided that they are:

  1. referred to somewhere in the document—perhaps in the defined terms section of the document eg 'Schedule means the Schedule annexed and executed as relative to this Contract', and

  2. are identified on the annexation as being the relevant annexation eg by wording along these lines appearing at the top of the annexation itself—'This is the Schedule referred to in the foregoing Contract between A and B of property C'

In order to minimise the number of pages that have to be signed, Scottish documents tend only to have a single schedule, split into parts—rather than a number of schedules.

Finally, if:

  1. the document relates to land, and

  2. the annexation describes or shows any part of the land

then the annexation must be signed—anywhere on it, not necessarily at the foot. This could apply eg to a plan showing the site boundary or photographs showing the condition of the property. This can be troublesome (eg to the signing parties to a lease which includes a schedule of condition with many photographs) and so planning is important if there are a large number of annexations to be signed in a time-sensitive transaction.

In practice, any schedule to a testamentary document will be subscribed by the granter on every page.

For example ordinary execution clauses, see Precedents:

  1. Execution clause (Scotland)—ordinary execution by a company by a director

  2. Execution clause (Scotland)—ordinary execution by a company by an authorised official

  3. Execution clause (Scotland)—ordinary execution by a company by the company secretary

  4. Execution clause (Scotland)—ordinary execution by a partner for a partnership or a limited liability partnership, signing firm name on behalf of the firm

  5. Execution clause (Scotland)—ordinary execution by a partner, for a partnership or a limited liability partnership, signing own name

  6. Execution clause (Scotland)—ordinary execution by an attorney acting under a power of attorney

  7. Execution clause (Scotland)—ordinary execution by an individual

  8. Execution clause (Scotland)—ordinary execution by two partners, for a limited liability partnership signing own names

  9. Execution clause (Scotland)—ordinary execution on behalf of a body corporate, by an authorised signatory, board member or the entity's secretary

  10. Execution clause (Scotland)—ordinary execution on behalf of a limited company, by an authorised signatory, director or company secretary

Self-proving execution—adding a witness

Although, to be validly executed, a document need only be signed as mentioned above, witnessing is required to get self-proving status for the execution. In addition, in order to minimise the risk of rejection of an application for registration in the Land Register, the subscription and the signature of any witness should be legible in order that the document may be said to ‘bear to have been signed’ by the granter and the witness respectively.

If the execution of a document is self-proving, then it is presumed to have been signed by the grantor(s). Anyone relying on that document is not required to produce any extra evidence that it was signed by the granter(s)—although it is open to a challenger to prove that it was not so signed. Conversely, if a document has only been subscribed, but not witnessed, anyone seeking to rely on it would have to prove that it has been subscribed by the granter(s)—perhaps by having the granter(s) appear in court to confirm their signature. This could be problematic if the person signing had died or simply could not be found or was unwilling to cooperate.

To make an execution self-proving, only a single witness is required and that person must sign on the last page, and provide their full name and address (which are then completed in the testing clause—or signing block—on the last page). There is no need for the witness to sign any annexations. The completion of the testing clause or signing block may be done at any time prior to the document being founded upon in legal proceedings or registered for preservation.

For example self-proving execution clauses, see Precedents:

  1. Execution clause (Scotland)—self-proving execution by a company by two authorised officials

  2. Execution clause (Scotland)—self-proving execution by a company by two directors or a director and the company secretary

  3. Execution clause (Scotland)—self-proving execution by a partner for a partnership or a limited liability partnership, signing firm name on behalf of the firm

  4. Execution clause (Scotland)—self-proving execution by a partner, for a partnership or a limited liability partnership, signing own name

  5. Execution clause (Scotland)—self-proving execution by an attorney acting under a power of attorney

  6. Execution clause (Scotland)—self-proving execution by an individual

  7. Execution clause (Scotland)—self-proving execution by two partners, for a limited liability partnership signing own names

  8. Execution clause (Scotland)—self-proving execution on behalf of a body corporate, by an authorised signatory, board member or the entity's secretary

  9. Execution clause (Scotland)—self-proving execution on behalf of a body corporate, by an authorised signatory, director or company secretary and affixing the common seal

  10. Execution clause (Scotland)—self-proving execution on behalf of a limited company, by an authorised signatory, director or company secretary

Scottish property registers

Even if the parties to a document are prepared to forego the evidential benefits of self-proving execution, registration in certain registers cannot take place unless the document is self-proving or it bears a certificate endorsed by court that it was subscribed by its granter (or there exists a decree to that effect). Any document that is to be registered in either of the two Scottish property registers (the Land Register or the Register of Sasines) or in the Books of Council and Session will have to be executed in a self-proving manner, bear such a certificate or be the subject of such a decree.

For this reason alone, the execution of most Scottish documents that relate to land will be witnessed.

Delivery required for a document to be effective

For a document to be effective it must not only be validly executed but it must also be delivered.

Delivery of documents executed in a traditional manner, can be achieved physically or electronically.

Electronic delivery can be done by transmitting (by fax or as an attachment to an email) an electronic copy of:

  1. the whole of the signed document, or

  2. the pages or parts of the signed document that have been signed—provided that these pages or parts are sufficient to show that they are part of the document

Date of the document and date of delivery of the document

Scottish documents are described with reference to the date upon which they were executed.

A unilateral document although executed is only effective from the date of delivery. There is no requirement to deliver a testamentary document.

For a traditionally executed multilateral document, unless the parties have agreed something different, the document will be effective once the last party has signed it.

Some solicitors opt to add this date of delivery to the document post execution—usually on the front page or in the testing clause (or signing block information) on the last page.

Physical delivery still required in most cases

Whilst delivery, for the purposes of creating binding obligations under a document, can be achieved electronically, the electronic copy of the document or part of it does not, and is not deemed to, constitute the physical document. Sometimes the actual 'wet ink'-signed physical document is needed eg:

  1. if it requires to be registered in a public register such as the Land Register, or

  2. to provide a court with best evidence

As part of the response to the Coronavirus (COVID-19) outbreak in the UK, it will soon be permitted to submit a document for registration in the registers maintained by Registers of Scotland (including the Land Register) by electronic means. This is subject to the Keeper publishing guidance as to what constitutes acceptable electronic service. At the time of writing this guidance has not been issued and electronic submission remains impossible.

In most cases, therefore, even if the binding obligations have been created by electronic delivery, the party who wishes to be able to rely on the document should ensure that physical delivery follows soon after electronic delivery.

Assurance regarding speedy delivery of the physical document, after electronic delivery, will usually be covered by the sending solicitor providing the following confirmations in their email to the receiving solicitor:

  1. from the instant of sending, the sending solicitor is holding the document to the order of the receiving solicitor, and

  2. the signed document will be posted or delivered to the receiving solicitor on that day or the next working day

For further information on electronic documents and their execution under Scots law, see Practice Note: Virtual execution under Scots law.

Counterpart execution—Scotland

Execution in counterparts in Scotland is governed by the Legal Writings (Counterparts and Delivery) (Scotland) Act 2015 (LW(CD)(S)A 2015) which came into force on 1 July 2015.

Counterpart execution in Scotland and the law

LW(CD)(S)A 2015 permits the execution of Scots law documents in counterpart. This allows two or more identical copies of a document to be subscribed by different parties in different locations meaning it is not necessary for all parties to sign the same physica...

Read More > Produced in partnership with David Blair of Anderson Strathern 29th Jul

The rules regarding Scottish electronic documents and their execution are contained in:

  1. The Requirements of Writing (Scotland) Act 1995 (RW(S)A 1995)

  2. Regulation (EU) No 910/2014 on electronic identification and trust services for electronic transactions in the internal market (eIDAS)

  3. The Land Registration etc (Scotland) Act 2012 (LRE(S)A 2012)

  4. The Electronic Documents (Scotland) Regulations 2014, SSI 2014/83 (SSI 2014/83)

  5. The Land Registration etc (Scotland) Act 2012 (Commencement No.2 and Transitional Provisions) Order 2014, No. 41 (C. 4) (2014 Order)

  6. The Land Register of Scotland (Automated Registration) etc Regulations 2014, and

  7. The Legal Writings (Counterparts and Delivery) (Scotland) Act 2015 (LW(CD)(S)A 2015)

The Law Society of Scotland has issued a ‘beta’ version of its guide on electronic execution of documents, see: Law Society of Scotland—Electronic signatures guide (beta version).

Electronic documents permitted under Scots law

Any document that is required to be in writing under Scots Law can be an electronic document except for wills and other testamentary writings.

The law is in place to permit electronic wills and other testamentary writings but it has not yet been brought into force.

Although electronic wills and other testamentary writings are the only exception in law, in practice there is another—being documents transferring or creating title to property to be registered in the Land Register, the Books of Council and Session and the Register of Sasines eg dispositions or leases.

Documents that are to be registered in the Land Register must be PDFs created using the digital registration system. Currently, no such system is in place, however, so electronic conveyancing other than under Automated Registration of title to Land (ARTL) has not yet begun.

As part of the response to the coronavirus (COVID-19) outbreak in the UK, it will soon be permitted to submit a document for registration in the registers maintained by Registers of Scotland (including the Land Register) by electronic means. This is subject to the Keeper publishing guidance as to what constitutes acceptable electronic submission. At the time of writing this guidance has not been issued and electronic submission remains impossible. The Registers of Scotland have indicated it may be the case in due course that scanned pdfs of traditional deeds can be lodged by attaching them to an email sent to Registers of Scotland.

At present therefore the bulk of electronic documents executed by electronic signature tend to be contracts executed on behalf of clients by their solicitors—to whom the appropriate electronic signatures have been issued (see AES and Scottish solicitors below).

For more information about execution of traditional documents ie hard copy 'wet-ink' signed documents, as distinct from electronic documents under Scots law, see Practice Note: Execution of documents under Scots Law.

Electronic documents as distinct from electronic copies of traditional documents

This Practice Note covers the electronic (or digital) execution of electronic documents of a type that are required to be in writing.

This should not be confused with the electronic transmission of a physical document eg the attachment to a fax or email of an electronic copy of a physical document that was executed in hard copy by a wet-ink signature.

Also, other contracts (of the type that do not have to be in writing) can be created by electronic exchanges—without the need for the use of an electronic or digital signature eg any online purchase of consumer goods.

Valid electronic execution and the advanced electronic signature

Electronic execution (otherwise described as the authentication of the document) is achieved by the application to the electronic document of the advanced electronic signature (AES) of the granter of, or party to, that document. Application is done by the granter or party incorporating their AES in the document, or logically associating the AES with the document.

It should be noted that an advanced electronic signature is not the only form of electronic signature. Simpler examples would include:

  1. signing a touchscreen device

  2. pasting the image of a signature onto a pdf or word document

  3. clicking ‘I agree’ or other confirmatory declarations in an electronic form

However these ‘simple electronic signatures’ do not meet the requirements of the Electronic Documents (Scotland) Regulations 2014, SSI 2014/83 for the purposes of documents which require to be in writing as a result of RW(S)A 1995, s 1(2). They may, however, carry some additional evidential value for documents and contracts which do not require to be in writing in terms of RW(S)A 1995. That evidential weight is likely to vary from case to case.

An AES is one which is:

  1. uniquely linked to the signatory

  2. capable of identifying the signatory

  3. created using means that the signatory can maintain under their sole control, and

  4. linked to the data to which it relates in such a manner that any subsequent change of the data is detectable

An AES will rarely include the name of the signatory—in practice it is more likely to be a number or a combination of numbers, letters and other characters.

Before any AES is applied to an electronic document, any annexations to that document must be:

  1. referred to in the document itself

  2. identified on their face as being the annexation that is referred to in the document, and

  3. annexed to the document

Provided that this is done, the AES only needs to be applied once, and does not need to be applied separately to any of the annexations (as has to be done for physical document execution).

Where a party to an agreement being signed by AES is a partnership, the AES must be applied by a ‘partner’ or by someone properly authorised to sign by the partnership.

For limited liability partnerships, the AES must be applied by a member (reg 5(3)), in the case of a company, it may be applied by a director, the company secretary or by a person authorised by the company (reg 5(4)). The regulation makes provision for AES application in other special cases and should be referred to.

Self-proving electronic execution

Although, to be validly executed, an electronic document need only have the AES of the parties applied to it, something more is required to get self-proving status for the electronic document.

If the execution of the electronic document is self-proving, it is presumed to have been authenticated (or electronically signed) by, or on behalf of, the parties to it—although it is open to a challenger to prove that it was not so signed.

To make an electronic execution self-proving, the AES must be certified by a qualified certificate for electronic signature as defined in Article 3(15) of eIDAS. These certificates are issued by third party trust service providers. This certification under electronic execution is the equivalent of the witnessing of a physical document. For the avoidance of doubt, an electronic signature does not become self-proving by virtue of having been witnessed, even if the witness signs (electronically or in hard copy) to confirm that they have witnessed the electronic signature being applied.

If the electronic signature is not self-proving, practitioners will need to assess the risk of using it as a means to execute the document. Relevant factors will include the likelihood of a dispute over the document and the importance of the subject matter, as well as whether it will be presented for registration. This assessment is one which requires to be carried out with non-electronic documents where signatures are applied but not witnessed.

Details of the requirements for qualified certificates and their providers are set out in Annex 1 and 2 of eIDAS.

AES and Scottish solicitors

The Law Society of Scotland has set up a system for electronic signatures which complies with all of the requirements for an AES. Many Scottish solicitors have now been issued with their own AES, embedded within a smartcard which includes their practising certificate.

The Law Society of Scotland system incorporates the qualified certificate within the AES applied by the signatory solicitor—so that the certifica...

Read More > Produced in partnership with David Blair of Anderson Strathern 29th Jul

Scots contract law has in many ways become similar to its English counterpart despite their different roots. Some English law concepts, such as undue influence and anticipatory breach, have been incorporated into Scots contract law and some leading authorities are the same in both systems. However, there are some key differences of which it is important to be aware. The aim of this Practice Note is to highlight some of the key differences in Scots contract law. In particular, the Practice Note looks at:

  1. the formation of contracts

  2. rights under contracts, and

  3. enforcing rights following a breach of contract

Formation of contracts

The doctrine of unilateral promise

The first distinction which should be considered is that under Scots law it is possible for a unilateral promise to be binding on the party making that promise without the requirement for a formal acceptance. A promise can become binding on the promisor on the basis of their actions alone and does not require any action on the part of the promisee.

A recent example of a case involving a promise was the case of Royal Bank of Scotland v Carlyle, where the Supreme Court held that the first instance court was correct to have held that a property developer's bank had made a legally binding promise to fund a particular development.

Lord Hodge noted, at paragraph 35, that:

'In Scots law a unilateral undertaking that is intended to have legal effect, such as a promise, is binding without consideration passing from the promisee. The promise may but does not need to be collateral to another contract. The issue is simply whether a legally binding obligation has been undertaken'

A promise is therefore distinguishable from a contract.

Essential contract terms

Modern Scots law follows the principle that agreements which intended to have legal effect should be classed as contracts. This is the necessary starting point to determine whether a contract has been formed.

Attention should be paid to whether there has been agreement on the essentials of the contract (which is referred to as a consensus in idem). Without this a valid contract will not have been formed. However, the actual terms which it is necessary to agree will be a question of fact and an important difference arises here because, under Scots law, there will not always be a requirement for a consideration to have been agreed.

An example of this is the case of Avintair v Ryder Airline Services where the Inner House found that a contract existed even though there had been no agreement regarding the remuneration (in the form of commission) to be paid to consultants for their services. They considered that, as the consultants had performed their part of the contract without agreement regarding the level of remuneration due to them, the law would imply from the parties conduct that a reasonable sum should be paid.

In the event of a dispute, in addition to considering whether all the legally essential elements of a bargain have been agreed, the Scottish courts will adopt an objective approach with regard to what the parties said and did in negotiations. They can consider evidence of the negotiations and the acts of the parties after the time of conclusion of the bargain and look at the facts and circumstances of the case to determine whether a contract has been formed. It is therefore possible that, following this approach, the circumstances of a case will mean that a price is classed as an essential term.

This focus on the facts and circumstances of a case can also mean that the use of the phrase 'subject to contract' in negotiations relating to contract would not necessarily have the intended effect of demonstrating that a contract has not yet been formed as it has been held that there is no rule under Scots law which provides that the use of this phrase automatically excludes a concluded agreement.

For further information on the general position in relation to contract terms under English law, see Practice Notes: Contract interpretation—when is a statement a representation or a contractual term? and Contract interpretation—express terms in contracts.

Execution of a contract

It is possible for a contract to exist without being set out in writing in Scots law although, for certain types of contracts, setting the terms out in writing will be essential. The requirements in relation to this are set down in the Requirements of Writing (Scotland) Act 1995 which also sets out the requirements with regards to the execution of contractual documents and the requirements to make written documents self-proving.

It was, until recently, the case that it was not possible for a document to be executed in counterpart under Scots law. However, this was reformed in 2015 when the Legal Writings (Counterparts and Delivery) (Scotland) Act 2015 came into force. This Act introduced substantial practical changes intended to modernise Scots law and bring it into line with the rest of the UK by making it possible to create a legally binding document when copies had been signed in counterpart and also allowed for the delivery of documents electronically.

For more on the execution of documents under Scots law, see Practice Notes: Execution of documents under Scots law and Virtual execution under Scots law.

Rights under a contract

Waiver of rights

In Scotland the situations under which a party can waive their rights in relation to a contract are covered by the concept of 'personal bar' which is similar to estoppel. Under the doctrine of personal bar, a party will lose the ability to enforce rights under a contract against a second party where the first party, either through their words or course of conduct, justifies the second party in believing that a particular state of facts exists and the second party then acts on that belief to their prejudice. It is important that the second party is induced into acting on the basis that the first party consents to them acting in this way, rather than the secured party simply believing that they are entitled to act in this way, as the latter option will not be sufficient to engage the personal bar doctrine.

Transferring rights—assignation and assignment

Under Scots law, there is no distinction between statutory and equitable assignments as the Law of Property Act 1925 does not apply in Scotland. In accordance with section 1(2) of the Requirements of Writing (Scotland) Act 1995, it is not always necessary for an assignment to be in writing under Scots law (although it will require to be in writing if the assignment relates to land). However, Scots law does require the additional step of the intimation of an assignment before any rights can be enforced by the assignee.

Rights for third parties

The rules governing the rights which third parties can have in relation to a contract are different in Scotland as the legislative provisions which are set down in the Contracts (Rights of Third Parties) Act 1999 (C(RTP)A 1999) do not apply in Scotland. Traditionally the applicable rules in Scotland were set out in the common law doctrine of jus quaesitum tertio.

In order for these types of rights to arise under a contract, it is necessary for there to be evidenced in the contract, an intention (which can be either expressly stated or implied) by the parties to the contract to confer a benefit upon an identifiable third party who does not, necessarily, need to be named or even be in existence at the time of formation of the contract. It was held by the House of Lords in the case of Carmichael v Carmichael's Executrix that it is necessary for the third-party right to have become irrevocable before third party rights could arise under a contract. This may occur through:

  1. delivery of the document containing the relevant rights t...

Read More > Produced in partnership with Morton Fraser LLP 29th Jul

This Practice Note considers exclusion and limitation of liability in business-to-business (B2B) contracts. It provides guidance on the common law and statutory controls affecting exclusion and limitation of liability clauses (also known as limitation of liability clauses, limitation clauses, exclusion of liability clauses, exclusion clauses and exemption clauses), including the provisions of the Unfair Contract Terms Act 1977 (UCTA 1977) and the Misrepresentation Act 1967 (MA 1967).

It looks at what types of clauses constitute exemption clauses and the three key issues to consider when drafting such clauses or analysing them in a dispute:

  1. incorporation

  2. construction, and

  3. statutory controls

It also considers the court’s approach to the exclusion or limitation of liability for certain types of breach (eg fundamental breach) and types of loss (eg direct loss, indirect and consequential loss, loss of profits, loss of use and loss of data), some of the common ways in which parties exclude or limit liability (eg financial caps, time bars, excluding rights of set-off) and exemption clauses and third parties.

For an overview of each section in this Practice Note and links to summaries of the key issues addressed, see: Quick view—contents and navigation below.

In this Practice Note, exclusion and limitation of liability clauses are collectively referred to as ‘exemption clauses’.

Drafting and negotiating exemption clauses

For a checklist of issues to consider when drafting or negotiating a limitation of liability provision, see: Drafting and negotiating a limitation of liability clause—checklist.

The Checklist sets out general drafting points for limitation of liability clauses, key issues to consider, party specific considerations, guidance on drafting financial caps, a summary of the key common law and statutory controls discussed in detail in this Practice Note, and some examples of other ways to limit or exclude liability.

For a short form and long form limitation of liability clause for use in a B2B contract, see Precedent: Limitation of liability clause.

Exclusion and limitation of liability in business-to-consumer (B2C) contracts

A different statutory regime applies to B2C contracts and it is generally more difficult for businesses to exclude or limit their liability in relation to consumer contracts. For more information, see Practice Notes:

  1. Exclusion and limitation of liability—business-to-consumer

  2. Consumer Rights Act 2015—unfair terms

The key issues

When considering the effectiveness of an exemption clause, the following key issues must be considered:

  1. incorporation—has the clause been incorporated into the contract?

  2. construction—does it cover the relevant losses and breaches?

  3. statutory controls—is it affected by legislation?

This Practice Note considers these issues in turn, providing guidance when drafting exemption clauses or analysing them in a dispute.

The ‘Quick view’ table below provides an overview of the contents of each section in this Practice Note.

Quick view—contents and navigation

The table below provides an overview of the content in each section of this Practice Note to assist in its navigation.

Links are provided to each section of this Practice Note, together with links to the ‘Quick view’ tables which provide brief summaries of the key points and quick tips to address the issues raised.

Section of Practice Note: Contents of section:
What are exemption clauses?

For a summary of the key points from this section and quick tips, see: Quick view—what are exemption clauses?
—What are some examples of common ways in which parties exclude or limit liability in a contract?

—How do the courts determine whether a clause is an exemption clause?

—What clauses do not constitute exemption clauses?

—Are exemption clauses defined in UCTA 1977?

—Are force majeure clauses exemption clauses?

—Are indemnities exemption clauses?
Incorporation

For a summary of the key points from this section and quick tips, see: Quick view—incorporation.
—Signed documents

—Unsigned documents

—Onerous/unusual clauses

—Are exemption clauses ‘onerous or unusual’ clauses?

—How are these principles applied in practice?

—How can standard terms become incorporated into an agreement?

—Non-contractual notices/disclaimers

—Points to note for effective incorporation
Construction

For a summary of the key points from this section and quick tips, see: Quick view—construction.
—Who bears the burden of proof?

—Case law on construction of exemption clauses

—General rules of contract interpretation

—The court’s approach to exemption clauses:
  1. pre-UCTA 1977—contra proferentem and strict construction

  2. post-UCTA 1977—common sense principles


—Fundamental principles of the modern approach

—Negligence and the Canada Steamship guidelines:
  1. how does the court determine whether a clause covers negligence?

  2. example wording considered by the courts

  3. continued relevance of the Canada Steamship guidelines

  4. notices/disclaimers excluding or limiting tort liability


—Are exclusions treated differently to limitations?

—Purpose of the contract, statement of intent and leaving a party with no remedy:
  1. statement of intent and leaving a party with no remedy

  2. criticisms of the statement of intent rule

  3. Kudos and Astrazeneca in context

  4. how do these principles affect the construction of exemption clauses?


—Considering the document as a whole:
  1. inconsistencies


—Representations as to the effect of exemption clauses
Types of breach

For a summary of the key points from this section and quick tips, see: Quick view—types of breach.
—Fundamental breach

—Deliberate repudiatory breach

—Fraud
Types of loss

For a summary of the key points from this section and quick tips, see: Quick view—types of loss.
—Direct loss

—Consequential and indirect loss

—Special damages

—Loss of profit:
  1. examples of ‘loss of profit’ interpretations

  2. what is a claim for ‘loss of profits’?


—Loss of use

—Loss of data
Statutory controls under UCTA 1977

For a summary of the key points from this section and quick tips, see: Quick view—statutory controls under UCTA 1977.
—What is an exemption clause for the purposes of UCTA 1977?

—Scope of UCTA 1977:
  1. what are contract terms or notices?

  2. what is ‘business liability’?

  3. what contracts are excluded from the scope of UCTA 1977?

  4. what is an international supply contract?

  5. what states are considered part of the UK for the purposes of UCTA 1977?

  6. what impact does UCTA 1977 have on other legislation?


—Negligence liability

—Liability arising in contract:
  1. who bears the burden of proof?

  2. what are ‘standard terms of business’?

  3. standard forms drafted by trade/industry bodies

  4. when does section 3(2)(b) of UCTA 1977 apply?

  5. does section 3(2)(b) of UCTA 1977 apply to entire agreement clauses?

  6. does section 3(2)(b) of UCTA 1977 apply to force majeure clauses?


—Implied terms for sale and supply of goods:
  1. quick view—exclusions and limitations of implied terms

  2. construction of implied term exclusions

  3. example of application

  4. what about services contracts?

  5. exclusions


—The reasonableness test:
  1. who bears the burden of proof?

  2. statutory guidelines

  3. guidance provided by case law

  4. the relevance of insurance

  5. are limitations more likely to be reasonable than exclusions?

  6. effect of unreasonableness

  7. appellate court’s approach to reasonableness

  8. case law on unreasonableness


—Anti-avoidance measures
Statutory controls under the MA 1967

For a summary of the key points from this section and quick tips, see: Quick view—statutory controls under the MA 1967.
—Misrepresentations:
  1. who bears the burden of proof?

  2. when does the MA 1967 apply?

  3. negligent misstatement

  4. fraudulent misrepresentation

  5. agent’s authority

  6. points on construction of exemptions for misrepresentations

Ways of excluding/limiting liability

For a summary of the key points from this section and quick tips, see: Quick view—ways of excluding/limiting liability.
—Financial caps:
  1. construction of financial caps

  2. location of financial cap in the contract

  3. application of UCTA 1977 to financial caps


—Time bars:
  1. construction of time bars

  2. application of UCTA 1977 to time bars


—Excluding rights of set-off:
  1. application of UCTA 1977 to ‘no-set off’ clauses

  2. insolvency and set-off


—Auditors and ‘Bannerman’ clauses
Other issues

For a summary of the key points from this section and quick tips, see: Quick view—other issues.
—Exclusive remedies clauses

—Exemption clauses and third parties:
  1. third parties obtaining the benefit of an exemption clause

  2. original parties using exemption as a defence to a third-party claim

  3. other exceptions


—Exemption clauses in the context of specific contract types

—Frequently asked questions:
  1. can I exclude liability entirely?

  2. should an exemption apply in circumstances of wilful default or gross negligence?

  3. what types of breach are commonly carved out of exemption clauses?

  4. does any part of an exemption clause need to be in capital letters?

  5. do I need to draw specific attention to exemption clauses?

  6. what is the general approach of the courts to exemption clauses?

  7. if a contract contains no exclusions or limitations, is liability effectively uncapped?

Quick view—what are exemption clauses?

This section considers what types of clauses constitute exemption clauses and how the courts determine whether a clause is an exemption clause.

To navigate to this section, go to: What are exemption clauses?

Topics Key points Quick tips
What are exemption clauses? Exemption clauses are used to apportion risk by excluding or limiting liability.

There are broadly three categories—clauses which exclude or limit:

—a party’s duties
—liability for breach of certain duties
—rights or remedies available to the innocent party
Do not assume that something is or is not an exemption clause on the basis of clause headings or where in the contract it is located.
What are some examples of common ways in which parties exclude or limit liability in a contract? Exclusions and limitations of liability can take many forms, including exclusions of implied terms or specific types of loss, time bars, financial caps, exclusions of remedies, indemnities and entire agreement clauses.
How do the courts determine whether a clause is an exemption clause? Whether a clause is an exemption clause is a matter of substance and effect, not form. Focus on the effect and substance of the clause—is the effect to exclude, limit or transfer liability?

If yes, the clause is likely to be considered an exemption clause.
Are exemption clauses defined in UCTA 1977? UCTA 1977 does not define exemption clauses but provides a non-exhaustive list of forms that exemption clauses can take. UCTA 1977 cannot be evaded by drafting exemption clauses in such a way that they fall outside of the traditional form of exemption clauses.
Are force majeure clauses exemption clauses? Force majeure clauses have been said by the courts not to be exemption clauses but the distinction is a difficult one to draw given that the effect can be the same.

Such clauses may be subject to the reasonableness test under section 3(2)(b) of UCTA 1977.
Force majeure clauses and indemnities can in certain circumstances amount to exemption clauses.
Are indemnities exemption clauses? An indemnity clause may be treated as an exemption clause if it has the effect of transferring liability.

Quick view—incorporation

This section considers how terms are incorporated into a contract between two parties and what steps a party must take in order to ensure that terms are effective against the other party.

To navigate to this section, go to: Incorporation.

Topics Key points Quick tips
Contract For an exemption clause to be effective, it must be properly incorporated into the agreement between the parties. Take care to ensure that an exemption clause is in fact incorporated into the contract, in particular if it is set out in a separate ‘terms and conditions’ document.

Give the terms and conditions containing the exemption clause to the other party at the time the contract is formed.

Draw the other party’s attention to the terms and conditions in writing or on the face of the document (eg on the front page of an order form).

Take reasonable steps to highlight exemption clauses and any other onerous or unusual terms. The more unusual or onerous a term is, the more prominence must be given to it.

Get the other party to sign the terms and conditions containing the exemption clause as evidence of acceptance.
Signed documents The general rule is that, in the absence of fraud or misrepresentation, a party is bound by terms or conditions in a document they have signed, irrespective of whether they have read it.
Unsigned documents In order to bind a party to terms or conditions contained in an unsigned document, that party must be given sufficient notice of them before the contract is made.
Onerous / unusual clauses Any term or condition that is particularly onerous or unusual must be fairly and reasonably brought to the party’s attention for it to be incorporated. The more unusual or onerous a clause is, the greater prominence must be given to it.
How can standard terms become incorporated into an agreement? There are several ways in which terms and conditions can become incorporated, including by reference, by conduct or as a result of previous dealings.
Non-contractual notice / disclaimer Similar principles as to notice also apply to non-contractual documents including exemptions.

For a non-contractual notice or disclaimer to be effective, reasonable steps must be taken to bring the disclaimer or notice to the attention of the other party.
Take reasonable steps to bring the disclaimer or notice to the attention of the other party.

The more unusual or onerous the disclaimer or notice is, the more prominence should be given to it.

Quick view—construction

This section considers the construction of exemption clauses by the courts and the various common law principles that have been developed in case law.

To navigate to this section, go to: Construction.

Topics Key points Quick tips
The issue In order for an exemption clause to be effective, it must be:

—clear and unambiguous
—cover the liability or obligation in question
Be precise in your drafting.

Clearly identify:

—what types of losses are excluded or limited (eg loss of profits, consequential loss), and
—under what circumstances those losses are excluded or limited (ie cause / origin) (eg repudiatory breach)
Who bears the burden of proof? It is generally for the party seeking to rely on the clause to prove that it covers the liability or obligation in question.

However, if there are exceptions to the exemption, the claimant has to establish that the case falls within the exception.
Consider under what circumstances the exemption clause is likely to be invoked and determine whether it clearly covers the liability or obligation of most concern.

Consider whether the clause clearly carves out liability or obligations that you do not want to exclude or limit.
Case law Case law on construction pre-dating UCTA 1977 and/or Investors Compensation Scheme v West Bromwich Building Society [1998] 1 All ER 98 should be treated with caution. Treat case law on construction with caution.

Do not rely on a specific case as guidelines or authority for the way in which particular wording or drafting will be construed by the courts (even if the wording used is very similar or identical).

Context is key.
General rules of contract interpretation There is no simple set of rules to follow when it comes to construction, but some general principles have been developed by the House of Lords and the Supreme Court, which apply to the construction of contracts generally. Remember that while the general principles and rules of contract interpretation provide useful guidelines, how an exemption clause will be construed will depend largely on the individual facts of the case.
The court’s approach to exemption clauses Although strict construction and the contra proferentem principle are less important following UCTA 1977 and the general approach to construction following Investors Compensation Scheme, the principle may still be applied by the courts where there is ambiguity.

The contra proferentem principle will not apply where:

—the exclusion clause is clear and unambiguous
—the clause is a mutual clause (ie reciprocal)
—the parties are of equal bargaining power

If the general principles of construction provide a clear meaning, the court must give effect to that meaning and is not entitled to strain the construction to avoid the result.
Ensure that exemption clauses are drafted clearly and unambiguously so that a clear meaning can be ascertained to avoid the application of the contra proferentem principle.
Fundamental principles of the modern approach Some fundamental principles of the court’s modern approach to the construction of exemption clauses are:

—the approach taken is the same as for any other term of a contract
—clear words must be used to exclude or limit remedies arising by operation of law
—express language must be used to exclude or limit obligations implied by law
—parties can limit or exclude their remedies for breach of contract (including repudiatory breach) by using clear words
—the contra proferentem applies only if the other canons of construction cannot resolve the ambiguity
Use clear words and express language if you are excluding or limiting remedies arising by operation of law or obligations implied by law.

Be clear as to what types of breach the exclusion or limitation should and should not apply to. For example, does it apply in the event of a repudiatory or deliberate breach?
Negligence and the Canada Steamship guidelines The Canada Steamship guidelines continue to be of relevance when determining whether an exemption clause extends to liability for negligence although they are now treated as guidance only, with the court focusing on the parties’ intentions. Depending on the wording used, exemption clauses can have the effect of limiting or excluding liability in tort as well as in contract.

Expressly refer to negligence in the exemption clause.
Are exclusions treated differently to limitations? In a number of cases, the courts have held that an exclusion clause will be interpreted more strictly than a limitation clause. When drafting exemption clauses, assume that the courts may construe exclusions more strictly than limitations.
Purpose of the contract, statement of intent and leaving a party with no remedy If an exemption clause is so broad that it defeats the main purpose of the contract, the courts may limit or modify the clause to the extent necessary to give effect to the main object and intent of the contract.

If an exemption clause deprives one party’s stipulations of all contractual force (eg leaves a party with no remedy), the courts may apply an alternative interpretation if available.
Avoid drafting broad exemption clauses that leave a party with no remedy or exclude liability in respect of all contractual obligations.
Considering the document as a whole When construing the exemption clause, the courts will look at the document as a whole.

This means that an exemption clause may be interpreted in conjunction with other clauses in the contract, including, for example, entire agreement clauses.

Be wary of creating collateral contracts or express terms via oral assurances that could override the exemption clause.
Consider the exemption clause in the context of the contract as a whole.

Consider how other clauses interact with, or could impact the interpretation of, the exemption clause.

Look out for entire agreement clauses and non-reliance clauses.

Avoid inconsistencies.

Include an entire agreement clause to preclude reliance on oral assurances which may otherwise override the exemption clause.

Consider any schedules or annexes which may override exemption clauses in the main body of a contract. Include a clause which specifies the order of precedence in the event of a conflict.

Quick view—types of breach

This section considers how certain types of breach have been construed by the courts in the context of exemption clauses.

To navigate to this section, go to: Types of breach.

Topics Key points Quick tips
Fundamental breach It is a matter of construction in each case to determine the extent to which an exemption clause applies to any particular breach of contract, fundamental or otherwise. Be clear as to what types of breach the exemption clause should or should not apply to.
Deliberate repudiatory breach Exclusions and limitations are likely to apply to deliberate defaults in the absence of clear wording to the contrary.
Fraud It is not possible to exclude or limit liability for fraud, including fraudulent misrepresentation. Carve out fraud and fraudulent misrepresentation.

Failure to do so could lead to the whole clause being ineffective.

Quick view—types of loss

This section considers how certain types of loss have been construed by the courts in the context of exemption clauses.

To navigate to this section, go to: Types of loss.

Topics Key points Quick tips
Direct loss Direct loss can be described as losses arising naturally, according to the ordinary course of things, from a breach of contract.

Clear words must be used to exclude liability for direct loss.
Use clear words to exclude liability for direct loss.

Exclude direct loss in a separate clause or sub-clause.
Consequential and indirect loss What may be indirect or consequential loss in one case may be considered direct loss in another—much depends on the contract and its surrounding context. Exclude indirect and consequential losses in a separate clause or sub-clause.

Consider defining what types of losses fall within ‘indirect or consequential’ losses.

Consider specifying what losses are intended to be recoverable.
Special damages Any exemption provisions attempting to exclude liability for ‘special damages’ will need to be clearly drafted to explain the meaning and intent of that terminology.

‘Special damages’ has a specific meaning in the context of litigation.
Specify what types of damages constitute ‘special damages’.

Exclude special damages in a separate clause or sub-clause.
Loss of profit Loss of profits can be both direct loss and indirect loss. Avoid referring to loss of profits in a clause that deals with indirect loss.

Be clear as to whether it includes both direct and indirect loss of profits.

Exclude loss of profits in a separate clause or sub-clause.
Loss of use Loss of use has no specific meaning and so would be interpreted in the context of the contract as a whole. Consider defining loss of use.

Exclude loss of use in a separate clause or sub-clause.
Loss of data Loss of data has no specific meaning and so would be interpreted in the context of the contract as a whole. Consider defining loss of data.

Exclude loss of data in a separate clause or sub-clause.

Quick view—statutory controls under UCTA 1977

This section looks at the statutory controls imposed on certain exclusions or limitations of liability by UCTA 1977.

To navigate to this section, go to: Statutory controls under UCTA 1977.

Topics Key points Quick tips
What is an exemption clause for the purposes of UCTA 1977? Exemption clauses are not defined in UCTA 1977, but its remit extends to clauses which:

—make the liability or its enforcement subject to restrictive or onerous conditions
—exclude or restrict any right or remedy in respect of the liability, or subject a person to any prejudice in pursuing any such right or remedy
—exclude or restrict rules of evidence or procedure

In respect of the provisions on negligence liability and implied terms for sale of goods, it also prevents excluding or limiting the relevant obligation or duty.
UCTA 1977 has wide application and cannot be avoided by drafting the exemption clause in a certain ‘form’ so that it falls outside the traditional form of an exemption clause.

Whether a clause is an exemption clause is a matter of substance and effect.
Scope of UCTA 1977 UCTA 1977 applies to B2B contract terms or notices which exclude or restrict liability.

For the most part, UCTA 1977 applies only to the exclusion or limitation of ‘business liability’.

Certain contract types, such as international supply contracts, are specifically excluded from its scope.
Check to what extent UCTA 1977 is disapplied in respect of the contract type at issue.

Keep in mind that the exemption clause will still be subject to common law controls and potentially sector-specific rules.
Negligence liability Liability for death or personal injury caused by negligence cannot be excluded or limited.

Any other type of loss or damage resulting from negligence can be limited or excluded subject to the reasonableness test.
Carve out death or personal injury caused by negligence.

Ensure that any other exclusions or limitations of negligence liability are reasonable.
Liability arising in contract When dealing on one party’s written standard terms of business, a party cannot, by reference to any contract term:

—exclude or restrict liability for their own breach of contract
—claim to be entitled to render a contractual performance substantially different from that reasonably expected of them or render no performance at all

unless it satisfies the requirement of reasonableness.

Whether parties are dealing on one of the contracting party’s standard terms of business is a question of fact and degree in each case.
Parties have less freedom to exclude or limit liability when dealing on one party’s standard written terms of business.

The fact that there were negotiations in respect of the terms does not automatically mean that they are not ‘standard terms of business’.
Implied terms for sale and supply of goods Implied terms as to title in goods cannot be excluded or limited.

Implied terms as to conformity of goods with description or sample, or relating to their quality or fitness for purpose, can be limited or excluded subject to the reasonableness test.

In a contract not covered by the Sale of Goods Act 1979 (SGA 1979) (primarily contracts for services where goods are also provided), implied terms as to the right to transfer ownership of goods or give possession or assurance of quiet possession can also be limited or excluded subject to the reasonableness test.
Consider whether you are dealing with an international supply contract in respect of which UCTA 1977 does not apply.

If you are excluding or limiting terms as to conformity of goods etc, use the expression ‘conditions’ rather than ‘warranties’, ‘guarantees’ or ‘representations’.
The reasonableness test Where the reasonableness test applies, the term must have been a fair and reasonable one to be included having regard to the circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties at the time the contract was made.

The test is slightly different in respect of non-contractual notices.

It is for the party claiming that a contract term or notice satisfies the test to show that it does.

Both statutory guidelines and guidance provided by case law are used by the courts to determine reasonableness.
Reasonableness is more likely to be established where a remedy of some sort remains available to the innocent party or the term limits rather than excludes liability entirely.

Note that the availability of insurance will be considered.

Draft exemption clauses as a series of separate clauses to avoid the whole clause being deemed ineffective.

Include a severance clause in the contract.
Appellate court’s approach to reasonableness An appellate court is unlikely to interfere with the decisions of the first instance judge in respect of reasonableness. Keep this in mind in respect of disputes.
Case law on reasonableness The reasonableness of a term has to be considered on a case-by-case basis in light of the particular circumstances of the parties in question at the time the contract was made. Terms are considered on a case-by-case basis and so reliance should not be placed on previous judicial decisions.
Anti-avoidance measures UCTA 1977 contains a variety of anti-avoidance measures which prevent parties from circumventing its application. UCTA 1977 cannot be avoided by form, secondary contracts or choice of law provisions.

Quick view—statutory controls under the MA 1967

This section looks at the statutory controls imposed on exclusions or limitations of liability for misrepresentations under the MA 1967.

To navigate to this section, go to: Statutory controls under the MA 1967.

Topics Key points Quick tips
Misrepresentations To be effective, a contract term or notice which excludes or limits liability for pre-contractual misrepresentations, or any remedy for such misrepresentations, must satisfy the reasonableness test under UCTA 1977. Consider the reasonableness test when excluding or limiting liability for misrepresentations.
Who bears the burden of proof? The party claiming that a clause satisfies the reasonableness test must prove that it does. Keep records as to the reasoning used to conclude that the term is reasonable.
When does the MA 1967 apply? The courts will look at the substance and effect of a term to determine whether it falls within the remit of the MA 1967.

Generally speaking, entire agreement clauses (to the extent they don’t incorporate non-reliance wording) are not subject to the MA 1967, whereas non-reliance clauses are. However, this depends significantly on the specific drafting of the clause.

For example, if the entire agreement clause incorporates non-reliance wording, it may be subject to the MA 1967.
Consider any non-reliance or entire agreement clauses in the contract.

Do they have the effect of excluding or limiting liability for representations made, or do they simply define the basis on which the parties are contracting?

This is likely to determine whether MA 1967 applies.
Negligent misstatement Exemption clauses excluding or limiting liability for negligent misstatement are subject to the reasonableness test under UCTA 1977. Consider the reasonableness test when excluding or limiting liability for negligent misstatements.
Fraudulent misrepresentation A party cannot limit or exclude its liability for fraudulent misrepresentation. Carve out fraudulent misrepresentation.

Failure to do so could lead to the whole clause being ineffective.
Agent’s authority The MA 1967 does not qualify the right of a principal publicly to limit the otherwise ostensible authority of their agent. Make sure you are clear as to when the MA 1967 can be relied on.
Points on construction Clear words are required to exclude or limit liability for misrepresentations. Expressly exclude liability for misrepresentations or use an appropriately drafted ‘non-reliance clause’.

Quick view—ways of excluding/limiting liability

This section considers some of the common ways used by parties to exclude or limit liability in a contract.

To navigate to this section, go to: Ways of excluding/limiting liability.

Topics Key points Quick tips
Financial caps Parties may limit their liability by reference to a financial cap.

The same principles of construction in respect of exemption clauses apply to financial caps.

Where a cap sits in the contract can influence how it is interpreted.

UCTA 1977 sets out specific criteria to determine whether limitations to a specific sum are reasonable.
If UCTA 1977 applies, consider the reasonableness test and the specific criteria taken into account in respect of financial caps.

Consider specifying different caps for different types of breaches.

Don’t confuse insurance obligations and financial caps. An obligation to maintain insurance at a specified amount does not in itself mean that liability under the contract is capped at that amount.
Time bars A party’s liability may be excluded by specifying a time limit before the expiry of which the other party must bring a claim or notify a breach.

The same principles of construction in respect of exemption clauses apply to contractual limitation periods.

Statutory limitation periods can be amended by agreement of the parties but shorter limitation periods specified in the terms will be subject to the reasonableness test.
Consider whether the reasonableness test applies to any time bars specified in the agreement.
Excluding rights of set-off It is possible to exclude rights of set-off.

Where a party deals on the other’s standard written terms of business, the clause which limits or excludes the right will be subject to the reasonableness test.

Attempts to exclude or limit rights of set-off are not effective if either party has entered insolvency proceedings.
Use clear and unequivocal words to exclude rights of set-off.
Auditors and ‘Bannerman’ clauses It has become standard practice for auditors to include disclaimer wording in their statutory reports to the effect that the audit work is undertaken solely for the company (and its members) and that the auditor does not accept any liability to third parties who may rely on the report.

The purpose of such a clause is to negate any duty of care that may be claimed by a third party, such as a bank.

This type of clause has been successfully tested in the courts.
Consider using the standard form of wording provided by the Institute of Chartered Accountants in England and Wales (ICAEW).

Quick view—other issues

This section looks at other issues to consider in the context of exemption clauses, including whether equitable remedies can be excluded and third party rights.

To navigate to this section, go to: Other issues.

Topics Key points Quick tips
Exclusive remedies clauses Once the assistance of the court is involved by one of the parties in a discretionary matter, that party is bound by the general discretion of the court to grant or refuse the remedy sought. The court’s discretion to grant or refuse an equitable remedy cannot be fettered by agreement between contracting parties.
Exemption clauses and third parties In general, a person who is not privy to a contract can neither be sued nor sue on that contract.

However, in certain circumstances a third party may be able to enforce the provisions of the contract (including an exemption clause) subject to the Contracts (Rights of Third Parties) Act 1999.

Generally, a party is able to rely on the exemption clause as a defence to claims brought by third parties.
Consider whether any third party should or can have the protection of the exemption clause.

Ensure this is accurately reflected in any ‘rights of third parties’ clause.
Exemption clauses in the context of specific contract types There are some specific considerations to keep in mind when looking at certain contract types (eg contracts for the carriage of goods by sea or air). Consider whether there are any sector- or contract-specific considerations in the context of the exemption clause at issue.

What are exemption clauses?

Exemption clauses are used by parties to exclude or limit their liability in contract and/or tort as a way of apportioning risk. In non-contractual documents, these commonly take the form of ‘disclaimers’ or ‘notices’ excluding or limiting tortious liability.

Exemption clauses can be divided into three categories—clauses which limit or exclude:

  1. what would otherwise be a party’s duties (ie the substantive obligations of a party under the contract)—eg excluding implied terms

  2. the liability of a party for breach of specific aspects of those duties—eg excluding rights or remedies a party would have for breach

  3. the financial compensation or remedies available for breach of those duties—eg financial caps, time limits within which a claim has to be made

What are some examples of common ways in which parties exclude or limit liability in a contract?

Exclusions and limitations of liability can take many forms. Common examples include:

  1. exclusions of warranties and conditions otherwise implied into the contract

  2. exclusions of specific types of loss—eg loss of profits, loss of data, indirect and consequential loss

  3. terms permitting a party to unilaterally vary their obligations under the contract

  4. time bars—eg within which a claim must be brought or notified

  5. financial caps

  6. exclusions of remedies—eg excluding the right to set-off

  7. conditions on ability to exercise remedies

  8. exclusive remedies clauses

  9. indemnities

  10. force majeure clauses

  11. entire agreement clauses or non-reliance clauses

  12. liquidated damages clauses

How do the courts determine whether a clause is an exemption clause?

Whether a clause is considered an exemption clause is a matter of substance and effect, rather than form. For example, just because a clause is contained within a section of an agreement titled ‘limitation of liability’ will not be conclusive in determining whether that clause does in fact amount to an exclusion or limitation of liability. The courts will look at the substance of the clause and consider its effect to determine whether it is an exemption clause.

What clauses do not constitute exemption clauses?

As it is a matter of substance and effect, it is not possible to provide an exhaustive list of types of clauses that are not exemption clauses; what amounts to an exemption clause in one contract may not be considered an exemption clause in another.

Examples of clauses that have been held as not constituting exemption clauses include:

  1. agreed or liquidated damages clauses (provided they are a genuine pre-estimate of loss likely to be suffered in the event of a breach)

  2. arbitration clauses (unless such a clause excludes a party’s liability under certain conditions, for example, by barring a claim unless arbitration is commenced within a specified time period)

Are exemption clauses defined in UCTA 1977?

Exemption clauses are not defined in UCTA 1977, but it does provide a non-exhaustive list of forms that an exemption clause could take for the purposes of its application.

For more information, see: What is an exemption clause for the purposes of UCTA 1977? below.

Are force majeure clauses exemption clauses?

‘Force majeure’ clauses in commercial contracts generally provide for one (or both) of the parties to be excused from performance, suspend performance for a certain period of time or cancel the contract on the happening of a specified event outside the parties’ control.

Force majeure clauses have been said by the courts not to be exemption clauses. Drawing a distinction between force majeure clauses and exemption clauses can be difficult since the effect can be the same.

In Classic Maritime v Limbungan Makmur, the court distinguished between force majeure and frustration cases which automatically terminate the contract and excuse the parties from further performance, and express contractual provisions negotiated between the parties excluding liability for breach of an obligation to perform (as a primary obligation) and to pay damages (as a secondary obligation) in certain circumstances. The Court of Appeal considered the construction and application of an exceptions clause in a Contract of Affreightment. The defendant had cross-appealed against the initial finding of the lower courts that liability had not been effectively excluded by the clause on the basis that, although it was headed ‘exceptions’, it was in reality a ‘force majeure’ clause.

The court held that construction of the clause depended primarily on the words used, according to context and language. Referring to Wood v Capita, the court noted it should check its provisional conclusions against the contract as a whole and the commercial consequences of the proposed construction. The clause excused responsibility ‘for loss or damage to, or failure to supply, load, discharge or deliver cargo’, which appeared to exempt a party from responsibility for breach and the court therefore held that it should be construed as an exception clause rather than a force majeure clause.

See News Analysis: Contractual exception clauses, force majeure, causation and damages (Classic Maritime v Limbungan Makmur).

Where one party is contracting on the other party’s written standard terms of business, a force majeure clause may arguably be subject to the reasonableness test under section 3(2)(b) of UCTA 1977 where it has the effect of entitling a party to render no contractual performance at all or a performance substantially different from that reasonably expected of them. However, section 3(2)(b) of UCTA 1977 is far from clear and the courts have struggled with its interpretation. See: Liability arising in contract below.

For more information on force majeure, see:

  1. Practice Note: Force majeure—consequences and contract discharge, and

  2. Precedent: Force majeure clause

Are indemnities exemption clauses?

An indemnity clause which has the effect of transferring liability may, in certain circumstances, be treated as a term excluding or limiting liability. This can be contrasted to a clause requiring a party to indemnify a third party.

Whether an indemnity amounts to an exemption clause is a matter of substance and effect, and the effect of an indemnity is a matter of construction.

For example, in Farstad v Enviroco, the Supreme Court unanimously concluded that an undertaking by one party (A) to ‘defend, indemnify and hold harmless’ the other party (B), excluded B’s liability to A on the proper construction of the clause. This conclusion was reached by the courts on the basis of various contextual factors, including that the undertaking was contained in a clause headed ‘Exceptions/Indemnities’ and that the expression ‘defend, indemnify and hold harmless’ was used throughout the clause, including in sub-clauses that were clearly intended to be exclusions.

Lord Clarke, giving the leading judgment, considered that the obligation to ‘hold harmless’ went further than the obligation to reimburse because they were words of exception. However, he acknowledged that, in some contexts, the words ‘indemnify’ and ‘hold harmless’ have the same meaning, and that ‘indemnify’ can sometimes mean indemnify a third party, but that it will always depend on the context.

In this case, he considered it was particularly relevant that the word ‘indemnify’ was accompanied by ‘defend…and hold harmless’, and that the scope of the indemnity was widely drawn. Since the clause required A to ‘defend...and hold harmless’ B not only against liabilities and causes of action but also against ‘all claims, demands’ and ‘proceedings’, the natural meaning of that expression was that, since A holds B harmless from a claim by A in respect of damage to A’s property caused by B’s negligence, B cannot be liable to A in respect of such damage.

Lord Mance considered that both the words ‘hold harmless’ and ‘indemnify’ alone can be used in a sense wide enough to exclude the other contracting party from responsibility. He also considered that it made no sense as a contractual scheme for the parties to provide that B should be indemnified against third party claims, demands and liabilities incurred resulting from loss or damage in relation to A’s property, but made no provision at all for claims, demands, etc by A itself, leaving A free to make direct claims against B for damage to A’s property.

For more information on this case, see: LNB News 10/05/2010 39 and Journal: Indemnities as exclusion clauses in guaranteed transactions (2012) 3 JIBFL 146.

This can be contrasted with the House of Lords decision in Great Western Rly v James Durnford & Sons, where a supplemental agreement to a lease of railway company premises permitting the erection of a portable gangway included a term that the merchants ‘agree and undertake to indemnify the [railway company] against all claims and demands or liability whatsoever, whether in respect of damage to person or property, arising out of or in connection with the existence or use of the gangway.’

The railway company sought to rely on the term to deny liability in an action for damages for negligence and/or breach of duty brought by the merchants after certain shunting operations by the railway company led to one of the merchant’s lorries being seriously damaged.

This was rejected by the House of Lords, where the court held that the indemnity did not cover claims against the railway company by the merchants themselves. The undertaking was only one to hold the railway company harmless against claims by third parties. In reaching this conclusion, Viscount Summer noted that ‘there is no doubt that an abundant content for the clause can be found in third-party liabilities without having recourse to liabilities between the contracting parties themselves’.

It is therefore important to consider any indemnities alongside exemption clauses. It should not be assumed that an indemnity always relates to third party claims or liabilities; depending on the context and the indemnity’s substance and effect, it may be treated as an exemption clause.

When drafting indemnities, if they have the effect of transferring liability, consider if this is better addressed in the exemption clauses for clarity or ensure that it is clear in the drafting that the indemnity extends to claims by, or liabilities to, the indemnifying party.

For more information on drafting indemnities, see:

  1. Precedent: Indemnity clause—commercial contracts

  2. Drafting and negotiating an indemnity clause—checklist, and

  3. Q&A: What do the words ‘defend, indemnify and hold harmless’ mean?

Incorporation

To create an enforceable exemption provision, it must be properly incorporated into the contract between the parties at the time the contract is made.

Signed documents

In the absence of fraud or misrepresentation, where a party has signed a document containing contractual terms, it is generally bound by it; it is wholly immaterial whether they have read the document or are ignorant of its effect.

However, the court still has to determine what terms form part of that signed agreement. For example, standard terms are commonly incorporated by reference (eg ‘This order is subject to our standard terms and conditions for the supply of goods available at…’) so that even if the order constituting the contract between the parties is signed, the standard terms themselves may not be, which could result in a party claiming insufficient awareness of the exemption clause in those standard terms.

Unsigned documents

Where a term or condition is contained in an unsigned document, in order to bind the recipient of that document it is necessary to prove that they were aware (or ought to have been aware) of the term or condition. The party seeking to rely on the term must show that they have done what is reasonably sufficient to give the other party notice of them before or at the time the contract is made. This is a question of fact in each case.

Onerous/unusual clauses

Even where the terms are signed or notice of the terms has been given, a party may still argue that an exemption clause has not been validly incorporated on the grounds that it is too onerous and should therefore have been specifically brought to their attention before signing.

It is a well-established principle of common law that a term or condition which is particularly onerous or unusual must be fairly and reasonably brought to the party’s attention in order for it to be incorporated into the contract (the Interfoto principle).

As noted by Denning LJ in J Spurling v Bradshaw (obiter), ‘the more unreasonable a clause is, the greater the notice which must be given of it. Some clauses…would need to be printed in red ink on the face of the document with a red hand pointing to it before the notice could be held to be sufficient’. What would constitute ‘good notice’ of one condition is therefore not necessarily ‘good notice’ of another (Interfoto Picture Library v Stiletto Visual Programmes).

It remains an undecided question whether the Interfoto principle can ever apply to a signed contract given that this would require a departure from the important principle that a party who signs a document knowing that it is intended to have legal effect will be bound by its terms and will be taken to have read them and be on notice of them (in the absence of fraud or misrepresentation). The courts seem to agree that it should only apply to signed contracts in ‘extreme cases’ (eg where a signature was obtained under pressure of time or other circumstances).

However, note that where UCTA 1977 applies, whether the customer knew or ought reasonably to have known of the existence and extent of the term is one of the factors that will be taken into account by the courts when assessing the reasonableness of an exemption clause. It is therefore advisable to give greater prominence to any exemption clauses (particularly any onerous or unusual clauses) both for the purposes of ensuring effective incorporation and reasonableness under UCTA 1977, even if the contract will be signed.

Are exemption clauses ‘onerous or unusual’ clauses?

Whether an exemption clause is particularly onerous or unusual has to be considered in the context of the contract as a whole. The mere fact that a clause is an exemption clause does not automatically render it onerous or unusual.

How are these principles applied in practice?

An example of the application of these principles can be found in Goodlife Foods v Hall Fire Protection where, following a fire at its factory premises, Goodlife commenced proceedings against Hall Fire for breach of contract and/or negligence in the supply and installation of a fire suppression system which Hall Fire had installed ten years earlier.

In their defence to the claim, Hall Fire sought to rely on clause 11 in their standard terms and conditions:

‘11) We exclude all liability, loss, damages or expense consequential or otherwise caused to your property, goods, persons or the like, directly or indirectly resulting from our negligence or delay or failure or malfunction of the systems or components provided by [Hall Fire] for whatever reason. In the case of faulty components, we include only for the replacement, free of charge, of those defected parts. As an alternative to our basic tender, we can provide insurance to cover the above risks. Please ask for the extra cost of the provision of this cover if required.’

The standard terms and conditions were expressly referred to on the quotation that had been provided to Goodlife in January 2001 and were also sent with the quotation. Goodlife provided a purchase order in 2002. Coulson LJ, giving the leading judgment in the Court of Appeal, held that the clause was incorporated into the contract between the parties:

  1. the clause was not particularly unusual or onerous, on the basis that:

    1. it was a one-off supply contract carried out for a modest sum—other than a limited warranty provided by Hall Fire, it had no maintenance obligations or any other connection with the premises after it had installed the system. In those circumstances, it was neither particularly unusual nor onerous for Hall Fire to fully protect itself against the possibility of unlimited liability arising from future events

    2. Hall Fire had indicated (as an alternative) that it would have been prepared to accept wider liability but that this would have involved (among other things) insurance arrangements and an increase in the contract price—Goodlife had not pursued this alternative

    3. although the clause was on the far end of the spectrum, it was not particularly onerous or unusual in comparison with the terms and conditions of other fire suppression sub-contractors and suppliers in evidence before the judge

  2. even if the clause had been particularly onerous or unusual, the clause was fairly and reasonably brought to Goodlife’s attention, on the basis that:

    1. it was one of the standard conditions which were expressly referred to on the front of the quotation and which were printed in clear type

    2. its potentially far-reaching effect was expressly identified at the start of those conditions—the fact that the warning was cast in ‘almost apocalyptic terms’ worked against Goodlife. A buyer who started reading the conditions would have seen by the very first words used that (at the very least) the conditions contained terms which were emphatically not in the buyer’s interests

    3. Goodlife had over a year between the sending of the quotation (with the relevant standard terms and conditions) and the entering into of the contract—Goodlife never indicated that it did not read the terms or did not understand them and, even if it was unsure about the clause, it had enough time to take advice

In such circumstances, Coulson LJ considered that it would be ‘commercially unrealistic’ to say that the clause was not fairly and reasonably brought to Goodlife’s attention. Even if the clause had been particularly onerous or unusual, it would therefore still have been incorporated into the contract. Incorporation by reference can therefore be effective.

See News Analysis: Context is key in exclusion clauses (Goodlife Foods Ltd v Hall Fire Protection Ltd).

How can standard terms become incorporated into an agreement?

There are several ways in which terms and conditions can become incorporated into the contract between the parties, including by reference, by conduct or as a result of previous dealings.

For more information on the use of standard terms and conditions and the practical steps which can be taken to successfully incorporate them, see Practice Notes:

  1. Standard terms and conditions—incorporation

  2. Standard terms and conditions—advantages and disadvantages

  3. Contract interpretation—battle of the forms—on whose terms have parties contracted?

For more on incorporating express terms, see Practice Note: Contract interpretation—express terms in contracts.

Non-contractual notices / disclaimers

Similar principles apply to non-contractual notices or disclaimers of tort liability: reasonable steps must be taken to bring the disclaimer to the notice of the other party in order for the exemption to be effective. Unusual or onerous disclaimers or notices will require greater prominence.

See also Practice Note: Defences to Tort Claims.

Points to note for effective incorporation

To avoid issues in respect of the effective incorporation of exemption clauses contained in standard terms and conditions, ensure that:

  1. the terms and conditions containing the exemption clauses are given to the other party at the time the contract is formed

  2. the other party’s attention is drawn to the terms and conditions in writing or on the face of the document

  3. reasonable steps are taken to highlight the exemption clauses and any other particularly onerous or unusual terms, and

  4. the other party signs the terms and conditions containing the exemption clauses as evidence of acceptance

Construction

For an exemption clause to be effectively relied on, it must:

  1. be clear and unambiguous, and

  2. cover the type of breach and type of loss that has occurred

Construction therefore plays an important role in determining the effectiveness of exemption clauses; the court’s approach to their construction has significantly influenced how such clauses are drafted to ensure the parties can effectively rely on them.

This section considers:

  1. general rules of contract interpretation

  2. the court’s approach to exemption clauses

  3. fundamental principles of the modern approach

  4. negligence and the Canada Steamship guidelines

  5. the treatment of exclusions v limitations

  6. purpose of the contract, statements of intent and leaving a party with no remedy

  7. considering the document as a whole, and

  8. representations as to the effect of exemption clauses

Who bears the burden of proof?

It is generally for the party seeking to rely on the exemption clause to prove that the clause, on its true construction, covers the obligation or liability which it purports to limit or exclude. If there is an exception to the exemption, then the claimant has to establish that the case falls within the exception. However, the matter is in every case a question of construction of the contract as a whole.

Case law on construction of exemption clauses

There is considerable case law which deals with the construction of exemption clauses and the specific wording used in exemption clauses. Some examples are provided throughout this Practice Note. It is important to exercise caution in relying on previous case law when considering the construction or drafting of exemption clauses, particularly cases pre-dating:

  1. Investors Compensation Scheme v West Bromwich Building Society, which started what is now considered the ‘modern approach’ to construction adopted by the courts

  2. UCTA 1977, which had a major impact on the way that courts interpret exemption clauses

As it is a matter of construction whether an exemption clause successfully excludes or limits liability in each case, when considering the wording used in a particular exemption clause, it is important to keep in mind that the views of the courts on the construction of differently worded clauses are of limited assistance and that context plays a key role in construction.

General rules of contract interpretation

Although there is no simple set of rules to follow in respect of how terms may be construed and interpreted (as much will depend on the individual facts of the case), some general principles and rules of contract interpretation have been developed by a considerable body of case law.

A simplified and brief summary of these principles is provided in Practice Note: General rules of contract interpretation—summary.

The court’s approach to exemption clauses

There has been a shift in the court’s approach to the construction of exemption clauses since the enactment of UCTA 1977.

Pre-UCTA 1977—contra proferentem and strict construction

Traditionally, the courts took a restrictive approach to the construction of exemption clauses, doing ‘all kinds of gymnastic contortions’ to produce a reasonable result where two parties of unequal bargaining power entered into a contract, and the party with little bargaining power was otherwise bound by unreasonable terms in the name of ‘freedom of contract’.

They did so by applying a strict (ie narrow) construction and the contra proferentem principle: that any ambiguity in a clause must be construed against the party seeking to rely on it.

By way of example, it would follow from the contra proferentem principle that a clause excluding warranties does not cover a breach of a term which is a condition.

Post-UCTA 1977—common sense principles

Since the enactment of UCTA 1977, a large body of case law has significantly limited the role of the contra proferentem principle to commercial contracts where the parties are of equal bargaining power. As noted by Lord Wilberforce in Photo Production v Securicor Transport:

‘After [UCTA 1977], in commercial matters generally, when the parties are not of unequal bargaining power, and when risks are normally borne by insurance, not only is the case for judicial intervention undemonstrated, but there is everything to be said, and this seems to have been Parliament’s intention, for leaving the parties free to apportion the risks as they think fit and for respecting their decisions.’ (at 843)

Lord Diplock agreed, stating that it is ‘wrong to place a strained construction on words in an exclusion clause which are clear and fairly susceptible of one meaning only’ in ‘commercial contracts negotiated between businessmen capable of looking after their own interests and of deciding how risks inherent in the performance of various kinds of contract can be most economically borne (generally by insurance)’.

Following Investors Compensation Scheme, the courts have moved away from ‘rules of construction’ towards ‘common sense principles by which any serious utterance would be interpreted in ordinary life’.

The principle has subsequently been referred to as an ‘aid of last resort’ with ‘little utility’ in the context of commercially negotiated agreements, to be applied only if other canons of construction cannot resolve the ambiguity that has been identified.

For example, in Taberna Europe v Selskabet, the Court of Appeal considered whether a disclaimer excluded liability for damages for misrepresentation under section 2(1) of the MA 1967.

The judge at first instance had concluded that the defendant was not entitled to rely on any of the paragraphs of the disclaimer, and that although certain paragraphs were to be regarded as exclusion clauses on which the defendant could rely, and that they satisfied the requirement of reasonableness under UCTA 1977, they were to be construed contra proferentem and were insufficiently clear to exclude liability for damages for misrepresentation.

The Court of Appeal disagreed, with Moore-Bick LJ stating the following:

‘In the past judges have tended to invoke the contra proferentem rule as a useful means of controlling unreasonable exclusion clauses. The modern view, however, is to recognise that commercial parties (which these were) are entitled to make their own bargains and that the task of the court is to interpret fairly the words they have used. The contra proferentem rule may still be useful to resolve cases of genuine ambiguity, but ought not to be taken as the starting point…’ (at para [23])

Similarly, in Transocean Drilling v Providence Resources Moore-Bick LJ, sitting in the Court of Appeal, considered that the judge had been wrong to invoke the contra proferentem principle in that case, on the basis that it should be invoked only if the language chosen by the parties is one-sided and genuinely ambiguous (ie equally capable of bearing two distinct meanings) but has no part to play when the meaning of the words is clear or in relation to a clause which favours both parties equally, especially where they are of equal bargaining power.

Although the contra proferentem principle has therefore not been eliminated entirely, its application is limited. The courts have indicated that it will not apply where:

  1. the exemption clause is clear and unambiguous

  2. the clause is a mutual clause (ie reciprocal)

  3. the parties are of equal bargaining power

In respect of the principle of ‘strict construction’, the Supreme Court in Impact Funding Solutions v AIG Europe Insurance held that it is not an overarching principle but applies only to clauses which seek to limit or exclude liability arising by operation of law:

‘An exclusion clause must be read in the context of the contract of insurance as a whole. It must be construed in a manner which is consistent with and not repugnant to the purpose of the insurance contract. There may be circumstances in which in order to achieve that end, the court may construe the exclusions in an insurance contract narrowly…But the general doctrine…that exemption clauses should be construed narrowly, has no application to the relevant exclusion in this Policy. An exemption clause, to which that doctrine applies, excludes or limits a legal liability which arises by operation of law, such as liability for negligence or liability in contract arising by implication of law’ (at para [7])

Fundamental principles of the modern approach

Since UCTA 1977, the courts have generally been willing to recognise that parties to commercial contracts are entitled to apportion risk of loss as they see fit.

Some fundamental principles of the court’s modern approach to the construction of exemption clauses can be summarised as follows:

  1. the approach taken by the courts in the construction of exemption clauses should be no different to the approach taken for the construction of any other term—see: General rules of contract interpretation above

  2. there is no presumption that neither party agreed to give up or limit their remedies for breach of contract (even for breach of ‘fundamental’ obligations)—provided that the words used are clear, the court will give effect to the commercial allocation of risk in the contract

  3. there is a presumption that neither party intends to abandon any remedies arising by operation of law—clear express words must be used in order to rebut this presumption, and the more valuable the right, the clearer the language will need to be

  4. similarly, obligations implied by law can only be excluded by express language—the more significant the departure from obligations implied by law or ordinarily assumed under contracts of the kind in question, the more difficult it will be to persuade the court that the parties intended that result

  5. the contra proferentem principle is to be applied only if other canons of construction cannot resolve the ambiguity and does not apply if:

    1. the exemption clause is clear and unambiguous

    2. the clause is a mutual clause (ie reciprocal)

    3. the parties are of equal bargaining power

The Privy Council in The Cape Bari relied on Gilbert-Ash v Modern Engineering and a number of other authorities in concluding that it may be possible to exclude a legal right arising under statute without express reference to the statute, provided that right is clearly excluded (either expressly or by implication).

The case of Alghussein Establishment v Eton College has previously been relied on to argue that there is a general rule that exemption clauses should be construed in such a way as to prevent a party from profiting from its own wrong. This argument was rejected by the court in both Inframatrix Investments v Dean Construction and Fujitsu Services v IBM on the basis that Alghussein involved extreme and different facts.

In Alghussein, a tenant was not allowed to rely on their own wilful default to obtain the contractual benefit of a new lease under the agreement between the parties.

In Inframatrix and Fujitsu, the defendants were not seeking to obtain a benefit under a continuing contract on account of their own breach but rather were relying on an exemption clause applicable only in the event of breach of contract.

Further consideration is given to the court’s approach to the construction of exemption clauses in the context of liability for negligence below. See: Negligence and the Canada Steamship guidelines below.

For more information on the rules of construction generally and the contra proferentem principle, see Practice Notes:

  1. Contract interpretation—the guiding principles, and

  2. Contract interpretation—rules of contract interpretation

Negligence and the Canada Steamship guidelines

At common law, liability for negligence can be limited or excluded provided that the words used expressly refer to negligence or are wide enough to cover negligence.

How does the court determine whether a clause covers negligence?

The Privy Council case of Canada Steamship Lines v R introduced a three stage test, commonly referred to as the Canada Steamship guidelines, to be applied by the courts when determining whether an exemption clause covers liability for negligence. The guidelines were set out by Lord Morton as follows:

‘(1) If the clause contains language which expressly exempts the person in whose favour it is made (hereafter called “the proferens”) from the consequence of the negligence of his own servants, effect must be given to that provision…

(2) If there is no express reference to negligence, the court must consider whether the words used are wide enough, in their ordinary meaning, to cover negligence on the part of the servants of the proferens. If a doubt arises at this point, it must be resolved against the proferens…

(3) If the words used are wide enough for the above purpose, the court must then consider whether “the head of damage may be based on some ground other than that of negligence,” to quote again Lord Greene in the Alderslade case. The “other ground” must not be so fanciful or remote that the proferens cannot be supposed to have desired protection against it; but subject to this qualification, which is no doubt to be implied from Lord Greene’s words, the existence of a possible head of damage other than that of negligence is fatal to the proferens even if the words used are prima facie wide enough to cover negligence on the part of his servants.’ (at 208)

This approach also applies in respect of the party’s own negligence, even though the guidelines refer to negligence on the part of the servants or the proferens, and is seemingly based on the premise that it is ‘inherently improbable that one party to the contract should intend to absolve the other party from the consequence of the latter’s own negligence’.

For this reason, Lord Fraser in Ailsa Craig Fishing v Malvern Fishing suggested that the guidelines were ‘not applicable in their full rigour’ to clauses which limited rather than excluded liability. This distinction has subsequently been criticised by the courts (see, for example, HIH Casualty and General Insurance v Chase Manhattan Bank and BHP Petroleum v British Steel). See: Are exclusions treated differently to limitations? below.

The Canada Steamship guidelines also apply to a clause of indemnity in respect of negligence.

The Canada Steamship case began a line of cases commonly cited as authority for the principle that if an exemption clause does not expressly refer to liability for negligence or some synonym for negligence, the court must consider whether the words used are wide enough to exclude such liability and resolve any doubt against the party who put the clause forward and seeks to rely on it (ie the contra proferentem principle).

It has therefore become common practice to expressly state that the parties intend the clause to apply to negligence on the basis that, in the absence of express wording, it is less likely that a clause would be construed as absolving a party of liability for their own negligence.

Example wording considered by the courts

The following are examples of wording that have previously been held by the courts as sufficiently wide to cover liability for negligence:

  1. at sole risk/at customer’s sole risk/at owner’s risk

  2. under any circumstances whatsoever (Harris (Harella) Ltd v Continental Express Ltd [1961] 1 Lloyd’s Rep 251 (not reported by LexisNexis®))

  3. howsoever caused/however caused/howsoever arising

  4. arising from any cause whatsoever

  5. connected with any act or omission (The Raphael [1982] 2 Lloyd’s Rep 42 (not reported by LexisNexis®))

  6. no liability of any nature

  7. all liability

However, context is critical and the court will consider the entire contract when ascertaining the intention of the contracting parties. Therefore, the above wording may be sufficient to exclude liability for negligence in some cases but not in others.

Disclaiming liability for ‘any loss’ may not be sufficient to exclude liability for negligence as it directs the attention to the kinds of losses rather than their cause or origin.

Continued relevance of Canada Steamship guidelines

The continued relevance of the Canada Steamship guidelines has been put into question in the context of the general trend in matters of construction following Investors Compensation Scheme to discard ‘all the old intellectual baggage of “legal” interpretation’.

In HIH Casualty and General Insurance v Chase Manhattan Bank, Lord Bingham considered that the Canada Steamship guidelines are simply helpful guidance on the proper approach to interpretation. They do not lay down a code or provide a litmus test which provides a certain and predictable result when applied to the terms of a contract. The court is still required to ascertain the parties’ intention in their particular commercial context.

Lord Hoffman concluded that the question to be considered by the courts is: ‘whether the language used by the parties, construed in the context of the whole instrument and against the admissible background, leads to the conclusion that they must have thought it went without saying that the words, although literally wide enough to cover negligence, did not do so’. The answer to this question depends on:

  1. the precise language used by the parties, and

  2. how inherently improbable it is in all the circumstances that the parties would have intended to exclude such liability

In MIR Steel v Morris, Rimer LJ (giving the sole judgment in the Court of Appeal) considered the discussion by the House of Lords in HIH Casualty on the Canada Steamship guidelines and noted that:

‘Those various comments about the Canada Steamship principles [by the House of Lords in HIH Casualty] show that they should not be applied mechanistically and ought to be regarded as no more than guidelines. They do not provide an automatic solution to any particular case. The court’s function is always to interpret the particular contract in the context in which it was made. It would be surprising if it were otherwise.’ (at para [35])

In Persimmon Homes v Ove Arup, Jackson LJ (giving the sole judgment in the Court of Appeal) acknowledged that there had been a long running debate about the judicial comments which had given rise to the Canada Steamship guidelines and about the extent to which those guidelines were still good law.

He observed that ‘in commercial contracts, the Canada Steamship guidelines (in so far as they survive) are now more relevant to indemnity clauses than to exemption clauses’, concluding that the canons of construction explained in the Canada Steamship line of cases were of very little assistance in that case.

However, Jackson LJ went on to note that even if he was wrong and those guidelines applied, the outcome would have been the same.

See News Analysis: Court of Appeal considers limitation and exclusion clause (Persimmon Homes v Arup).

There is now a clear judicial trend against reliance on the contra proferentem principle in the context of commercial agreements between commercial parties of equal bargaining power where there is no ambiguity.

However, given that a major purpose of any commercial contract is to give each party certainty as to its liabilities, it is good practice to continue drafting exemptions on the assumption that the contra proferentem principle and Canada Steamship guidelines may apply (regardless of whether the parties arguably have equal bargaining power).

It is also important to consider the restrictions placed on the exclusion or limitation of liability for negligence by UCTA 1977. See: Negligence liability below.

For commentary on what wording would fall within the various stages of the Canada Steamship guidelines, see Commentary: Negligence: Contract: The Law of Contract (Common Law Series) [3.58].

Notices/disclaimers excluding or limiting tort liability

At common law, a party may be able to rely on the principle of volenti non fit injuria (‘to a willing person, no injury is done’—ie the willing acceptance of risk) to defeat a claim for damages for negligence where a non-contractual notice or disclaimer excluded liability for negligence. For more information, see Practice Note: Defences to Tort Claims.

In respect of the statutory restrictions placed on negligence exemption clauses under UCTA 1977, a notice or contract term which excludes or limits liability for negligence is not conclusive evidence of voluntary acceptance of risk (ie not evidence of volenti).

Are exclusions treated differently to limitations?

In a number of cases, the courts have held that an exclusion clause will be construed more strictly than a limitation clause. The majority of these cases, in particular Ailsa Craig Fishing which is often cited as authority for this point, were dealing specifically with exemption clauses limiting or excluding liability for negligence where this distinction was drawn in respect of the application of the Canada Steamship guidelines.

In more recent cases, the courts have suggested that this distinction should be replaced by a general rule that the more extreme the consequences are, in terms of excluding or modifying the liability which would otherwise arise, the more stringent the court’s approach should be in requiring that the exclusion or limitation should be clearly and unambiguously expressed.

Rather than applying a mechanistic rule (ie distinguishing between an exemption and a limitation clause), the courts should focus on the language of the clause construed in the context of the whole instrument and against the admissible background.

In either case, the conclusion can be drawn that the courts may interpret exclusion clauses more strictly than limitation clauses so this must be borne in mind when drafting exemption clauses.

This distinction also seems to impact on the likelihood of a clause being considered reasonable under UCTA 1977. See: The reasonableness test below.

Purpose of the contract, statement of intent and leaving a party with no remedy

If an exemption clause is so broad that it defeats the main purpose of the contract, the courts may limit or modify the clause to the extent necessary to give effect to the main object and intent of the contract.

In Glynn v Margetson, a bill of lading under which oranges were shipped from Malaga to Liverpool had a wide deviation clause, giving the ship ‘liberty to proceed to and stay at any port or ports in any rotation in the Mediterranean, Levant, Black Sea, or Adriatic, or on the coasts of Africa, Spain, Portugal, France, Great Britain, and Ireland, for the purpose of delivering coals, cargo, or passengers, or for any other purpose whatsoever’. The ship proceeded to a port in the northeast of Spain and, owing to the delay caused by the deviation, the cargo arrived at Liverpool damaged.

The court held that the shipowners could not rely on the clause to avoid liability for the damage to the oranges. Although the ship had permission to deviate, the main intent and object of the bill of lading had to be considered (the delivery of perishable cargo) and the clause had to be limited so as not to conflict with that intent and object. Accordingly, the clause was limited so as only to confer a liberty to proceed to and stay at ports which were in the course of the voyage between the south of Spain and Liverpool, and therefore the shipowners were in breach of the bill of lading.

This principle has been applied in a number of cases (mostly relating to carriage of goods by sea) primarily to prevent a party from benefiting from such clauses where there has been a serious defect in performance or non-performance, or where giving effect to the exemption clause would lead to a party’s obligations having no contractual force.

Statement of intent and leaving a party with no remedy

In Suisse Atlantique, Lord Wilberforce considered that:

‘[An exceptions clause] must, reflect the contemplation of the parties that a breach of contract, or what apart from the clause would be a breach of contract, may be committed, otherwise the clause would not be there; but the question remains open in any case whether there is a limit to the type of breach which they have in mind. One may safely say that the parties cannot, in a contract, have contemplated that the clause should have so wide an ambit as in effect to deprive one party’s stipulations of all contractual force; to do so would be to reduce the contract to a mere declaration of intent.’ (at 431–432)

A similar approach was adopted by Lord Roskill in Tor Line v Alltrans Group of Canada, later applied by Flaux J in Astrazeneca v Albemarle International Corporation:

‘In construing an exception clause against the party which relies upon it…the court will strain against a construction which renders that party’s obligation under the contract no more than a statement of intent and will not reach that conclusion unless no other conclusion is possible. Where another construction is available which does not have the effect of rendering the party’s obligation no more than a statement of intent, the court should lean towards that alternative construction. This is an application of the principle enunciated by Lord Roskill in Tor Line AB v Alltrans…’ (at para [313])

In Kudos Catering v Manchester Central Convention Complex, the Court of Appeal considered that if an exemption clause was construed in such a way that no remedy was available, the agreement would effectively be devoid of contractual content and that it would be ‘inherently unlikely’ that this was the parties’ intention. See News Analysis: Construction of contracts and business common sense.

Criticisms of the statement of intent rule

The ‘statement of intent’ rule was criticised by the court in Fujitsu, where Carr J considered that the rule (if not merely part of the normal process of commercial contract construction to consider the provision in the context of the factual matrix and contract as a whole) is of little assistance ‘where the wording is plain, the exclusion clause of mutual benefit and detailed in its form’. Referring to Photo Production, the judge noted that Lord Diplock had made it clear that a strained construction should not be placed on words in an exemption clause which are clear.

Carr J also noted that, even if there had been scope for the court to strain its construction in favour of Fujitsu, the effect of accepting IBM’s construction did not deprive the contract of all contractual force as substantive rights and remedies remained available to the parties, even if they were difficult to obtain or uncertain (ie claim for debt for non-payment of an invoice, declaratory and/or injunctive relief). The question was not whether Fujitsu had ‘adequate’ remedies, but whether IBM’s construction of the exemption clause would deprive the contract of all contractual force, and in that case it did not.

In Transocean Drilling, Moore Bick LJ sitting in the Court of Appal referred to the ‘statement of intent’ principle as ‘one of last resort’, referring to Great North Eastern Rly v Avon Insurance as authority that it applies only in cases where the effect of the clause is to relieve one party from all liability for breach of any of the obligations which they have purported to undertake:

‘I fully accept that where the language of an exclusion clause leaves room for doubt as to its meaning, the [statement of intent] principle applied in these cases [eg Tor Line, Kudos] may provide a valuable tool for ascertaining its correct meaning and in some cases it may lead to the conclusion that a restricted meaning must be given to the clause in question in order to achieve the parties’ common objective. But it does not in my view provide sufficient justification for overriding the parties’ intention where that has been clearly expressed. The principle of freedom of contract, which is still fundamental to our commercial law, requires the court to respect and give effect to the parties’ agreement. One of the striking features of this contract, to which I have already adverted, is the extent to which the parties have agreed to accept responsibility for losses that might otherwise have been recoverable as damages for breach of contract. If, as a result of incorporating several different provisions of that kind, the parties have effectively agreed to exclude any liability for damages for any breaches, it is difficult to see why the court should not give effect to their agreement.’ (at para [28])

He went on to distinguish between a clause which purports to relieve one party from all liability for breach of any of its obligations (as was the case in Tor Line and Kudos) on the one hand, and a clause which excludes all liability for certain kinds of loss or damage (as was the case in Transocean Drilling) on the other. In the former, the court is concerned with identifying the nature of the breach to which the clause applies in which case the ‘statement of intent’ principle may be relevant, whereas in the latter the court is concerned with identifying the kind of loss to which the clause applies in which case it is unlikely to be.

Kudos and Astrazeneca in context

An interesting discussion of these cases was provided by Moulden J in Motortrak v FCA Australia, where he considered that the approach adopted in Astrazeneca and Kudos turned largely on the interpretation of the particular exemption clause in the context of the contract as a whole.

In Motortrak, the agreement contained an exemption clause which provided that neither party was liable to the other for ‘any loss of business, capital, profit, anticipated saving, reputation or goodwill, arising out of or in connection with the Agreement or its subject matter’. Motortrak had brought a claim for damages for loss of profits against FCA for its repudiation of the contract, and FCA sought to rely on the exemption clause to exclude its liability.

Motortrak relied on Lord Wilberforce’s dicta in Suisse Atlantique (quoted above) to argue that the construction put forward by FCA would render the agreement meaningless from their perspective as they would be deprived of their ‘real loss’, and on Kudos and Astrazeneca to argue that they would be left with no effective remedy. Instead, they submitted that the clause should be interpreted so that the exclusion for loss of profit only applies where the loss is suffered ‘in connection with the performance’ of the agreement but not where profits are lost because the other party refuses to perform the agreement. FCA, on the other hand, submitted that the language of the exemption clause was clear and should be construed in the same way as any other term (relying on Tradigrain).

The judge accepted that Motortrak would have no remedy in the circumstances for FCA’s refusal to perform the contract (other than a claim for wasted cost) if FCA’s construction of the exclusion clause was accepted. While the judge noted that the language of the clause was (on its face) clear and unambiguous, and that additional wording would need to be read into the clause to arrive at the meaning suggested by Motortrak, the Supreme Court had made it clear in Wood v Capita that ‘the approach to construction should be a literalist exercise focused solely on the parsing of wording of the particular clause but that the court must consider the contract as a whole’.

Moulden J concluded that the decisions in Kudos and Astrazeneca largely turned on the interpretation of the relevant sub-clause in the context of the remaining clause and contract as a whole and that, unlike in those cases, there was nothing in the other sub-clauses which suggested that the exemption clause should be construed more narrowly than a literal construction would suggest. The claim for loss of profits arising out of FCA’s failure to perform was excluded by the exemption clause and the court held that it could not be said that FCA’s construction would deprive the contract of all contractual force. Applying the approach set out in Fujitsu, this conclusion was based on the following:

  1. there was nothing in the language that would support Motortrak’s interpretation

  2. Flaux J’s dicta in Astrazeneca (quoted above) is limited to the situation where another construction is possible on the literal reading of the exemption clause, and that this was not the case in Motortrak

  3. Motortrak were not precluded from claiming for wasted costs—although it was a feature of Motortrak’s business that the revenue to be earned from the contract was largely (if not wholly) profits, there was no evidence that this was part of the factual matrix against which the agreement was concluded

He concluded that:

‘The court has to balance the indications given by the literal interpretation of the words used and the provisions of the contract against the factual background and the implications of the rival constructions. In my view in this case [unlike in Kudos or Astrazeneca] there is nothing in the factual background or the contract as a whole to override the language used in [the exemption clause]. The commercial consequences, whilst adverse to Motortrak, are not in my view such as to have the effect that the court can find that the objective meaning of the language of [the exemption clause] is other than as it appears on its face. It is a clear exclusion in the context of a clause which taken as a whole appears to have been drafted with some precision from the perspective of Motortrak and in relation to [the exemption clause], to the mutual benefit of both parties. As stated in Wood the court has to be alive to the possibility that one side may have agreed to something which in hindsight did not serve his interest.’ (at para [130])

How do these principles affect the construction of exemption clauses?

The narrative in these cases emphasises the importance of context and the court’s obligation to look at the contract as a whole when interpreting an exemption clause. The ‘statement of intent’ principle is not a cure for a bad bargain; the courts will not apply an interpretation that is unsupported by the factual background or context, even if this leaves a party with inadequate remedies.

Arguably, the courts may adopt a different approach where the interpretation would leave a party with no remedies at all, but even then, the case law suggests that there must be something in the language, context or factual background which would support an alternative interpretation and that such an alternative interpretation must be possible on the literal reading of the exemption clause in the first place.

For information on this principle, see Commentary:

  1. The main purpose rule: Contract: The Law of Contract (Common Law Series) [3.62]

  2. Construction to serve the purpose or main objects of the contract: Halsbury’s Laws of England [192]

Considering the document as a whole

One of the general rules of contract construction is that the document must be considered as a whole. For example, commercial agreements will often include both an entire agreement clause and an exemption clause. Where this is the case, the two must be interpreted in conjunction with one another.

In Watford Electronics v Sanderson, a contract for the supply of an integrated software system included exemption clauses and an entire agreement clause which provided that ‘no statement or representations made by either party have been relied upon by the other in agreeing to enter into the contract’.

Thornton J in the lower court had concluded that the exclusion of liability went beyond the exclusion of contractual claims and purported to exclude pre-contractual misrepresentations and was therefore unreasonable under UCTA 1977. The Court of Appeal disagreed; Chadwick LJ considered that the acknowledgment of non-reliance contained in the entire agreement clause meant that the exclusion of liability had to be construed on the basis that:

  1. the parties intended for their whole agreement to be contained and incorporated in the document which they signed, and

  2. neither party relied on any pre-contractual representations when they signed that document

There was therefore no reason why the parties should have intended to exclude liability for negligent pre-contract misrepresentation. He noted that liability in damages under the MA 1967 could only arise where the innocent party had relied on the representation; given that both parties had acknowledged in the contract that they had not relied on any pre-contract representation, it would have been ‘bizarre’ to attribute an intention to the parties to exclude a liability which they thought could never arise. The entire agreement clause ‘coloured the meaning and effect which the parties must be taken to have intended should be given to [the exclusion and limitation clause]’.

When there are several limbs to an exemption clause, the courts will look at all limbs as a whole and consider whether they can be reconciled.

Inconsistencies

Issues may also arise where other terms of the contract appear to be inconsistent with the exemption clause.

For example, in J Evans & Son v Andrea Merzario, the Court of Appeal held that the defendants were not entitled to rely on the printed conditions that formed part of the contract of carriage between the parties to exempt them from liability for breach of an oral promise that amounted to an enforceable contractual promise, because the printed conditions were repugnant to the oral promise and therefore would have rendered the promise illusory. Accordingly, the oral promise was treated as overriding the printed conditions.

The court had concluded that the oral assurance given by the defendant was either binding as a collateral contract or amounted to an express term of the contract; that contract was partly oral, partly written and partly by conduct and, in those circumstances, the court was entitled to look at all the evidence to determine the bargain struck between the parties.

In respect of oral assurances such as those given by the defendant in J Evans & Son, valid entire agreement clauses can preclude reliance on oral assurances which may otherwise override exemption clauses.

For more information on the interpretation of entire agreement clauses, see Practice Note: Contract interpretation—interpreting entire agreement clauses.

Representations as to the effect of exemption clauses

If the effect of an exemption clause is misrepresented by the party seeking to impose it (or by their agent), whether fraudulently or otherwise, they will prima facie be held to the meaning of the clause as represented.

Types of breach

This section looks at the court’s approach to the exclusion or limitation of liability for certain types of breach, including:

  1. fundamental breach

  2. deliberate repudiatory breach, and

  3. fraud

Fundamental breach

Historically, the courts considered that liability for fundamental breaches could not be excluded or limited by an exclusion clause.

This rule was disregarded by the House of Lords in Photo Production, where Lord Wilberforce confirmed that it is a matter of construction in each case to determine the extent to which an exclusion or limitation of liability applies to any particular breach of contract, fundamental or otherwise. There is therefore no presumption that an exemption clause will not apply to a fundamental breach or breach of a fundamental term (ie repudiatory breach); it will be a matter of construction of the clause in each case.

Lord Wilberforce also provided an explanation of the House of Lords’ decision in Suisse Atlantique which considered whether an exemption clause was intended to give exemption from the consequences of fundamental breach, in respect of which there had been conflicting case law. If there has been a breach of contract which would entitle the innocent party to terminate the contract (ie repudiatory breach), the operation of the exemption clause is not affected by the innocent party’s decision to affirm the contract, nor a decision to terminate it.

For further information on this, see Commentary: Operation of exemption clauses on termination of contract: Halsbury’s Laws of England [194].

Deliberate repudiatory breach

Exclusions and limitations are likely to apply to deliberate defaults in the absence of clear wording to the contrary. It will, however, turn on the construction of the contract as a whole in each case.

Some doubt was created following Internet Broadcasting Corporation v MAR LLC, in which the defendant admitted committing a deliberate repudiatory breach, but sought to rely on an exclusion clause to avoid liability for the claimant’s claim for loss of profit. The clause itself was silent as to whether deliberate repudiatory breaches were within its scope. The court therefore had to consider whether, on its true construction, the exclusion clause had been intended to cover such a breach.

The court held that there was a strong presumption that an exclusion clause would not be construed to cover deliberate, repudiatory breach of contract involving personal wrongdoing. When considering its construction, it distinguished between deliberate repudiatory breaches which were personal to a wrongdoer and deliberate repudiatory breaches in general (eg where there is repudiation by reason of vicarious liability). In the court’s view, a stricter approach to construction should be taken where the wrongdoing is personal and the court noted that it was much less likely that the parties would have intended the clause to cover a deliberate personal repudiation. It is not clear whether the scope of Internet Broadcasting is limited to personal deliberate repudiatory breach, or whether it may have application to more general deliberate repudiatory breaches.

However, the decision in Internet Broadcasting was treated negatively in Astrazeneca, where Flaux J stated (in obiter comments) that he considered the decision to be wrong on the basis that it was an attempt to revive the doctrine of fundamental breach, which the House of Lords had concluded was no longer good law in both Suisse Atlantique and Photoshop Production (see: Fundamental breach above).

Whether exclusion clauses cover certain types of breach or scenarios is a question of construction and no presumption should be applied as to whether it covers wilful or deliberate breaches. In his view, the words ‘claims of any kind’ in the exclusion clause in this case would have covered claims that arose out of a deliberate or wilful breach as a matter of construction.

For more information, see News Analyses:

  1. Decision creates doubt over presumption that exclusion clauses do not cover deliberate or wilful breach, and

  2. No presumption that exclusion clause inapplicable to deliberate repudiatory breach

In Suisse Atlantique, Lord Wilberforce noted that while it was a matter of construction whether deliberate breaches were within an exemption clause and no special rule of construction is necessary in such cases, that does not mean that ‘deliberateness’ cannot be a relevant factor: ‘depending on what the party in breach “deliberately” intended to do, it may be possible to say that the parties never contemplated that such a breach would be excused or limited’.

If the parties to a contract do agree that certain types of breach of contract are not to be subject to an exemption clause, clear and unambiguous wording should be used. Although the judge’s comments in Astrazeneca were obiter, parties should draft on the basis that exemption clauses may apply to deliberate repudiatory breaches of contract, subject to the normal rules of construction as to whether a particular breach is covered.

For further discussion on these cases and the use of the term ‘deliberate default’ in exemption clauses in commercial agreements, see Practice Note: Wilful misconduct and deliberate default in commercial contracts.

See also Q&As:

  1. What do gross negligence, wilful misconduct and deliberate default mean in commercial law?

  2. What is the difference between negligence and gross negligence in commercial contracts?

Fraud

For public policy reasons, it is not possible for a party to limit or exclude liability for its own fraud, either in inducing the other party to enter into the contract or during the course of it.

A clause will not be naturally construed as purporting to exclude liability for fraud, although it is common for exemption clauses to specifically carve out fraud.

Types of loss

It is common for parties to seek to exclude liability entirely in relation to certain types of loss.

This section considers the court’s approach to interpreting references to the following heads of loss in exemption clauses:

  1. direct loss

  2. consequential and indirect loss

  3. special damages

  4. loss of profit

  5. loss of use

  6. loss of data

When drafting an exemption clause, each excluded head of loss should be set out in a separate sub-clause. This increases the likelihood that, if one sub-clause is deemed to be unenforceable, it may be severed without rendering the whole clause unenforceable. A severance clause should also be included in the agreement. For an example severance clause, see Precedent: Severance clause.

Particularly the exclusion of ‘consequential and indirect loss’ should be kept separate to avoid the inference that the parties intend only to exclude other losses where they arise indirectly from the breach (eg excluding only indirect loss of profit). By way of illustration, see the examples provided in: Loss of profit below.

Exemption clauses are very unlikely, if ever, to operate to exclude losses which relate to the sums that, but for a party’s breach, would have been earned by either party under the agreement.

Direct loss

Where the phrase ‘direct loss’ is used in a commercial contract, it has generally been regarded as referring to losses within the fist limb of Hadley v Baxendale: losses arising naturally, according to the ordinary course of things, from a breach of contract.

In order to exclude liability for direct loss, clear words must be used.

The courts have construed ‘direct loss’ widely. For example, compensation payments to customers arising from problems with a customer billing system have been held to be direct.

Consequential and indirect loss

In the absence of any agreed definition, where the phrase ‘consequential loss’ or ‘indirect loss’ is used in a commercial contract it has generally been regarded as referring to losses within the second limb of Hadley v Baxendale: potentially foreseeable losses, which were in the reasonable contemplation of the parties at the time they entered into the contract.

In Ferryways v Associated British Ports, the court noted that ‘in the light of the well-recognised meaning which has been accorded to such words in a variety of exemption clauses by the courts from 1934 to 1999 it would require very clear words indeed to indicate that the parties’ intentions when using such words was to exclude losses which fall outside that well-recognised meaning. This is particularly so when “indirect” is used as well as “consequential”.’

However, following the developments in the principles of contractual interpretation discussed above, the courts have arguably adopted a more flexible approach in recent cases.

In Transocean Drilling, the Court of Appeal acknowledged that the wording ‘consequential losses’ had caused difficulty for English lawyers when attempting to define its meaning, before noting that courts are now more willing to recognise that words take their meaning from their particular context and that the same word or phrase may mean different things in different documents. The consequential loss clause in that contract included a definition of ‘consequential loss’ that was clearly intended to include direct costs of a type falling within the first limb of Hadley v Baxendale, and the court was concerned with whether spread costs fell inside or outside the definition of consequential loss in the relevant clause.

See News Analysis: Clarifying consequential loss clauses in contracts.

In Star Polaris v HHIC-Phil, the court suggested that technical terms will be interpreted against the relevant factual matrix, and that, for example, there is no strict rule that ‘consequential loss’ and ‘special loss’ will always be interpreted as meaning indirect loss within the second limb of Hadley v Baxendale.

The court had to consider the correct construction of an exclusion of liability for ‘consequential or special losses, damages or expenses’. The court concluded, on the specific facts of the case, that the exclusion had a broader meaning than indirect loss under the second limb of Hadley v Baxendale. Rather, in Star Polaris, the phrase meant that all financial losses caused by guaranteed defects (above and beyond the cost of replacement and repair of physical damage), were excluded regardless of whether such losses were ‘direct’ or ‘indirect’.

See News Analysis: In brief: ‘Consequential loss and special damages’ in exclusion clauses (Star Polaris LLC v HHIC-Phil Inc).

In 2 Entertain Video v Sony, the court agreed with Sony’s submission that any general understanding of the meaning of ‘indirect or consequential loss’ must not override the true construction of the clause when read in context of the other provisions in the agreement and the relevant factual matrix (per Star Polaris) but nevertheless reached the same conclusion as the traditional approach. Based on the natural and ordinary meaning of the clause, the claims did not fall within the scope of the exclusion as they were claims for direct losses. The other provision put forward by Sony as being part of the ‘relevant matrix’ for consideration did not assist in ascertaining the true meaning of the exclusion as it did not attempt to define the extent of Sony’s liability for all breaches under the agreement (as had been the case in Star Polaris) and there was no definition of indirect or consequential loss in the agreement that would indicate a wider meaning than the second limb of Hadley v Baxendale (as had been the case in Transocean). For more information, see News Analysis: Indirect and consequential loss exclusions—English law holds the line for now.

Note that if the parties do not have equal bargaining power and consequential losses are a foreseeable result of a breach of contract, then excluding all consequential losses may be found to be unreasonable under UCTA 1977 where it applies. For more information, see the section: Statutory controls under UCTA 1977 below.

Special damages

The term ‘special damages’ does not have a specific meaning in English contract law under a breach of contract claim.

As such, any exemption provision found in a contract attempting to exclude liability for ‘special damages’ will need to be very clearly drafted in order to explain what meaning is intended by that particular terminology.

The term ‘special damages’ has a very specific meaning in the context of litigation under English law. It is a head of loss in tort claims which compensate the claimant for quantifiable monetary losses suffered as a result of the defendant’s act or omi...

Read More > 29th Jul

Produced in partnership with Kirstie McBirnie and Beverley Wood of Morton Fraser LLP

DISCHARGE

by

Parties

  1. 1

    [insert name of Lender], a company incorporated in [England and Wales OR Scotland] with registered number [insert company number] whose registered office is at [insert address] (the Lender);

in favour of

  1. 2

    [insert name of Chargor] a company incorporated in [England and Wales OR Scotland] with registered number [insert company number] whose registered office is at [insert address] (the Chargor).

Recitals

  1. (A)

    In accordance with a [bond and] floating charge dated [insert date] (the Floating Charge), the Chargor charged the Charged Assets (see below for definitions) in favour of the Lender.

  2. (B)

    The Chargor has requested the Lender discharge and release the security constituted by the Floating Charge and the Lender has agreed to do so.

The parties agree:

  1. 1

    Definitions and interpretation

    1. 1.1

      Unless otherwise provided, the words and expressions in and the interpretation of this Discharge shall be as set out in the Floating Charge.

    2. 1.2

      In this Discharge, Charged Assets means all the undertaking, property, rights and assets of the Chargor charged by the Floating Charge.

  2. 2

    Release and discharge

  3. The Lender unconditionally and irrevocably releases and discharges (i) all of the Lender’s rights to and interest in the Charged Assets free and clear from any charges, security rights and/or interests created by the Floating Charge and (ii) the Chargor from all and any obligations under the Floating Charge.

  4. 3

    Governing law

    1. 3.1

      T...

Read More > 29th Jul

Coronavirus (COVID-19) impact on tribunals: For information on the coronavirus implications for appeals to, and hearings at, the Scottish tax tribunals, see Practice Note: Coronavirus (COVID-19)—tax implications—Tax tribunals.

This Practice Note outlines the procedure for appealing a decision made by Revenue Scotland in relation to any of the Scottish devolved taxes. Where relevant, it also compares the Scottish procedure to the procedure for appeals against a decision by HMRC in the UK tribunals (the UK procedure is explained in further detail in Practice Note: Appealing an HMRC decision.

It is important to note that there are time limits at all stages of the appeal process, so failing to adhere to a time limit may mean that the right of appeal is lost.

For an introduction to the Scottish tax tribunal system, which deals with appeals in devolved tax matters in Scotland, see Practice Note: Scotland: devolved taxes and the Scottish tribunal system.

For ease of reference, this Practice Note refers to:

  1. the First-tier Tribunal for Scotland (Tax Chamber) as the Scottish FTT

  2. the Upper Tribunal for Scotland as the Scottish UT

  3. the First-tier Tribunal (Tax Chamber) as the UK FTT

  4. the Upper Tribunal (Tax and Chancery Chamber) as the UK UT

  5. the First-tier Tribunal for Scotland Tax Chamber (Procedure) Regulations 2017, SSI 2017/69 as the Scottish FTT Rules, and

  6. the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009, SI 2009/273 as the UK FTT Rules

Decisions and the right of appeal

Right of appeal

Before you can appeal, section 241 of the Revenue Scotland and Tax Powers Act 2014 (RSTPA 2014) makes it clear that Revenue Scotland must have made an appealable decision.

An ‘appealable decision’ is given an exhaustive definition in RSTPA 2014, s 233 and covers a wide range of decisions by Revenue Scotland.

In addition, a taxpayer is not permitted to give notice of appeal:

  1. against an amendment of a self-assessment while an enquiry is in progress—the taxpayer must wait until Revenue Scotland has issued the decision

  2. while a review by Revenue Scotland of its own decision in respect of the same matter in question is in progress—if a taxpayer has requested Revenue Scotland to review its original decision, the taxpayer must wait until Revenue Scotland has concluded its review or, failing that, when the review is treated by legislation as having been concluded, or

  3. in respect of a matter that is covered by a settlement agreement between the taxpayer and Revenue Scotland—the taxpayer must withdraw from that agreement

Appealable decisions

The following decisions of Revenue Scotland are appealable decisions:

  1. a decision under RSTPA 2014, s 66 to make adjustments to counteract a tax advantage under the Scottish general anti-avoidance rule (Scottish GAAR)

  2. a decision in relation to the registration of any person in relation to any taxable activity

  3. a decision which affects whether a person is chargeable to tax

  4. a decision which affects the amount of tax to which a person is chargeable

  5. a decision which affects the amount of tax a person is required to pay

  6. a decision which affects the date by which any amount by way of tax, penalty or interest must be paid

  7. a decision in relation to a penalty under RSTPA 2014, Pt 8 (the main penalties provisions) or under any of the following provisions:

    1. RSTPA 2014, s 76 for failing to keep and preserve records

    2. RSTPA 2014, s 112 for breach of reimbursement arrangements

    3. RSTPA 2014, s 151 for obstructing a Revenue Scotland request to inspect computer records

    4. RSTPA 2014, s 231 for failing to provide information about persons owing sums to Revenue Scotland

    5. RSTPA 2014, Sch 3, para 5 for failing to keep records

  8. a decision in relation to the giving of an information notice or in relation to the use of any of the other investigatory powers in RSTPA 2014, Pt 7, and

  9. a decision in relation to the giving of a notice under RSTPA 2014, s 228 for a third party’s failure to provide information about persons owing sums to Revenue Scotland

However, some of the above-mentioned Revenue Scotland decisions are only appealable in certain circumstances, so it is important to carefully check the legislation to ensure that those conditions have been satisfied. Guidance is also available at RSTP6004.

Non-appealable decisions

Certain decisions are specifically provided not to be appealable.

The giving of a notice under RSTPA 2014, s 68 regarding the proposed counteraction of a tax advantage under the Scottish GAAR is not appealable. In this respect, the Scottish GAAR and the UK general anti-abuse rule (UK GAAR) are the same. A taxpayer has no right of appeal against the notice itself but can make an appeal against the making of the counteracting adjustments. For more information on the procedure applicable to the Scottish GAAR, see Practice Note: Scottish general anti-avoidance rule (Scottish GAAR). For the UK GAAR, see Practice Note: The GAAR procedure.

There is no right of appeal against a Revenue Scotland determination (made to the best of its information and belief) under RSTPA 2014, s 95 about the amount of tax to which a taxpayer is chargeable in circumstances where the taxpayer has failed to make a tax return. There is similarly no right of appeal against an HMRC determination about a taxpayer’s tax liability in circumstances where the taxpayer has failed to make a tax return. In both cases (ie whether it is a determination of Revenue Scotland or HMRC), although there is no right of appeal, the taxpayer can displace the tax authority’s determination by submitting its own tax return within a specified period of time. For more information on determinations made by HMRC and a taxpayer’s ability to displace them, see Practice Note: What is a tax determination? and step 1 of Checklist: Practical steps following a decision in tax matters—checklist.

There is also no right of appeal against a decision to give a notice of the intention to make an enquiry under RSTPA 2014, s 85 or RSTPA 2014, Sch 3, para 13. The same is true for an HMRC enquiry—a taxpayer cannot appeal against the notice of HMRC’s intention to make an enquiry. The taxpayer must wait until HMRC has issued a decision, such as a closure notice.

Review of its own decisions by Revenue Scotland

As a precursor to appeal, and a potential alternative, Revenue Scotland may review its own appealable decisions.

RSTPA 2014, s 234(1) permits a person aggrieved by an appealable decision to ask Revenue Scotland to review its own decisions by submitting a notice of review to Revenue Scotland specifying the grounds of review. This right is subject to certain conditions and a time limit, all of which are discussed below.

This position, putting the onus on the taxpayer to request a review in relation to the Scottish devolved taxes, contrasts to practice in relation to the UK reserved taxes, where:

  1. in respect of VAT, HMRC must offer a review at the same time that it issues its original decision, and

  2. in respect of UK direct taxes, HMRC may offer a review even if the taxpayer hasn’t requested one

Although no definition of ‘person aggrieved’ is provided by the RSTPA 2014 and the Scottish FTT has also not considered this definition, the term ‘person aggrieved’ is well-known, and it seems likely that existing case law established outside the Scottish tax tribunals will be used in considering its application here. Person aggrieved should include the taxpayer in respect of whose tax affairs Revenue Scotland has made a decision.

When a review cannot be requested

Even if a decision is an appealable decision (and therefore a decision in respect of which a taxpayer can normally request a review from Revenue Scotland), a taxpayer is not permitted to request such a review:

  1. while a Revenue Scotland enquiry is in progress and has not been completed—in this circumstance, the taxpayer is also prevented from submitting a notice of appeal to the tribunal

  2. the taxpayer has given notice of appeal in relation to the same matter in question, or the tribunal has determined the matter in question under RSTPA 2014, s 244, and/or

  3. the taxpayer has entered into a settlement agreement with Revenue Scotland in relation to the same matter in question and has not withdrawn from that agreement—in this circumstance, the taxpayer is also prevented from submitting a notice of appeal to the tribunal

In relation to UK direct taxes, a taxpayer is not permitted to request a review by HMRC if:

  1. the taxpayer has already given a notice to review in respect of the matter in question

  2. HMRC has already offered the taxpayer a review, or

  3. the taxpayer has already notified the appeal to the UKFTT

Contents of notice of review

A taxpayer’s notice of review must:

  1. be in writing—Revenue Scotland’s guidance also requests that the heading of the notice should be ‘Notice of review’

  2. specify the grounds of review, and

  3. be submitted to Revenue Scotland within the time limit (discussed below) unless Revenue Scotland or the Scottish FTT gives permission for late notice

Time limit for requesting a review

Notice requesting a review must be given by a ‘person aggrieved’ (ie the taxpayer) within 30 days of the date:

  1. the taxpayer was notified of Revenue Scotland’s decision

  2. on which an enquiry was completed, or

  3. the date that the taxpayer withdrew from the settlement agreement with Revenue Scotland

If a taxpayer submits its notice of review late, Revenue Scotland must agree to undertake a review if it is satisfied that:

  1. there was a reasonable excuse for the delay, and

  2. the taxpayer made the request without unreasonable delay after the reasonable excuse ceased to apply

Revenue Scotland’s guidance:

  1. requests that a late notice is marked with ‘Request for late notice of review’, and

  2. provides information on the types of factors that it might or might not consider to be a reasonable excuse

If Revenue Scotland refuses to accept the late notice of review, the taxpayer can ask the tribunal for permission.

Taxpayers (and their advisers) appealing against an HMRC decision relating to UK direct tax will be familiar with this 30-day time limit as that also applies to such appeals and reviews. For more information, see Q&A: Is there a time limit for asking for a review of an HMRC decision? and Practice Note: HMRC review of a decision.

Duty and nature of Revenue Scotland’s review

Revenue Scotland must respond with an initial view of the matter within 30 days of the review or such longer period as is reasonable.

Revenue Scotland must then carry out a review, the nature and extent of which are such as appear appropriate in all the circumstances to Revenue Scotland and:

  1. have regard to steps taken before the beginning of the review:

    1. by Revenue Scotland in deciding the matter in question, and

    2. by any person in seeking to resolve disagreement about the matter in question, and

  2. take into account any representations made by the taxpayer at a stage which gives Revenue Scotland a reasonable opportunity to consider them

Revenue Scotland must notify the taxpayer of its conclusions on the review within 45 days of communicating its initial view or such longer period as may be agreed. Therefore, normally, the whole review process is completed within 75 days of the review request being received.

If Revenue Scotland fails to give the taxpayer notice of the review conclusions within the 45 days or other agreed extended period, the review is treated as having concluded that Revenue Scotland’s view of the matter in question is upheld.

Taxpayers (and their advisers) appealing against a decision relating to UK direct tax will be familiar with the 30-day time limit applicable to Revenue Scotland for providing its initial view of a review and the further 45-day deadline for providing the conclusions of its review, as these are the same as the deadlines that apply to HMRC when a taxpayer has requested a review. In addition, the scope and nature of a Revenue Scotland review are identical to the scope and nature of an HMRC review.

Effect of conclusion of review

Revenue Scotland’s review may conclude that its initial view of the matter is to be:

  1. upheld

  2. varied, or

  3. cancelled

The conclusions of a review are treated as settled by agreement (ie treated as if the tribunal had determined the appeal) unless the taxpayer:

  1. enters into mediation and concludes that mediation by entering into a settlement agreement, or

  2. gives a notice of appeal to the Scottish FTT within 30 days of being notified of the conclusions of the review

Taxpayers (and their advisers) appealing against a decision relating to UK direct tax will be familiar with the effect of the conclusions of a Revenue Scotland review since they are very similar to the effects of the conclusions of an HMRC review. The only substantive difference is that there is no reference in the UK legislation to mediation.

Mediation

Rule 3 of the Scottish FTT Rules encourage the use of mediation to resolve tax disputes, even requiring the Scottish FTT, where the parties so wish, ‘to facilitate the use of mediation’ to resolve tax disputes.

This provision is substantively the same as the alternative dispute resolution (ADR) and arbitration provision in the UK FTT Rules, except for the terminology—rule 3 of the UK FTT Rules refers to ADR rather than mediation and also explains that Part 1 of the Arbitration Act 1996 doesn’t apply to proceedings before the UK FTT.

In a tax dispute with Revenue Scotland, a taxpayer can request to enter into mediation at any time before the appeal is determined.

RSTPA 2014, s 240 expressly envisages mediation being an option where a review by Revenue Scotland of its own decision has not settled the dispute. If the conclusions of Revenue Scotland’s review supports its original decision, the fact that mediation has been entered into does not, according to RSTPA 2014, s 240, prevent Revenue Scotland’s conclusions from being treated as if they were settled by agreement, yet the deadline for appealing is, under RSTPA 2014, s 242(2)(d), pushed back where, following a review by Revenue Scotland, there is a mediation underway. Although the result of the review appears to stand while mediation is underway, the better view is that it must be deemed to be suspended while the mediation is in progress, otherwise the mediation would not serve any purpose. If either party then withdraws from mediation, the review decision will be final and treated as if it were settled by agreement unless the taxpayer makes an appeal within 30 days of the date of withdrawal from mediation.

Unlike RSTPA 2014, which expressly refers to mediation, the provisions of TMA 1970 on appeals does not expressly refer to mediation or ADR. In addition, starting ADR does not stop the clock for appealing an HMRC decision. The taxpayer must still make an appeal or else HMRC’s decision will become final.

Making an appeal

A taxpayer makes an appeal directly to the Scottish FTT by submitting a notice of appeal, which must specify the grounds of appeal.

The notice of appeal must be submitted directly to the Scottish FTT just like in an appeal against a VAT decision which must be submitted directly to the UK FTT. This contrasts with the position that applies if a taxpayer is appealing against a UK direct tax decision made by HMRC, in which case the taxpayer must first make the appeal to HMRC (by submitting a notice of appeal) and then notify the appeal to the UKFTT. For more information, see Practice Note: Appealing an HMRC decision.

No form is prescribed, however the the Scottish FTT Rules prescribe that the contents of the notice of appeal must include:

  1. the name and address of the appellant and the appellant’s representative (if any)

  2. an address where documents for the appellant may be sent or delivered

  3. details of the decision appealed against

  4. the result the appellant is seeking, and

  5. the grounds for making the appeal

Although no form is prescribed in the Scottish FTT Rules, the Scottish FTT has published a non-statutory form to facilitate appeals.

These content requirements are identical to those that are prescribed by the FTT Rules for a notice of appeal in relation to a UK direct tax dispute.

In Redwing Property, the Scottish FTT suggested that it would be desirable if grounds of appeal followed the form required in the Sheriff Appeal Court, which is the intermediate civil appeal court in Scotland. The Sheriff Appeal Court Rules require that an appellant should ’state the grounds of appeal in brief specific numbered paragraphs setting out concisely the grounds on which i...

Read More > Produced in partnership with Kenneth Campbell QC of Arnot Manderson Advocates 28th Jul

Produced in partnership with David Small of Arnot Manderson Advocates and Ronnie Brown of Burness Paull LLP

CORONAVIRUS (COVID-19): the Coronavirus (Scotland) (No 2) Act 2020 received royal assent on 26 May 2020. This includes provisions at part 4 of schedule 4 to extend the time period for selling a previous main residence from 18 to 27 months (where the effective date of the transaction fell within the period beginning 24 September 2018 and ending 24 March 2020) in order to claim repayment of the Land and Buildings Transaction Tax (LBTT) Additional Dwelling Supplement (ADS). See: Revenue Scotland guidance: Coronavirus (Scotland) (No 2) Act 2020 and Second Coronavirus (Scotland) Bill.

How is LBTT calculated?

The amount of land and buildings transaction tax (LBTT) that is due on a land transaction is calculated by applying the appropriate rate or rates of tax (including a nil rate) to the amount of the chargeable consideration. Where apparently separate transactions are linked by the legislation, the LBTT due has to be calculated as if there were only one transaction.

This Practice Note explains the meaning of chargeable consideration and linked transactions and summarises the applicable rates and bands of LBTT and, where relevant, comparisons between LBTT and stamp duty land tax (SDLT) are highlighted. For details of the equivalent SDLT provisions, see Practice Notes:

  1. SDLT chargeable consideration, and

  2. Rates of SDLT

For further background information about LBTT, see Practice Note: Scotland: Land and buildings transaction tax (LBTT)—the basics.

Chargeable consideration

Chargeable consideration is defined in sections 17–23 and Schedule 2 to the Land and Buildings Transaction Tax (Scotland) Act 2013 (LBTT(S)A 2013). The provisions largely follow the definitions in the equivalent legislation applying to SDLT (for further details, see Practice Note: SDLT chargeable consideration). The following outline draws particular attention to any significant differences between LBTT and SDLT.

Money, money’s worth and foreign currency

The basic definition of chargeable consideration includes ‘any consideration in money or money’s worth given for the subject matter of the transaction by the buyer or a person connected with the buyer’. The value of any non-monetary consideration is to be taken as its market value. Where the consideration includes the provision of services, their value is to be taken as the amount that would have been paid to obtain them in the open market. If consideration is expressed in a foreign currency, it is to be converted into Sterling at the rate used by the parties for the transaction, failing which, at the London closing exchange rate for the effective day, which will normally be the day of completion.

Contingent consideration

Contingent consideration includes both consideration that is subject to a suspensive condition and consideration that is subject to a resolutive condition.

For example, a farmer may sell his land to a developer for £X payable immediately and a further payment of £Y receivable when a certain number of houses have been built and sold; the payment of £Y is subject to a suspensive condition. In such a case the basic rule is that the developer must account for LBTT on the basis that he will pay £X + Y for the land. However, he is entitled to apply to defer payment of LBTT in respect of any contingent consideration that he has not actually paid at the time of making the application. Following a successful application for deferment, he must make an LBTT return in respect of any further proceeds received.

Alternatively, the farmer might sell for £Z but be obliged to repay £A if a certain number of houses have not been built and sold by a certain date; the repayment of £A is subject to a resolutive condition. In such a case the developer must initially account for LBTT on £Z but, if the farmer subsequently repays £A, the developer may claim a repayment of LBTT in accordance with LBTT(S)A 2013, s 32.

These provisions are similar to those applying for SDLT.

Uncertain or unascertained consideration

To vary the examples given above, suppose that the farmer were to sell land to the developer for £X payable immediately and £Y per house to be built and sold by the developer on that land. Here the total that the developer will pay is uncertain—it depends on future events. In that situation the developer must include a chargeable consideration in his first LBTT return not only £X but also a reasonable estimate of the total of the £Y payments that he will receive. If the estimate proves to be too low or too high, the position is adjusted by subsequent returns.

These provisions are again similar to those applying for SDLT.

Annuities

Where the chargeable consideration for a land transaction consists of or includes an annuity, the consideration to be taken into account is limited to a maximum of 12-years’ payments. The LBTT and SDLT rules on this point are essentially the same.

Deemed market value

Neither LBTT nor SDLT has a general rule to the effect that the chargeable consideration payable in a transaction between connected persons must be taken to be equal to the market value of the land involved. However, both the LBTT and SDLT rules provide that, with certain exceptions, the chargeable consideration is to be the market value of the land where there is an acquisition of land by a company from a person who is connected with that company or the consideration consists of or includes an issue of shares by a company with which the seller is connected.

VAT

For the purposes of LBTT, the chargeable consideration includes VAT chargeable in respect of the transaction, other than VAT chargeable by virtue of an option to apply VAT exercised after the effective date of the transaction.

Postponed consideration

The amount of the chargeable consideration is determined without any discount for postponement (in other words, consideration left outstanding on loan is to be brought in at face value).

Apportionment

Consideration that is only partly chargeable, or that is attributable to two or more transactions, is to be apportioned on a ‘just and reasonable basis’. This rule will apply, for example, to the purchase of a house with some movable items included, eg carpets and curtains, where consideration apportioned to carpets and curtains will not fall within the scope of chargeable consideration for LBTT purposes. It will also commonly apply to the purchase of a business, which may include land and buildings and a variety of other assets that are not liable to LBTT, such as machinery and ‘free’ goodwill. Other situations in which apportionment would be necessary include:

  1. the purchase of land that straddles the border between England and Scotland, and

  2. where a transaction comprises a mix of commercial and residential property and the Additional Dwelling Supplement (ADS) is payable on the latter (for more on ADS see below)

In relation to the equivalent SDLT provisions, HMRC takes the view that an apportionment agreed between the parties is not necessarily a ‘just and reasonable’ one that must be respected for tax purposes, even if the parties are at arm’s length. For further details, see Practice Note: Land transactions, chargeable interests and chargeable transactions—Fixtures vs fittings and chattels.

Exchanges

LBTT has rules specifying the amount of chargeable consideration to be taken into account when parties make an exchange between themselves of their interests in land or buildings. These rules are described in Practice Note: Scotland: Land and buildings transaction tax (LBTT)—particular transactions and taxpayers.

Carrying out of works

Where the consideration for a land transaction consists of, or includes, the carrying out of works on the land to enhance its value, the general rule is that the value of the works will count as chargeable consideration. However, there are certain limited exceptions from this general rule. The main exception requires three conditions to be satisfied:

  1. the works must be carried out after the effective date of the transaction

  2. the works must be carried out on land acquired or to be acquired under the transaction, and

  3. it must not be a condition of the transaction that the works are to be carried out by the seller or a person connected with the seller

The second condition is more narrowly framed than its equivalent under the SDLT rules. Whereas in the case of LBTT the works must be carried out on land acquired or to be acquired under the transaction, in the case of SDLT the works may be carried out also on other land held by the buyer or a person connected with him.

Land transaction entered into by reason of employment

Where a land transaction is entered into by reason of the buyer’s employment, or that of a person connected with the buyer, the consideration for the transaction is taken to be not less than the market value of the subject matter of the transaction. This is a simpler and broader approach to the topic than is taken by SDLT. The reason for the simpler approach taken by LBTT is likely to be that most residential leases are exempt from LBTT and so the rules of LBTT do not need to provide for the situation in which an employee occupies property rented for him by his employer. For further details on the treatment of residential leases for LBTT purposes, see Practice Note: Scotland: Land and buildings transaction tax (LBTT)—particular transactions and taxpayers.

Debt as consideration

The LBTT legislation specifies the amount that is to be taken as chargeable consideration in a variety of circumstances in which debt is satisfied, assumed or released as consideration for a land transaction. These rules are similar to the equivalent rules that apply for SDLT.

Consideration not to be taken into account

There are certain circumstances or events that are specified as not amounting to the giving of chargeable consideration. These rules are again similar to those that apply for SDLT and include:

  1. the buyer indemnifying the seller in respect of a liability re the land

  2. a buyer bearing an inheritance tax liability

  3. a buyer bearing a capital gains tax liability in a non-arm’s length transaction, and

  4. sale, leaseback and construction arrangements involving public or educational bodies

Tax rates and tax bands

The tax bands and percentage tax rates of LBTT that apply are specified by order of Scottish Ministers. The bands and rates were first announced on 9 October 2014 as part of the Scottish government’s Draft Budget for 2015/16. Different rates and bands were proposed for residential and non-residential property respectively.

Following the UK government’s reform of the residential SDLT rates effective from December 2014 (for further details, see Practice Note: Rates of SDLT), the Scottish government made a further announcement on 21 January 2015 proposing revised LBTT rates and bands for residential property, and these were subsequently incorporated into the Scottish Statutory Instrument setting the rates that apply from 1 April 2015.

The rates were revised with effect from 25 January 2019.

The definition of residential and non-residential properties is essentially the same for both LBTT and SDLT (for further details, see Practice Note: SDLT—residential property vs non-residential property).

The rates and bands of LBTT applying from 1 April 2015 (but not in the period from 15 July to 31 March 2021) are as set out below.

Residential property

Chargeable consideration Rate of tax
Up to £145,000 0%
£145,001 to £250,000 2%
£250,001 to £325,000 5%
£325,001 to £750,000 10%
£750,001 and over 12%

As a temporary measure in response to the coronavirus (COVID-19), from 15 July 2020 to 31 March 2021, the LBTT nil rate band for residential property transactions is £250,000 (increased from £145,000). The rates and bands of LBTT applying from 15 July 2020 to 31 March 2021 are set out below.

Purchase price LBTT rate (15 July 2020 to 31 March 2021)
£250,000 or under 0%
Above £250,000 to £325,000 5%
Above £325,000 to £750,000 10%
Over £750,000 12%

Following an announcement on 14 December 2017 during the presentation of the Scottish draft Budget 2018/2019, the Scottish Government consulted during 2018 on the introduction of a first-time buyer’s relief. This was less generous and slower to come into force than its SDLT equivalent. The relief raises the LBTT threshold for first-time buyers to £175,000 with effect from 30 June 2018 and applies to all buyers that meet the eligibility conditions where the purchase price of the property is over £175,000 (buyers pay LBTT on any remaining consideration). Revenue Scotland have published on how the relief interacts with the temporary increase of the nil rate band.

In relation to leases, SDLT includes rates applicable to residential leases (see: Rates of SDLT — Rates of SDLT—rent). There is no ...

Read More > 28th Jul

CORONAVIRUS (COVID-19): Revenue Scotland is not currently processing paper returns due to COVID-19. Agents are encouraged to make returns through SETS (the Scottish Electronic Tax System). See: Revenue Scotland: COVID-19.

Produced in partnership with David Small of Arnot Manderson Advocates and Ronnie Brown of Burness Paull LLP

The background to land and buildings transactions tax (LBTT) is set out in Practice Note: Scotland: Land and buildings transaction tax (LBTT)—the basics. For information about chargeable consideration and rates of LBTT, see Practice Note: Scotland: Land and buildings transaction tax (LBTT)—chargeable consideration and rates of LBTT.

This Practice Note deals with compliance issues related to LBTT, including:

  1. the obligation to make an LBTT return

  2. payment of LBTT

  3. enquiries, assessments and appeals, and

  4. penalties for non-compliance

This Practice Note refers to key concepts and terms of LBTT that are described in more detail in Practice Note: Scotland: Land and buildings transaction tax (LBTT)—the basics.

For coverage of similar issues in relation to stamp duty land tax (SDLT), see Practice Note: SDLT—administration and compliance.

LBTT returns

Obligation to make an LBTT return

It is the duty of the buyer of Scottish land interests to notify Revenue Scotland about every notifiable transaction within 30 days after the effective date of the land transaction in question using an LBTT return. LBTT returns are in a form, and contain information, prescribed by Scottish Ministers. This contrasts with SDLT where the buyer has an obligation, from 1 March 2019, to make a return within 14 days of the effective date of the land transaction.

The ‘buyer’ for these purposes is ‘the person who acquires the subject matter of the transaction’.

For the purposes of LBTT, a person may ‘acquire’ an interest in land or buildings in a variety of ways. An acquisition includes the creation, renunciation, release or variation of the interest (but not, usually, the variation of a lease). The acquisition may be effected by the parties to a transaction, by order of a court or by operation of law.

The terms 'acquisition' and 'buyer' therefore have a wider meaning for the purposes of LBTT than they have in everyday speech.

Notifiable transactions

The buyer must make a return of ‘notifiable’ transactions. All land transactions are notifiable unless they are:

  1. exempt

  2. the acquisition of the ownership of land for chargeable consideration of less than £40,000

  3. the acquisition of a chargeable interest other than a major interest in land for chargeable consideration not exceeding the limit of the nil rate tax band, or

  4. certain transactions in leases of less than seven-years duration and/or for low consideration

For the purposes of LBTT, a major interest in land means ownership, or the tenant’s interest in land subject to a lease.

Making an LBTT return

Buyers have 30 days to make their LBTT return, beginning with the day after the effective date of the transaction. The effective date of a transaction will vary according to what kind of transaction it is, although in the usual case the effective date will be the date of completion. 'Completion' of a land transaction usually means the settlement of the transaction. So, in the ordinary case of the sale and purchase of a house, completion will occur when the purchase price is paid in exchange for delivery of a conveyance, all in accordance with the contract (missives) that the parties entered into some time beforehand. In the case of a lease, completion occurs on the execution of the formal lease (or on its otherwise taking legal effect).

An example of a transaction having an effective date that precedes completion is the case of substantial performance of a contract before it is completed. Substantial performance occurs if the buyer takes possession of the land or a substantial part of the purchase price is paid, and in certain other circumstances. Unlike HMRC, Revenue Scotland take the view that amounts less than 90% may be substantial. They will consider this on a case-by-case basis.

Although there is formally a 30-day limit for making the return, there is a practical incentive to make a return as soon after the effective date as possible. The Registers of Scotland may not accept an application for registration of a document effecting or evidencing a notifiable transaction unless a land transaction return has been made in relation to the transaction. The strength of a buyer’s title to property usually depends on the registration process being completed.

LBTT is a self-assessment tax and the LBTT return must include an assessment of the tax that, on the basis of the information contained in the return, is chargeable in respect of the transaction.

In addition to the original return in respect of a land transaction, further returns must be made in a number of different situations. These include transactions in which the consideration has been contingent or uncertain and the contingency or uncertainty is purified, cases in which certain reliefs claimed in the first return are subsequently withdrawn, and cases of linked transactions where the later transaction causes more tax to be payable in respect of the earlier transaction.

Most reliefs from LBTT (ie those listed in Schedules 3–16 of Land and Buildings Transaction Tax (Scotland) Act 2013 (LBTT(S)A 2013), including, for example, relief for transfers within groups of companies) must be claimed in the first LBTT return made in relation to that transaction, or in an amendment to that return.

LBTT returns are in a form, and contain information, prescribed by Scottish Ministers. LBTT returns must contain a declaration by the buyer that it is, to the best of the buyer’s knowledge, correct and complete. Many LBTT returns are likely to be completed by solicitors (or other agents) acting for buyers. In that event, the agent must certify that the buyer has declared that the information in the return is correct, with the exception of certain technical information that the agent must certify.

Tenants of commercial property have an obligation to submit three yearly LBTT returns for the duration of the lease. For more on leases and LBTT, see Practice Note: Scotland: Land and buildings transaction tax (LBTT)—particular transactions and taxpayers.

Payment of LBTT

Liability to pay LBTT in respect of a chargeable transaction also falls on the buyer, as defined above.

In most cases the tax (or additional tax, in the case of a further LBTT return) must be paid at the same time as the LBTT return is made. Similarly, tax payable as a result of the amendment of a return must be paid at the same time as the amendment is made.

In Munro, the First-tier Tribunal for Scotland Tax Chamber (Scottish FTT) upheld a penalty notice issued to Ms Munro because she had not paid the LBTT at the same time as the LBTT return had been made even though the return had been submitted earlier than the due date for filing. The LBTT was paid four days after the return was submitted. The Scotttish FTT held that the obligation in LBTT(S)A 2013, s 40 (to pay the tax at the same time as the LBTT return is made) was unambiguous and clear.

The buyer may apply to defer payment of tax in certain cases where the amount of chargeable consideration is contingent or uncertain. No such application can be made in respect of any consideration that has already been received at the time when the application is made.

Generally speaking, LBTT must have been paid before a document relating to a land transaction can be accepted for registration in the Registers of Scotland. However, tax will be treated as paid if arrangements satisfactory to Revenue Scotland are made for the payment of the tax.

Management and collection of LBTT

HMRC has no responsibility for the management and collection of LBTT. The management and collection of LBTT is the responsibility of Revenue Scotland, an independent body within the Scottish government created by the Revenue Scotland and Tax Powers Act 2014 (RSTPA 2014), an Act of the Scottish Parliament. RSTPA 2014 is the ‘Management Act’ for LBTT and the other Scottish taxes. It confers powers on Revenue Scotland relating to matters such as enquiries, assessments, penalties and enforcement of payment. It also contains the framework legislation for the creation of a tribunal system to hear appeals. Revenue Scotland has published guidance on its website about its powers of management and collection under the 2014 Act. It should be borne in mind that RSTPA 2014 is not an exclusive code for the management and collection of LBTT because LBTT(S)A 2013 itself also contains some provisions relating to the making of returns and payment of tax.

Enquiries

Once an LBTT return has been made, Revenue Scotland may commence an enquiry into that return by giving notice to the taxpayer within three years of the ‘relevant date’. The relevant date is the later of:

  1. the due date for the return, or

  2. the date on which it was actually made

An enquiry by Revenue Scotland may extend to any question affecting the chargeability of the taxpayer, or the amount of tax chargeable on a taxpayer.

In the course of an enquiry any question arising may be referred to the appropriate tribunal for decision. Such references must be made jointly by Revenue Scotland and the taxpayer. Either party may withdraw the reference. No steps to close the enquiry may be made while the decision is pending.

Amendment and correction of returns

Revenue Scotland has power to amend...

Read More > 28th Jul

Produced in partnership with David Small of Arnot Manderson Advocates and Ronnie Brown of Burness Paull LLP

Land and buildings transaction tax (LBTT) replaced stamp duty land tax (SDLT) in Scotland with effect from 1 April 2015. This Practice Note provides an introduction to LBTT. Three other Practice Notes focus in more detail on particular aspects of the tax, as follows:

  1. Scotland: Land and buildings transaction tax (LBTT)—chargeable consideration and rates of LBTT

  2. Scotland: Land and buildings transaction tax (LBTT)—particular transactions and taxpayers, and

  3. Scotland: Land and buildings transaction tax (LBTT)—administration and compliance

Background to LBTT

The Scotland Act 1998 (SA 1988) created the Scottish Executive (now known as the Scottish government) and the Scottish Parliament. SA 1998 devolved limited powers over income tax to the bodies but these powers were never used. The Scotland Act 2012 (SA 2012) then amended SA 1998 to give further powers to the Scottish Parliament, including wider powers over taxation. In particular, the Scottish Parliament was given power to legislate for a new tax, to be charged on the acquisition of land and buildings, which would replace SDLT in Scotland. In exercise of those powers, the Scottish Parliament passed the Land and Buildings Transaction Tax (Scotland) Act 2013 (LBTT(S)A 2013), which received Royal Assent on 31 July 2013.

Commencement of LBTT

LBTT(S)A 2013 provides for some of its provisions to come into effect immediately and for the remainder to come into effect from such dates as the Scottish Ministers may appoint by order. Parts of LBTT(S)A 2013 took effect on 7 November 2014, but most of LBTT(S)A 2013 came into operation on 1 April 2015. The UK Treasury made an order under SA 2012, s 29 disapplying SDLT in Scotland from 1 April 2015.

Transitional provisions

Transactions in land are not usually agreed upon, performed and completed on the same day. In many cases, therefore, some steps towards a transaction will have been taken before, and some after, 1 April 2015. The legislation contains transitional provisions applying to certain situations in which events straddle the commencement date of LBTT. These provisions are unlikely to affect straightforward cases, such as house purchases where a conveyance is delivered in return for payment of the purchase price; in such cases it will normally be clear whether SDLT or LBTT applies. Rather, the transitional provisions apply to more complex or unusual circumstances, including cases where a contract is substantially performed before 1 April 2015 but is completed afterwards, cases involving alternative finance arrangements, and certain partnership transactions. Guidance on the transition from SDLT to LBTT has been prepared by HMRC and a link to it is provided on the Revenue Scotland website.

Administration of LBTT

Revenue Scotland, a non-ministerial body created by the Revenue Scotland and Tax Powers Act 2014 (RSTPA 2014) (an Act of the Scottish Parliament), is responsible for the collection and management of LBTT in accordance with the powers given to it by that Act. Revenue Scotland has published guidance about LBTT, including worked examples, on its website.

RSTPA 2014 allows Revenue Scotland to delegate functions relating to LBTT to the Keeper (ie Chief Executive) of the Registers of Scotland. The Registers of Scotland include the two Scottish property registers: the Land Register and the Register of Sasines. In Scots law, generally speaking, title to land is defective if it is not registered in either the Land Register or the Register of Sasines. LBTT(S)A 2013 provides that the Keeper may not make an entry in those registers reflecting a transaction within the scope of LBTT unless the appropriate tax return has been made and any LBTT due has been paid. It is expected that the Keeper and his staff will play a significant role in the routine administration and collection of LBTT.

Rates and structure of LBTT

The Scottish government intended LBTT to be a more progressive tax than SDLT. In particular, the Scottish government intended that LBTT would avoid the original ‘slab’ structure of SDLT, under which marginal increases in the price of a property could cause a disproportionate increase in the amount of tax payable. The tax bands and percentage tax rates of LBTT that apply are specified by order of Scottish Ministers. The proposed rates were first announced on 9 October 2014 as part of the Scottish government’s Draft Budget for 2015/16; different rates and bands were to apply for residential and non-residential property respectively. On 3 December 2014 the UK government announced new rates of SDLT and a reform of the tax to remove its ’slab’ structure for residential property (for further details, see Practice Note: Rates of SDLT). In turn, the Scottish government made a further announcement on 21 January 2015 proposing revised LBTT rates and bands for residential property. Those revised rates and bands took effect on 1 April 2015. The additional dwellings supplement applies from 1 April 2016. Revised rates for non-residential property and the additional dwellings supplement apply from 25 January 2019. An additional rate for rent applies from 7 February 2020. For further information on the rates and bands that apply in LBTT and SDLT, see Practice Note: Scotland: Land and buildings transaction tax (LBTT)—chargeable consideration and rates of LBTT.

Key concepts of LBTT

Land transactions

LBTT is to be charged on any land transaction, a term meaning the acquisition of a chargeable interest. The tax is chargeable whether or not there is a written instrument giving effect to the transaction, and whether or not the parties are resident or present in Scotland.

The terms ‘acquisition’ and ‘chargeable interest’ have specific definitions for LBTT purposes, as further detailed below.

Acquisition

'Acquisition' is widely defined and includes events that would probably not be regarded as acquisitions in everyday speech, for example if a tenant renounces his lease, the landlord will, for the purposes of LBTT, 'acquire' vacant possession.

Chargeable interest

Chargeable interest is defined as including ‘a real right or other interest in or over land in Scotland, or the benefit of an obligation, restriction or condition affecting the value of any such right or interest’. ‘Real right’ is not specifically defined in the legislation. Scots lawyers understand real rights to be rights in or over property (including intangible or incorporeal property), which may be asserted or defended against the whole world, in contrast to ‘personal rights’ (such as rights arising from contracts), which may only be asserted or defended against particular people (see further reading link to K G C Reid, The Law of Property in Scotland (1996), paras 3 et seq). In any event, it is clear that ‘chargeable interests’ may include both real and personal rights. For example, an option to buy or sell land (a personal, contractual right) is a chargeable interest and the legislation specifically provides that the acquisition of such an option is a land transaction in its own right, separate from the land transaction that wil...

Read More > 28th Jul

Trust deeds have, for many years, been utilised by debtors as a means of reaching a compromise with their creditors as an alternative to formal sequestration (see Practice Note: Scotland: the process for applying for sequestration). Trust deeds have their roots in common law and, although the law has historically taken a ‘light touch’ approach to them, it has now taken a closer interest in this area. As a result, trust deeds are now much more tightly regulated than ever before.

The purpose of this Practice Note is to consider the general principles of law of trust deeds and the process and effect of obtaining protected status. For a glossary of commonly used Scottish insolvency terms, see Practice Note: Glossary of Scottish insolvency words and expressions.

Coronavirus (COVID-19)

This content is affected by the coronavirus (COVID-19) pandemic. For further details, take a look at our Coronavirus (COVID-19) toolkit. For related news, guidance and other resources to assist practitioners working on restructuring and insolvency matters, see: Coronavirus (COVID-19)—Restructuring & Insolvency—overview and News Analysis: The Coronavirus (Scotland) (No 2) Bill—impact on restructuring and insolvency.

The nature of a trust deed

A trust deed is a voluntary arrangement between a debtor and their creditors whereby the debtor agrees to convey some or all of their assets to a trustee for the benefit of the creditors. In return, the creditors agree that once the debtor’s estate has been distributed, they will discharge the debtor of their debts.

Trust deeds, in the words of Sheriff Holligan in Pattullo v Massey 6 May 2016 (unreported, Edinburgh Sheriff Court), are ‘in an anomalous position. The legal structure straddles both the law of trusts and the law of insolvency. The matter is yet further complicated by the [statutory provisions] which supplement such common law rules as do exist’.

The hybrid nature of trust deeds has advantages in that they can be flexible, so as to meet the needs of particular circumstances, are potentially faster and cheaper than sequestrations, are private and can avoid some of the legal disabilities that prevent undischarged bankrupts holding certain public offices or professions.

Common law trust deeds do however have serious shortcomings. The unregulated nature of them means that they can be slower, more expensive and less than transparent than sequestrations. A trustee’s powers to recover assets, especially those situated abroad, and to force uncooperative debtors to comply with their obligations are not as effective as in sequestrations. Debtors and their families do not enjoy the same protections that are provided in sequestrations (see Practice Note: Scotland: dealing with the debtor's home in sequestration).

The biggest drawback to common law trust deeds is that they require all creditors to accede for them to be effective. If only one creditor is not prepared to agree to the terms proposed, they are not bound by a trust deed and therefore they can apply to sequestrate the debtor, or indeed carry out any other diligence, thus frustrating the process. It was for this reason that the Protected Trust Deed (PTD) was introduced by the Bankruptcy (Scotland) Act 1985 (B(S)A 1985). This was a statutory structure that allowed a trust deed to receive statutory protection provided a specified proportion of creditors agreed to it.

Further refinements to the law relating to protected trust deeds took place in 1993, but it was not until the banking crisis, and a concern that trust deeds were not being administered in the best interest of creditors, that regulations were introduced in 2008 and then in 2013. These regulations have now been incorporated in the Bankruptcy (Scotland) Act 2016 (Ba(S)A 2016).

Protected trust deeds

Definition of a trust deed

A trust deed, for the purposes of the B(S)A 1985 is defined in Ba(S)A 2016, s 228 as:

‘(a) a voluntary trust deed granted by or on behalf of a debtor whereby the debtor’s estate (other than such of that estate as would not, under any provision of this or any other enactment, vest in the trustee were the estate sequestrated) is conveyed to the trustee for the benefit of the debtor’s creditors generally, and

(b) any other trust deed which would fall within paragraph (a) but for:

(i) the exclusion from the estate conveyed to the trustee of the whole or part of a debtor’s dwellinghouse, where a secured creditor holds a security over it, and

(ii) the fact that the debtor’s estate is not conveyed to the trustee for the benefit of the of the creditors generally because the secured creditor has, at the debtor’s request, agreed before the trust deed is granted not to claim under the trust deed for any of the debt in respect of which the security is held.’

Conditions for protection

Not all trust deeds are eligible for protection under the Ba(S)A 2016. There are certain conditions that must be fulfilled if a trust deed is to qualify for protection.

Conditions as to the debtor

The parties who may seek the benefits of protected status under a PTD include:

  1. a living individual

  2. a partnership

  3. a limit partnership

  4. a trust

  5. a corporate body; and

  6. an unincorporated body

(see Ba(S)A 2016, ss 164(1)(a)–164(1)(f)), provided that the debtor’s debts are not less than £5,000 (see Ba(S) 2016, s 164(3)).

Parties ineligible for this protection include:

  1. a debtor who has been sequestrated, unless their trustee has been discharged (see Ba(S)A 2016, s 164(2)(a))

  2. a limited company (see Ba(S)A 2016, ss 164(2)(b) and 6(2)(a))

  3. a limited liability partnership (LLP)(see Ba(S)A 2016, ss 164(2)(b) and 6(2)(a)); and

  4. any other entity which it is not competent to sequestrate (see Ba(S)A 2016, ss 164(2)(b) and 6(2)(c))

Conditions as to the trustee

The trustee must be someone who would not be excluded from acting as a replacement trustee in the debtor’s sequestration. These parties are listed in Ba(S)A 2016, s 49(4). All trustees must be qualified insolvency practitioners.

Conditions as to the debtor’s estate

The trust deed must convey all of the debtor’s estate other than estate that would be excluded if the debtor had been sequestrated (see Ba(S)A 2016, s 167(1)(a) and Practice Note: Scotland: the process for applying for sequestration).

In certain circumstances, the debtor may exclude all or part of their dwelling house where it is subject to a heritable security (see Ba(S)A 2016, s 167(1)(a)). If this is proposed, then there is a statutory process to be followed and the secured creditor must consent to their debt being excluded from the trust deed (see Ba(S)A 2016, s 166).

The trust deed must also convey any estate acquired by them during the four years commencing on the date of granting the trust deed and which would have been conveyed to the trustee had it been part of their estate at that date (Ba(S)A 2016, s 167(1)(b)). This mirrors the provisions relating to Glossary of Scottish insolvency Acquirenda in sequestrations (see Ba(S)A 2016, ss 86(4), 86(5) and 79(5) for definition of ‘relevant date’ and Practice Note: Scotland: the process for applying for sequestration).

A debtor’s income is excluded from vesting in a sequestration and so it is with trust deeds. It is, however, common that a debtor will agree to make a contribution from their income, even although this is not a requirement for protection. If a debtor does agree to make a contribution, then there are certain conditions that must be complied with (see Ba(S)A 2016, s 168):

  1. the trust deed must state that the debtor is to pay contributions from their income at regular intervals during the ‘payment period’

  2. the payment period is (see Ba(S)A 2016, s 168(2)):

    1. 48 months from date of granting of the trust deed

    2. a shorter period, if the trustee determines that payment of the contributions will result in the debtor paying their debts in full; or

    3. a longer period, if there has been a period of non-payment of contributions or the trustee and debtor agree

  3. if the debtor is an individual:

    1. the contribution is to be assessed using the common financial tool (see Ba(S)A 2016, s 168(1))

    2. the total contributions over the payment period must be less than the total of their debts including interest (otherwise, a Debt Payment programme under the DAS Scheme is more appropriate (Ba(S)A 2016, s 168(4) and Practice Note: Scotland: the Debt Arrangement Scheme)

  4. the debtor’s whole surplus income must be applied to the contribution

Conditions preceding the grant of a trust deed

Before a debtor signs a trust deed, the proposed trustee must provide the debtor with money advice as set out in Ba(S)A 2016, s 167(3)(a). This is so that the debtor is aware of the repercussions of them entering into a trust deed. The trustee must also provide the debtor with a debt advice pack in accordance with section 10(5) of the Debt Arrangement and Attachment (Scotland) Act 2002 (DAA(S)A 2002) (see Ba(S)A 2016, s 167(3)(b)). Both the debtor and the trustee must sign a statement to confirm that the debtor has done this (see Ba(S)A 2016, s 167(3)(c)).

Procedure for obtaining protection

Notice in the register of insolvencies

Under the common law, the mere granting of a trust deed is not sufficient to convey the trust estate to the trustee. Delivery of the deed to the trustee is also required. Normally both execution of the deed and delivery occur at the same time as the debtor will sign the trust deed in the trustee’s office and simply hand it to them.

Once delivery takes place however, the trustee must, without delay, send a notice in the prescribed form to the Register of Insolvencies (ROI) (see Ba(S)A 2016, s 169).

Intimation to creditor

Not later than seven days after notice has been registered in the ROI, the trustee must intimate (ie notify) a copy of the trust deed to all of the creditors known to them together with the documentation listed in Ba(S)A 2016, ss 170(1)(b)–170(1)(e).

The trust deed must be acceded to by the creditors, but all are deemed to have acceded unless, within five weeks of intimation, no less than a third in value of the creditors object to it (see Ba(S)A 2016, s 170(2)).

Registration for protected status

As soon as reasonably practicable after the expiry of the five-week period (and in any event no later than four weeks after that), the trustee must send to the Accountant in Bankruptcy (AiB)(see Practice Note: Scotland: The Accountant in Bankruptcy) a copy of the trust deed and the documentation specified in Ba(S)A 2016, ss 171(1)(b)–171(1)(i) for registration in the ROI. The AiB must then register the trust deed in the ROI provided that they are satisfied that they have received all the specified documents; that the requirements of the Ba(S)A 2016 have been complied with and any contribution has been calculated in accordance with the common financial tool (see Ba(S)A 2016, s 171(2)).

The AiB must notify the trustee that the trust deed has been registered or that they have refused to register it. The trustee must then notify the debtor and the creditors of the AiB’s decision (see Ba(S)A 2016, ss 171(3)–171(4)). If the AiB refuses to register the trust deed, their refusal may be appealed to the sheriff (see Ba(S)A 2016, s 188(1)(a)).

Date of protection

The Date of Protection is the date on which the trust deed is registered in the ROI by the AiB (see Ba(S)A 2016, s 163).

Effect of protection

Creditors who were not notified in terms of Ba(S)A 2016, s 179 and creditors who were so notified, but who objected to the trust deed being granted protected status have no higher right to recover the debt due to them than creditors who acceded or are deemed to have acceded (see Ba(S)A 2016, s 172(1)(a)).

Such creditors may nevertheless apply to sequestrate the debtor (see Practice Note: Scotland: the process for applying for sequestration):

  1. within five weeks of the date of registration of the notice being registered in the ROI. A sheriff may grant such an application if satisfied that it would be in the best interests of the cred...

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The office of the Accountant in Bankruptcy (AiB) was created by section 156 of the Bankruptcy (Scotland) Act 1856 . Previously, the functions of the AiB were limited but since 1993, with the enactment of the Bankruptcy (Scotland) Act 1993 (B(S)A 1993), the role has expanded quite considerably. The AiB is now responsible for, not only, supervising the bankruptcy process in Scotland but also carrying out a number of administrative and quasi-judicial functions previously exercised by the court. The AiB also assists Scottish Ministers to formulate policy in a wide range of matters relating to personal and corporate insolvency and diligence.

The purpose of this Practice Note is to examine the role, functions and responsibilities of the AiB. For a glossary of commonly used Scottish insolvency terms, see Practice Note: Glossary of Scottish insolvency words and expressions.

Coronavirus (COVID-19)

This content is affected by the coronavirus (COVID-19) pandemic. For further details, take a look at our Coronavirus (COVID-19) toolkit. For related news, guidance and other resources to assist practitioners working on restructuring and insolvency matters, see: Coronavirus (COVID-19)—Restructuring & Insolvency—overview and News Analysis: The Coronavirus (Scotland) (No 2) Bill—impact on restructuring and insolvency.

The legal nature of the AiB

The AiB is a creature of statute being established by section 199 of the Bankruptcy (Scotland) Act 2016 (Ba(S)A 2016) and having functions conferred on them by Ba(S)A 2016, s 200.

The AiB is an individual appointed by Scottish Ministers (see Ba(S)A 2016, s 199). There is also a Depute AiB, being a member of the AiB staff, who is also appointed by Scottish Ministers (see Ba(S)A 2016, s 199(2)).

The AiB is an officer of Court (see Ba(S)A 2016, s 199(1)). They therefore owe their same duties to the court as a solicitor or an advocate would.

The AiB is also the Chief Executive of the Scottish government executive agency—Accountant in Bankruptcy. The agency, which is based at Kilwinning in Ayrshire, carries out the various statutory functions imposed on the AiB.

Statutory functions of the AiB

Ba(S)A 2016, s 200 confers a number of functions on the AiB. Broadly these are to:

  1. supervise the performance of trustees and interim trustees (where not the AiB) and investigate complaints against them

  2. determine debtor applications for bankruptcy

  3. maintain the Register of Insolvencies

  4. prepare an annual report, and

  5. such other functions as may be conferred on the AiB by Scottish Ministers

Supervisory functions

A key function of the AiB is that of supervising the performance of an interim trustee and trustees in sequestration (except where the AiB is themselves the trustee, see Practice Note: Scotland: the process for applying for sequestration), trustees under protected trust deeds (see Practice Note: Scotland: protected trust deeds) and commissioners (Ba(S)A 2016, s 200(1)).

If the AiB considers that any person has failed, without reasonable excuse, to perform any duty imposed on them by the Ba(S)A 2016 or any other enactment then they are obliged to report the matter to the sheriff (see Ba(S)A 2016, s 200(4)). If the failure is in a case where they are acting as trustee they must report that too. The sheriff, after hearing from the person, may remove them from office, censure the person or make any order as the circumstances may require (see Ba(S)A 2016, s 200(4)(a)(b)(c)).

It is very rare for the AiB to make such applications to the sheriff and there is only one modern example. The application of the Accountant in Bankruptcy in the sequestration of Frank James Docherty provides a useful discussion of the history of the remedy and the approach to be taken by the court.

The AiB issues Notes for Guidance of Trustees and Guidance for Trustees Acting Under Protected Trust Deeds. They also regularly issue letters to insolvency practitioners with updates on changes to policy and practice. All of these documents can be accessed on the AiB’s website here.

Where the AiB has reasonable grounds to suspect that an offence has been committed by a trustee, commissioner, a debtor or anyone else involved with the debtor’s assets or affairs, they must report the matter to the Lord Advocate (see Ba(S)A 2016, s 200(5), (6)). Trustees have a similar obligation imposed on them by section 50(3) of Ba(S)A 2016 to report such matters to the AiB. If the AiB is acting as trustee, then they too are obliged by Ba(S)A 2016, s 50(3) to report their concerns, in their capacity as trustee, to themselves in their capacity as the AiB.

The AiB is also responsible for investigating, seeking and in certain cases, imposing Bankruptcy Restrictions Orders (BROs) (see Ba(S)A 2016, s 155). As with potential offences, trustees are obliged to report to the AiB if they have reasonable grounds to suspect that a debtor’s behaviour is of a kind that would result in a sheriff imposing a BRO (see B(S)A 2016, s 50(3)(a)). Such a report by a trustee is absolutely privileged (see Ba(S)A 2016, s 50(4)). The AiB has the power to impose a BRO for up to five years if they are satisfied that it is appropriate to do so (see Ba(S)A 2016, ss 156(1) and 159(2)(a)). If the AiB considers that a longer period is merited, then they must make an application to the sheriff who has the power to impose a BRO for up to 15 years (see Ba(S)A 2016, ss 156(1) and 159(2)(b)).

Trustees in sequestration are required to consult with the AiB, as soon as may be after their appointment, in connection with the exercise of their own functions under Ba(S)A 2016, s 50(1)(a) (see Ba(S)A 2016, s 109(1)) and must comply with any directions given by the AiB. This latter requirement is subject to:

  1. Ba(S)A 2016, s 109(9), which permits the trustee to dispose of perishable goods if they consider that compliance would adversely affect any sale, and

  2. Ba(S)A 2016, s 109(12) which obliges the trustee to act in accordance with such directions only insofar as they consider it to be in the best interest of the creditors to do so

There are certain steps and actions specified in Ba(S)A 2016 which require the trustee to obtain the consent of commissioners before taking them—eg to refer a claim against the estate to arbitration; compromise a claim; dispense with formal requirements of a claim; alter the length of an accounting period etc. Where no commissioner is appointed, the trustee must seek the consent of the AiB.

The AiB also has the power to issue directions to trustees under protected trust deeds (see Practice Note: Scotland: protected trust deeds). Such directions can be issued on the AiB’s own initiative or (at their discretion) at the request of a debtor, trustee or creditor. The trustee must comply within the direction within 30 days (unless they appeal it). Should the trustee fail to comply, the AiB may report the matter to the sheriff who may censure the trustee or make such other order as the case requires (see Ba(S)A 2016, s 179).

Determining debtor applications

Until 1st April 2008, applications by debtors for their own sequestration were granted by the sheriff court. The process was, largely, administrative and was dealt with by the sheriff clerk. Given the administrative nature of the process, and to ease pressure on courts, jurisdiction to grant debtor applications was transferred to the AiB as a result of changes made to the Bankruptcy (Scotland) Act 1985 (B(S)A 1985) by the Bankruptcy and Diligence etc (Scotland) Act 2007 (BD(S)A 2007) and Practice Note: Scotland: the process for applying for sequestration).

Originally, jurisdiction extended only to individuals and other entities that could competently be sequestrated. As a consequence of further changes brought about by the Bankruptcy and Debt Advice (Scotland) Act 2014 (BDA(S)A 2014), jurisdiction was extended to cover sequestration of insolvent estates of deceased debtors which had, until then, been dealt with by a petition to the sheriff.

The AiB is obliged to determine debtor applications that are submitted to them. Although such applications could be submitted in paper(s) form, since 30 September 2017, the AiB only accepts debtor applications submitted electronically online.

The Register of Insolvencies

The AiB is required to maintain the Register of Insolvencies (ROI). In terms of Ba(S)A 2016, s 200(2), the ROI must contain particulars of:

  1. persona who are subject of notices under Ba(S)A 2016, ss, 195(1) and 196(1) (ie pre-application moratoria on diligence)

  2. estates which have been sequestrated (see Practice Note: Scotland: the process for applying for sequestration)

  3. trust deeds sent to the AiB for registration (see Practice Note: Scotland: protected trust deeds)

  4. bankruptcy restriction orders and interim bankruptcy restriction orders

  5. the winding-up and receivership of business associations which the Court of Session has jurisdiction to wind-up; and

  6. any other document specified in regulations made under Ba(S)A 2016, s 200(1) or other enactment

The Bankruptcy (Scotland) Regulations 2016, Regulation 30 and Schedule 2 specify what information the ROI must contain.

The AiB is obliged to make the ROI available for inspection at all reasonable times (see Ba(S)A 2016, s 200(7)(a)) and to provide any person on request with a certified copy of an entry in the register (see Ba(S)A 2016, s 200(7)(b)).

The ROI, which is free to use, can be accessed on the AiB web...

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Sequestration in Scotland is the legal process by which an insolvent debtor’s estate is gathered in, realised and then distributed among their creditors by a trustee appointed for that purpose. The process requires that a formal award of sequestration is made, sequestrating the debtor’s estate and appointing a trustee. This Practice Note considers the process by which that award of sequestration is made. For a glossary of commonly used Scottish insolvency terms, see Practice Note: Glossary of Scottish insolvency words and expressions.

Unless otherwise stated, all references are to the Bankruptcy (Scotland) Act 2016 (Ba(S)A 2016).

Coronavirus (COVID-19)

This content is affected by the coronavirus (COVID-19) pandemic. For further details, take a look at our Coronavirus (COVID-19) toolkit. For related news, guidance and other resources to assist practitioners working on restructuring and insolvency matters, see: Coronavirus (COVID-19)—Restructuring & Insolvency—overview and News Analysis: The Coronavirus (Scotland) (No 2) Bill—impact on restructuring and insolvency.

Brexit impact—cross-border insolvency (Insolvency (Amendment) (EU Exit) Regulations 2019, SI 2019/146)

As of exit day (31 January 2020) the UK is no longer an EU Member State. However, in accordance with the Withdrawal Agreement, the UK has entered an implementation period, during which it continues to be subject to EU law. References to exit day in many Brexit SIs are to be read as reference to IP completion day (Implementation Period completion day, defined in clause 39 as 31 December 2020 at 11.00 pm) (unless that provision is expressly disapplied by the SI in question). For further details, see News Analysis: Brexit—impact of the Withdrawal Agreement and European Union (Withdrawal Agreement) Act 2020 for R&I lawyers and Brexit Bulletin—key updates, research tips and resources.

For cross-border insolvency, the Insolvency (Amendment) (EU Exit) Regulations 2019, SI 2019/146 have an impact. For further details, see Practice Note: Brexit—impact on Recast Regulation on Insolvency.

Who may apply?

An application for the sequestration of a living debtor may be made by the debtor themselves, by a qualified creditor or creditor, a temporary administrator, a Member State liquidator appointed under main proceedings (for a discussion of the Recast Regulation on Insolvency, SI 2015/848, see Practice Note: Recast Regulation—personal insolvency and COMI) or a trustee under a trust deed (see section of 2(1) of Ba(S)A 2016 and Practice Note: Scotland: protected trust deeds).

The identity of the application will determine which procedure is appropriate. If a debtor wishes to apply for their own sequestration, then they must submit a debtor application to the Accountant in Bankruptcy (AiB) (see Practice Note: Scotland: the Accountant in Bankruptcy). Any other applicant must lodge a petition with the sheriff court having jurisdiction over the debtor.

Debtor applications

Money advice

It is an essential prerequisite of a debtor submitting a debtor application that they have obtained from an approved money adviser advice on their financial circumstances; the effect that the proposed sequestration will have on them, the preparation of the application and such other matters as may be prescribed (see section 4 of Ba(S)A 2016). In practice, debtors in financial difficulties will seek advice from Citizen Advice Bureaux or insolvency practitioners on their behalf.

Qualifying criteria

A debtor may apply for sequestration provided that they fall within one of two sets of qualifying criteria. The first of these applies to debtors having minimal assets. The other applies where the debtor has assets.

Minimal asset cases

This ground applies where (see ss 2(2)(a) – 2(2)(h) of B(S)A 2016):

  1. the debtor

    1. has been assessed using the Common Financial Tool as requiring to make no contribution from their income; or

    2. has been in receipt of prescribed benefits for six months before the application is submitted

  2. the total debts are not less than £1,500 or more than £17,000 (This limit is to be increased to £25,000 by the Coronavirus Scotland No 2 Act 2020 once it is passed by the Scottish Parliament and will remain at that level until September 2020 unless extended)

  3. the debtor’s assets are not worth more than £2,000

  4. no single asset is worth more than £1,000

  5. the debtor does not own land

  6. the debtor has been issued with a certificate for sequestration

  7. the debtor has not been sequestrated under the minimal-asset process in the ten previous years, and

  8. the debtor has not otherwise been sequestrated in the previous five years

The ‘common financial tool’ is a statutory method of assessing what proportion of their income a debtor should contribute towards their debts after taking into account their financial circumstances. Section 89 of Ba(S)A 2016 provides that Scottish Ministers may fix the method by issuing regulations and that has now been done in the form of the Bankruptcy (Scotland) Regulations 2016, SSI 2016/397, rr 2(1), 15(1). New regulations may, however be issued from time to time.

In assessing the value of the debtor’s assets, no account is to be taken of any assets that would be excluded from vesting in a trustee in bankruptcy by virtue of Ba(S)A 2016 or any other enactments. This would apply to, for example, furniture and furnishings in a family home or tools of trade (see section 88 of Ba(S)A 2016 and also section 11 of the Debt Arrangement and Attachment (Scotland) Act 2002 (DAA(S)A 2002). Also excluded is any motor vehicle worth not more than £3,000 (see section 2(3) of Ba(S)A 2016).

A certificate for sequestration is a certificate issued by a money adviser confirming that the debtor is unable to pay their debts (see section 9 of Ba(S)A 2016).

Asset criteria

If a debtor does not qualify under the minimal asset criteria, then they may still qualify if they can satisfy the conditions specified in section 2(8) of Ba(S)A 2016. This section applies where the debtor:

  1. has debts of not less than £3,000

  2. has not been sequestrated in the previous five years

  3. has received money advice from a money adviser

  4. has given a statement of undertakings, and

  5. is apparently insolvent (see Practice Note: Scotland: process for pursuing—establishing apparent insolvency or an inability to pay debts), has been granted a certificate for sequestration, or has signed a trust deed that has not achieved protected status (see Practice Note: Scotland: protected trust deeds)

Jurisdiction

The AiB has jurisdiction to award sequestration of debtor if, at the time of making the application, the debtor was either habitually resident or had a place of business in Scotland (see section 15(2) of Ba(S)A 2016).

Procedure

The procedure for applying for sequestration is relatively straight forward in that it involves completing the prescribed form and submitting it to the AiB together with supporting documentation. The form is Form 1 which is in schedule 1 of the Bankruptcy (Scotland) Regulations 2016, SSI 2016/397. A copy can be downloaded from the AiB’s website here.

Since 30 September 2017, applications must be submitted online and paper copies are no longer accepted.

A debtor may nominate an insolvency practitioner that they wish to be appointed as trustee, unless the application is under the minimal asset procedure; in which case the trustee will be the AiB (see Practice Note: Scotland: The Accountant in Bankruptcy).

On receipt of the application, the AiB will check it to ensure that it is complete and that all information required has been submitted. If the application is not complete or information is missing, the AiB will issue notice to the debtor requiring further information or evidence to be provided with 21 days (or such other period as the AiB considers appropriate). If the debtor does not provide this further information, then the AiB may refuse the application (see section 20 of Ba(S)A 2016).

The AiB may consider that an award of sequestration is not appropriate. In that event, the AiB must write to the debtor setting out why they consider that it would not be appropriate to award sequestration and setting out what further information they require to be provided within 21 days (or such other period as the AiB considers appropriate). The AiB may refuse to award sequestration if, at the end of the period, the AiB considers that it would not be appropriate. The Ba(S)A 2016 does not give any guidance as to the circumstances in which the AiB would be entitled to take the view that it would not be appropriate to award sequestration. It does however appear that the AiB has discretion in the matter, something which is at odds with the summary nature of sequestration proceedings before the sheriff (see section 21 of Ba(S)A 2016).

Where the AiB is satisfied that the requirements of the Ba(S)A 2016 have been complied with and that neither section 20 nor section 21 of Ba(S)A 2016 apply, the AiB is obliged to award sequestration forthwith (see section 22(1) of Ba(S)A 2016).

If sequestration is awarded, the AiB must send a certified copy of the determination to the Register of Inhibitions and Adjudications (see section 26(2) of Ba(S)A 2016).

If the AiB refuses to award sequestration, then the debtor may apply to the AiB for a review of that decision. An application for review must be submitted within 14 days of the date of refusal. The AiB must consider any representations made within 21 days of the day of refusal and then reach a decision whether to confirm the refusal or award sequestration within 28 days of that date (see sections 27(5)-27(7) of Ba(S)A 2016).

The AiB’s decision, following a review, can be appealed to the sheriff within 14 days (see section 27(8) of Ba(S)A 2016).

Date of sequestration

The date of sequestration is crucial as it crystallises the rights of all of the parties who have an interest in the sequestration. All of the debtor's assets owned by them, as at that date, vest in the trustee. Only creditors who were owed debts on that date are entitled to submit claims in the estate and receive a dividend. Generally all of the timescales within the Ba(S)A 2016 run from the date of sequestration.

Where sequestration is awarded by the AiB, the date of sequestration is the date on which sequestration is awarded (see section 22(7)(a) of Ba(S)A 2016).

Court applications

As has been stated above, a petition for sequestration can be brought by a number of parties, but this Practice Note only deals with the situation of a creditor since that is by far the most common situation that practitioners will encounter.

Qualifying criteria

In order that a creditor can petition for the sequestration of a debtor, they must be a ‘qualifying creditor’. In terms of section 7(1) of Ba(S)A 2016, a qualifying creditor is a creditor of the debtor in respect of relevant debts totalling not less than £3,000. Where more than one creditor applies for sequestration, the aggregate of their debts must not be less than £3,000 (see section 7(1) of Ba(S)A 2016). (The threshold for a creditor petition is to be increased from £3,000 to £10,000 by the Coronavirus Scotland No 2 Act 2020 once it is passed by the Scottish Parliament and will remain at that level until September 2020 unless extended).

The creditor must be able to establish that the debtor is apparently insolvent. Apparent insolvency is defined in section 16 of Ba(S)A 2016 (see Practice Note: Scotland: process for pursuing—establishing apparent insolvency or an inability to pay debts).

The petiti...

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This Practice Note relates to insolvent partnerships and limited partnerships in Scotland, by which it is meant:

  1. ordinary partnerships: with a principle place of business located in Scotland, and

  2. limited partnerships (LPs): registered at Companies House in Scotland as a Scottish LP

(referred to together for the purposes of this Practice Note as Scottish partnerships).

Scottish partnerships have separate legal personality under Scots law, and as such are governed by the Scottish bankruptcy regime for sequestration of individuals (see Practice Note: Scotland: the process for applying for sequestration), and are not within the reserved competency of the UK parliament at Westminster.

This Practice Note does not cover limited liability partnerships (LLPs) registered in Scotland, which are treated the same as companies for corporate insolvency purposes (for more information, see Practice Notes on Scottish compulsory liquidation—Scotland: compulsory liquidation, Scottish creditors' voluntary liquidation—Scotland: process to enter creditors’ voluntary liquidation (CVL)). For a glossary of commonly used Scottish insolvency terms, see Practice Note: Glossary of Scottish insolvency words and expressions.

Coronavirus (COVID-19)

This content is affected by the coronavirus (COVID-19) pandemic. For further details, take a look at our Coronavirus (COVID-19) toolkit. For related news, guidance and other resources to assist practitioners working on restructuring and insolvency matters, see: Coronavirus (COVID-19)—Restructuring & Insolvency—overview and News Analysis: The Coronavirus (Scotland) (No 2) Bill—impact on restructuring and insolvency.

Legal personality of Scottish partnerships and limited partnerships

In Scots law, a Scottish partnership ‘is a legal person distinct from the partners of whom it is composed’ (see Partnership Act 1890, s 4(2) (PA 1890)).

A Scottish partnership can therefore sue and be sued in its own name, enter into contracts, debts, credit, security and other legal relationships, and hold property in its own name.

The partners are agents of an ordinary partnership which is the principal, with joint and several liability for the obligations of the firm (PA 1890, s 9).

A Scottish limited partnership is one formed under the Limited Partnerships Act 1907 (LPA 1907) and registered in Scotland with its principal place of business in Scotland.

A Scottish ordinary partnership or LP, with separate legal personality, is subject to the Bankruptcy (Scotland) Act 1985 as repealed and replaced by the Bankruptcy (Scotland) Act 2016 (Ba(S)A 2016), under which the firm or LP may be sequestrated (see Practice Note: Scotland: the process for applying for sequestration).

Self-sequestration

A Scottish partnership can apply for its own sequestration, in a similar way to an individual seeking his or her own bankruptcy. As a separate entity, the process is to apply to the Accountant in Bankruptcy (AiB) (ie Scotland’s insolvency service) (see Practice Note: The Accountant in Bankruptcy) for sequestration under an ‘Entity Debtor’—see Accountant in Bankruptcy: How to Apply, and Accountant in Bankruptcy: Entity Application Pack—2016, for full details for the application.

The firm or LP must:

  1. pay the applicable fee

  2. provide a statement of assets and liabilities, and

  3. provide the agreement of concurring creditors in accordance with the applicable requirements in the application pack at the time of applying

Self-sequestration of the S...

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The Insolvency (Scotland) (Company Voluntary Arrangements and Administration) Rules 2018, SI 2018/1082 and Insolvency (Scotland) (Receivership and Winding up) Rules 2018, SSI 2018/347 together referred to as the ‘2018 Rules’, came into force on 6 April 2019. The content of this Practice Note has been updated to reflect the application of the 2018 Rules. This note does not address any transitional provision as may be applicable, on the assumption that there will be few cases remaining for which the transitional provisions would be relevant. Further information on the changes, see:

  1. Insolvency (Scotland) (Company Voluntary Arrangements and Administration) Rules 2018, LNB News 15/10/2018 111

  2. Insolvency (Scotland) (Receivership and Winding up) Rules 2018, LNB News 15/11/2018 7

  3. New insolvency rules for Scotland—what the changes will mean

  4. New changes under the Insolvency (Scotland) (Receivership and Winding up) Rules 2018

A creditors’ voluntary liquidation (CVL) in Scotland is a voluntary formal insolvency process, for the purpose of winding-up the affairs of an insolvent company (or limited liability partnership (LLP)) registered in Scotland, as an alternative to a winding-up by the court.

Save where the company is in administration and is exiting that process via a CVL, the process for an insolvent voluntary liquidation is initiated, in practice, by the directors of the company. The directors must conclude that the company is insolvent and unable to avoid liquidation (and, usually, that no other better route, such as administration, is available). Legally, CVLs formally commence upon the passing of a resolution for liquidation by the shareholders, but to get to that point, the procedure will have been instigated by the directors.

Generally, a ‘Scottish’ CVL (ie a CVL of a company incorporated and registered in Scotland) is less common, proportionately, than in England and Wales for a number of practical reasons:

  1. in a Scottish compulsory liquidation (for more information, see Practice Note: Scotland: compulsory liquidation on the process for entering a compulsory liquidation of a company in Scotland), there is no Official Receiver, so the directors may petition and nominate an insolvency practitioner to be appointed by the court as an interim liquidator

  2. for a Scottish compulsory liquidation, there is no Secretary of State charge (or Insolvency Services Account fee) on realisations in the liquidation, so there are fewer costs distinctions between a Scottish CVL and a Scottish court winding-up; and

  3. the process to obtain a winding-up order from the court can be relatively quick compared to England and Wales, because if there is no answer (ie opposition) to the directors’ petition, a winding-up order can be obtained after eight days from intimation (ie advertising and service) which is usually done immediately after the petition is presented and the court gives first orders for intimation

This Practice Note concerns the applicable law, procedure and practice of commencing a ‘Scottish CVL’ only, and does not cover Scottish members’ voluntary liquidation (MVL), directors’ duties or the process under the applicable Scottish insolvency rules for CVLs once the liquidation has been commenced and approved by creditors, through to exit and dissolution.

Coronavirus (COVID-19)

This content is affected by the coronavirus (COVID-19) pandemic. For further details, take a look at our Coronavirus (COVID-19) toolkit. For related news, guidance and other resources to assist practitioners working on restructuring and insolvency matters, see: Coronavirus (COVID-19)—Restructuring & Insolvency—overview and News Analysis: The Coronavirus (Scotland) (No 2) Bill—impact on restructuring and insolvency.

Law applicable to Scottish CVLs

Corporate insolvency law, including company liquidation, is part of the reserved competency of the UK Parliament. The Insolvency Act 1986 (IA 1986) provisions governing CVLs are, generally, applicable to Scottish CVLs, as for England and Wales (for the position in England and Wales, see Creditors' voluntary liquidation (CVL)—overview) subject to a number of specific provisions applicable only to Scotland, and a number of provisions of no application in Scotland:

  1. IA 1986, s 84(4) (Effect of Commonhold and Leasehold Reform Act 2002)—England and Wales only

  2. IA 1986, s 92A (Progress report to company at year’s end)—England and Wales only (note, this relates to MVLs)

  3. IA 1986, s 93 (General company meeting at each year’s end)—Scotland only, and relates to MVLs, and

  4. IA 1986, s 101(4) (Appointment of liquidation committee)—Scotland only, applying the powers and duties of commissioners on a bankrupt estate to the powers and duties conferred on a liquidation committee by the IA 1986

There are further statutory distinctions following the commencement of a CVL, but these are not covered by this Practice Note.

Excepted from the reserved competency of the UK Parliament is:

  1. the process of winding-up, including the person having responsibility for the conduct of a winding-up or any part of it, and his conduct of it or of that part,

  2. the effect of winding-up on diligence, and

  3. avoidance and adjustment of prior transactions on winding-up.

The process of a Scottish CVL is, governed by the Insolvency (Scotland) (Receivership and Winding...

Read More > Produced in partnership with Tim Cooper of Addleshaw Goddard 28th Jul

The Debt Arrangement Scheme (DAS) is a statutory scheme that is designed to allow certain categories of debtor to repay their debts over an extended period of time by means of a debt payment programme (DPP). During the period a DPP is in force, a debtor is protected from enforcement action being taken against them by creditors. For a glossary of commonly used Scottish insolvency terms, see Practice Note: Glossary of Scottish insolvency words and expressions.

The statutory basis of the DAS is found in Part 1 of the Debt Arrangement and Attachments (Scotland) Act 2002 (DAA(S)A 2002). However this merely provides the framework within which the scheme is to operate. The actual detail is to be found in secondary legislation promulgated under DAA(S)A 2002. Principally this is the Debt Arrangement Scheme (Scotland) Regulations 2011 (DAS(S)R 2011), SSI 2011/141 as amended by the Debt Arrangement Scheme (Scotland) Amendment Regulations 2014 (DAS(S)AR 2014), SSI 2014/294 and, since 29 October 2018, by the Debt Arrangement Scheme (Scotland) Amendment Regulations 2018 (DAS(S)AR 2018), SSI 2018/297.

Certain amendments made by the DAS(S)AR 2018, SSI 2018/297 do not have retrospective affect and do not apply to DPPs approved prior to 29 October 2018.

For further reading on the DAS(S)AR 2018, SSI 2018/297, see News Analysis: Debt Arrangement Scheme (Scotland) Amendment Regulations 2018, LNB News 19/06/2018 145.

Coronavirus (COVID-19)

This content is affected by the coronavirus (COVID-19) pandemic. For further details, take a look at our Coronavirus (COVID-19) toolkit. For related news, guidance and other resources to assist practitioners working on restructuring and insolvency matters, see: Coronavirus (COVID-19)—Restructuring & Insolvency—overview and News Analysis: The Coronavirus (Scotland) (No 2) Bill—impact on restructuring and insolvency..

Debt Arrangement Scheme administrator

DAA(S)A 2002 imposes responsibility for administering the DAS on the Scottish Ministers.

However it also permits the administrative functions to be delegated to other persons. These functions were delegated to the Accountant in Bankruptcy (AiB) on 30 November 2004 (see Practice Note: Scotland: the Accountant in Bankruptcy) from the commencement of the Debt Arrangement and Attachment (Scotland) Act 2002 (Transfer of Functions to the Accountant in Bankruptcy) Order 2004, SSI 2004/448) and continue to be discharged by their office.

The person carrying out these functions is known as the DAS Administrator.

Money advisers

A debtor cannot access the DAS or apply to vary an existing DPP, unless they have received advice from an approved money adviser in relation to:

  1. the debtor’s financial circumstances

  2. the effect of the proposed programme or, as the case may be, the proposed variation of the programme, and

  3. preparation of the application

Money advisers are persons approved to give such advice. Certain categories of person are automatically approved, for example a person qualified to act as an insolvency practitioner under section 390 of the Insolvency Act 1986 (IA 1986).

A person not automatically approved may apply to the DAS Administrator to be approved.

Certain persons are disqualified from being money advisers.

A list of money advisers can be found on the Accountant in Bankruptcy’s website here.

Money advisers have certain general functions which are to:

  1. provide money advice to a debtor

  2. liaise with creditors on behalf of a debtor

  3. assist a debtor with, and advise on an application:

    1. for approval, variation or revocation of a debt payment programme, or

    2. for review of a determination under DAS(S)R 2011, SI 2011/141, reg 47

  4. prepare and submit on behalf of a debtor an application for a DPP, in accordance with the Common Financial Tool in the case of a DPP for an individual (see Practice Note: Glossary of Scottish insolvency words and expressions)

  5. provide, as required by the DAS Administrator, evidence of or information about the participation of a debtor in a debt payment programme (including the debtor's consent to any application for approval, variation or revocation in relation to which the adviser provided money advice), and

  6. act as a lay representative in a court, where the adviser has accepted instructions by a debtor to act

Additional functions of a money adviser can be found in DAS(S)R 2011, SSI 2011/141, reg 12A.

Payment distributors

The payments made by a debtor under a DPP are made to a payment distributor who then distributes payments to creditors.

Payment distributors are approved by the DAS Administrator. The DAS Administrator must be satisfied that the payment distributor is a fit and proper person or body to be a payment distributor.

The functions of a payment distributor are to:

  1. assist the DAS Administrator and any continuing money adviser with, and advise on, payments distribution

  2. distribute sums received in accordance with the debt payment programme

  3. provide payment and distribution reports to the DAS Administrator, any continuing money adviser, and to creditors

  4. provide information to the DAS Administrator about the exercise of a function of a payments distributor, and

  5. remit the fee payable in accordance with DAS(S)R 2011, SSI 2011/141, reg 5 to the DAS Administrator

The payment distributor may charge the creditors an administration fee of up to 20% (inclusive of VAT) from the sums paid to them where the debtor is an individual. Where the debtor is a legal person, trust or unincorporated body the administration must not be more than 8% (inclusive of VAT).

Who may apply for a DPP?

A debtor who is habitually resident in Scotland may apply to the DAS Administrator for the approval of a DPP.

The DPP applied for must provide for the payment of all debts due by the debtor at the time of making the application.

This however subject to the proviso that, where the debtor is an individual, debts which are:

  1. constituted by a lease or tenancy agreement, or

  2. secured by a standard security (to the extent that the sum is arrears of a periodic payment for to be paid under a loan agreement so secured)

may be excluded from the DPP to the extent that the debts relate to the debtor’s sole or main residence.

The debtor must owe one or more debts.

A debtor may not apply for a DPP if:

  1. a debt is being paid under a conjoined arrestment order unless the creditor has attempted to enforce a debt due by the debtors

  2. they are party to a protected trust deed

  3. they are an undischarged bankrupt in Scotland

  4. they are an undischarged bankrupt in England, or

  5. they are subject to a bankruptcy restrictions order whether that has been made or given in Scotland or England and Wales

If a debtor only has one debt, they may not apply for a DPP if the debt is subject to a ‘time to pay order’ or ‘time to pay direction’ made under the Debtors (Scotland) Act 1987 (D(S)A 1987) or a time order under section 129 of the Consumer Credit Act 1974 (CCA 1974).

The DAS permits a joint application to be made by two debtors if they are jointly and severally liable for a debt which falls within the scope of the DAS and the debtors are:

  1. spouses or civil partners of each other, or

  2. living together as spouses of each other

Both parties must consent to the application being made for a DPP.

The DAS is also open to legal persons, trusts and unincorporated bodies of persons where they:

  1. have an established place of business in Scotland, or

  2. were constituted or formed under Scots law and at any time carrying on business in Scotland

These business DASs are not extended to those entities included in section 6(2) of the Bankruptcy (Scotland) Act 2016 (Ba(S)A 2016) ie limited companies registered under the Companies Act 2006 (CA 2006), limited liability partnerships and other entity which cannot be sequestrated.

Application process

The application must be in the prescribed form. The form for individual debtors is Form 1 (which can be found here) and for businesses is Form 1B (which can found here).

The application is submitted by the money adviser. The debtor need not sign the form and it is sufficient if it contains a declaration by the money adviser that the debtor has been given appropriate money advice and consented to proceed without signing the application.

The declaration by the money adviser need not be signed.

DAS(S)R 2011, SSI 2011/141, reg 22A specifies who is required to consent to an application being made for a DPP where the debtor is a legal person, trust or unincorporated entity.

The application may be submitted electronically or in paper form, however they are mostly lodged online via the DAS hub. There is no fee payable by the debtor. In addition to the fees payable to the payment distributor, 2% of contributions are deducted and paid to the DAS Administrator.

DAS Register

Details of the application are entered in the Debt Arrangement Scheme Register (DAS Register) maintained by the DAS Administrator.

The DAS Register holds information specified in DAS(S)R 2011, SSI 2011/141, reg 19(2) and 19(3).

Specified information need not be included in the DAS Register where the DAS Administrator is of the opinion that the inclusion of that information would be likely to put any person at risk of violence or otherwise jeopardise the safety or welfare of any person.

The DAS Register can be accessed here and is free to use.

Statutory moratoria

A debtor who intends to apply for a DPP may give notice of their intention to do so to the AiB. The AiB must then register the details in the DAS Register. Registration of the application provides the debtor with a moratorium period of six weeks to submit an application for approval of a DPP.

A debtor may only give such notice once in any twelve-month period.

Once the debtor has made an application for approval of a DPP, this too is registered in the DAS Register. Registration triggers a separate moratorium which lasts for six weeks, although it will end earlier on the application being granted. Rejection of an application will bring the moratorium to an end, subject to it remaining in place during any review of the decision. Withdrawal of the application will also terminate the moratorium.

During this period, a creditor may not serve a charge for payment, commence or execute any diligence or petition for the debtor’s sequestration.

This restriction also applies to any debt for which both an individual debtor and a legal person, trust or unincorporated body of person is liable in relation to which the individual is:

  1. a partner of a partnership

  2. a general partner of a limited partnership

  3. a trustee of a trust

  4. a person authorised to act on behalf of a corporate body, other than one registered under the CA 2006 or an unincorporated body

Funds that have been arrested may not be released to the creditor during this period.

Decision process

When an application for a DPP is submitted by a debtor, the DAS Administrator (or a continuing money advisor if there is one) will write to the creditors requesting them to consent to the programme. If a creditor does not respond within 21 days of the request, they are deemed to have given consent.

Provided that in the case of an individual debtor not less than 9/10 in value of all of the creditors consent—or are deemed to have consented—then the DAS Administrator must approve the DPP. If the debtor is a legal person, trust or unincorporated body of persons each creditor must consent or be deemed to have consented.

In the case of an individual, this is however conditional upon the approval being in accordance with the Common Financial Tool (see: Glossary of Scottish insolvency words and expressions).

If approval cannot being given under DAS(S)R 2011, SSI 2011/141, reg 24 then the DAS Administrator must under DAS(S)R 2011, SSI 2011/141, reg 25(1) still approve a DPP if it is fair and reasonable.

In determining whether a debt payment programme is fair and reasonable, the DAS Administrator is to have regard to:

  1. the total amount of debt

  2. the period over which a programme will operate

  3. the amount (if any) by which it appears to the DAS Administrator, on the basis of such information as the creditors and the debtor have provided, that the value of any land owned by the debtor exceeds so much of the total amount of debt as is secured by way of a standard security over any interest in that land

  4. the method, and frequency, of payments under a programme

  5. an earlier proposed programme that was not approved

  6. a matter specified in DAS(S)R 2011, SSI 2011/141, reg 21(2) that would have prevented an application being made, where the matter no longer has that effect

  7. the involvement of the debtor in a:

    1. debt payment arrangement, including a debt payment programme under DAS(S)R 2011, SSI 2011/141

    2. time to pay direction under D(S)A 1987, s 1, or time to pay order under D(S)A 1987, s 5, or

    3. time order under CCA 1974, s 129

  8. the extent to which creditors have consented (deemed or otherwise) to a programme

  9. any comment made by the money adviser, and

  10. an asset of a debtor that could be realised to pay debts to be included in a programme

Additionally, the DAS Administrator may have regard to any other factor that the DAS Administrator considers appropriate.

Standard and discretionary conditions

Where a DPP is approved, it is automatically made subject to certain standard conditions.

The conditions, which are to be found in DAS(S)R 2011, SSI 2011/141, reg 27(2) are aimed at ensuring that all of the payments due under the DPP are paid in a timely manner, that the debtor maintains all ongoing liabilities while not increasing their level of indebtedness and that the debtor cooperates fully with the DAS administrator.

There are additional standard conditions imposed on business debtors which require them to:

  1. declare all assets owned by them every 12 months

  2. not to sell any non-trading assets without the consent of the money adviser, and

  3. make all payments due under the DPP within five years of the date of the application for a DPP

‘Non-trading business assets’ are defined as any asset owned by the debtor other than items detailed in DAS(S)R 2011, SSI 2011/141, reg 27(4).

A DPP may also be subject to certain discretionary conditions specified in DAS(S)R 2011, SSI 2011/141, reg 28. These are that the debtor must:

  1. realise an asset other than an excepted asset and ...

Read More > Produced in partnership with James Lloyd of Harper Macleod LLP 28th Jul

Sections 242 and 243 of the Insolvency Act 1986 (IA 1986) govern the two main antecedent transactions which may be carried out by companies in Scotland. These sections do not apply to individuals or companies registered in England and Wales (for the position in England, see Practice Note: Can a liquidator or an administrator challenge or unwind transactions entered into by the company before it was wound up or entered into administration?). For details of antecedent transactions by individual/personal Scottish debtors, see Practice Note: Scotland: gratuitous alienations by individual debtors. For a glossary of commonly used Scottish insolvency terms, see Practice Note: Glossary of Scottish insolvency words and expressions.

Coronavirus (COVID-19)

This content is affected by the coronavirus (COVID-19) pandemic. For further details, take a look at our Coronavirus (COVID-19) toolkit. For related news, guidance and other resources to assist practitioners working on restructuring and insolvency matters, see: Coronavirus (COVID-19)—Restructuring & Insolvency—overview and News Analysis: The Coronavirus (Scotland) (No 2) Bill—impact on restructuring and insolvency.

Unfair preferences

What constitutes an unfair preference?

An unfair preference is a transaction entered into by a company, whether before or after 1 April 1986, which has the effect of preferring one creditor over the general body of creditors (see IA 1986, s 243(1)). The day an unfair preference is created is the day on which it became effectual.

Hardening periods

A transaction can be challenged as an unfair preference if it occurred not earlier than six months prior to the winding-up of the company (see Practice Notes: Scotland: compulsory liquidation and Scotland: process to enter creditors’ voluntary liquidation (CVL)) or the company entering administration (see IA 1986, s 243(1).

Transactions/conditions which are not classed as an unfair preference

A transaction is not an unfair preference if the company can show that:

  1. the transaction was in the usual course of trade or business

  2. a payment in cash for a debt which (when it was paid) had become payable, unless the transaction was collusive with the purpose of prejudicing the general body of creditors

  3. the transaction is one where the parties have reciprocal obligations and the transaction was not collusive (as described above)

  4. the granting of a mandate by a company authorising an arrestee to pay the arrested funds, where:

    1. there has been a decree for payment or a warrant for summary diligence, and

    2. the decree or warrant has been preceded by an arrestment on the dependence of the action or followed by the arrestment in execution

Unlike the English equivalent of voidable preferences (for the English position, see Practice Note: Can a liquidator or an administrator challenge or unwind transactions entered into by the company before it was wound up or entered into administration?), there is no requirement to show a desire to prefer.

Who can bring a challenge?

A preference is challengeable by:

  1. (in the case of a winding-up)—any creditor who is a creditor by virtue of a debt incurred on or before the date of the winding-up or the liquidator, or

  2. (where the company has entered into administration)—the administrators

A liquidator and administrator have the same right as a creditor to challenge a transaction as an unfair preference.

How to bring a challenge

Any challenge is a court process involving an application to court. The two main routes are:

  1. a challenge under common law. These actions are not subject to the short statutory time limit (six months) but are harder to bring due to the onus of proof lying firmly with the creditor, administrator or liquidator (as the case may be)

  2. a challenge under IA 1986. The applicant needs to show that there has been an alienation within the relevant time limit (six months prior to the event) and it is then up to the company to defend the challenge and establish that the transaction falls within one the defences mentioned above

In the case of liquidation, it is common to lodge the application in the joint names of the creditor and liquidator.

Recourse available to the court

In the event of a successful challenge, the court may:

  1. grant a decree of reduction

  2. restore the property to the company's assets, or

  3. grant any other redress as it believes appropriate

Gratuitous alienations

What constitutes a gratuitous alienation?

A gratuitous alienation is a transaction which takes place on the relevant day, before or after the 1 April 1986, on which:

  1. any part of the company's property is transferred, or

  2. any claim or right of the company is discharged or renounced

Hardening periods

A transaction can be challenged as a gratuitous alienation if it occurred a relevant day being:

  1. (to an associate)—five years before the winding-up of the company or the company entered administration (see IA 1986, ss 242(3)(a)(i), 242(3)(a)(ii))

  2. (to any other person)—two years before the winding-up of the company or the company entered administration (see IA 1986, s 242(3)(b))

Associate is defined in section 229 of the Bankruptcy (Scotland) Act 2016 (Ba(S)A 2016) and is deliberately wide. A company is an associate of another company if:

A company is an associate of another person (in this subsection referred to as ‘B’) if:

List of transactions/conditions which are not classed as gratuitous alienation

A transaction is not a gratuitous alienation if the company can demonstrate that:

  1. immediately, or at any other time after the alienation, the company's assets were greater than its liabilities (see IA 1986, s 242(4)(a))

  2. the alienation was made for adequate consideration (see IA 1986, s 242(4)(b))

  3. the alienation was a birthday, Christmas or other conventional gift or a gift made for charitable purposes to a person who is not an associate of the company. In both cases, it must be reasonable for the company to make the alienation (see IA 1986, ss 242(4)(c)(i), 242(4)(c)(ii)). Charitable purposes is defined in section 242(5) of IA 1986 as any charitable, benevolent or philanthropic purposes, whether or not it is charitable within the meaning of any rule of law (see IA 1986, s 242(5))

As regards adequate consideration, in MacFadyen's Trs v MacFadyen, the judge stated that:

The word ‘consideration’ is not defined in the Act and we consider that it must be...

Read More > Produced in partnership with Tim Cooper and Emma Widdowson of Addleshaw Goddard LLP 28th Jul

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