Scottish Law

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...

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.

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

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.

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...

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.

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...

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.

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...

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?

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

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.

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])

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).

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]

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.

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.

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.

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

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.

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...

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 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)).

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).

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).

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...

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

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...