Assignations in security: an experiment in quantum mechanics?

If you put your car into the garage, the mechanic will probably not give you the keys back until you’ve paid for work that’s been carried out.

You still own the car, but the mechanic keeps possession of it as security for the sum you owe.

So, does something similar happen if you borrow money from a bank to pay a contractor to build a building for you?

Generally speaking, banks will only lend when they get security in return.

Sometimes they demand the benefit of the building contract as part of this security package.

Banks taking security

There is, of course, a question of why a bank would want to take security over a building contract.

What would they get out of it that they wouldn’t get through a collateral warranty, which in practical terms can provide them with a mechanism for procuring the completion of a project if the borrower/client becomes insolvent, or is otherwise in breach of the loan agreement.

Unlike the car mechanic, there is nothing physical the bank can take possession of to “secure” the building contract (other than, perhaps, the pages the building contract is printed on).

How, then, can the bank take security?

Current practice has been for this to be done through what is called “an assignation in security.”

An assignation is a legal agreement whereby one party (“the cedent”) transfers their interest in a contract to another party (“the assignee”).

A pure “absolute” assignation therefore means that the cedent loses their entire interest in the contract.

Under Scots law, an assignation in security requires the debtor to assign the contract “absolutely” to the creditor but with a side / back agreement that stipulates the assignation is only in security.

That side agreement obliges the creditor to transfer the contract back into the name of the debtor once the debt is satisfied.

Assignations in security are relatively simple affairs where there are no on-going provisions under the contract that may need to be operated whilst it is the subject of the security.

That is not, however, generally the case with a building contract.

Attempts to address the need for on-going operation during the security period are generally made through the inclusion of appropriate terms within the side agreement.

Such terms will generally allow the debtor to continue to administer the building contract notwithstanding the fact that it has technically been assigned to the creditor.

Title to sue?

But what happens if something goes wrong with the building, and a claim needs to be made against the contractor?

Under Scots law, a pursuer must have “title to sue.”

If the debtor has, however, assigned the building contract to a creditor some have thought that “title” has been transferred to the creditor, so the debtor might not be able to sue.

Edinburgh Schools Partnership Ltd v Galliford Try Construction (UK) Ltd

The Scottish Court of Session has recently considered this very point in the case of the Edinburgh Schools Partnership Ltd v Galliford Try Construction (UK) Ltd.

Here, ESP had assigned in security to a funder its interest in a building contract in connection with the now infamous Edinburgh Schools PPP project.

ESP had obtained an adjudicator’s award in its favour and then sought enforcement of that against the contractor, GT.

GT sought to avoid enforcement by saying ESP did not have title to raise proceedings because of the assignation in security. The judge ultimately sided with ESP.

His view was that “assignations in security” should not be treated in the same way as pure assignations.

Specifically, where the debtor had a continuing financial interest in the contract after the assignation in security they would not be deemed by the court to have lost all title to sue.

A lingering financial interest was enough for ESP to hang its hat on to justify raising the action.

Now for the science bit

The judge’s decision does have a bit of a quantum mechanics ring to it: something (an assignation) can be somewhere, whilst not being there at the same time.

Those at the sharp end of trying to put banks’ instructions into place are not physicists.

They will, in any case, be breathing a sigh of relief that the judge’s decision facilitates a current commercial practice. It will, however, be interesting to see if other judges would don their white lab coats when approaching this issue in the future: how much does Scots law reflect the laws of physics?

Those seeking security over interests in contracts, therefore, may well wish to continue to tread cautiously.