Restatement of guidance on a borrower’s solicitors accepting instructions from the lender

The Professional Practice Committee recently looked at this subject again following an exchange of correspondence with the Royal Bank of Scotland. In 1994 the then President circulated a guidance letter highlighting the increased risk in acting for lender and borrower in commercial security transactions. The Committee decided that that guidance remains as valid today as it was in 1994. The guidance refers to a de minimis level without defining that. For many years it has been accepted that de minimis in a commercial security is less than £100,000. The Royal Bank have now taken the view that that figure can be increased to £250,000. The Committee noted that position but felt that it was worth reminding members of the terms of the original guidance which reads:

The Scottish banks have confirmed that they all now intend to introduce policies in the very near future whereby in commercial security transactions they will instruct separate solicitors to represent them. Their solicitors will, as has been the custom, recover their fees and outlays from the borrower. It is the intention of the Scottish banks that they will use solicitors throughout Scotland and will not centralise their commercial security work. Furthermore the banks have indicated that they will expect those solicitors whom they instruct to charge reasonable fees.

[The President] understands that while this agreement has been reached with the Scottish banks, other banks operating in Scotland and members of the British Bankers Association will adopt similar policies.

Notwithstanding this general policy, the Scottish banks wish to reserve the right to instruct the borrower’s solicitor to act for them, in what they described as de minimis cases. Each bank may adopt a different view on what constitutes a de minimis case, but the Council expects that the banks will act responsibly when deciding on their individual policies.

The Council believes it would be helpful if a definition is provided of a commercial security transaction. It is:

“A commercial security transaction relates to the secured lending to a customer of a bank or other lending institution where the purpose of the loan is clearly for the customer’s business purposes.”

However we must remind you that should you receive instructions to act for a lender and a borrower in any type of transaction, but particularly a commercial security transaction, you must exercise your judgment standing the provisions of the Solicitors (Scotland) Practice Rules 1986 (the Conflict of Interest Rules) as to whether you can properly act for both parties. It is appropriate that in exercising that judgment you take account of the circumstances which might arise. There follow certain examples which you may find helpful when you exercise your professional judgment. You should not forget that, should you decide to act for both lender and borrower (even in what purports to be a de minimis case) and ultimately a claim arises, you may have exposed yourself and your firm to the risk of bearing a double excess/deductible and the possibility of a loading on your master policy premium.

Finally, please do not hesitate to contact the Society if you feel you require further advice or guidance in this type of transaction.

Examples of conflicts of interest

The following illustrate some of the instances where lenders and borrowers have separate interests in commercial security transactions.

1. Disclosure of all relevant circumstances

Either: (a) the solicitor may know more of the borrower’s position than has been communicated to the lender or vice versa; or

(b) there may have been a reluctance by the borrower or lender fully to disclose their respective positions because of dual representation.

This clearly affects the extent to which impartial “best advice” can be given.

2. Ongoing negotiations

Negotiations between the borrower and lender may have only reached the “outline terms” stage – requiring further detailed consideration or negotiation of covenants/undertakings/events of default. In such negotiations the borrower and lender may have different negotiating strengths and thus there may be competing pressures on the solicitor as to whose interests are to be promoted.

3. Defects in title

While a borrower may be prepared to live with a minor defect in title or some lack of planning or building consent the lender may take an entirely different stance.

4. Security by companies

Apart from the complexities and time restraints for registration of security, companies may well be subject to negative or restrictive covenants or powers affecting the security, on which the borrower but not necessarily the lender may be prepared to take a commercial view. This may merit separate consideration and advice.

5. Competing creditors’ ranking agreement

The circumstances as to the inter-relationship/enforcement of security between lenders may merit separate consideration and advice. Banks may not have “standard forms” of ranking agreements and this clearly may involve a solicitor in preparing a document and negotiating its terms on points which have a bearing on the borrower’s position.

6. Security over commercial property

The permitted use, associated licences/quotas and specific standard conditions may merit separate consideration and advice as they may not be covered by pre-printed “standard” bank forms. Particular risks arise on the transfer of a licence where the lender’s interests will sometimes conflict with the borrower’s commercial ambitions.

7. Leased property as security

The circumstances in which a lender requires protection in the event of irritancy may merit separate consideration and advice. Invariably the borrower is trying to strike the best deal while he is in occupancy while the lender needs protection in the event of the borrower’s failure through insolvency or otherwise.

8. Enforcement of security

The solicitor acting for both borrower and lender may be placed in difficulty in the event of subsequent enforcement of a security. For whom does the solicitor act in such circumstances? Do both clients know and understand their respective positions?

9. Powerful clients

A major business client may bring subtle or even open pressures on a solicitor to follow a particular course or to turn a blind eye to a matter which could prejudice a lender’s position, e.g. discrepancies between a valuation and purchase price.

10. “All sums due” securities

Solicitors should be mindful to advise fully, joint obligants (husbands and wives) of the nature of an “all sums due” security. In particular it should be drawn to their attention that additional loans for example in respect of one obligant’s business, may give rise to further secured borrowings without the other obligant requiring to sign the documentation. In such circumstances there is also a conflict of interest between the joint obligants.

11. Following changes to the ultra vires doctrine lenders may be able to rely on the provisions of what is now section 35 of the 1985 Companies Act.

If the solicitors involved act solely for the lender they would, as a generality, be entitled to rely on these same provisions if asked to do so by the instructing lender. On the other hand if the solicitors act also for the borrowing company it is quite clear that the solicitors would require to carry out a full examination of the company’s memorandum and articles of association. Since section 35 only provides protection for third parties it does not for example excuse the directors from any liability arising from acting ultra vires. In such circumstances the solicitors, as agents for the lender, would become aware of any ultra vires aspect of the arrangements and the lender could be similarly tainted with this knowledge.

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