Insolvency: Who gets the benefit?

Arrestment is, according to Graham Stewart on Diligence, “the diligence whereby the debtor in a moveable debt or obligation is prohibited and restrained from making payment of the debt or satisfaction of the obligation”. What is secured by the arrestment is the obligation of the debtor to account to their creditor. Most commonly, arrestments are used against bank accounts pursuant to decrees and summary warrants.

This was written almost a century before the Social Security Administration Act 1992 was brought into force. That Act provides that certain social security benefits are “inalienable”. As such, an arrestment in the hands of the Government department(s) distributing those benefits is thought incompetent.

Nevertheless, once those benefits are paid into the debtor’s bank account, they have long been thought subject to arrestment. Gloag & Henderson, for example, recognising that funds held for alimentary purposes are not usually arrestable, states that once paid into a bank account, social security benefits are arrestable. It cites North Lanarkshire Council v Crossan 2007 SLT (Sh Ct) 169 as authority for that proposition.

In its Report on Diligence and Debtor Protection (1985), the Scottish Law Commission also took the view that alimentary payments do not retain that character when transferred into a bank account. This largely formed the rationale behind the minimum protected balance and the ability to recall on grounds that an arrestment is “unduly harsh”, introduced by the Bankruptcy and Diligence (Scotland) Act 2007. The minimum protected balance now stands at £1,000.

Twist in the tale

This was the understanding of the law prior to the recent sheriff court judgment in McKenzie v City of Edinburgh Council [2023] SC EDIN 21.

In that case the council served an arrestment in the hands of McKenzie’s bank (which joined the action as an interested party). The account was at credit in a sum greater than the minimum protected balance. The bank therefore ring-fenced the arrested portion of the account. McKenzie applied to the court for recall of the arrestment, arguing that the whole of the funds at credit of his account consisted of benefits which would not have been arrestable in the hands of the DWP. Therefore, they should not be arrestable within his bank account.

By reference to Crossan, the council resisted the application.

However, there was a twist. Unknown to most (including, it appears, the authors of Gloag & Henderson), Crossan had been successfully appealed to the sheriff principal in an unpublished judgment.

The sheriff framed the issue by reference to the sheriff principal in Crossan: “whether an exemption from diligence which attached to a fund in the hands of a person having a duty to pay that beneficiary remains so attached when the fund is paid into the beneficiary’s bank”.

The council argued that once funds were transferred into a bank account, they were inmixed with the bank’s own funds and what remained was an obligation on the part of the bank to account to their customer for the amount of those funds. The nature of the funds changed by payment into a bank account. Thus, the arrestment was valid and effective.

Additionally, the bank argued that to find that funds paid into a bank account by way of benefits were not arrestable would put a burden on the bank to trace the source of funds paid into the account and to exercise a judgment on what was and was not arrestable. A mistake might open the bank to claims for damages.

Continued protection

The sheriff held that the judgment of the sheriff principal in Crossan was persuasive and adopted the reasoning of that judgment. The sheriff conceded that it “may technically be correct” to say it is the obligation to account that is attached by an arrestment and not the money or property, but considered that this is not how an arrestment is ordinarily explained.

Since the funds originated under a statutory provision, their arrestability had to be considered by reference to the statute. The statute states that no “charge” (which includes an arrestment) may be placed over benefits. That protection ought to follow through when those funds were placed in a bank account.

Any additional burden placed on the bank as a result, was not a relevant consideration.

One assumes the matter will be appealed (indeed the sheriff invites this at para 46 of his judgment). Given the probable effects on fundamental principles of banking law, particularly the relationship between banker and customer, it is an appeal which should be closely watched.