Mortgage shortfalls

We are often asked to give advice on whether mortgage shortfalls i.e. the amount left due to a secured lender once a property has been repossessed and sold, should be classed as pre or post sequestration debts. If the debt is a pre sequestration debt then the debtor will be discharged of it on being discharged and the lender may submit a claim in the sequestration. If, on the other hand, it is a post sequestration debt then the lender is not entitled to submit a claim but may instead pursue the debtor for it.

The answer lies in the provisions of Section 55 of the Bankruptcy (Scotland) Act 1985. This provides that, on the debtor’s discharge under section 54 he shall be discharged within the United Kingdom of “all debts and obligations contracted by him, or for which he was liable at the date of sequestration.” The section then lists certain debts and obligations (such a fines imposed by courts or debts occasioned by fraud, etc.) from which he will not be discharged.

Section 55(3) provides that the discharge of the debtor shall not affect the right of a secured creditor to enforce his security for payment of the debt and any interest on the debt until the debt is paid. This subsection was added with retrospective effect by the Bankruptcy (Scotland) Act 1993 following comments made by some academics at the time that Section 55 as it was then drafted had the effect of discharging secured debts.

Schedule 1 of the Act provides which amounts may be claimed in a creditor’s sequestration. Para 1 specifically provides that a creditor is entitled to submit a claim for the debt due as at the date of sequestration. Para 5 makes specific provisions in relation to secured debts.

In our view the cumulative effect of these provisions is that a debtor is discharged of all debts, including debts that are secured except to the extent that such debts are actually secured. In those cases a secured creditor can enforce its security to recover the debt due to it but only to the extent that the security allows it to do so i.e. if the property against which the debt is secured is worth less than the debt then whatever is realised by the sale of the asset is all that a secured creditor can recover. Any shortfall, being a debt incurred prior to the date of sequestration, will be discharged, although the creditor can submit a claim in the debtor’s sequestration.

In our view this situation applies, even if any sale occurs some time after the date of sequestration and discharge, although the ability of a creditor to submit a claim will be limited if the sequestration has concluded.