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Cite as: 2004 SCLR 403, [2004] ScotCS 50

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Smillie v. Olympic House Limited & Anor [2004] ScotCS 50 (27 February 2004)

OUTER HOUSE, COURT OF SESSION

CA34/03

OPINION OF LORD DRUMMOND YOUNG

in the cause

DAVID SMILLIE

Pursuer;

against

(FIRST) OLYMPIC HOUSE LIMITED and (SECOND) CAMERON K. RUSSELL

Defender:

________________

Pursuer: McIlvride, Solicitor; Morton Fraser

Defenders: Bartos; McGrigor Donald , McClure Naismith

27 February 2004

[1] On 17 July 2002 sheriff officers acting on behalf of the first defenders charged the pursuer for payment of the sum of £36,541.99. That sum was not paid, and on 20 August 2002 the first defenders presented a petition for sequestration of the pursuer to the Sheriff of South Strathclyde, Dumfries and Galloway at Ayr. On 12 September 2002 the Sheriff awarded sequestration, and appointed the second defender as the trustee on the pursuer's sequestrated estate. The pursuer now seeks reduction of three of the acts involved in the process of his sequestration: first, the charge for payment served on 17 July 2002 together with the first defenders' certificate of the pursuer's indebtedness to them upon which the charge for payment proceeded; secondly, the creditor's oath submitted by the first defenders to the Sheriff to support the petition for sequestration; and, thirdly, the Sheriff's deliverance of 12 September 2002 awarding sequestration. The ground on which reduction is sought is fraud on the part of the first defenders. In essence, the pursuer contends that the first defenders' certificate of indebtedness was fraudulent, with the result that the charge proceeded on a false ground; the creditor's oath submitted to the Sheriff was sworn fraudulently; and accordingly the award of sequestration was obtained by means of fraud on the part of the first defenders.

[2] In support of the foregoing contentions, the pursuer avers that in April 1999 the first defenders granted a lease of certain commercial premises in Dundonald to a company known as Express Logistics (Scotland) Ltd. The pursuer was a shareholder and director of the latter company, and in the lease he guaranteed payment to the first defenders of any sums due by the company under the lease. The rent payable under the lease was £150,000 per annum plus value added tax. The date of entry was in November 1999. The first defenders insisted upon payment in advance of the first quarter's rent before they allowed the company to take entry. Consequently payment of £40,673.07 was made by the company. In fact the company was not given actual occupation of the premises until 24 December 1999, and even then was allowed entry to part of the premises only. Thereafter, the pursuer avers, between January and April 2000 the company was unable to occupy most of the premises because of substantial ingress of water and delay in effecting the necessary repairs. The first defenders rendered an invoice for £44,062.50 on 2 February 2000 in respect of rent for the quarter beginning on that date. The pursuer avers that the company disputed liability for the previous quarter's rent, and that on 10 February 2000 the first defenders conceded that, by reason of their failure to allow entry timeously and to maintain the premises in a wind and watertight condition, no rent was due by the company for the quarter beginning on 2 February 2000. On 10 February 2000 the first defenders issued a credit note to the company whereby they cancelled their invoice for the quarter's rent which would otherwise have been due on 2 February. The pursuer avers that the first defenders have accordingly waived any rights to insist upon payment of the rent for that quarter. I will deal with the significance of the credit note at a later stage in this opinion. At this stage, however, I should record its terms. An invoice for rent amounting to £44,062.50 had been issued on 2 February; this was referred to as "Property Invoice No 5146", and the sum stated in it was described as "Rental due 2nd February, 2000". The credit note, which was typed on the first defenders' writing paper, was addressed to Express Logistics (Scotland) Limited. It was headed "Credit note", and the operative part read:

"To: Cancel Invoice No 5146 dated 2nd February, 2000

Total £44062.50".

[3] The pursuer goes on to aver the service of a charge for payment of £36,541.99 on 17 July 2002, and the presentation of the petition for sequestration on 20 August of that year. In the petition the first defenders averred that the pursuer was apparently insolvent by virtue of the expiry of the charge. With the petition the first defenders submitted a creditor's oath in which they stated that the pursuer was indebted to them in the sum of £36,541.99. The pursuer avers that he was not advised by his then solicitor to institute proceedings for suspension and interdict following service of the charge. Inquiries were made of the first defenders' solicitors as to whether it was accepted that no rent was due for the quarter beginning in February 2000. By fax dated 11 September 2002 the first defenders' solicitors wrote as follows:

"A charge was served on 17 July 2002 to which charge your client did not take objection. The days of charge having expired without challenge or payment your client is apparently insolvent and as such falls to be sequestrated.

The sums claimed in the charge include the rent due as at 2 February 2000 under deduction of the amount of £17,500 recovered from the insurance claim. They also include sums due in August and November 2001. We attach a copy of the calculation.

Our clients' position is that the credit note issued in February 2000 was as part of an internal accounting exercise. It is not a discharge of the Tenant's liability for the rent. Given that other sums are due, however, the question of the credit note is irrelevant we would suggest.

In all the circumstances we are instructed to move for sequestration tomorrow".

The petition was heard by the Sheriff on 12 September 2002. The pursuer was represented by his then solicitor, who informed the Sheriff that the pursuer disputed that he was liable to pay £36,541.99 to the first defenders. A copy of the credit note of 10 February 2000 was produced, and it seems clear that that credit note formed the basis of the submission that the sum of £36,541.99 was not due. The pursuer avers that the solicitor appearing for the first defenders advised the court that the credit note had simply been prepared as part of an internal book-keeping exercise by the first defenders. He stated to the Sheriff that the credit note was a "red herring". The Sheriff awarded sequestration, and the second defender was appointed permanent trustee on the sequestrated estate.

[4] The pursuer then makes formal averments of fraud. He avers that, in the creditor's oath made on behalf of the first defenders and accompanying their petition for sequestration, it was stated that the debt due to the first defenders by the pursuer amounted to £36,489.10, being arrears of rent and interest allegedly due under the lease and accordingly due under the pursuer's guarantee. The calculation of that sum was further specified; it included rent of £26,562.50 due but not paid for the quarter beginning in February 2000 together with interest thereon amounting to £6,612.80. A deduction was made for an insurance claim made by the first defenders in respect of the ingress of water at the premises in January 2000; this resulted in a payment of £17,500 from their insurers, and that amount was set against the total quarterly rental payment (£44,062.50) for the quarter beginning in February 2000. The pursuer goes on to aver as follows:

"In fact, as the first defenders were well aware, the company did not owe the first defenders £33,175.30 in respect of rent as at 2nd February 2000 and interest thereon and the pursuer did not owe that sum to the first defenders by virtue of the guarantee granted by him in their favour. The first defenders had agreed that no rent was payable by the company for the quarter beginning 2nd February 2000.... The rent actually due by the company to the first defenders, and accordingly by the pursuer under his guarantee, amounted to £3,313.80 inclusive of the expenses of the charge for payment. The first defenders falsely and fraudulently certified that the sum due to them by the pursuer under his guarantee amounted to £36,489.10. They instructed Sheriff Officers to charge the pursuer for payment of that sum. In the Creditor's oath which accompanied their petition for sequestration of the estate of the pursuer they fraudulently misled the Court by stating that they were entitled to payment of that sum by the pursuer. They fraudulently obtained the award of sequestration of the pursuer's estate".

It is on the basis of those averments that the pursuer seeks reduction of the certificate of indebtedness, charge for payment, creditor's oath and deliverance awarding sequestration.

[5] The defenders have tabled pleas to the relevancy of the pursuer's averments. The first defender has also tabled a plea to the competency of the action, but that was not ultimately insisted on. The case was appointed to a debate, at which counsel for the defenders argued that the pursuer's averments of fraud were fundamentally lacking in specification and were accordingly irrelevant. He submitted that there was no indication in the pleadings of who was said to have made the false statements that were alleged; nor was anything said to indicate why the inference should be drawn that the various statements made were fraudulent. He submitted that the averments were equally consistent with the makers of the statements' having a reasonable belief that the debt claimed was due by the pursuer to the first defenders. Reference was made to Kaur v Singh, 1998 SC 233, Royal Bank of Scotland PLC v Holmes, 1999 SLT 563, Erskine, Institutes, III.i.16, and Boyd & Forrest v Glasgow and South-Western Railway Company, 1912 SC (HL) 93. Counsel further argued that the pursuer's conclusion for reduction of the award of sequestration was irrelevant because reduction of such a decree required exceptional circumstances, amounting to a miscarriage of justice. That requirement was not satisfied in the present case, where the defender had had the benefit of legal advice and had in fact opposed the award of sequestration. Reference was made to Bain v Hugh LS McConnell, 1991 SLT 691, Stewart v Lothians Construction (Edinburgh) Ltd, 1972 SLT (Notes) 75, Central Motor Engineering Company v Galbraith, 1918 SC 755, and Arthur v The SMT Sales and Service Company Limited, 1999 SC 109. The agent for the defender submitted that a proof before answer should be allowed on the pursuer's averments. While exceptional circumstances were required for reduction of a decree, that requirement would be satisfied if a decree were obtained by means of a fraud on the court. Reference was made to Adair v Colville & Sons, 1924 SC (HL) 51, Walker v Walker, 1911 SC 163, and Central Motor Engineering Company v Galbraith, supra. It was further submitted that the pursuer's averments gave adequate specification of the fraud. The documents that it was sought to reduce were all in the possession of or available to the defenders, and indeed the pursuer sought production of those documents in each of the conclusions for reduction. The defenders should have lodged those documents, or a copy, with the defences, in accordance with Rule of Court 53.4 and .7. The circumstances of the false representations, and the makers of the statements, should be apparent from those documents. The critical point was that the credit note issued on 10 February 2000 was capable of amounting to a permanent, or at least a temporary, waiver of the liability to pay the rent for the quarter that started in that month. In that event the indebtedness stated in the charge and accompanying certificate and the creditor's oath could not have existed. At proof, therefore, the inference could be drawn that the statements of indebtedness in those documents had been made fraudulently, with the result that the documents and the decree of sequestration should be reduced.

[6] In my opinion the pursuer's averments are irrelevant, for two distinct reasons. In the first place, the pursuer has not in my opinion averred a relevant and sufficiently specific case of fraud. When fraud is alleged, specific averments are required to explain precisely how the fraud is said to have taken place. Those averments must indicate the person or persons responsible, and they must be sufficient to support the inference that those persons knew that they were making false statements, or were reckless as to the accuracy of the statements that they made: Royal Bank of Scotland PLC v Holmes, 1999 SLT 563, per Lord Macfadyen at 569K . That general rule applies to commercial actions in exactly the same way as ordinary actions. The relevant principle was stated by Lord Hamilton in Kaur v Singh, 1998 SC 233, as follows (at 237A-D):

"The current rules for commercial actions were devised against a recognition that the requirements for expeditious and satisfactory disposal of business disputes justify a different procedural approach to that traditionally adopted in ordinary actions.... It by no means follows that the requirements of fair notice are dispensed with. On the contrary, it is a cardinal feature of commercial action business that full and frank disclosure is made by parties. Sometimes such disclosure may be in a form other than formal pleadings. When, however, an allegation of fraud is made, the basis for that allegation must, in my view, be set forth to the same standard of relevancy and specification as is required for such an allegation in any other proceedings. Ordinarily, the basis for any allegations of that kind made in a commercial action will require to be set out in formal pleadings.... These require to be tested to the same standard as in ordinary actions".

[7] The pursuer's case is based quite squarely on the proposition that the credit note issued on 10 February 2000 amounted to a waiver or discharge of Express Logistics (Scotland) Limited's liability for rent during the quarter beginning in that month. That was made clear by his solicitor in the course of the argument. In any event, if the pursuer relies on any other basis for the contention that the liability for rent for the relevant quarter was waived or discharged, that basis is not set out on record, in which case the pursuer's case is fundamentally lacking in specification. Thus the averments, referred to in paragraph [2] above, that the first defenders had conceded that no rent should be due by the company for the quarter beginning on 2 February 2000 and that the first defenders had waived any entitlement to rent for that quarter, were based on the issuing of the credit note. It is necessary, however, to consider the general significance of a credit note. The normal function of a credit note is not to discharge or waive a debt. It is rather to cancel an invoice that has been issued. An invoice is a statement that goods or services have been supplied and that a payment is due in consequence. Thus an invoice does not normally create any contractual obligation; it recognises that contractual obligations have been created, and indicates that a debt is due. Likewise a credit note, which can be regarded as the converse of an invoice, does not normally affect the underlying contractual obligations of the parties. I use the word "normally" because in certain circumstances an invoice or credit note may have greater significance. It is possible, for example, that as a result of a course of dealing two parties might come to regard the issuing of an invoice as the basis for a contractual obligation to pay for particular goods or services. Similarly, the issuing of a credit note might be regarded, in an appropriate context, as indicating that a debt had been discharged; if, for example, goods had been returned to the seller and accepted by him and a credit note was subsequently issued, that might reasonably be interpreted as a discharge of the obligation to pay for the goods. Such cases are exceptional, however, and they are dependent on the existence of surrounding circumstances that indicate that the credit note functions as something more than the mere cancellation of an invoice.

[8] In the present case the pursuer alleges fraud by the individual who issued the certificate of indebtedness that accompanied the charge and the individual who swore the creditor's oath. It is of the essence of fraud that a false statement is made either in the knowledge that it is false or recklessly, that is to say, without caring whether it is true or false. Consequently, if fraud is to be established, the pursuer must prove that the individuals responsible for the certificate of indebtedness and creditor's oath were or must have been aware of the issue of the credit note. The pursuer must also prove that those individuals believed that the credit note discharged or waived the underlying debt, or at least did not care whether the credit note achieved that result. It may be reasonable to draw the inference that the individuals responsible for the certificate and oath had acquainted themselves with the relevant accounting records of the first defenders, and were thus aware of the existence of the credit note. The normal significance of that document, however, would be as indicated in the last paragraph: that an invoice had been cancelled but not that the underlying debt had been discharged or waived. If the granters of the certificate and oath were to accord the credit note greater significance than the cancellation of an invoice, it would be necessary that they were aware of surrounding circumstances that produced such a result. All that is averred by way of surrounding circumstances, however, is that actual entry to the premises was delayed until 24 December 1999, and that until April 2000 entry was only given to part of the premises because of water ingress and the necessity for repairs. Thus the failure to give entry is only partial, and extended over two quarters. Moreover, the terms of the credit note itself, which as quoted above, amount to a cancellation of the invoice of 2 February 2000 but nothing more. That is wholly consistent with the normal function of a credit note. In the circumstances I am of opinion that no necessary inference can be drawn that the credit note had any greater significance than the cancellation of an invoice, no doubt to await resolution of the underlying dispute. The pursuer does not aver that the individuals responsible for the certificate of indebtedness and creditor's oath were or must have been aware of the failures to give entry timeously or to the whole of the premises. Indeed, no averment is made as to the state of knowledge of those individuals. Averments are made, however, about the fax sent by the first defender's agents on 11 September 2002, the terms of which are quoted in paragraph [3] above. The argument advanced in that fax is that the credit note issued in February 2000 was part of "an internal accounting exercise", and was not a discharge of the tenant's liability for the rent. That argument is consistent with the normal significance of a credit note, namely that it has no bearing on the underlying debt but merely cancels an invoice. The fax is not correct in suggesting that the accounting exercise was "internal", because a credit note is issued to another party and thus cannot fulfil a function that is merely internal to the party issuing it. It is, however, correct to suggest that the function of a credit note is essentially a matter of accounting. The terms of the fax clearly indicate that the writer did not consider that the credit note of 10 February 2000 discharged or waived the underlying debt. In the circumstances it is in my opinion quite impossible to state that that belief was in any way dishonest, as it accorded with the normal function of a credit note and there are no averments to suggest that the belief was for some other reason dishonest. If that is true of the writer of the fax, however, it must be equally true of the individuals responsible for the certificate of indebtedness and creditor's oath, at least in the absence of averments relating to their respective states of mind. In these circumstances I am of opinion that the pursuer's averments do not disclose a relevant case of fraud.

[9] My second reason for holding the pursuer's averments irrelevant is that fraud is excluded because of the statements made to the Sheriff when sequestration was awarded. It is clear from the pursuer's averments that the existence of the credit note was made known to the Sheriff in the course of the hearing; indeed, it appears that arguments were presented on the significance of the credit note. The pursuer's fundamental contention is that the charge and accompanying certificate of indebtedness and the creditor's oath failed to take account of the existence of the credit note issued on 10 February 2000, and that that failure was dishonest. The practical consequence of the charge and creditor's oath, however, was to induce the Sheriff to sequestrate the pursuer. Where decree of sequestration was pronounced in full knowledge of the existence of the credit note, it cannot be said that there was any dishonesty; the document that is said to render the representations false was itself before the court, and it was up to the Sheriff to make what he would of that document. The point is particularly strong because, on the pursuer's own averments, it appears that at the hearing before the Sheriff the pursuer's solicitor stated that the pursuer disputed that he was liable to pay the sum referred to in the charge and creditor's oath, and the first defenders' solicitor advised the court that the credit note had been prepared as part of an internal book-keeping exercise by the first defenders and stated that it was a "red herring". Those submissions by the solicitor acting for the first defenders appear to echo the view advanced in the fax of 11 September 2002. I have criticised the use of the word "internal" in this context; nevertheless, the basic point that was made seems quite clear: the first defenders contended that the credit note did not involve the discharge or waiver of the underlying debt. It appears, therefore, that the pursuer's argument about the credit note was before the Sheriff, together with the first defenders' reply. In these circumstances there was no deception or concealment of facts. The significance of the charge and creditor's oath is, as I have indicated, that they led to the award of sequestration by the Sheriff. Thus the only practical consequence of importance is one that was reached without deception. In the circumstances there is in my opinion no room for any allegation of fraud.

[10] For the two reasons that I have stated I am of opinion that the pursuer's averments are irrelevant. I should, however, mention two further matters that were touched upon in the course of the debate. First, I am satisfied that the present action is competent, notwithstanding that it involves a conclusion for reduction of an award of sequestration and that the Bankruptcy Act makes provision in sections 16 and 17 for the recall of such an award. The general competency of reduction in relation to an award of sequestration appears from the majority of the opinions in Central Motor Engineering Co v Galbraith, 1918 SC 755, and in particular from the opinions of Lord Johnston at 769 and Lord Mackenzie at 770; the contrary view of Lord President Strathclyde at 765 does not appear to be supported by the authorities. Nevertheless, as Lord Mackenzie points out, "The Bankruptcy Act contains a statutory code in which careful provision is made for the method by which a sequestration may be recalled. It is only in a case where exceptional circumstances can be pleaded that the exceptional remedy by way of reduction could be granted.". He goes on to give as examples a case where an award of sequestration has been obtained by forgery or gross fraud. In my opinion it is clear that fraud, if it is relevantly averred, is a ground for the reduction of almost any sort of decree. The reason lies in the fact that, if fraud is established, the decree of the court has been obtained by dishonesty, which must always raise special circumstances. That in my opinion accords with the decisions of the House of Lords in Adair v Colville & Sons, 1926 SC (HL) 51, and of the Second Division in Bain v Hugh LS McConnell Ltd, 1991 SL T. 691. In the first of these cases, Viscount Dunedin stated in a well-known passage (at 55-56) that reduction may be competent to set aside a judgment when other means of review are not available, but that, generally speaking, reduction was not competent when other means of review were prescribed but had not been utilised. In the second, Lord Justice Clerk Ross pointed out that Viscount Dunedin had recognised, in his use of the expression "generally speaking", that exceptions might exist to the general rule that the existence of other means of review would preclude reduction. In that case, accordingly, the Second Division held that reduction could be available notwithstanding the existence of other means of review if the circumstances were exceptional and disclosed a miscarriage of justice. In my opinion fraud can be considered an exceptional circumstance, and if a court decree has been impetrated by fraud that certainly involves a miscarriage of justice.

[11] That must be read subject to the important qualification laid down in Arthur v The SMT Sales and Service Co Ltd, 1999 SC 109. In that case Lord Macfadyen, delivering the opinion of the First Division, stated (at 115B-E):

"It is clearly established... that reduction is not a remedy to which a pursuer is entitled as of right on proof of some invalidity in the deed or decree under challenge. The availability of another remedy, which has gone unused, is a matter of importance. In the context of the law of bankruptcy, which is regulated by a statutory code, interference by way of reduction is, as was recognised in Central Motor Engineering Co v Galbraith, a matter of particular delicacy. The 1985 Act makes express provision for recall of sequestration, and by section 17(1) confers on this court a wide discretion as the grounds on which it may recall the award of sequestration. By section 16(4), however, a petition for recall must be presented within 10 weeks after the date of the award. We accept that after the expiry of that period it is competent to seek to have the award set aside by reduction, but it is important not to lose sight of the time limit on the statutory remedy. The longer a sequestration has been proceeding, the more complex and unfortunate are likely to be the consequences of undoing it".

In that case, the length of time taken to challenge the award and the fact that the pursuer's estate was evidently grossly insolvent led the court to the view that reduction could not be justified. In the present case, sequestration was awarded on 12 September 2002 and the present proceedings began in April 2003. I do not consider that a delay of that magnitude would have been sufficient to refuse reduction of an award of sequestration if fraud had been established; the delay in the present case can clearly be distinguished from that in Arthur, which amounted to nearly ten years. In this connection, I think it relevant to bear in mind that evidence of fraud will often not become available until some time after the award.

[12] Secondly, it was submitted on behalf of the pursuer that the credit note issued on 10 February 2000 was capable of amounting to a temporary waiver of Express Logistics' obligation to pay the rent due for the quarter that started in February 2000. This argument is not spelled out in the pleadings, which treat the credit note as either a concession that no rent was due or the waiver of any right to insist on payment of rent, apparently on a permanent basis. If a temporary waiver is to be alleged, it is in my opinion important that at least some indication of the terms of the waiver should be given in the pleadings. Such a waiver obviously cannot involve the permanent abandonment of the right concerned. Thus it is necessary to indicate how the waiver may come to an end. For example, the waiver may be a matter of mere concession that is terminable on demand. Alternatively, it may be implied that the waiver is to last for a reasonable time, or the waiver may come to an end on the happening of a particular event. Specification of how the waiver terminates is important if its legal significance is to be properly assessed. In the present case, as I have said, the pursuer does not make any averments about a temporary waiver, or its alleged duration. The pleadings indicate that the charge was served on 17 July 2002, some two years and five months after the date of the alleged waiver. They further indicate that an insurance claim relating to the ingress of water at the premises in January 2000 had been taken into account as a deduction from the sum said to be due from the pursuer. In these circumstances, where a considerable time had elapsed and the first defenders had taken steps to settle liability for rent for the quarter in question, there must at least be a question as to whether any temporary waiver would have come to an end. That emphasises the need for the terms of any such waiver to be set out properly in the pleadings. Those terms have not been stated, however, and for that reason I consider the argument that there might have been a temporary waiver of liability to be irrelevant.

[13] In the foregoing circumstances I will repel the first defenders' first plea in law, which is to the competency of the action. I will, however, sustain the first defenders' second plea in law and the second defender's first plea in law, which are to the relevancy of the pursuer's averments. I will accordingly pronounce decree of dismissal.