5The European Bank for Reconstruction and Development’s Secured Transactions Project: a model law and ten core principles for a modern secured transactions law in countries of Central and Eastern Europe (and elsewhere!)

when it was possible at all, only concerned debtors who owned land or buildings.

As Central and Eastern European states started moving towards a market economy, it became clear that business development was closely dependent on the availability of credit. In Poland, for example, in the few years following 1989 and the radical economic and political changes in the country, new businesses managed to flourish without recourse to bank finance, thanks to the nature of their activities (mainly services, requiring little initial capital) and funds provided by relatives and friends. However, as the years passed, it became clear that external finance was necessary and that creditors would require some sort of security to guarantee their loans and overdraft facilities. If foreign investment was to pour into the countries, as hoped, foreign investors had to be confident that they could secure their loans efficiently, using at least some of the legal techniques commonly found in the West.

The EBRD Model Law on Secured Transactions: four objectives

In this context, the European Bank for Reconstruction and Development decided in 1992 to make secured transactions law reform a priority. Specifically, discussion of the problem at a roundtable held in Budapest that year led to three eminent lawyers from Central Europe1 requesting that the EBRD propose a basis for uniform or similar regulation of secured transactions across the region. The outcome was the EBRD Model Law on Secured Transactions, which was published in April 1994.2 It was stressed from the outset that the Model Law is not intended as detailed legislation for direct incorporation into local legal systems of the region. The Model Law was prepared in order to fulfil four distinct objectives.

First, the Model Law can be used as an illustration of the principal components of a set of rules for secured transactions and of the way in which these rules can be incorporated into legislation. Although a national law could play this role, it is more practical to have all components listed in one single document in a rational and progressive fashion. It also avoids the issue of national pride when it comes to deciding which foreign legal system is to be looked at in the context of legal reform.

1Professor Dr Atilla Harmathy of Hungary, Professor Petar Sarcevic of Croatia and Professor Stanislaw Soltysinski of Poland.

2The Model Law on Secured Transactions, EBRD, 1994; see also http://www.ebrd.com/english/ st.htm.

100 f r e d e r i q u e d a h a n a n d j o h n s i m p s o n

Second, the Model Law acts as a reference point and checklist for the law reformer. Since each country has to take into account its own legal background and the existing legal and institutional framework, it is important to provide a list of points that have to be covered in order to establish a comprehensive system. The Model Law puts particular emphasis on a number of issues where the existing legal provisions are likely to be the weakest, for example, the type of assets that can be offered as collateral and the registration of security interests. The Model Law is intended to form a basis from which national legislation for transition countries can be developed, to act as a starting point, indicating through a detailed legal text how the principal components of a secured transactions law can be drafted but allowing for a high degree of flexibility to enable adaptation to local circumstances. Although the issues are complex, the Model Law had to be kept simple in order to be of use for market economies in transition. From this basic system, more sophisticated rules can be developed.

Third, the Model Law provides guidance as to the expectations of international investors and lenders. Clearly, the Model Law was drafted by an international financial organisation which is also a commercial bank that applies sound banking and investment principles in all its operations. When signing a deal, the Bank pays particular attention to the security package and seeks to take security over property according to modern financial practice. The Model, for example, permits security over all types of movable and intangible assets without the need to take possession of the collateral. It also proposes solutions to enable rapid and effective enforcement and to facilitate the situation where a number of lenders (a banking syndicate) want to share the same security.

Fourth and finally, the Model Law is also intended to promote some harmonisation in the approach to secured transactions legislation across the region. Harmonisation is an attractive but very complex concept. Confined to the European Union, it has shown its limits in many areas. The Common Core of European Private Law’s objective is not harmonisation but, in our understanding, the identification of the main differences between the legal systems. Once the differences are highlighted -- or possibly the lack of real differences -- it is only a short step towards proposing ways of eliminating them completely. The Model Law was itself the result of a comparative study and has been influenced by a number of legal systems, thanks to the support of an international advisory board (comprising twenty members from fifteen different jurisdictions). One principle which has guided the drafting of the Model has been to produce a text which is compatible with the civil law concepts

which underlie many Central and Eastern European legal systems and, at the same time, to draw on common law systems which have developed many useful solutions to accommodate modern financing techniques.3 The drafters drew on a broad range of legal and practical sources both in Central, Eastern and Western European countries and elsewhere in the world, in particular in the United States. For countries which already have well-established legal provisions on secured transactions, any change to the system requires an overwhelming desire for change on the part of all stakeholders and an agreement as to the contents of the new rules. In Central and Eastern Europe, at least, the impetus for change was (more or less) already there. There was thus an opportunity for trying to introduce some sort of uniformity into legal regimes for secured transactions throughout the region, if only to facilitate intraregional commercial transactions. Yet, this was not the primary objective of the Model Law and its success should not be measured accordingly.

The EBRD Ten Core Principles

Another important contribution of the EBRD to the reform process on secured transactions in the region is the Ten Core Principles, which followed the publication of the Model Law. In effect, during the countryspecific work of the Bank’s Legal Transition Team, it became evident that the Model Law was an important and helpful instrument for local reformers. However, it also became clear that a more general formulation of the goals and principles of successful reform to foster economic development was needed. This has led to the EBRD defining a set of ten core principles for a modern secured transactions legislation. These principles form the basis for assessing a country’s secured transactions law and for identifying the need for reform. The principles draw on the assumption that the role of a secured transactions law is economic. It is not needed as part of the essential legal infrastructure of a country: its only use is to provide the legal framework which enables a market for secured credit to operate. To some extent, the Core Principles serve to remind law-makers that they would be making a mistake if they took the Model Law as immediately available material that they can ‘cut and paste’ into their own legal system. To put it in even more blunt terms, translating the Model Law into the local language cannot provide the

3Although it is acknowledged that the division of civil law and common law in this area of the law may not be as fundamental as in other areas. This volume brings detailed and compulsive evidence of that.

102 f r e d e r i q u e d a h a n a n d j o h n s i m p s o n

country with an up-and-running new pledge law. There is no substitute for the long and pains taking process of legal reform, which implies designing a law that really suits the local circumstances and interfaces efficiently with existing laws.

The Core Principles do not seek to impose any particular solution on a country -- there may be many ways of arriving at a particular result -- but they do seek to indicate the result that should be achieved. As with any set of general principles of this nature, they must be read within the context of the law and practice of any particular country and they do not aim to be absolute; exceptions inevitably have to be made.

The Principles read as follows:

1Security should reduce the risk of giving credit, leading to an increased availability of credit on improved terms. This goes to the basic

assumption made by the EBRD in all its work on secured transactions law reform.

2The law should enable the quick, cheap and simple creation of a proprietary security right without depriving the person giving the security of the use of his assets. In most market economy scenarios depriving the debtor of the use of his assets is self-defeating; non-possessory security which gives a remedy attached to the charged asset is an essential element of a

modern secured transactions law. Any delay, cost or complexity in the creation process reduces the economic efficiency of security.

3If the secured debt is not paid, the holder of security should be able to have the charged assets realised and to have the proceeds applied towards satisfaction of his claim prior to other creditors. The exact nature of the proprietary right that arises when security is granted has to be defined in the

context of the relevant laws. If it is to be effective it must link to the creditor’s claim the remedy of recovering from the assets given as security in priority to other creditors.

4Enforcement procedures should enable prompt realisation at market value of the assets given as security. A remedy is only as good as the procedures and practice for exercising it allow it to be. If the value received on realisation is expected to be only half the market value, then the provider of credit will require more assets to be given as security. If it

is expected that enforcement will take two years, then the creditor will give less favourable credit terms to the debtor.

5The security right should continue to be effective and enforceable after the bankruptcy or insolvency of the person who has given it. The position against which the creditor most wants protection is the insolvency of the debtor. Any reduction of rights or dilution of priority upon insolvency will reduce the value of security. A limited exception to this principle may be necessary to make it compatible with rules which permit a moratorium at the commencement of insolvency.

6The costs of taking, maintaining and enforcing security should be low. A person granting credit will usually ensure that all costs connected with the credit are passed on to the debtor. High costs of security will

be reflected in the price for credit and will diminish the efficiency of the credit market.

7Security should be available (a) over all types of assets, (b) to secure all types of debts, and (c) between all types of person. This principle covers a multitude of issues that may arise between the way law is applied and commercial reality. Such issues may appear technical but can be of critical importance when seeking to implement a commercial agreement. With very limited exceptions (e.g. personal clothing), a person should be able to give security over any of his assets, including assets he may acquire in the future. Similarly, a charge should be capable of securing any type of present or future debt or claim that can be expressed in money terms. The charged assets and the secured debt should be capable of general description (e.g., all machines in a factory, all debts arising under a sales contract). It should also be possible to charge constantly changing ‘pools’ of assets such as inventory, debts receivable and stocks of equipment and to secure fluctuating debts such as the amount due under a bank overdraft facility. Any physical or legal person (whether in the public or private

sector) who is permitted by law to transfer property should be able to grant or receive security.

8There should be an effective means of publicising the existence of security rights. Where security is possessory the mere fact that the assets are held by the creditor is enough to alert third parties that the debtor has charged them. Where security is non-possessory some other

means (normally a public registry or notification system) is needed to ensure that third parties do not acquire charged assets without being made aware of the existence of the charge.

9The law should establish rules governing competing rights of persons holding security and other persons claiming rights in the assets given as security. Even when an effective means of publicity is in place there remain some cases for which the law has to provide, for example,

sales of charged assets in the ordinary course of the owner’s business (where the purchaser cannot be expected to inspect a register before

purchasing).

10As far as possible the parties should be able to adapt security to the needs of their particular transaction. The law is there to facilitate the operation of the secured credit market and to ensure that necessary protections are in place to prevent debtor, creditor or third parties being unfairly prejudiced by secured transactions. It should not be the purpose of the law to create rules and restrictions for the operation of secured credit which are aimed principally at directing the manner in which parties to secured credit should structure their transaction.