учебный год 2023 / Wibier, Security over moveable assets

TICOM

TILBURG INSTITUTE OF COMPARATIVE AND TRANSNATIONAL LAW

WORKING PAPER No. 2009/11

SOME INITIAL THOUGHTS IN RELATION TO CHAPTER IX (PROPRIETARY SECURITY IN MOVABLE ASSETS) OF THE DRAFT COMMON FRAME OF REFERENCE

REINOUT M. WIBIER

FACULTY OF LAW

TILBURG UNIVERSITY

November 2009

This paper can be downloaded without charge at TICOM Working Paper Series on Comparative and Transnational Law, available at the Social Science Research Network http://www.ssrn.com/link/Tilburg-TICOM.html

Electronic copy available at: http://ssrn.com/abstract=1499043

SOME INITIAL THOUGHTS IN RELATION TO CHAPTER IX (PROPRIETARY SECURITY IN MOVABLE ASSETS) OF THE DRAFT COMMON FRAME OF REFERENCE

Reinout M. Wibier, Tilburg University

r.m.wibier@uvt.nl

ABSTRACT

This article investigates whether Book IX of the Draft Common Frame of Reference (DCFR), which deals with proprietary security rights in movable assets, is suitable for sophisticated lenders and borrowers active in European credit markets. The reason for choosing this perspective is that it is exactly in this field that there is actually a European market and (consequently) a clear excuse for harmonising the law.

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Electronic copy available at: http://ssrn.com/abstract=1499043

Some Initial Thoughts in Relation to Chapter IX (Proprietary security in movable assets) of the Draft Common Frame of Reference

Dr. Reinout M. Wibier*

1.Introduction

For legal scholars in the field op private law with an international orientation the abbreviation ‘DCFR’ does not stand for Dallas County Fire & Rescue as might be concluded by simply entering it into an internet search engine.1 The abbreviation refers to the Draft of a Common Frame of Reference, a text of ‘Principles, Definitions and Model Rules of European Private Law’. The text has been prepared the Study Group on a European Civil Code (the Study Group) and the Research Group on Existing EC Private Law (the Acquis Group). It has been published in an outline edition containing ten Books:2

I. General provisions

II. Contracts and other juridical acts

III. Obligations and corresponding rights

IV. Specific contracts and the rights and obligations arising from them

V. Benevolent intervention in another’s affairs

VI. Non-contractual liability arising out of damage caused to another

VII. Unjustified enrichment

VIII. Acquisition and loss of ownership of goods

IX. Proprietary security rights in movable assets

X. Trusts.

The wide range of subject covered in the DCFR suggests that it could serve as a first draft of a European Civil Code. There has been some fundamental criticism on the DCFR. This criticism challenges both the methods used by its drafters3 and the contents of the model rules themselves.4 Although some of this criticism is, in my view, well founded, I have chosen to take a different approach by going into the merits of one specific part of the DCFR, thus, at least as a starting point, ignoring the question whether there should be a DCFR to begin with

* Dr. Reinout M. Wibier (r.m.wibier@uvt.nl) is an associate professor at Tilburg University, Faculty of Law, specialising in international aspects of insolvency and security interests. He is a fellow of the European Banking Center of Tilburg University and of the Tilburg Institute of Comparative and Transnational Law (TICOM). He is also an advocaat at Allen & Overy LLP in Amsterdam.

1 http://www.dcfr.org/.

2 Christian von Bar, Eric Clive and Hans Schulte-Nölke (ed.), Principles, Definitions and Model Rules of European Private Law outline edition, Sellier 2009, also available online at www.law-net.eu (DCFR).

3 J.M. Smits, ‘The Draft Common Frame of Reference, Methodological Nationalism and the Way Forward’, TICOM Working Paper on Comparative and Transnational Law No. 2008/12, Electronic copy available at: ssrn.com/abstract=1300965.

4 Horst Eidenmüller, Florian Faust, Hans Christoph Grigoleit, Nils Jansen, Gerhard Wagner and Reinhard Zimmermann, ‘The Common Frame of Reference for European Private Law-Policy Choices and Codification Problems’, Oxford Journal of Legal Studies, Vol. 28, No. 4 (2008), pp. 659-708 (Eidenmüller c.s.) and Nils Jansen, ‘The Authority of the “Draft Common Frame of Reference”’, in: After the Common Frame of Reference—What Future for European Private Law? 3 (Hans Micklitz & Fabrizio Cafaggi eds., forthcoming 2009), available at ssrn.com/abstract=1264011. For a more positive view see Martijn W. Hesselink, ‘The Common Frame of Reference as a Source of European Private Law’, Tulane Law Review, [Vol.83:919], pp. 919971.

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Electronic copy available at: http://ssrn.com/abstract=1499043

or whether an entirely different method of harmonising European private law should be used. Consequently, of course, I am also ignoring the interesting question whether or not harmonisation of European private law is a good thing and whether there are parts of private law that need not be harmonised at all.5

In this article I will give a brief critical analysis of Book IX of the DCFR which relates to proprietary security rights in movable assets.6 My analysis does not come close to covering all rules and principles of Book IX. That would require a much longer article. It relates to a relatively small number of rules that from my perspective are especially interesting or noteworthy. I have chosen a very specific perspective for my review: the perspective of international secured transactions involving large sophisticated lenders and borrowers: situations where large corporations, banks or other financial institutions provide security for their debts. In these type of transactions the parties have specialised legal counsel that is able to help them negotiate the terms of the transaction and advise on the consequences of the transactions. Participants are usually repeat players and even if they themselves are not, their legal counsel will have experience with the type of transaction. This is true for both lenders and borrowers. There is no party that is naturally or by the nature of the transaction in a weaker position.

Apart from the fact that this perspective coincides with the general focus of my research, there is another good reason to choose specifically this point of view. Whereas the European project does not seem to be overly popular with the citizens of Europe in general, low turn-out for the elections for the European Parliament, no-votes to the Lisbon treaty in France, the Netherlands and Ireland and a general rise in EU-scepticism are only a few of the more obvious examples,7 capital markets are increasingly international and borderless. It is not surprising then that in the field of international finance transactions, there seems to be far less scepticism towards Brussels because the fact is that capital markets, including the markets for secured credit are in fact European as far as large companies and financial institutions are concerned. European legislation facilitating the capital markets transactions is generally received with a lot more enthusiasm. In addition, a European private law could potentially bring the most benefits to these type of transactions because of their cross-border nature. Harmonisation is probably a lot less controversial in this area of private law.

Large borrowers in Europe more often than not attract loans from syndicates of banks and these syndicates are often comprised of banks from various EU member states. A company that issues bonds in order to satisfy its needs for credit will do so by tapping into the international capital markets. An Irish (French, Dutch German, etc.) company borrowing funds is thus likely to borrow these from either a syndicate comprised of a large number of European banks or (in case of a bond issue) from investors from all over Europe.8 In these

5 I will use the potential benefits of harmonisation of European security law for sophisticated lenders and borrowers as an argument for choosing the perspective of these market participants for my analysis. This does not conflict with the foregoing. In my view, harmonization has the potential to bring the most benefits to these type of transactions so it should at least be suitable for the purpose of the participants in this market. Whether that also means that there should in fact be a European Civil Code is an entirely different and markedly more complicated question.

6 Movables are defined in the DCFR as corporeal and incorporeal property other than immovable property.

7 Cfr. Briefing The EU after the Irish vote - The future’s Lisbon, the Economist, October 10-16th 2009, pp. 2528, also see p. 9 (Wake up Europe!).

8 In both instances, London holds a dominant position in the sense that its capital markets are the most sophisticated and largest in Europe. The same can be said for London based financial institutions: in international syndicates of banks they are often the dominant parties.

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types of transaction, having clear rules for the granting of security and its enforcement would offer clear benefits. This can be clarified by an example.

In a typical syndicated loan transaction a Dutch holding company will be the main obligor of a loan provided by a syndicate comprised of three Dutch banks, one English bank and a German bank. The Dutch company will have to provide a security interest over the shares it holds in its Dutch, French, Italian and German subsidiaries. These subsidiaries are to guarantee the loan and to provide security over their assets. Rules of private international law mean that the shares in the subsidiaries are to be pledged9 in accordance with local law (i.e. French law for the French subsidiary, Dutch law for the Dutch subsidiary, etc.). In addition, movable assets of these subsidiaries are to be pledged in accordance with the law of their location pursuant to the lex rei situs-rule. Any receivables held by these subsidiaries need to be pledged in accordance with (i) the law applicable to such receivable, (ii) the law of the location of the pledgor, (iii) the law of the location of the pledgee or (iv) the law applicable to the agreement whereby the pledgor has undertaken to create the right of pledge, depending on the rules of private international law of the court that has jurisdiction in the matter.10

This example shows that the English, German and Dutch banks participating in the syndicate that extends the loan will be confronted by a large number of different, local law governed security rights. Each local law determines the way in which the security is created and the rights that the bank will have pursuant to the security interest. In addition, local law will determine the rights of the secured party upon enforcement of the security. This leads to complex transactions, which are costly to effect because local advice needs to obtained from each jurisdiction that is involved and which may still lead to disappointments once the security becomes enforceable. Most of these problems would go away by harmonising EU security law. The (legal departments of the) banks in the syndicate (in a European context) would then only have to deal with one type of security (law), irrespective of the location of the borrower, the location of its assets in Europe and the conflict rules applicable in these jurisdictions. One single European security law is thus likely to lead to cost-savings in relation to large international secured transactions. This leads to the fairly obvious conclusion that any EU-wide security law should first and foremost be suitable for these large market participants. In addition these parties would probably actually welcome EU-wide security law which may be another incentive to make sure that any proposals for EU wide security law would be suitable for this important group.

The focus on these large sophisticated parties is also taken by the EU Financial Collateral Directive (the Collateral Directive or the Directive)11 which deals with providing security over financial assets (i.e. bank accounts and securities), especially in relation to banks and other financial institutions.12 This Directive does not harmonise the law in relation to financial collateral but it does prohibit EU Member States to require the performance of any formal act for the creation, validity, perfection, enforceability or admissibility in evidence of a financial

9 I have assumed that the relevant security interest will be a right of pledge, but the question whether this is actually the case depends on the law applicable to the creation of the security and thus may also differ from jurisdiction to jurisdiction.

10Each court applies its own conflict rules. Whereas the situs rule for proprietary aspects of movables is almost universal, conflict rules in relation to pledging claims and receivables vary widely across Europe.

11Directive 2002/47/EC of the European Parliament and of the Council of 6 June 2002 on Financial collateral arrangements, L 168/43 (the Collateral Directive).

12See article 1(2) of the Collateral Directive, which states that it only applies if at least one of the parties is a central bank, the ECB, a credit institution, insurance undertaking, etc.

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collateral arrangement or the provision of financial collateral under such an arrangement.13 The EU Collateral Directive has generally been welcomed by market participants. Moreover, ISDA14 has been an important proponent of the law reforms that have eventually led to adoption of the EU Collateral Directive.15

If the above shows anything it is that if there is a need for harmonising security law in Europe this need is much more obvious in relation to large financial transactions than anywhere else. In addition these large market participants are the most likely candidates to actually welcome harmonisation. This offers a convincing argument for testing the proposals of Book IX of the DCFR against the needs posed by these type of transactions and the sophisticated lenders and borrowers that enter into these type of transactions.16

The central question in this paper consequently is whether the proposals of Book IX of the DCFR would be suitable for large international financial secured finance transactions entered into by sophisticated market participants. It is too early for a comprehensive review of the entire proposal, for one thing such a review should include a detailed analysis of the explanatory materials and comparative analysis,17 but it is possible to make a few preliminary remarks which may be helpful in further discussions that will undoubtedly follow publication of the DCFR and its explanatory materials.

2.Is book IX of the DCFR suitable for international secured transactions?

The brief answer to the question posed in the heading of this paragraph is that the DCFR unfortunately in its current form is not suitable for international secured transactions entered into by sophisticated parties. First I will give a very brief description of the contents of Book IX. In the remainder of the paragraph I will give the reason for this rather disappointing answer.

2.1Brief overview of Book IX of the DCFR

Book IX of the DCFR deals with security rights in movable assets, including retention of title arrangements. Movable assets include both corporeal and incorporeal movable assets.18 Book IX consists of seven chapters: 1. General rules; 2. Creation and coverage; 3.Effectiveness as against third persons; 4. Priority; 5. Predefault rules; Termination; and 7. Default and enforcement.

13See article 3 of the Directive.

14ISDA is the International Swaps and Derivatives Association. It is an important organisation in the field of derivatives transactions, amongst other things providing standard documentation and arranging for legal advice as to the enforceability of this documentation in different jurisdictions. For further information see www.isda.org.

15See http://www.isda.org/c_and_a/pdf/NeedLawReform.pdf .

16The argument that unification may also help protecting weaker parties in transactions where the borrower is not a professional party is not of the same level because in that case protecting the weaker party would be a goal in itself. This goal could also be reached by improving protection of the weaker party in national law and of itself it is no argument for harmonising the law. For one thing: harmonisation would not of itself guarantee better protection of the weaker party.

17The full version of the DCFR including explanatory comments and notes and detailed comparative legal material was not yet available at the time of this writing. In addition, it would not be possible to complete this analysis within a reasonable period of time or to report on it in the form of a fairly brief paper.

18As per the definitions of the DCFR corporeal in relation to property means having a physical existence in solid, liquid or gaseous form. Incorporeal means not having a physical existence in solid, liquid or gaseous form.

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Article IX. - 1:102(1) gives a definition of security rights:

“A security right in a movable asset is any limited proprietary right in the asset which entitles the secured creditor to preferential satisfaction of the secured right from the encumbered asset.”

In brief, Book IX of the DCFR gives detailed rules on the creation of security, its effectiveness as against third parties and the rights of the secured creditor upon enforcement of the security. An interesting feature is that it creates a system where the security right is first created between the parties (described in chapter 2 of Book IX) and subsequently needs to be perfected in order for it to have effect against third parties as well (chapter 3 of Book IX). In the remainder of this paragraph I will give a number of reasons why I think that the current rules are not suitable for sophisticated lenders and borrowers.

2.2Starting point ignores the reality of international secured transactions

The outline edition of the DCFR starts with an introduction and a number of remarks made in this introduction already foreshadow that it will not be particularly suitable for large international secured transactions between sophisticated lenders and borrowers. Under the heading ‘Fundamental principles’ the flowing remark is made:

“It is clear that the DCFR does not perceive private law, and in particular contract law, as merely the balancing of private law relations between equally strong natural and legal persons.”

However, in the world of international financial transactions, this (i.e. the balancing of private law relations between equally strong legal persons) is exactly what the parties would seem to need most. Large international borrowers need not be protected against themselves and there are no grounds to assume that they are by definition in a weaker position than the banks or financial institutions that act as lenders. Both parties usually are professional repeat players and even if they are not, the specialised legal counsel that are hired on both sides definitely are. Moreover, it is usually impossible to identify the party that would as a rule be in the weaker position. Sometimes banks are desperate for business and borrowers are able to play out the different banks against each other in search of the best possible deal. Sometimes it is the other way around, credit is tight and borrowers are in the weaker position. There are ven times that both parties are equally weak. The credit crunch may have resulted in such a situation. Companies are desperate form credit and banks are unwilling to provide loans because they themselves are very weak.

The starting point of the DCFR does not seem well suited for large sophisticated market participants at all because it adopts a philosophy that does not fit their profiles.

In § 16 there is another remark that would seem to be a bit odd in light of security law for large internationally operating market participants. The following is presented as an overriding principle of the DCFR:

“Into the category of “overriding principles” of a high political nature we would place the protection of human rights, the promotion of solidarity and social responsibility, the preservation of cultural and linguistic diversity, the protection and promotion of welfare and the promotion of the internal market.”

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Directive assumes that providing collateral will mean that the collateral will be brought in the possession or under the control of the collateral taker.24

These requirements of the Collateral Directive have been followed more or less in the DCFR. First, the definition of the term ‘financial instrument’ in article 1:201(7) of Book IX of the DCFR25 seems to have been derived from the definition used in article 2(1)(e) of the Collateral Directive,26 although there are slight differences.

It is a bit puzzling why the DCFR refers to share certificates in stead of shares. If this is deliberate it leads to the question if indirectly held securities are excluded from the definition and if so why.

The requirements for creation of security over moveable assets (which include incorporeal assets) can be found in article 2:105 of Book IX of the DCFR. The asset needs to be specified by the parties (105 sub a), the security provider needs to have the right or authority to grant a security right (105 sub b), the secured creditor is entitled against the security provider to the granting of a security right (105 sub c) and the parties agree to creation of the security (105 sub d). These requirements do not seem to conflict with the requirements of the Collateral Directive. Subsequently, the DCFR requires further formalities in order to make sure that the security is effective against third parties (see article 3:101 Book IX: Effectiveness as against third persons). For this purpose article 3:204 Book IX requires that the secured party take control over the asset, which, as we have seen, does not conflict with the requirements of the Collateral Directive. Thus, the creation of security over financial instruments would seem to be in line with the requirements of the Collateral Directive.

All is well that ends well, but unfortunately this is not where it ends. Article 2:102 of book IX of the DCFR sets general requirements for creation of security. The article introduces at least two requirements that potentially could violate the Collateral Directive because it states that the asset and the secured right must both exist before security can be validly created. Especially in transactions with sophisticated parties there may be situations where future secured rights need to be secured by the provision of financial collateral. Also, why can a valid security interest that will of course only become effective once the relevant collateral exists, not be created in advance? why should the parties be obliged to repeat the formalities for creating security each time that a new asset comes into existence and why shouldn’t they be able to secure future claims? These are potential limitations on the provision of security over financial assets that do not seem to be in line with the Collateral Directive which seeks to reduce hurdles and formalities in relation to the provision of security.

24See article 2(2) of the Directive.

25“Financial instruments are: (a) share certificates and equivalent securities as well as bonds and equivalent debt instruments, if these are negotiable; (b) any other securities which are dealt in and which give the right to acquire any such financial instruments or which give rise to cash settlements, except instruments of payment; (c) share rights in collective investment undertakings; (d) money market instruments; and (d) rights in or relating to the instruments covered by sub-paragraphs (a) to (d).

26The definition in the Collateral Directive: “‘financial instruments’ means shares in companies and other securities equivalent to shares in companies and bonds and other forms of debt instruments if these are negotiable on the capital market, and any other securities which are normally dealt in and which give the right to acquire any such shares, bonds or other securities by subscription, purchase or exchange or which give rise to a cash settlement (excluding instruments of payment), including units in collective investment undertakings, money market instruments and claims relating to or rights in or in respect of any of the foregoing.”

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The above shows that the DCFR does not seem to follow the EU Collateral Directive. Definitions are sometimes different. Also, the DCFR introduces fresh limitations on the creation of security whereas the goal of the Collateral Directive was to simply this area of the law and to require Member States to have wide possibilities for granting security. There seem to be different policy choices behind the Collateral Directive and the DCFR. It is hard to see why the rules form the Collateral Directive have not been simply copied into the DCFR.

2.4Enforcement of collateral

Once a security right has become enforceable the secured creditor should have wide enforcement possibilities, at least if sophisticated parties that knew exactly what they were doing when they created the security are involved. Of course there should be rules aimed at making sure that the highest possible value is obtained for the relevant asset, but other than that sophisticated security providers should not be protected against themselves by limiting the secured creditor’s rights upon enforcement. Moreover, a secured lender that is not being repaid the money it is owed, should be able to try and recover as much as possible through enforcement of its security interests that is the whole point in creating security. This is important for a number of reasons, including the fact that banks are often required to hold security for regulatory purposes. Having security means that the risks for a bank are lower than in situations where no security has been provided. Thus the costs of borrowing are lower if security has been granted: an unsecured loan will generally carry a higher interest rate than a secured loan. However, in order to have these effects, it is essential that the secured creditor can in fact take recourse against the encumbered assets if and when the borrower defaults under his obligations. Notice requirements, enforcement through court proceedings and other well intended measures are unnecessary and unhelpful if sophisticated parties are involved. The kind of requirements lead to additional costs and usually have a negative effect on the price that can be obtained for the relevant assets. In this light, there is a number of rules in Chapter 7 of Book IX of the DCFR that warrant mentioning here.27

First there is the rule of article 7:103(4) which reads as follows:

“Enforcement is to be undertaken by the secured creditor in a commercially reasonable way and as far as possible in cooperation with the security provider and, where applicable, any third person involved.”

This is a very strange rule in deed. First, it is extremely vague which is never good when enforcement of security is at stake. Vague rules lead to litigation and wastes time and money. In addition, the rule raises all kinds of questions. Why should a secured creditor cooperate with the security provider once the secured creditor is authorised to enforce the security? What the secured creditor should do is obtain the highest possible bid for the relevant asset and security law should give the secured creditor the necessary tools to achieve this in a timely manner. Introducing an obligation to cooperate will lead to endless discussions and delays if the security provider intends to frustrate the enforcement process.

27 There is a wide selection of literature on the subject, here is a selection: Armour, John, ‘The Law and Economics Debate About Secured Lending: Lessons for European Lawmaking?’, European Company and Financial Law Review, Vol. 5, available at ssrn.com/abstract=1118030, Mann, Ronald J., ‘Explaining the Pattern of Secured Credit’, Harvard Law Review, Vol. 110, No. 625, pp. 625-83, 1997, available at ssrn.com/abstract=587266, Mokal, Riz, ‘The Floating Charge - An Elegy’, COMMERCIAL LAW AND COMMERCIAL PRACTICE, Sarah Worthington, ed., Oxford: Hart, August 2003, ssrn.com/abstract=386040, Philip Wood, Law and Practice of International Finance, University Edition Sweet & Maxwell, London 2008, §§ 16-01 et seq.

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