ENFORCING SECURITY: THE CHALLENGES KEY POINTS  While the process in England and Wales may require secured to Feature wait a considerable period of time before they receive any proceeds of enforcement, they are usually required to wait even longer in France and Germany.  Secured creditors are likely to be concerned by the implications of proceedings in France, where their to the ’s employees may result in substantially impaired recovery.  Secured creditors should be aware of the ability of the German courts to order a stay of enforcement of any mortgage with a view to assisting the sale of the as a . Authors Peter Baldwin, Andrew Barker and Andrew Rotenberg Enforcing security: the challenges

Th e 2004-2007 leveraged buyout As global economic conditions lead to increasing numbers of defaulting borrowers, boom saw the rapid proliferation of Andrew Barker, Andrew Rotenberg and Peter Baldwin look at some of the specifi c complex leveraged fi nance structures across challenges facing lenders looking to enforce security in England and Wales, France Europe. Th ese structures often had security and Germany. packages which purported to grant security interests over located in multiple European jurisdictions. A key concern is September 2008, a company can be placed greater the delay before senior creditors whether enforcement action will, in fact, into administration extremely quickly. get paid out (as lenders to Enron Europe yield the results or off er the protection Enforcing security in Europe is prescribed Limited discovered). expected by lenders. by the relevant national regime. For this reason, generally lenders As global economic conditions worsen, In France, three types of proceedings historically used to look to appoint an many lenders now have cause to analyse the are relevant, namely (a) pre-insolvency administrative receiver rather than seek eff ectiveness of security packages, if only to proceedings (mandat ad hoc and conciliation an administration order. Th is is because assess what their options are in respect of proceedings), (b) insolvency proceedings an administrative receiver owed his duties struggling borrowers. Th is article considers (sauvegarde and reorganisation proceedings) specifi cally to his appointor rather than to all the challenges of enforcing security in and (c) liquidation proceedings, although creditors (as is the case with an administrator). England and Wales, France and Germany and secured creditors can enforce their security Th e ability to appoint an administrative in particular: against a solvent company with relative ease. receiver, however, was dramatically scaled back  the extent to which enforcement In Germany, insolvency proceedings are by the Enterprise Act 2002, which provided proceedings are dealt with in an carried out under the Insolvency Code, which that an administrative receiver may only be expeditious manner; will usually open two to three months after appointed in certain limited circumstances.  the rights of third party creditors to stay the fi ling of the insolvency application. While a lender that had the right to or frustrate the enforcement of security; appoint an administrative receiver prior to 15  the recognition of contractual INSOLVENCY OBJECTIVES AND September 2003 still retains that right (this intercreditor arrangements in the context TIMING was the date the Enterprise Act 2002 came of any security enforcement process; and England and Wales in to force), the vast majority of holders of  if there are any circumstances in which Once a company has been placed into qualifying fl oating charges created after 15 the relevant security can become void. administration, the administrator is required September 2003 will only be able to enforce to attempt to rescue the company as a going their security by appointing an administrator. INSOLVENCY REGIMES concern. If this is not reasonably practical, In England and Wales, if a lender wants or would not produce the best result for France to enforce its security it will invariably the creditors as a whole, the administrator Enforcing security in France may take do so through an administrator or an will then look to other alternatives with a even longer. First, secured creditors should administrative receiver. Under the view to getting a better result for creditors be aware that there is an automatic stay Enterprise Act 2002, if a company is or is than merely winding the company up. of between four and eighteen months likely to become insolvent, an administrator Only if the administrator thinks none when insolvency proceedings are opened. may be appointed: (a) by court order; (b) of these is reasonably practical will he be Secondly, the typical outcome of insolvency out of court by the holder of a ‘qualifying required to wind up the company and realise proceedings is the rescheduling of the debt fl oating charge’; or (c) out of court by its (for distribution fi rstly to over a ten-year period in accordance with the company or its directors. As was secured or preferential creditors). As such, the terms of a continuation plan, during demonstrated in the case of four UK a considerable period of time may elapse which time a secured cannot enforce Lehman – Lehman Brothers from the commencement of enforcement its security (although it can during pre- International (Europe), Lehman Brothers proceedings before secured creditors receive insolvency proceedings). Limited, Lehman Brothers Holdings PLC any cash. Moreover, as a general rule, the Furthermore, secured creditors to a and LB UK RE Holdings Limited – which more complex the capital structure and the company in liquidation proceedings will not be went into administration early on 15 greater the number of stakeholders, the able to enforce their security directly. Instead,

Butterworths Journal of International Banking and Financial Law April 2009 187 Biog box Feature Peter Baldwin is a partner in the Mergers & Acquisitions (M&A) Team in Jones Day’s London offi ce and advises on all aspects of public and private M&A transactions (both domestic and cross-border). He also advises on a broad range of corporate fi nance transactions, joint ventures, , innovative special situation deals and corporate governance issues. Email: [email protected]

a court-appointed will sell the assets RIGHTS OF THIRD PARTY CREDITORS security’s ‘hardening period’. In the main, of the company, including the pledged assets, Generally, it is very diffi cult for third party the relevant provisions of IA 1986 concern for the benefi t of all of the creditors and will creditors to stay or frustrate the enforcement transactions at an undervalue (s 238), pay the proceeds out in accordance with the of valid security. Th e primary exception preferences (s 239) and the avoidance of rules of priority. As the liquidator’s primary to this rule is if such persons have rights certain fl oating charges (s 245). responsibility is to the company’s employees, pursuant to an intercreditor agreement.

ENFORCING SECURITY: THE CHALLENGES SECURITY: ENFORCING however, the purchase price for the business as It is worth noting that French law has yet Transactions at an undervalue a going concern will often be nominal so as to to establish fully the applicability of such An administrator (or a liquidator) can apply compensate the purchaser for the assumption agreements in insolvency proceedings. to court to set aside security if the chargor of signifi cant employment obligations and will received either no benefi t or signifi cantly typically be equivalent to the amount of the INTERCREDITOR ARRANGEMENTS less benefi t than it pledged and in both cases employees’ claims. As French rules of priority Contractual intercreditor arrangements the security was granted within two years of rank secured claims behind employees’ claims regulate both the order in which creditors the onset of the chargor’s insolvency. Such and the costs of the proceedings, secured will benefi t from the proceeds of enforcement security must have been granted at a time creditors can fi nd themselves in a more and also the rights of various creditors to either when the chargor was insolvent or disadvantageous position than they might commence an enforcement action. So long where it became insolvent as a result of the expect, as was the case in the Smoby case as the intercreditor agreement is given for transaction being entered into. Th e security where the lenders suff ered severe losses. valuable consideration, or executed as a deed, will not be set aside if the directors can Th at said, liquidators will not be able to sell its provisions are likely to be enforceable in demonstrate that the security was granted those assets of the company which are secured England and Wales. in good faith and for the purpose of carrying by: (a) a over trade receivables under Intercreditor agreements are also generally on the company’s business and that they had Dailly Law; (b) a pledge over goods with a enforceable in Germany. By contrast, recent reasonable grounds for believing it would right of retention (dépossession); or (c) the new reforms have muddied the position in France. benefi t the company. fi ducie, which was introduced under French As of December 2008, a continuation plan is (A similar concept exists under French law in 2006, improved under the new order of not required to treat creditors equally if their law. If a lender extends credit to a company 18 December 2008 and which came into eff ect diff erent situations justify it. Th e reforms that is in diffi culty and requires it to grant on 15 February 2009. As such, lenders should are too recent for French case-law to assign pledges or other or security interests ensure that these security interests are granted. any meaning to ‘sisi lleses ddiffiff érencesérences dede situationsituation lele which are disproportionate to the loan, a justifi ent’, although the French government court may fi nd that the lender has abused Germany has made it clear that this new language is its superior position to the detriment of the As in England and Wales, secured creditors intended to give legal authority to a departure company and render the guarantees between (absonderungsberechtigte Gläubiger) hhaveave a from a uniform approach to senior and junior the lender and company null and void.) right to separate or preferential satisfaction. creditors. As such, it is now unclear if junior Generally, such right allows them to claim the creditors are barred from making any recovery Preferences proceeds of enforcement up to the amount in circumstances where senior creditors do not Security can also be set aside if the chargor of the secured claim after the insolvency recover in full, potentially making the position does anything which has the eff ect of putting administrator’s costs have been deducted. for junior creditors more favourable than the creditor into a position which, in the Th e obvious caveat to this is the commonly in England and Wales. Similarly, turnover event of the chargor going into insolvent exercised ability of the German court to order provisions in intercreditor agreements liquidation, would improve the creditor’s a stay of enforcement of any mortgage. Th e requiring junior creditors to return monies to position. To be set aside though, the security rationale for this is that enforcement of any senior creditors may no longer be enforceable. must have been granted within six months of mortgage would prevent the continuation of Some judicial interpretation of these reforms the onset of the chargor’s insolvency unless the chargor’s business and make a sale of the is eagerly awaited. the security was granted to a connected business as a going concern near impossible. person, in which case the period is extended As such, secured creditors may experience CIRCUMSTANCES IN WHICH SECURITY to two years. Again, the security will also considerable delay in enforcing their security CAN BECOME VOID only be set aside if it was granted when the interests, although German law does England and Wales chargor was insolvent or where it became compensate for this delay. As long as their In England and Wales, when new security insolvent as a result of the transaction security interests remain unrealised, secured is granted, there is a period of time when it being entered into. Moreover, the security creditors may claim interest. In addition, any is vulnerable to be set aside by a liquidator will not be set aside unless the chargor resulting loss in value of the secured assets must pursuant to the provisions of the Insolvency was demonstrably infl uenced by a desire to be compensated for by the insolvency estate. Act 1986 (‘IA 1986’). Th is is known as the improve the creditor’s position on insolvency.

188 April 2009 Butterworths Journal of International Banking and Financial Law ENFORCING SECURITY: THE CHALLENGES Biog box  Andrew Barker is a partner in the Banking & Finance Team in Jones Day’s London offi ce Feature  and has wide experience in complex cross-border leveraged fi nancings, structured fi nancings,   restructurings and non-performing loan acquisitions, representing both lenders and  sponsors. Email: [email protected]  Andrew Rotenberg is a partner in the Business & Reorganisation Team in Jones Day’s London offi ce. He also represents lenders and borrowers in various types of cross-border secured fi nancings. Email: [email protected]

Avoidance of certain fl oating from being set aside. may be set aside if granted either within charges Security may also be set aside if one month of the fi ling of the insolvency Pursuant to s 245 of IA 1986, fl oating abusive lending practices (soutien abusif) application or after such application. In charges can be set aside if not granted for are established. Article L650-1 of the cases where the creditor has been wilfully valuable consideration, but only if they are Commercial Code states that ‘creditors disadvantaged (vorsätzliche Benachteiligung), granted within 12 months of the onset of may not be held liable for harm in relation however, this period is extended to ten years. the chargor’s insolvency. If the security was to credits granted, except in cases of fraud, granted to a connected person, the period is indisputable interference in the management SUMMARY extended to two years. If the creditor is not of the or if the guarantees obtained While the administration process in England a connected person, the fl oating charge will for the loans or credits are disproportionate. and Wales may require secured creditors only be set aside if it was granted when the If the liability of a creditor is established, the to wait a considerable period of time before chargor was insolvent or became insolvent court may reduce or nullify the guarantees they receive any proceeds of enforcement, as a consequence of the transaction under obtained for the loans'. they are usually required to wait even which the charge was created. longer in France and Germany. Th is would Germany particularly be the case for French security France Likewise, the German Insolvency Code gives if the outcome of the insolvency proceedings French law also provides for a period of the insolvency administrator a right to set was the rescheduling of the debt over a time when security is vulnerable to be set aside (Insolvenzanfechtung) security interests ten-year period, during which time secured aside. Th is is known as période suspecte and is potentially applicable to all transactions which have been entered into by a company "Secured creditors are also likely to be concerned by currently undergoing any of the insolvency the implications of liquidation proceedings in France." proceedings described above. While this period is established on an ad hoc basis and cannot be simply calculated from the date, it is commonly defi ned as the granted either within a certain period of time creditors would not be able to enforce their period before the insolvency proceedings of the fi ling of the insolvency application security. – either judicial restructuring or liquidation or after such application, provided that Secured creditors are also likely to be – were offi cially opened and during which certain requirements are met. Generally, concerned by the implications of liquidation the company began to show outward signs security interests will be set aside if: (a) proceedings in France, where their  of distress. In exercising its discretion, the granted within three months of the fi ling of subordination to the company’s employees court cannot allow this period to exceed 18 the insolvency application; (b) the debtor may result in substantially impaired recovery. months from the default date. was illiquid, namely unable to fulfi l its due As such, it is crucial that lenders, when French law makes a distinction between payment obligations, at the time they were negotiating security packages, benefi t from transactions entered into during this période granted; and (c) the creditor knew of this those security interests as are excluded from suspecte. Some transactions, such as the illiquidity. If the security interests were the liquidator’s power of sale. Likewise, granting of security to secure existing debt, granted after the fi ling of the insolvency secured creditors should be aware of the will be void automatically, while other application, they will only be set aside if ability of the German courts to order a stay of transactions, such as the granting of security the creditor was aware of the fi ling or of the enforcement of any mortgage with a view to to secure new money, will only be nullifi ed if debtor’s illiquidity. seeking alternative or additional security. the counterparty knew or should have known However, this three-month hardening Finally, the recent reforms in France that the company was insolvent. As such, it is period may vary. In cases where the creditor have cast a great deal of uncertainty over the crucial that lenders making secured loans in receives a to which he is not eff ectiveness of intercreditor arrangements. distressed situations obtain court approval for entitled or of a diff erent kind to which he is Th ere is considerable uncertainty as to how the new loan in the conciliation proceedings, entitled or at a time when he is not entitled to the contractual positions of senior and junior whereupon their security will be protected it (inkongruente Deckung), the security interest creditors may be interpreted by the courts. 

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