Enforcing Security: the Challenges

ENFORCING SECURITY: THE CHALLENGES SECURITY: ENFORCING KEY POINTS While the administration process in England and Wales may require secured creditors 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 liquidation proceedings in France, where their subordination to the company’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 business as a going concern. 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 assets 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 insolvency 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 property (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 creditor cannot enforce Lehman companies – 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, restructurings, innovative special situation deals and corporate governance issues. Email: [email protected] a court-appointed liquidator 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 pledge 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

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