A portfolio of receivables as collateral: Pledge or assign? | In Principle

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A portfolio of receivables as collateral: Pledge or assign?

In various types of financing transactions, one of the borrower’s main assets is a portfolio of receivables, e.g. under leases (when financing commercial property) or under loans (when the borrower is in the business of granting loans). In such cases, the lender seeking effective security will often require such a portfolio to serve as collateral.

Under Polish law, assets in the form of a set of receivables can generally be encumbered in only two ways: a registered pledge or assignment as security. This raises the question: pledge or assign?

Registered pledge on a set of receivables

Under Art. 7(2) of the Act on Registered Pledges and the Pledge Register, the subject of a registered pledge may be, in particular, a set of movables or rights constituting an economic whole, even if the composition of the set is changeable. The first difficulty arises here, as the legal commentaries are not in agreement on whether a pledge can be established on a set of rights alone. A literal reading of this provision, and in particular the use of the conjunction “or,” should indicate that it is possible to establish such a pledge. But some commentators take the view that there is no such thing as a set of rights alone.

A bigger challenge is to demonstrate that the portfolio of claims to be pledged constitutes an economic whole. This issue must be determined on a case-by-case basis, but it should be pointed out that the views of the Polish legal literature on determining what conditions must be met for a set of rights to constitute an economic whole are becoming more liberal.

It seems that if the subject of the pledge is to be, for example, all of the pledgor’s claims under loans granted as part of its business, it may be easier to demonstrate that they constitute an economic whole. In the case of encumbering such a defined portfolio, the advantages of a registered pledge become more apparent. The primary advantage is that such a pledge has a construction similar to a “floating charge” from common-law systems. A registered pledge on a set of items is essentially a joint pledge of the specific elements of property making up the set. It can automatically cover further, future elements, e.g. claims under new loans granted after the pledge is established. If the new claims meet the criteria defined in the pledge agreement, they automatically become subject to the registered pledge.

Difficulties arise when for various reasons the borrower cannot establish a pledge on a set of all claims that will arise within its business operations, but only on a segment of its portfolio. In that case, the lender may be interested in maintaining a constant value of the pledged portfolio, which requires a detailed determination of the mechanism for new claims to “join” the pledged assets.

Another demand by the pledgee in this respect may be to require the pledgor to prepare a list of receivables and regularly update it according to the rules set forth in the pledge agreement. Creation of a list of elements covered by the pledge requires a description of the legal relationships under which the claims arise adequate to identify them. If the subject of the pledge is loans made to individuals, their personal details need to be stated, and if the pledgee requires such a list to be filed with the registry court, it might violate data protection regulations.

Turning to the issue of execution, it should be stressed that with a registered pledge, an extrajudicial method of enforcement may be provided for in the pledge agreement—for example, taking over ownership of the collateral. But it should be borne in mind that exercising such a method will require issuance of a number of notices. And thus in a situation where the secured claim is due and payable but remains outstanding, the pledgee seeking to claim satisfaction out of the collateral must notify the pledgor of its intention to pursue such measures. In the case of a pledge on a set of rights, the pledgee may also demand in such notice that the pledgor draw up a list of the elements of the set in order to secure the pledgee’s claims. But this is dubious security, as the Act on Registered Pledges and the Pledge Register does not provide for any method of enforcing such a demand by the pledgor if the pledgor refuses to prepare the list. Nonetheless, from the time of the notice, the pledgor cannot dispose of the pledged collateral.

Then the pledgee may proceed to take ownership of the pledged receivables, which occurs through submission to the pledgor of a declaration of assumption of ownership. Passage of title to the receivables occurs upon delivery of the declaration to the pledgor.

While issuance of the two notices described above ensures passage of title to the receivables to the pledgee, it is only the third notice, to the debtors, that enables the pledgee to obtain payment under the claims. As a rule, until the debtor is notified of the change in creditors, it can effectively discharge the obligation by paying the prior creditor.

Consequently, although the possibility of providing for an extrajudicial method of execution is clearly easier than pursuing enforcement through the courts, taking title to the collateral may not occur as quickly as the pledgee hoped.

It follows that establishment of a registered pledge will not always be the most convenient and safest security. No doubt the openness of the pledge register and a number of related presumptions—in particular maintenance in force of the pledge when the pledgor sells the set of receivables (although the pledge does not continue if the acquirer shows that it did not know and with due diligence could not have known of the existence of the registered pledge, which is very hard to prove given the openness of the register)—does give the pledgee greater comfort. It must be remembered, however, that these effects only arise upon entry of the pledge in the register, which in extreme instances can take up to several weeks.

Assignment of a portfolio of receivables for security

Assignment of receivables as contractual security is characterised by greater flexibility than a registered pledge. This is particularly evident in the mechanics of how this instrument functions.

When concluding an agreement on assignment of receivables for security, selected, specific receivables can be assigned without having to meet the requirement of constituting an “economic whole.” This is an undoubted convenience, particularly when only a selected portfolio of receivables is to be encumbered. (A global assignment of all the debtor’s receivables under any and all legal relationships is not permissible under Polish law, however, and in that situation a registered pledge has a distinct advantage.)

Assignment of receivables under new contracts concluded in the future is also possible. For this purpose, it is necessary to frame the assignment agreement appropriately to allow further claims arising under new contracts to be assigned.

The typical provision authorising the assignee (lender) to satisfy itself out of the receivables in question by definitive passage and enforcement of the rights under the claims is an essential advantage of assignment. Upon occurrence of the event described in the agreement, the assignee (lender) obtains the right to pursue satisfaction under the assigned receivables. In practice this may mean that the borrower’s creditor receives an instruction to make all payments directly to the account of the assignee (lender).

The evident advantage of assignment is thus that the process of satisfaction of the assignee out of the assigned receivables is much less formalised than the process of execution, even extrajudicial execution, pursuant to a registered pledge.

What about bankruptcy?

The issue of effectiveness in bankruptcy is essentially similar for both of these methods of security. Neither receivables assigned for security nor pledged receivables can be excluded from the bankruptcy estate; notwithstanding their assignment or pledge, they remain part of the bankruptcy estate. However, assignees or pledgees are in a better position than unsecured creditors, in that they enjoy a right of segregation, i.e. a right to satisfy their claim out of the proceeds of sale of the assigned or pledged receivables before the debtor’s other creditors, who may obtain satisfaction under general rules out of any surplus, which passes to the general funds to the bankruptcy estate.

However, to exercise this privilege, the assignment agreement must bear a certified date, which guarantees the effectiveness of the transaction as against the bankruptcy estate. A registered pledge agreement does not require this form, as the date of entry of the pledge in the register serves as a kind of certified date.

A major difference may arise, however, when analysing the regulations on ineffectiveness of transactions concluded prior to declaration of bankruptcy (i.e. during the “clawback” period). Determination of when the period for ineffectiveness begins to run may then prove vital. In the case of a pledge or assignment of receivables, particularly in the context of future claims, the point from which the period when the transaction may be deemed ineffective under the Bankruptcy Law or the Restructuring Law is measured may differ.

For these reasons, a precise examination of the circumstances of the case is essential. Attention should be paid first and foremost to identification of the receivables, as well as the frequency and scope of the changes occurring in the portfolio serving as collateral. All of these circumstances will be relevant for structuring the security instruments in a way that is legally and commercially effective in the specific case.

Aleksandra Nalewajko, Daniel Smarduch, adwokat, Banking & Project Finance practice, Wardyński & Partners