article 5 (rights in rem)
by Jennifer Marshall – Allen & Overy (England)1
Introduction
1. since the european Insolvency regulation (eIr) came into force across the eu almost 9 years ago, there have been many articles written, and presentations given, on the jurisdiction to commence main and secondary proceedings, the issue of forum shopping and the meanings of the key expressions “centre of main interests” and “establishment”.
2. There has been less focus, however, on the choice of law rules under the eIr and, in particular, the impact of insolvency proceedings on security and rights in rem that may have been granted in favour of bank lenders and other secured creditors.
3. Indeed, of the 238 case summaries that we have collected to date for the sweet & Maxwell publication
European Cross Border Insolvency, only 24 (i.e. about 10%) deal with the choice of law issues (and 3 of these predate the EIR coming into effect). However, the choice of law rules raise some fundamental ques-tions and I suspect it is only a matter of time before the courts (and ultimately the ECJ) will be asked to consider these issues. guidance from the commission (and potentially reform of the eIr) in this area would therefore be extremely welcome.
4. In this paper, I have focused on article 5 and rights in rem. Similar questions could be raised, however, regarding the interpretation of many of the other choice of law provisions (including, in particular, articles 6 and 13). I have focused on the following questions:
(a) What is a right in rem for the purposes of article 5? (b) Where are secured assets located (and why does it matter)?
(c) What does “shall not affect” mean and, in particular, are rights in rem protected from any moratorium on security enforcement which may arise under the main proceedings?
(d) Does article 5 protect the secured debt as well as the right in rem in the strict sense? (e) What impact does article 5 have on inter-creditor provisions?
(f) Which law determines the priority of the security?
(g) how does article 5 relate to the provisions regarding the applicability in time of the eIr under article 43?
Purpose of Article 5
5. When the eIr was being negotiated, the representatives of the Member states recognised the importance of security. The virgos-schmit report (para 97) states that the fundamental policy behind article 5 is to protect the trade in the Member state where the assets are situated and the legal certainty of the rights over them. such rights are fundamental to credit and the mobilisation of wealth.
6. The problem is that different Member states have very different approaches towards security. The uK (for example) has traditionally been seen as a “pro-secured creditor” jurisdiction, giving a significant level of control and/or priority to secured lenders (even though this has been eroded somewhat by the enterprise act 2003). In france, traditionally the emphasis has been on employee rights although the reforms in January 2006 have improved the position of the secured creditor.
7. article 5 is therefore a compromise: it immunises rights in rem from the effects of insolvency proceedings but only where the secured assets are located in a Member state other than the one in which either main or secondary proceedings are commenced.
Relevant case law
8. until last year (and so far as I am aware), there had only been one reported case which considers the impact of the eIr on a secured creditor’s rights in rem, namely the decision of the antwerp court of ap-peal in Stella Europe SA v Apex International NV2. unfortunately that decision does not answer any of
the issues of interpretation set out below and, indeed, Article 5 was not referred to in the judgment. The case concerned main insolvency proceedings (redressement judiciare proceedings) which were opened in france in respect of stella europe sa, a french registered company. following the commencement of such proceedings, the commercial court of antwerp allowed apex International nv, a Belgian creditor of Stella Europe SA, to enforce a “gage commercial” under Belgian law3 over goods belonging to the french
registered company. The goods were in transit within the Belgian jurisdiction.
9. The french registered company appealed and the Belgian court of appeal in principle suspended the enforcement procedure but held that the creditor could pursue the enforcement of the “gage commercial” in Belgium. The court of appeal’s reasoning was as follows:
(a) the effect of the EIR was that the French insolvency proceedings must be recognised in Belgium; (b) however, the effects of the French insolvency procedure on the enforcement of the “gage
commer-cial” in Belgium must be determined according to what the position would have been in Belgium had judicial composition proceedings been opened in Belgium. This conclusion was reached on the basis that judicial composition proceedings were the closest Belgian equivalent to a French redressement judiciaire proceeding; and
(c) as the creditor could have enforced the “gage commercial” in a Belgian judicial composition proceed-ing the creditor therefore had a right to pursue enforcement over the goods.
10. The Belgian court did not, however, refer to article 5 and it is not clear why the Belgian court considered the position under the equivalent Belgian insolvency proceeding to the main proceedings opened in france.
11. On 15 November 2010, it is understood that a reference was made to the ECJ for a preliminary ruling in relation to Article 5 by the Magyar Köztársaság Legfelso”bb Bírósága (Hungary) in the case of ERSTE Bank Hungary Nyrt v Magyar Állam, B.C.L Trading GmbH, ERSTE Befektetési Zrt. The question referred was as follows:
“Does Article 5(1) of Council Regulation (EC) No 1346/2000 of 29 May 2000 on insolvency proceed-ings (“the Regulation”) govern civil proceedproceed-ings relating to the existence of rights in rem (security deposits) where the country in which the bond, and subsequently the money it represented, was deposited as a security was not a Member state of the european union at the time when insolvency proceedings were instituted in another Member state, but was a Member state of the european Union by the time the application initiating the proceedings was submitted”. (Case C-527/10).
What is a right in rem?
12. Article 5 raises the question of what rights in rem are the subject of the protection given by Article 5 and what law is to determine whether a right is to be regarded as a right in rem for these purposes. Does this expression include all types of security and quasi-security interest (such as retention of title clauses, flawed asset arrangements, finance leases and sale and repurchase agreements)? What about powers of attorney which may be given to support or protect the security interest - do these form part of the right
in rem? and what about rights in rem which may be recognised by one Member state but not others (such as the beneficial interest under a remedial constructive trust)?
2. 2004/rK/274, rgDc/TBBr 2006, 558, antwerp court of appeal, august 23, 2004.
3. This gives a creditor the right to get paid in priority from the proceeds of the sale of goods when the goods have remained in the creditor’s possession. The creditor is deemed to be in possession when the goods have not reached the debtor and the creditor holds the bills of lading over the goods.
13. The eIr provides no definition of a right in rem, except that article 5(3) states that a right which is entered in a public register and is enforceable against third parties shall be considered to be a right in rem. The virgos-schmit report states that the failure to provide a definition (at least in respect of the november 1995 convention on Insolvency proceedings) was deliberate, allowing the law of the state where the as-sets are located to determine the question of whether a right is a right in rem.4 however, this simply begs
the question as to where the assets are located (and which law determines this) – see below.
14. paragraphs 102 to 104 of the virgos-schmit report may provide some guidance in relation to what will constitute a right in rem. It appears that:
(a) a right in rem is not to be given an unreasonably wide interpretation. It should not include, for in-stance, rights simply reinforced by a right to claim preferential payment;
(b) in particular, a right in rem may not only be established with respect to floating charge assets but also rights which are characterized under national law as rights in rem over intangible assets or over other rights5; and
(c) a right in rem basically has two characteristics:
• its direct and immediate relationship with the asset to which it relates, which remains linked until the debt has been satisfied (without depending upon the asset belonging to a person’s estate, or on the relationship between the holder of the right in rem and another person); and
• the absolute nature of the allocation of the right to the holder. In other words, the person who holds a right in rem can enforce it against anyone who interferes with his right without his consent. such rights are typically protected by actions to recover the property which is subject to the right in rem. The right in rem survives a transfer of the asset to a third party (in other words, it can be claimed against a purchaser, unless that purchaser is acting bona fide).
15. The following provisions of article 5 are also helpful in determining whether particular rights fall within article 5:
(a) the reference to both “specific assets” and “collections of indefinite assets” means that an English floating charge (for which there may not be an equivalent in all Member States) would fall within Article 5;
(b) it is not clear whether the “right to dipose of assets and to obtain satisfaction from the proceeds” would include the right to appoint a receiver to dispose of the assets although there does not seem to be any reason why this right should not be included. The virgos-schmit report suggests that, for example, the owner of the right in rem may exercise the right to separate the security from the estate and, where necessary, to realise the asset individually to satisfy the claim. In addition, the office-holder, even if he is in possession of the asset, cannot take any decision in relation to that asset which might affect the right in rem created over it, without the consent of its holder;6 and
(c) article 5(2) provides a list of the types of rights which are normally considered by national laws to be rights in rem (and see also para 103 of the virgos-schmit report).
Where are the secured assets located?
16. The protection given by article 5 only applies where the secured asset is situated within the territory of a Member state other than the one in which the insolvency proceedings are commenced. hence the loca-tion of a secured asset is crucial. Article 5, however, leaves open the quesloca-tion of when assets are situated within the territory of another Member state. In the context of certain assets (such as real property) it may 4. see virgos-schmit report para 100.
5. Whether the court will construe the scope of an article in the eIr by reference to the virgos-schmit report on the november 1995 convention on Insolvency proceedings is by no means clear.
be easy to determine their location but where are debts and other intangibles situated for this purpose? The conflicts rules of the forum where this issue is litigated could be relevant in determining this issue. 17. The virgos-schmit report states that the applicable rules governing the creation, validity, and scope of
rights in rem are those of their own applicable law (in general the lex rei sitae at the relevant time) and are not affected by the opening of insolvency proceedings.7 however, there is no assistance as to which
law should determine the lex rei sitae, and therefore the applicable law, and it is possible that conflicts may arise.
18. article 2(g) of the eIr gives some guidance as to where certain types of assets are located for the pur-poses of the eIr:
(a) in the case of tangible property, the assets will be located in the Member state within which the property is situated;
(b) in the case of property and rights where ownership or entitlement must be entered in a public regis-ter, those assets will be situated in the Member State under whose authority the register is kept; and (c) in the case of claims, the claim will be situated in the Member State where the third party required
to meet the claim has its centre of main interests.
19. It is not clear whether all assets are intended to fall under one of the three categories listed in article 2(g) or whether the conflicts rules outside the eIr are intended to determine the situs of assets which do not readily fall within the categories listed in article 2(g). for example, are private company shares to be treated as a bundle of claims falling within the third category or do shares fall outside the scope of article 2(g)? 20. furthermore, some assets may be capable of falling into more than one category. a ship, for example, is
tangible property falling within the first limb of article 2(g) but the ownership of that ship could also be recorded in a public register as per the second limb of article 2(g). In such a case, it is not clear whether the three limbs of Article 2(g) create an order of priority so that the “tangible property” limb trumps the “public register” limb.
21. These definitions could lead to surprising results in respect of certain intangible assets. for example, if the insolvent debtor has a bank account in england with the english branch of an overseas bank, article 2(g) would seem to suggest that the bank account will not be situated in england but instead will be situated in the Member state in which the bank has its centre of main interests. This does not appear to be the view of Professor Virgos who has stated that “[i]n the case of current accounts and deposits in banking institutions, for these purposes each branch must be considered as an autonomous entity (i.e. as if it were a distinct debtor) in accordance with the special structure of these institutions; consequently the claim will be considered situated in the State where the office serving the customer account is located”.8
unfortunately the virgos-schmit report does not contain such an assertion.
22. It should be noted that article 5 does not appear to apply where the assets are situated in a non-Member state (although the conflict laws of that non-Member state may achieve a similar result). This should be compared with article 6, for example, where the law applicable to the insolvent debtor’s claim (which determines whether set-off is permitted) does not need to be the law of a Member state. It is not clear whether this distinction is deliberate. The reference to the ECJ by the Hungarian court referred to above should be interesting in this context.
What does “shall not affect” mean?
23. article 5 states that the opening of insolvency proceedings shall not affect the rights in rem of creditors or third parties. The Article therefore raises the question of the meaning of the word “affect”. For example, 7. para 95 of the virgos-schmit report.
8. virgos and garcimartin, The european Insolvency regulation: law and practice, 2004, Kluwer law International, p.168 (original emphasis).
does a moratorium on security enforcement in the main proceedings, which is required to be recognised in other Member states pursuant to article 25, affect a right in rem? It could be argued that such a mora-torium does not derogate from the underlying security interest but merely postpones the right to enforce. I would argue, however, that the right to enforce is a fundamental part of the right in rem.
24. No definition of what is meant by “affect” is provided by the EIR, but it is to be expected that the word will be construed in order to give effect to the purpose of the article, namely to protect third party rights
in rem. some indication of the intention of the eIr in this regard is given by recital (25). This states that the basis, validity, and extent of a right in rem should normally be determined according to the lex situs
and should not be affected by the opening of insolvency proceedings. The recital states that the proprietor of the right in rem should be able to continue to assert his right to segregation or separate settlement of the collateral security. This suggests that a secured creditor should be able to enforce its security notwith-standing any moratorium which might arise pursuant to the main proceedings. The recital also indicates that the liquidator in the main proceedings should be able to open secondary proceedings in the jurisdic-tion where the rights in rem arise if the debtor has an establishment there—such secondary proceedings may have an impact on the enforcement of security if, for example, they give rise to a moratorium on security enforcement.
25. The question also arises as to whether Article 5 would prevent a liquidator in the main proceedings from “paying off” the bank, thereby gaining control of the secured asset. The Virgos-Schmit Report makes it clear that, if the value of the security is greater than the value of the secured claim, the creditor will be obliged to surrender to the insolvent estate any surplus proceeds of sale9 and this is unobjectionable. The
Report also states that the liquidator has the power to decide on the immediate payment of the secured claim and thus to avoid any loss in value that certain assets could suffer if they were to be realized sepa-rately10. This is more problematic as it could be argued that such a right on the part of the liquidator affects
the right in rem of the secured creditor, particularly in circumstances where the security is underwater. for example, if the secured debt is 100 but the secured asset (at the current time) is only worth 50, the secured creditor would be deprived of its chance to wait and see if the value of the secured asset might increase in the future if the liquidator in the main proceedings were able to discharge the security by paying the secured creditor 50.
Does Article 5 protect the secured debt or merely the right in rem in the strict sense?
26. Perhaps the most fundamental question regarding Article 5 is unanswered by the EIR and is not ad-dressed in the Virgos-Schmit Report. The question is this: does the Article merely protect the right in rem
in the strict sense (i.e. the security interest over the relevant assets) or does it also protect the underly-ing secured debt? In order words, does article 5 prevent a composition plan or proceedunderly-ing which would be effective under the state of the opening of proceedings (and which other Member states would be required to recognise under Article 25) from amending or discharging the debtor’s secured indebtedness and therefore protect the secured lender’s rights to enforce its security in respect of that indebted-ness over assets located in another Member state? although an english company voluntary arrangement (which is available as a main proceeding in the united Kingdom) cannot, by virtue of section 4(3) of the Insolvency act 1986, affect the right of a secured creditor to enforce its security without its concurrence, it may well be that main proceedings opened in another Member state (for example french safeguard proceedings) could provide for the variation or discharge of a secured debt governed by english law11
without the express consent of the secured creditor and this could have an effect on the enforcement 9. para 99.
10. Ibid.
11. By way of analogy, an english voluntary arrangement provides for the variation or discharge of all (unsecured) debt, whatever the governing law.
of security in england. The composition plan or proceeding could, for example, purport to discharge the secured indebtedness or the indebtedness could be reduced to 50% (or even 99.9%) of its face value. In these circumstances, having a right in rem in relation to the remaining 0.1% of the debt would seem fairly pointless. I would argue that, for these reasons, article 5 must protect the secured indebtedness as well as the security interest but clarification is needed on this point12.
What impact does Article 5 have on inter-creditor provisions?
27. A further question which arises from the use of the words “shall not affect the rights in rem of creditors” is what effect (if any) article 5 would have on the turnover trust provisions in an inter-creditor agreement between the secured creditors inter se. These provisions provide that, if the junior creditors receive any payments before the senior creditors have been paid in full, the junior creditors have to hand over the amount received. Take an example of a french safeguard proceeding pursuant to which both senior and junior creditors receive realisations in respect of their compromised claims but taking into account their respective priority. The senior creditors may receive the full 85% to which they are entitled under the plan but the junior creditors may receive, say, 15% before the money runs out. Can the senior creditors insist that the junior creditors hand over all proceeds that they receive until the senior creditors have been paid the full amount of their uncompromised claim?
28. This is likely to depend on whether (but for Article 5) the insolvency proceedings in question purport to affect the rights of the secured creditors as between themselves (rather than merely affecting the posi-tion as between the insolvent debtor and its creditors). following the decision in Prudential Assurance Company Ltd and others v PRG Powerhouse and others13, it is clear that an english company voluntary
arrangement (if properly drafted) could affect the position between a creditor and a third party (such as another creditor) and it is theoretically possible that main proceedings commenced in other Member states could purport to have the same effect. If so, it is hard to see how article 5 could protect the rights of the senior lenders under the inter-creditor agreement. article 5 refers to rights in rem over assets of the insolvent debtor; as a matter of English law, the turnover trust created by the inter-creditor agreement would create a right in rem over assets of the junior lenders (e.g. any recoveries made by them pursuant to the french compromise plan in the example above) but would not create rights in rem over assets of the insolvent debtor.
Which law determines the priority of the security?
29. article 4(2)(i) of the eIr states that the law of the state of the opening of proceedings will govern the question of when and how distributions of proceeds will take place. This law will also determine the rank-ing and treatment of claims in the insolvency proceedrank-ings (includrank-ing, for example, whether any claims are to be given preferential status in the insolvency proceedings).14 article 4(2)(i) also determines whether a
secured creditor that has obtained partial satisfaction of its claim, either through the exercise of a right in rem or by way of set-off, may make a claim in the insolvency proceedings for the balance of its claim. 30. under english law, certain categories of preferential claims have priority to the claims of a floating
charge-holder15 but not to the claims of a fixed charge-holder. It is not clear whether these rules of priority fall
12. While I am not aware of any case law on this point, it is helpful that one of the authors of the european convention on Insol-vency Proceedings, Professor Balz, considers that secured creditors may not be impaired by a plan: see Balz, The European Convention on Insolvency Proceedings, 1996, 70 ABLJ 485 at p.509. That is also the view of Philip Smart in Rights in rem, Article 5 and the ec Insolvency regulation: an english perspective, Int. Insolv. rev., (2006) vol 15-55 at p.33.
13. [2007] EWHC 1002 Ch.
14. The priority of secured claims inter se will be determined by other matters such as the date of registration of the security or any deed of priorities.
15. see section 754, companies act 2006 which applies outside of a winding-up and section 175, Insolvency act 1986 which ap-plies in a winding-up.
within article 4(2)(i). although the priority given to preferential debts arises, generally, pursuant to the insolvency legislation, it is at least arguable that these rules relate to the priority of security (since they regulate the relationship between secured creditors and preferential creditors) and are not therefore an effect of the insolvency procedure. Furthermore, difficult questions arise regarding the effect on Article 4(2)(i) of article 5 if there are different rules regarding the ranking of secured claims under the law of the state of the opening of proceedings and the law of the member state where the secured assets are located.
How does Article 5 relate to the provisions regarding the applicability in time of the EIR?
31. article 43 of the eIr states that the provisions of the eIr shall apply only to insolvency proceedings opened after its entry into force and “[a]cts done by a debtor before the entry into force of this Regulation shall continue to be governed by the law which was applicable to them at the time they were done”. The ques-tion therefore arises as to whether article 5 will protect security created pursuant to agreements entered into prior to 31 May 2002, using a broad interpretation of the words “acts done” to encompass the entry into of the security.
32. although there is no case law yet on this issue, I do not consider that article 5 should be disapplied in the context of security created prior to 31 May 2002 (although the contrary view is possible). In my view, the relevant “acts done” refer to actions undertaken to place a debtor into insolvency proceedings and not other “acts” more generally. If a wider interpretation were to be applied, this would (for example) prevent voidable transactions from being treated under the choice of law rules set out in the eIr (if those transactions were entered into prior to 31 May 2002) and I do not consider that this could be correct. If (contrary to this view) the expression “acts done” were to encompass the entry into of the security, a possible interpretation of article 43 is that the creation, validity and scope of any right in rem created by a security agreement or act pre-dating 31 May 2002 should be determined by the applicable law applying conflicts rules outside of the eIr. so, for example, if the security was created prior to 31 May 2002 and the english court were to determine the lex situs of a secured asset that comprised a debt, it may well apply the general rule under english common law that a debt is situate where it is expressly or impliedly payable (rather than applying the lex situs rules in article 2(g) of the eIr).
Conclusion
33. given the importance of article 5 to credit and the mobilisation of wealth and the even greater need for legal certainty in this area given the state of the global economy, it is very much hoped that the com-mission will take the opportunity to clarify some of the areas of uncertainty identified in this paper. The most important question is whether Article 5 protects the secured indebtedness as well as the security interest per se. It is hoped that the courts of the Member states would take a sensible and commercial approach in this regard. Without clarification, however, litigation (and ultimately a reference to the ECJ) may be necessary.
slide 1
slide 2
slide 4
slide 5
