What practical issues do secured creditors face in enforcing their security (e.g. timing issues, requirement for court involvement)?
Restructuring & Insolvency (2nd Edition)
In respect of a mortgage secured on the debtor’s immovable property, the creditor may commence a forced sale procedure before the enforcement court of the debtor’s jurisdiction if the debtor defaults on the debt. However, it is a condition that the creditor levies execution on the debtor’s immovable property and subsequently the creditor may file a request for a forced sale with the enforcement court of the debtor’s jurisdiction.
In case of a charge on movable property, it is also possible for the creditor to request that execution be levied on the charged item. Based on the execution the creditor may dispossess the item as security for the creditor’s agreement with the debtor and the creditor may sell the item in question for the purpose of covering the arrears. The creditor’s request for execution may also be filed with the enforcement court of the debtor’s jurisdiction.
Recovery through the enforcement court assumes that the creditor has obtained a basis for the recovery, for instance a judgment, instrument of debt, settlement etc.
In bankruptcy proceedings, security interests in collateral rank higher than taxes due and employees’ claims to the extent of the value of the collateral. But this general rule does not apply to employees’ claims established before August 27, 2006. During restructuring, the exercise of security interests in collateral is suspended, unless the collateral is in danger of damage or significant decrease in its value. In bankruptcy liquidation or settlement proceedings, a secured creditor may at any time request the administrator to dispose of the collateral and repay debts owed to the creditor in priority to other subordinate creditors with the proceeds obtained from the proposal. In bankruptcy of real estate companies, claims of housing purchasers and those for construction costs take precedence over security interests.
In a voluntary administration, a statutory moratorium under section 440B of the Corporations Act 2001 (Cth) (Corporations Act) prevents a security interest from being enforced against the company’s assets without the administrator’s consent or leave of the court.
There are exceptions to this general rule, the primary one being where a secured creditor has security over the whole or substantially the whole of the company’s property. Where this occurs, the secured creditor may enforce its security and appoint a receiver within 13 business days’ following the date the administrator gave notice of his or her appointment. If a secured creditor does not enforce its security within this time period, the section 440B moratorium will attach preventing enforcement during the period of administration. Notwithstanding this short window available to secured creditors to enforce their security, there are often practical difficulties associated with being satisfied that the security is ‘over the whole or substantially the whole’ of the company’s assets.
A similar moratorium on enforcement operates in a liquidation (under section 471B of the Corporations Act), however secured creditors are usually granted immunity from this process (by section 471C), assuming their security is valid, as they remain entitled to realise their security despite the liquidation.
A mortgage over real estate is enforced by the sale of the mortgaged property. The mortgagee must have an executory title, which requires an enforceable court judgment or a notarised executory deed. The mortgagee has no right to appropriate the property. A court-appointed notary public will be charged with effecting the (public or private) sale, and the distribution of proceeds in accordance with the ranking of creditors. The time required for enforcement will depend on the debtor’s attitude and the court’s strain.
Unless agreed otherwise, the pledgee of financial collateral is entitled to enforce the security without prior court approval or prior notification. For financial instruments, enforcement will occur by selling or (if agreed by the pledgor in the pledge agreement or at a later time) appropriating the financial instruments, and for bank accounts by appropriating the amounts standing to the credit of the bank account. Appropriation may only occur in accordance with agreed valuation rules between parties.
Any sale of shares might be subject to limitations by law, in the articles of association or in contracts. These transfer restrictions are opposable to third parties, if not waived at the time of the creation or enforcement of the pledge.
As regards the enforcement of pledges granted by pledgors that are not consumers over other movable assets such as tangibles, trade receivables, IP rights or a business, foreclosure is subject to notice that the pledgee intends to enforce the pledge, triggering a 10 day waiting period (which is shortened to 3 days in case of perishable goods or goods subject to fast value reductions), after which the pledgee is entitled to instruct a bailiff to rent out the goods or sell them by way of a public or private sale. In addition, the pledgee may appropriate the goods if agreed by the pledgor in the pledge agreement or at any later time, subject to the condition that the agreement states that the value of the goods at the moment of appropriation will be determined by an expert or, for goods traded on a market, according to the market price.
In case of a non-possessory pledge, the pledgee will need to obtain the pledged goods from the pledgor. Hence, the pledgor’s cooperation will be required. If the pledgor does not cooperate, the pledgee will need to obtain a court order, ordering the pledgor to deliver the assets to the pledgee.
Upon request by the pledgor, the pledgee or any other third party with an interest, a dispute in relation to the enforcement may be brought before a court (i.e. the attachment judge). Such court proceedings suspend the enforcement of the pledge but will be decided by the judge as a matter of priority.
The holder of a security right qualifies as a secured creditor. Secured creditors are in principle not affected by a suspension of payments or bankruptcy of the pledgor. The holder of security right may in these cases enforce its security rights as if there were no suspension of payments or bankruptcy. The exceptions to this are outlined below.
- Ad (i) Cooling off period: In bankruptcy of the pledgor a cooling off period (maximum of 4 months) may apply, during which the right to enforce is temporarily suspended.
- Ad (ii) Reasonable term: The trustee in bankruptcy may set a reasonable term to the mortgagee in which the mortgagee should complete enforcement of the mortgage. In case enforcement is not timely completed, the trustee may sell the property himself.
Enforcement can take place by way of (i) auction, (ii) private sale with court approval or (iii) only in case of movable assets, private sale with approval from the pledger. Depending on the type of asset, and the circumstances of the case, enforcement is usually completed in a period of 1-3 months.
A secured creditor may enforce its security in a number of ways, most of which are governed by state law. As noted above, for the security interest to be valid, it must first be validly perfected through the applicable process – usually through the filing of a UCC-1, by taking possession, or through a mortgage or trust deed. If a creditor fails to properly perfect its security interest, its claim will be stripped of secured status and instead be deemed an unsecured claim against the debtor’s estate. Article 9 of the UCC also permits a secured party to repossess collateral through self-help measures when doing so would not breach the peace.
Once a debtor is in bankruptcy proceedings, however, as discussed more thoroughly below, section 362 of the United States Bankruptcy Code (the “Bankruptcy Code” or the “Code” ) – the automatic stay – generally prohibits creditors from taking action to enforce their security interests. In certain circumstances, upon filing a motion and a hearing, the court may provide a creditor relief from the stay.
Unlike amicable proceedings, insolvency proceedings trigger an automatic stay on claims which prevents creditors from suing the debtor and enforcing the securities. However, there are a few exceptions:
- Claims secured by a security interest may confer a lien (droit de retention) over the collateral. During the observation period, at the request of the judicial administrator, the insolvency court may exceptionally authorise the payment of a pre-filing secured creditor to obtain the surrender of the retained pledged asset to the estate to the extent that the pledged asset may be necessary to the debtor’s pursuit of its business activity.
- Claims assigned by way of Dailly assignment of professional receivables. The creditor to which the debtor's receivables have been assigned by way of Dailly assignment, can directly seek payment of those assigned receivables despite any filing.
- Claims secured by a fiducie agreement. The creditor can enforce its rights over the assets transferred to the trust, except where the creditor initially agreed, at the time the fiducie agreement was executed, that those assets would remain in the debtor's possession.
Enforcement of financial collateral security is quick and not very costly (except for valuation) and may be done out of court even in a bankruptcy scenario.
Other security interests are more burdensome, time consuming and costly to enforce and will normally, in case of bankruptcy, require court involvement.
The timing requirements that secured creditors are faced with will depends on the nature of the procedure in which they are involved.
Secured creditor direct enforcement
If a registered mortgage has been granted over real property, and the mortgagor has defaulted under the mortgage, the mortgagee may be entitled to exercise its powers of enforcement, which may include taking possession of the real property and/or exercising its powers of sale. It is not necessary under New Zealand law for a mortgagee to enter into possession of the subject property in order for a mortgagee to exercise the power of sale.
A statutory default notice (in accordance with the requirements of the Property Law Act 2007) must be given to the relevant mortgagor and any other guarantors or parties with a subsequent registered interest in the land, and time must be given for the mortgagor to remedy the default (usually at least 20 business days), before any mortgagee powers of possession and/or sale can be exercised. Expiry of that default notice is also a pre-condition to the exercise of any power to accelerate amounts outstanding which are secured by a registered mortgage.
Mortgagee sale (and entry into possession where applicable) is a self-help method where Court approval is not required (other than in rare circumstances of a mortgagee sale conducted through a Court registrar process), and the powers of enforcement arise by virtue of the mortgage documents.
In addition Part 9 of the PPSA and the Property Law Act 2007 contain provisions that allow a secured party to exercise direct enforcement remedies (including taking possession and selling the collateral) against personal property collateral when a debtor is in default.
A receiver, mortgagee or secured party must act in good faith in relation to any sale it conducts and is subject to a statutory duty to obtain the best price reasonably obtainable as at the time of sale.
Receivership is one of the main methods of enforcing security in respect of real and personal property in New Zealand and is discussed further in relation to question 4 below.
Almost all receivers are appointed by a secured creditor, pursuant to a contractual power to do so in a security agreement. No Court approval for such appointment by virtue of the security document is required, subject to compliance with the requirements of that security document for default by the relevant debtor to trigger the power of appointment.
As discussed above in the context of direct secured creditor enforcement, a statutory default notice (in accordance with the requirements of the Property Law Act 2007) may also be required to be given in a receivership context, before any receivers power of sale can be exercised. Where required, notice must be served upon the relevant obligor and any other guarantors or parties with a subsequent registered interest in the relevant assets, and time must be given for the obligor to satisfy the demand (usually at least 20 business days), before any receiver's power of sale can be exercised. This requirement is most commonly relevant in the context of a receiver's sale of real property.
Where the relevant obligor is a body corporate and the receiver is appointed pursuant to an all asset security agreement, then any required statutory default notices can be issued after the appointment of receivers (i.e. management of the relevant property by receivers in such circumstances is not restrained) however no sale of the subject assets can be completed by receivers until such time as the relevant default notices have been served and expired un-remedied. Where the debtor is not a body corporate (e.g an individual, unincorporated partnership or trust) the relevant notices must have been served and expire un-remedied as a pre-condition to acceleration of the subject debt and before any receiver's power of management or sale can be exercised.
The insolvency procedure is a concurrent procedure, so that also secured creditors may recover their receivable only in the conditions of the insolvency law, any enforcement procedure existing at the moment of opening of the insolvency procedure being stayed de jure. Sometimes this may imply a longer time for the recovery of the receivables than in individual enforcement, but the insolvency legislation provides as remedy for certain situations in which the court of law may order the lifting of the above-mentioned stay and the immediate sale, in the same insolvency procedure, of the asset that is the object of the security, provided that the proceeding expenses are paid.
If security is enforced outside of formal proceedings on the basis of a relevant contractual authorization, Swiss law does not establish major obstacles for secured creditors. A robust and clear authorization language is particularly important for enforcement by way of appropriation, though. In any event, appropriation without proper accounting of the value of the relevant collateral against the secured obligations is prohibited under Swiss law. Secured creditors could become liable to the provider of the security if the security is not being enforced in good faith. To our knowledge, such proceedings are very exceptional, though.
Enforcing security through debt enforcement proceedings is only available for pledge type of security interests and requires the involvement of the authorities. This may significantly slow down the enforcement process. Also, the statutory default enforcement route of a public auction does often yield a depressed result below the fair value of the collateral. Secured creditors, thus, have a preference for sales outside of an auction process which generally requires the consent of all relevant parties.
In a bankruptcy context, secured creditors benefitting from a regular pledge type of security interest are under a general obligation to hand in the collateral to the insolvency practitioner who would then sell the relevant asset. This results in a significant delay. Exceptions apply (i) for book-entry / intermediated securities with a value which may be determined objectively and (ii) under insolvency regimes for certain regulated entities (such as banks). Again, the standard enforcement route is a public auction but sales outside of an auction process are permissible with the consent of the relevant parties. No obligation to hand in the collateral exists for secured parties benefitting from a transfer or assignment for security purposes or from an irregular pledge.
In a composition proceeding, there would not be an obligation to hand in the collateral to the insolvency practitioner. However, during the moratorium phase enforcement in the collateral would generally not be permissible. Again, the exceptions referred to above apply.
We should mention as a general note that on March 2018, the new Israeli Insolvency and Economic Rehabilitation law, 2018 (the "Insolvency law") has been approved. The provisions of the Insolvency Law will generally become affective with respect to proceedings commenced or collaterals registered 18 months after the legislation. Therefore, the provisions of the Insolvency Law shall not apply in the present Q&A period.
However, as the new Insolvency Law effectively replaces and/or amends the entire existing Israeli insolvency regime, we would include a general note at the end of each chapter where the new Insolvency Law materially differs from the existing laws. In general, the provisions relating to the creation and perfection of collaterals remains unchanged under the new Insolvency Law.
Self-foreclosure of collaterals permitted under the Israeli law in very limited circumstances, only by Israeli banks or financial institutions, and only with respect to certain tangible assets and traded securities, deposited with such institutions.
Any other foreclosure of collaterals will be reported and supervised by the court, execution office or court officer, depends on the type of proceedings and the assets value/debt amount ratio:
(a) Receivership – the Law Enforcement and Collection System Authority appoints receivers and they will report to it. A receiver may be required to deposit a guarantee to secure performance of his duties.
(b) Liquidation – a creditor is entitled to foreclose his pledge independently from the insolvency proceeding, subject to appropriate notices to the debtor trustee or the liquidation court. However where the value of the collateral exceeds the debt, the court may supervise the foreclosure process and may even get involved where there is a concern that the process will not protect the residual value of the collateral, for example, where the creditor makes a "fire sale" that may generate lower values.
(c) Recovery and Re-organization – In the event of a recovery arrangement in accordance with Section 350 of the Companies Law, 1999 (the "Companies Law", and an "Arrangement", in short – a court-run settle¬ment between a company and its creditors and sharehold¬ers, similar in essence to U.S. "Chapter 11" proceed¬ings), there is no automatic stay ("freezing") order, and the court may grant such a stay order if the court is satisfied that a stay of proceedings would help facilitate the preparation or approval of a recovery plan, for a period of up to nine months (which may be extended).
When such stay order is granted, a secured creditor must apply to the court in order to realize an asset charged in its favor, and according to the provisions of the Companies Law the court shall permit such realization if: (a) it is satisfied that the creditor's rights in the asset have not been properly protected, or (b) the realization of the charged asset is not likely to have an adverse effect on the possibility to recovery of the company.
Furthermore, a court may, under certain circumstances, allow the trustee to create additional pledges in any rank of seniority including on pledged assets, or even to sell such pledged assets without the secured creditor's consent, all provided that such creditor's rights are properly secured and that such action is essential for the Arrangement proceedings.
The new Insolvency Law generally maintains the previously mentioned principles, but subjects the consideration from foreclosure of the floating charge to a 75% limit of recovery in favor of the secured creditor. To the extent any debt remaining, it shall be treated as unsecured debt.