The judicature to date regarding security transfers of rights has unequivocally supported the view that a security transfer of right pursuant to Section 553 of Act no. 40/1964 Coll. of the Civil Code (hereinafter the “CC”) is an agreement to transfer a right with a condition subsequent. When such condition is met, the original owner again becomes the owner. From the introduction of this institution into the CC, it was not at first glance clear that this involved a condition subsequent since Section 553 CC did not expressly determine so and the original debates even admitted the possibility of a fiduciary transfer of right.
A fiduciary transfer of right is such transfer of right where there is no condition subsequent and by meeting the secured obligation the debtor does not become the restored owner of the collateral, but there must first be legal action taken by the creditor. It is thus possible to arrange for the return transfer of the collateral after a certain period of time following fulfillment of the secured obligation or possibly after meeting other conditions. Likewise, the debtor is not protected in any way in the event the creditor violates its obligation to return the collateral, leaving a damage compensation claim as the only recourse (unless agreed otherwise). The possibility of negotiating a fiduciary transfer of right pursuant to Section 553 CC has been discussed for example in Advocacy Bulletin no. 03/1997.
However, later judicature concluded that it was not possible to negotiate a fiduciary security transfer of right (e.g. judgment of the Grand Chamber of the Civil and Commercial Division of the Supreme Court dated October 15th, 2008, ref. no. 31Odo 495/2006).
Act no. 89/2012 Coll. of the new Commercial Code (hereinafter “NCC”) introduces several fundamental changes in this respect and presents an entirely different view of security transfers of rights than the judicature to date.
This particularly concerns:
1. The possibility of negotiating a security transfer of right as a fiduciary
2. The settlement between the parties presumed by law, where the debtor fails to meet the securing obligation and the creditor becomes the owner of the collateral, i.e. when the transfer changes from conditional to unconditional.
Re 1) fiduciary transfers of rights
The basis of a security transfer is to improve the legal standing of the creditor by having the debtor or third party temporarily transfer its right (usually the right of ownership) for the purpose of securing a debt to the creditor. It is clear in such cases that this must be a temporary transfer, i.e. conditional. In Section 2040 par. 2 NCC, legislators expressly make a rebuttable presumption that a security transfer of right is a transfer with a condition subsequent, which differs from the current legal treatment which does not make such statement. Since this is a rebuttable presumption, it is also clear that the parties will retain some autonomy and will therefore be able to negotiate security transfers of rights as fiduciary transfers (see above for a definition of “fiduciary”). The conditions for returning the transferred collateral will then be entirely up to the will of the parties.
Re 2) security transfer of right as a forfeitable pledge
Another significant change compared to the current legal situation is the ability to negotiate a security transfer of right where the creditor will automatically become the owner of the collateral, de facto creating a forfeitable pledge. To date, such arrangement has been considered absolutely invalid (e.g. judgment of the Grand Chamber of the Civil and Commercial Division of the Supreme Court dated October 15th, 2008, ref. no. 31Odo 495/2006).
Such consequence is even directly presumed by the law upon failure to repay the debt (see Section 2044 par. 1 NCC). Further, it will be possible for the parties to agree to disregard the dispositive provisions of Section 2044 par. 2 NCC so that the creditor will not be required to pay the debtor the difference in the event that the price of the collateral exceeds the value of the secured debt. As the parties hereby clearly intend to sanction the debtor in case of default, the amount gained exceeding the value of the secured debt shall not be considered unjust enrichment, because the justifying reason in this case is precisely the intent of the parties to bring about such outcome.
This possibility is limited however by the disproportionate reduction clause (§ 1793 et seq. NCC). This clause grants the debtor, in the event of gross disparity between the amount of the secured debt and the market value of the collateral, the right to demand settlement or terminate the agreement. This right may also be waived in advance so there is actually nothing preventing the negotiation of a security transfer of right as essentially a forfeitable pledge.
Therefore, the creditor is in the strongest position when excluding agreements of the parties and application of the disproportionate reduction clause (§ 1793 et seq. NCC).
Restriction of security transfers of rights
The aforementioned possibilities will probably not be possible to negotiate in cases where one of the contracting parties is a consumer. A consumer is a person who enters into a relationship with an entrepreneur outside his/her business activity or professional activity (i.e. concludes a contract or otherwise negotiates with the entrepreneur). Arrangements in consumer contracts which establish disproportionate or imbalanced rights or obligations to the detriment of the consumer are prohibited, and thus invalid. According to the NCC however, this concerns relative nullity, which must be invoked by the consumer.
Likewise, it will be possible in certain cases for the aforementioned clause to be considered when one of the parties is a “weaker party” (see Section 433 par. 2 NCC).
Conclusion
Considering the above, it is clear that the NCC introduces truly fundamental changes to security transfers of rights. In the spirit of the NCC, great autonomy is left to the parties and there are minimal restrictions in the negotiation of securities. A new development of particular interest is the ability to negotiate fiduciary transfers of rights (without conditions subsequent) previously forbidden by the judicature.
As a manner of settlement, the law now automatically presumes that if the debtor does not meet its obligations, the creditor becomes the permanent unconditional owner of the collateral (typically a right of ownership) and a security transfer of a right is thus clearly a stronger form of security than a lien, where the law still presumes the liquidation of the collateral to satisfy the creditor’s claim.
Security transfer of right is thus according to the NCC de facto ex lege a forfeitable pledge and every debtor which chooses such form of security should be well aware of the consequences that such security may have for it.
For more information, please contact our office’s partner, Mgr. Jiří Kučera, e-mail: jkucera@kuceralegal.cz ; tel.: +420604242241.