The Supreme Court has ruled that a reciprocal security or surplus value arrangement does not violate any provision of property or insolvency law.(1)
If the arrangement is (timely) made with the cooperation of the borrower, the surplus that remains after the enforcement of security by one financier can be applied to settle the outstanding claim of another financier, even in the event of the borrower's bankruptcy.
On April 8 1998 NMB-Heller NV entered into a disbursement and service agreement with ICT International BV. Pursuant to this agreement, NMB-Heller agreed to grant a credit to ICT through the disbursement of ICT's trade receivables.
The parties also agreed that NMB-Heller would collect the receivables and keep the accompanying records. ICT created an undisclosed right of pledge with respect to the receivables in favour of NMB-Heller, in order to secure NMB-Heller's claims with regard to ICT. In addition, ING Bank NV granted credit to ICT. In order to secure the repayment, ICT established a non-possessory right of pledge on its inventory in favour of ING.
Also on April 8 1998 NMB-Heller, ING and ICT entered into a so-called reciprocal security or surplus value arrangement. Pursuant to the arrangement, NMB-Heller obliged itself to pay ICT's debts to ING, subject to certain conditions. NMB-Heller agreed first to seek recourse of its own claims against ICT by means of enforcement of its right of pledge. Any surplus after such enforcement would then be applied to settle ING's claims, to the extent that NMB-Heller could recover its recourse claim against ICT (from the guarantee towards ING) and up to a maximum of Fls1.5 million. ICT obliged itself to repay NMB-Heller's (conditional) recourse claim. ING made a similar guarantee for the benefit of NMB-Heller, under similar conditions.
On April 1 1999 ICT was declared bankrupt. Shortly after, NMB-Heller notified ICT's debtors of its right of pledge and commenced collecting the receivables. On April 16 1999 NMB-Heller's claims from the service and disbursement agreement had been fully repaid. However, ING still had an outstanding claim against ICT in to the amount of approximately Fls300,000, excluding interest. ING's security on the inventory was insufficient to settle this debt. Therefore, ING claimed this outstanding amount from NMB-Heller, as stipulated in the arrangement. By this time not only had NMB-Heller notified ICT's debtors, but also the receiver had notified them that they could make only discharging payments to the bankrupt estate's bank account (and thus not to NMB-Heller). Subsequently, the receiver and NMB-Heller agreed that the receiver would collect the receivables and hold them in escrow in order for the court to decide whether NMB-Heller could seek recourse with respect to ICT's receivables for its payment to ING.(2)
In cassation NMB-Heller claimed that, although not explicitly stated in the arrangement, it acted as a guarantor. Since it paid ING's claim with regard to ICT as a guarantor, the payment led to a recourse claim towards ICT, which was secured by its right of pledge on ICT's receivables. The receiver took the view that ING's claim against NMB-Heller, and consequently NMB-Heller's recourse claim against ICT, were at the time of ICT's bankruptcy future - not actual - claims, which could not be invoked against the bankrupt estate. In addition, the receiver claimed that the arrangement must be considered a modern transfer of debts. Therefore, set-off should not be possible given Sections 53 and 54 of the Bankruptcy Act and/or the fixation principle.
The Supreme Court referred to one of its earlier judgments(3) in which it ruled that the recourse claim of a guarantor is deemed to be an actual claim provided that the guarantor has paid under the guarantee (the condition precedent). The claim was considered to be actual from the moment that the guarantee was given, not from the later point when the guarantor paid under the guarantee. Since according to Section 3:231(1) of the Dutch Civil Code a right of pledge can also be validly created to secure a future debt, such can also be created to secure an actual debt under a condition precedent. Since the recourse claim was present (although conditional) at the time of ICT's bankruptcy, the arrangement did not violate the fixation principle.
The Supreme Court considered that the parties could have achieved the same result as envisaged by the arrangement by creating a second ranking (undisclosed) right of pledge on ICT's receivables in favour of ING. The alternative structure would not have violated any provision of property or insolvency law. Apparently for practical reasons, the parties decided not to create a second ranking right of pledge. Under the arrangement, NMB-Heller's security was essentially also created for the benefit of ING and NMB-Heller enforced the security in its own name but for the benefit of ING, neither of which violated any provision of property or insolvency law. In addition, ICT's bankruptcy did not prejudice NMB-Heller's right and authority to enforce its security (also in favour of ING).
Section 53 of the Bankruptcy Act provides the conditions for set-off by a creditor against a bankrupt debtor. Section 54 of the Bankruptcy Act provides that set-off is not permitted if the creditor has acquired a certain debt (that it desires to set-off) after the date of bankruptcy of the debtor or if the creditor acted in bad faith. However, these provisions did not apply in this case, since NMB-Heller recovered its claims by enforcing its recourse claims and not by set-off. NMB-Heller did not have a debt towards ICT. The Supreme Court considered that if Sections 53 and 54 should be applied by analogy (which was not the case), NMB-Heller would still be entitled to enforce its security rights with respect to its recourse claim.
According to the Supreme Court, NMB-Heller enforced the surplus security in its own name, but for the benefit of ING. Arguably, this means that, according to the Supreme Court, NMB-Heller acted as an indirect representative within the meaning of Sections 7:424 and following of the Dutch Civil Code. When drafting the appropriate reciprocal security documents, the possible applicability of these provisions should be borne in mind.
When the Supreme Court established that the arrangement did not violate any provision of property or insolvency law, a decisive fact seems to be that ICT was a party to the arrangement. Therefore, the cooperation of a borrower seems essential for a reciprocal security arrangement to hold up if the borrower goes bankrupt.(4)
First published on website.
(1) Supreme Court, July 9 2004, JOR 2004/222.
(2) Mr S-J Spanjaard, note under Supreme Court, July 9 2004, Ondernemingsrecht 2004/12, pp 472 to 475.
(3) Supreme Court, May 3 2002, NJ 2002/393.
(4) Professor mr JJ Van Hees, note under Supreme Court, July 9 2004, JOR 2004/222.