FINANCIAL COLLATERAL ARRANGEMENTS IN THE BALTIC STATES
A financial collateral arrangement provides effective security to the creditor with minimal cost since it may be included in a master agreement or general terms and conditions without certification, registration, perfection or other assigned costs. The enforcement of financial collateral arrangements constitutes a significant advantage of this type of agreements over pledges and is in fact viewed as a major characteristic distinguishing it from agreements on pledge of cash collateral without a title transfer. The aim of a financial collateral arrangement is established in the preamble of Directive 2002/47/EC which provides that Member States should ensure the inapplicability of certain provisions of insolvency law to financial collateral arrangements. It follows that the protection of financial collateral arrangements in case of insolvency (bankruptcy and restructuring) is essential in this directive and the Member States should secure their enforceability. The right of the beneficiary of financial collateral to unilaterally realise the financial collateral in insolvency proceedings does not cease from the start of insolvency. Another difference in comparison with other creditors (including the creditor of an agreement on pledge of cash collateral) is the possibility to set off the monetary claim against the bankrupt undertaking.
An analysis of the legal acts of the three Baltic States shows that there are no rules pertaining to the form of publicity of financial collateral arrangements, including registration. These considerations imply that financial collateral arrangements, contrary to agreements on pledge of cash collateral, should produce effects only to the parties to such agreements. Lithuanian case law provides that disclosure of the provisions of a pledge or mortgage bond by registering and indicating them in the mortgage extract is a prerequisite to invoking these provisions against third parties. For that reason, the question arises whether the mode of regulation of financial collateral arrangements does not infringe the rights of other creditors in insolvency proceedings, as they may satisfy their claims only from what is left after the unilateral realisation of financial collateral arrangements.
Lithuanian law, contrary to the legislation of Latvia and Estonia, lays down certain additional requirements to the form of financial collateral arrangements, which are stipulated in Lithuanian case law. These restrictions are aimed to protect the rights of other creditors since the creditors do not have a possibility to evaluate the possible influence of the financial collateral arrangement entered into by the undertaking on its interests inter alia in the event of insolvency or restructuring of the undertaking. According to Directive 2002/47/EC a Member State may not require that the creation, validity, performance, enforceability or admissibility in evidence of a financial collateral arrangement or the provision of financial collateral under a financial collateral arrangement be dependent on the performance of any formal act.
Directive 2002/47/EC establishes a rule that persons other than natural persons, including unincorporated firms and partnerships, may be parties to financial collateral arrangements, provided that the other party is a financial institution. In Estonia and Lithuania this rule was implemented by a provision that only legal persons may be the providers of financial collateral, provided that the other party to the arrangement is a supervised financial institution; therefore, in insolvency proceedings financial institutions became privileged creditors.
The Lithuanian Supreme Court has evaluated the fact that such inequality in performing commercial activities, i.e. restriction and nondisclosure of entities that could be the parties to a financial collateral arrangement, may violate the rights of other creditors and addressed it to the Constitutional Court requesting the latter to examine whether the regulation stipulated by the Lithuanian legislator does not prejudice the constitutional principles of regulation of economic activities.
Finally, according to Latvian law, both natural persons (that are eliminated in both Lithuania and Estonia) and legal persons or other forms of entities may be providers as well as recipients of financial collateral. No doubt, such regulation does not undermine the equality of persons, i.e. their possibility to secure their rights in insolvency proceedings, but may cause other legal problems. In this case, where a financial collateral arrangement is entered into and performed, the provisions protecting the rights of consumers come into operation; even the application of the mechanism protecting human rights is possible, should the fundamental human rights and the dignity of a human being be violated. Until now, Latvia has no case law on the matter; however, in the future a solution for the above problems could be found in court.
Summing up, the legislators of Estonia and Lithuania have granted privileges to financial institutions in insolvency proceedings; in other words they just restricted themselves to the implementation of the goals of Directive 2002/47/EC, whereas the Latvian legislator has provided broad opportunities to enter into financial collateral arrangements. In the absence of case law, it is difficult to predict the scope of risks which financial institutions will have to assume concerning the non-fulfilment of these arrangements and whether it will be without prejudice to the safety and stability of the financial services market.
Head of Baltic B&F
TARK GRUNTE SUTKIENE
Remuneration of management and key personnel of financial institutions regulated. A new regulation on the remuneration policies of, including payment of bonuses to, management and other key personnel of credit institutions, insurance undertakings, fund management companies as well as listed companies was introduced. Market participants need to comply with such new requirements by 30 June 2011 at the latest. The new remuneration policy is, to a great extent, based on Directive 2010/76/EU. Although the above directive only applies to credit institutions and investment firms, similar requirements were extended to listed companies and other financial sector professionals, taking into consideration certain European Commission recommendations and ongoing regulatory initiatives, as appropriate with regard to circumstances specific to the Estonian financial market. The main idea behind the amendments is to ensure that benefits distributed to the management of a financial institution or a listed company are based on the actual financial condition of the particular financial institution or company pursuant to pre-determined policies. Remuneration and, in particular, bonuses should not be based on short-term performance only, and the payment thereof should be spread over a longer period of time so as to take into account the long-term sustainability of the company.
Assessment of suitability when providing investment linked products. Amendments in law were introduced imposing an obligation on the service provider (i.e. a credit institution, an insurance undertaking or an investment firm) to assess the suitability of certain investment products (i.e. investment deposits, unit-linked insurance products and voluntary pension funds) when offering them to clients. As similar requirements are applicable to investment firms when providing portfolio management or investment advice for investments in MiFID financial instruments, the amendments aim to eliminate regulatory arbitrage in the offering of investment products with a similar risk profile and to enhance consumer protection. Market participants need to comply with such new requirements latest by 30 June 2011.
Market manipulation clarified. The amendments of the Estonian Securities Market Act governing market manipulation entered into force on 3 April 2011. The amendments mainly relate to specifications of certain requirements and obligations concerning market manipulation deriving from the Market Abuse Directive (2003/6/EC). In particular, such amendments clarify indicators for determining market manipulation. The amendments are mainly due to recent court cases in Estonia on market manipulation in order to provide clearer instructions on what kind of trading practices indicate market manipulation and therefore could be considered illegal and punishable pursuant to law.
Pension fund system changed to implement lessons learnt from crisis. As from 1 August 2011 certain amendments to the Estonian regulation of pension funds will take effect. The amendments are based on research conducted in order to assess the effect of the financial crisis on the Estonian pension system.
As a result of the said analysis, additional and considerably stricter restrictions on investment were imposed on mandatory pension funds. Among other things, restrictions were placed on instruments in which the assets of a mandatory pension fund can be invested, based inter alia on the types and ratings of such instruments.
The amendments also establish more detailed requirements for reports concerning mandatory pension funds which must be provided to clients and which must clearly differentiate between the service of managing mandatory pension funds and other services offered by the management company.
Moreover, rules governing the change of a mandatory pension fund and the making of contributions to a new fund were made more flexible, making it easier for a unit-holder to change the mandatory pension fund. Under the new rules, units can be exchanged three times a year instead of only one time as currently permitted, and there are no longer limitations on making contributions to a new pension fund.
The Estonian regulator issues guidelines on responsible lending. The Estonian Financial Supervisory Authority recently issued its advisory guidelines regarding responsible lending requirements, which come into effect on July 1 this year. The guidelines expand upon certain statutory preconditions that currently apply to lending in Estonia. Among these preconditions are the obligations of credit institutions to collect and store information on the size of the financial obligations and performance of payment obligations by their clients and to use such data to calculate a reasonable loan load for the clients, as well as to inform their clients of the dangers related to the taking of loans. The guidelines, although recommendatory in nature, are aimed at increasing transparency in the provision of loans. The guidelines are available in English on the Financial Supervisory Authority’s website:
Estonian-funded start-ups win acclaim in Europe. This year has already brought fame (and money) to two budding start-up companies from the portfolios of Estonian venture capitalist firms. LSVenture’s portfolio company Delicioustaste AG, whose goal is to offer premium responsible foods to urban citizens, won the final stage prize of CHF 100,000 at the Swiss Venturekick start-up competition. Astrec Invests’s portfolio company, the Estonian-founded Virtual engineering bureau GrabCAD was selected as one of the three winners of the prestigious European start-up contest Seedcamp, bringing with it a EUR 50,000 investment by Seedcamp into the company. Both LSVenture and Astrec Baltic are Estonia-based investors whose portfolio is mainly comprised of companies active in the fields of IT, technology and life sciences.
Investment accounts now recognised in Estonian tax law. At the start of this year, amendments to the Estonian Income Tax Act entered into force, enabling natural persons to postpone the creation of their income tax liability for assets placed in an investment account under a specific taxation regime. Although the existence of investment accounts and related tax liability can be declared for the first time in 2012, the creation of investment accounts and the transfer of assets to those accounts can begin now. In addition to opening new accounts, any existing bank account can be converted into an investment account. The tax payer then simply has to declare that account as his or her investment account in the tax return in order for the taxation regime to be activated.
Conciliation body for insurance disputes established in Estonia. On April 11, 2011, a conciliation body for insurance disputes established by the Estonian Insurance Association commenced work. This provides policyholders an opportunity for solving insurance disputes without having to go to court or to the Insurance Court of Arbitration which operates with the Estonian Traffic Insurance Foundation. The aim of conciliation proceedings is for the parties to reach a mutual agreement with the help of conciliators. The conciliators are independent experts in the field of insurance, e.g. lawyers, legal counsels to insurance undertakings, officials of the Consumer Protection Board and the Ministry of Finance. The costs of the conciliation proceedings are borne by the insurance undertaking or intermediary with respect to whom the claim is submitted, irrespective of the outcome of the proceedings (except that, as a rule, the policyholder has to cover the costs of its witnesses and experts).
A new law took effect enabling natural persons to transform their debt upon difficulties with their payment obligations. A new law took effect enabling natural persons to transform their debt upon difficulties with their payment obligations.
On 5 April 2011 a new Law on the Transformation of Debt and the Debt Protection took effect. According to the new law, a natural person having difficulties with performing his or her payment obligations is entitled to apply for the transformation of his or her debt. On the basis of such application, the court may resolve to transform the debt of the applicant by either extending terms for the performance of his or her payment obligations, determining that the debt is payable in instalments or reducing the amount of the debt. As a general rule, the new law enables to transform the debt, which has become due and payable by the time the debtor applies for the transformation. As an exception, the future debt arising from long-term contracts (e.g. the credit agreements and leasing agreements) can also be transformed by the court.
By the Law on the Transformation of Debt and the Debt Protection, several legal provisions applicable to the usual loan collaterals were also amended, including inter alia that as from 5 April 2011 a surety provided by a natural person is always considered as consumer surety meaning that the maximum amount of liability of respective surety provider must be agreed upon. The new law also specifies that, irrespective of the type of the pledge, a pledgor who is not the debtor of the claims secured by such pledge is entitled to set up all defences against a claim secured by such pledge, which could have been set up by the principal debtor. Until recently, such principle was clearly set forth in the laws only in respect of mortgages but not in respect of other types of pledges.
Supreme Court thoroughly addresses several issues relating to reorganisation proceedings. The court stresses that only those claims that have fallen due at the time of commencement of reorganisation proceedings can be restructured, and not claims that have not fallen due or have not even arisen yet. Therefore, it cannot be decided for instance that a company would pay only one-half of all electricity and heating bills to be submitted to the company within the next seven years.
As to collateral claims, the court notes that claims for interest and contractual penalty can be restructured in a reorganisation plan in a manner similar to that applicable to other claims. However, collateral claims can also be reduced to a level permitted by law by restructuring them in a reorganisation plan, e.g. by declaring part of the claim void or by reducing the claim.
As for the termination of contracts in the course of reorganisation proceedings, the court rules that although creditors may terminate a contract during reorganisation proceedings due to a breach that has taken place before the commencement of the proceedings, such termination lacks a legal effect during the reorganisation proceedings, which means that it can be relied on only if the reorganisation fails.
The court also addresses the issue of conversion of claims into shares, stating that such a measure could be appropriate above all in cases where the entire share capital of the company is restructured. This means that the company’s share capital is reduced to a zero and, by an increase of share capital, new shares are issued which are distributed at least among major creditors based on the amounts of their claims. If this is not the case and the former majority shareholder retains control of the company being reorganised, the purpose of reorganisation has not been met. The replacement of claims secured by a pledge with shares in the company being reorganised is permitted only with the consent of the pledgee.
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Head of B&F in Estonia
- the legislator has used the terms “undertaking” and “transfer” in introducing a new legal institute of “transfer of an undertaking of a credit institution”, but has given those terms a meaning different from that established in the Commercial Law. Moreover, the legislator has provided that the principle of joint and several liability, which applies to the transfer of an undertaking, is not applicable to the new legal institute;
- the implementation of a new specific regulation for transfer of an undertaking of a credit institution is contrary to the principle of legal certainty because the principle of joint and several liability mentioned in the Commercial Law is not applicable to the new regulation;
- the contested provisions established that in certain cases the transfer of an undertaking of a credit institution cannot be declared null and void and is contrary to the Constitution of the Republic of Latvia because persons are deprived of their rights to defend their rights and legitimate interests by an effective defence remedy;
- the contested provisions do not provide for the involvement of shareholders and creditors of an undertaking in the process of transfer of an undertaking of a credit institution nor for the informing of creditors and third persons (clients). The aforesaid are deprived of the possibility to receive information on the administration of their property and on the obligations of the new owner of the undertaking of the credit institution.
The Court recognized that the contested provisions do comply with the Constitution of the Republic of Latvia; inter alia, the Court concluded the following:
- the Court has no jurisdiction to evaluate a discrepancy between legal provisions of equal force. Thus, the Court did not examine the claimants’ arguments regarding non-compliance of the contested norms with the provisions of the Commercial Law;
- the restriction (transfer of an undertaking of a credit institution cannot be declared null and void) is not contrary to the Constitution of the Republic of Latvia. The contested provisions do not prohibit persons from addressing a court of general jurisdiction in the case of an unlawful infringement and does not infringe the rights of persons to receive compensation and to recover losses if unlawfulness is proved;
- the Court has no jurisdiction to evaluate the creditors’ rights to receive information about the transfer of an undertaking of a credit institution.
The judgment of the Court is final and not subject to appeal. It is in full force.For more information please contact:
Head of B&F in Latvia
Consumer Credit Law came into force. On 1 April 2011, the Consumer Credit Law came into force, implementing Directive 2008/48/EC of the European Parliament and of the Council on credit agreements for consumers, and repealing the previous Council Directive. The Consumer Credit Law lays down the conditions for provision of a consumer credit and disclosure of information concerning the terms of provision of a consumer credit. The Consumer Credit Law also regulates the status of a credit grantor and credit intermediary in providing consumer credits and verifying the solvency of borrowers. The law provides for a periodic supervision duty for lenders and credit intermediaries as well as entitles borrowers to repay a credit before its maturity by paying a repayment fee.
Draft Law on Bankruptcy of Natural Persons. On 29 March 2011, the Ministry of Economy proposed a draft Law on Bankruptcy of Natural Persons. If enacted, the law would entitle natural persons to initiate bankrupt proceedings if their debts due exceed 25 minimal monthly salaries (approx. EUR 5,792). The law would provide a framework for the bankruptcy proceedings of natural persons, regulating such issues as the status of a bankruptcy administrator and meetings of creditors. During the bankruptcy proceedings, a natural person may fulfil his or her obligations and dispose of property only under the specific procedure. It is proposed that the Law on Bankruptcy of Natural Persons should come into force on 1 January 2012.
Supreme Court of Lithuania stresses insurer’s cooperation duty. The Supreme Court of Lithuania stressed the cooperation duty of an insurer during the provision of an insurance policy. The court highlighted that a professional insurer should seek to obtain all information which could be significant for the conclusion of an insurance contract. The court further stated that the insurer has to give important information which could help the client to choose a suitable type of an insurance contract. Thus, an insurer may be found liable for failure to provide an appropriate insurance cover.
Supreme Court of Lithuania on mortgage of appurtenances. The Supreme Court of Lithuania interpreted the provisions of the laws and regulations concerning mortgage of appurtenances created after the execution of a mortgage bond. The mortgage bond in question stipulated that all appurtenances to the mortgaged land plot were also mortgaged whether they existed or would be built in the future.
According to the court only land plots, apartments and buildings which are formed as separate units of real estate, have a unique number and are registered in the Register of Real Estate may be mortgaged. After creation of a new structure, its owner has to decide its legal status. The owner can register it as a separate building or he can register it as an appurtenance to the land or other real estate object. Similarly, the parties to the contractual mortgage bond can agree on the status of future buildings which will be built on the mortgaged land. The court stressed that in each situation such a thing had to be legally defined and recorded in the mortgage and real estate registers, because it was the only way to ensure legal certainty and to enable a mortgage judge to solve the case without delay. Thus, the court held that only objects registered as appurtenances were mortgaged.
Supreme Court of Lithuania on bankruptcy proceedings of limited liability companies. The Supreme Court of Lithuania clarified some issues concerning the bankruptcy proceedings of unlimited liability companies. According to the court when bankruptcy proceedings are instituted against an individual company, its owner also has to be joined to the proceeding as a co-defendant. The creditors who have financial claims can make claims against the company or its owner (it depends on with whom the transaction was conducted). The court further explained that when the creditor concluded a transaction with the owner of the company as a natural person, his claim does not end when bankruptcy proceedings are initiated and he has a right to be included in the list of creditors.
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Head of Baltic B&F
This legislative review is for information purposes only and does not reflect all aspects of legal regulation. Please note that the overview of the case law given in this newsletter is for information purposes only. Please be informed that the rules formulated by courts can be not applicable if the factual circumstances of a dispute were different from factual circumstances in those cases where such rules were formulated. For full legal advice please contact our law firm by phones or e-mails indicated in our webpage.