Secured Creditors Celebrate

A December’s decision of the Czech Constitutional Court (I. ÚS 760/18) came as sweet ending for banks and other creditors of the otherwise grim year. The Constitution Court pleased the lenders by annulling a decision of the Supreme Court in the case known as “Elma-Therm” (29 Cdo 4340/2011).

In its 2015 decision related to the bankruptcy of the company Elma-Therm, the Supreme Court ruled against Komerční banka (No. 3 bank in Czechia). In the court’s opinion, the bank’s claims, which arose as a result of payments under a bank guarantee, cannot be registered as secured claims. This was rather surprising as the bank’s claims under the guarantee were secured by the debtor’s assets. Moreover, the guarantee and the related security were granted long before the beginning of the insolvency proceedings against the debtor.

To put it simply, the bank guarantee was drawn by a third party only after insolvency filing against the debtor. The Supreme Court concluded that since the bank’s claims against the debtor related to the drawn guarantee arose after the insolvency filing, they cannot be considered secured claims. Although the reasoning was based on a the Czech insolvency code in force at that time, its effects actually stretched also to the current regulation, which precludes the debtor from establishing security over its assets after an insolvency filing.

The decision has been widely criticized by lenders and legal professionals as too formalistic and lacking economic rationale. Security for the bank’s claims related to disbursement of the guarantee was perfected in line with the hardening period. Challenging its enforceability could jeopardise the whole concept of bank guarantees on the Czech market.           

The issue was so serious that even the lawmakers had to react and have passed an amendment to the Insolvency Act which partially rectified the situation. Nevertheless, a certain degree of uncertainty for creditors remained.

The Constitution Court went the extra mile to make sure that secured creditors are appropriately protected and may rely on their security in case of the debtor’s insolvency when annulling the above decision. The court held that the mortgage shall be protected under the Czech constitution to the same degree as an ownership right. In the view of the Constitutional Court, the “Elma-Therm” decision of the Supreme Court negatively affected the constitutional rights of the creditor. The Constitution Court cited the Supreme Court’s failure to properly distinguish between the security purpose and payment purpose of the mortgage.

The conclusions of the Constitution Court and the related reasoning may be extended to the current legal and market practice. The key arguments of the court strengthen the position of secured creditors. They may refer to the persuasiveness of the decision in case of dispute or litigation.      

The emphasis of the Constitution Court on protection of legitimate interests and expectations of the creditors may be useful in other cases as well. For instance, the main arguments should also apply to other security instruments, which are subject to somehow ambiguous legal assessment when it comes to reliance on these instruments in insolvency, in particular pledge of future claims (typically insurance proceeds, rent payments, trade receivables) and enforceability of such pledge if those claims (i.e. object of security) arise after insolvency filing. In our opinion, the conclusions of the Constitution Court should apply accordingly and thus support the actual lending and collateral practice on the market.                   

By Martin Holler and Mgr. Radek Werich

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