One of the main factors influencing the decision to invest in bonds is how to secure claims on those bonds. At the same time, and importantly, a particularly careful analysis of the investment in terms of the quality of its collateral should accompany high-interest bonds. Bond collateral – do they provide effective protection for bondholders’ claims? We will answer this question in the following article.
Security for bondholders’ claims in legislation
The Bond Law, in Article 5(1)(9), stipulates that where collateral has been established for claims arising from bonds, or the issuer has undertaken to establish such collateral or additional collateral in the future, the WEO (terms and conditions of the bond issue) is to include the amount, form and terms of such collateral, including information on the manner of satisfaction from the subject of the collateral, the date of establishment of the collateral or the planned date of its establishment, and the valuation referred to in Article 30, or an abbreviation of the valuation and justification for the selection of the valuator.
Among the many types of bond collateral, I would like to pay special attention to two of them, which, according to my practice, are most often used.
Speaking of collateral for bond claims, you most often hear about the so-called “three sevens” (although formally they do not constitute collateral for claims, but only facilitate the enforcement of claims).
The debtor subjects the company to execution under Article 777 par. 1 para. 5 of the Code of Civil Procedure in a notarial deed, up to a certain amount, as to the obligation to pay to the creditor all monetary amounts due to be paid by the issuer, which will result from bonds held by bondholders, in particular the obligation to pay interest and principal.
Upon fulfillment of the specific conditions under the deed, the creditor may apply to the court for an enforceability clause to be placed on the subject deed.
After obtaining an enforcement title (which is a notarial deed with an enforcement clause), the creditor may go to a court bailiff with a request to initiate enforcement proceedings against the issuer. The issuer’s submission to enforcement under Article 777 par. 1 para. 5 of the Code of Civil Procedure up to the amount specified in the deed, allows the creditor to identify virtually all of the issuer’s assets from which enforcement is to be carried out.
At about this stage, optimism and hope for efficient and effective recovery of invested funds by the bondholder-creditor often fades. Why? Firstly – to the surprise of the bondholder, it turns out that the initiation of enforcement proceedings entails considerable costs (including the conduct of enforcement, search for assets, advance payments for the opinion of an expert), secondly – covering the costs of court enforcement does not at all guarantee effective enforcement of the debt. This is because it often turns out that the bailiff returns to the bondholder with the information that the issuer has no assets, or that the assets it does have are secured by a mortgagor, or that the issuer’s assets from which enforcement was conducted are of such low value (not infrequently contrary to the original valuation conducted by the issuer) that their auction turns out to be ineffective.
Thus, it is not difficult to see that the debtor’s submission to execution under Article 777 par. 1(5) of the Code of Civil Procedure protects the interests of the bondholder insofar as the issuer actually has assets that the bondholder could subsequently cash as a result of enforcement proceedings.
The practice of issuing notarial deeds specified in Article 777 pr. 1 points 4 and 5 , in which a person who is not a personal debtor and whose property, claim or right is encumbered by a mortgage or pledge submits to execution from the encumbered object in order to satisfy the monetary claim of the secured creditor, is also relatively common in the ECO (Article 777 par. 1 point 6 of the Code of Civil Procedure).
The bondholder may then make expedited use of the security interest established by the debtor in rem in the form of a mortgage or a registered pledge, without the need for court proceedings, by merely filing an application with the court for a clause of enforceability on the notarial deed in which the debtor in rem has subjected himself to enforcement under Article 777 par. 1 pt. 6 of the Code of Civil Procedure.
Unfortunately, if the bondsman is counting on quick and effective enforcement against the property of the debtor in rem, he may be disappointed here as well.
The ingenuity of debtor companies in making it difficult for mortgage creditors to satisfy their claims from the subject matter of the claim is really high, and although the legislature is trying to keep up with it by introducing new solutions to protect the interests of creditors, the satisfaction of the bondholders’ claims, even if they eventually come to fruition, can be significantly postponed.
Thus, one of the creative methods of debtors in rem to avoid the realization of the claims of the mortgagor are sales and subsequent resales of the property subject to the mortgage in a short interval. The practice of transferring ownership of the mortgaged property “from hand to hand” by two or more companies is designed to prevent the creditor from obtaining a writ of execution on the debtor in rem – that is, the current owner of the property.
In order to successfully initiate enforcement against a mortgaged property, a mortgage creditor must have an enforceable deed issued to the current owner of the property. However, in practice, it often looks like this: when the creditor applies for an enforcement clause on the deed under Article 777 par. 1 para. 5 in connection with para. 6 against the current owner of the real estate, even before the court grants an enforceability clause (or just after it is granted, but before enforcement proceedings are initiated) the mortgaged real estate changes hands making it impossible to initiate enforcement proceedings against the subject of the security in rem.
The examples listed here are only an outline of the issues that bondholders realizing their claims from bond collateral often face.
Dishonest debtors in rem (and often the issuers themselves) are also known to act to bring about a situation in which the attractiveness of the property significantly decreases through which, the chance of acquiring it by auction also decreases.
An example of this is leasing or renting out mortgaged real estate for a fixed term of, for example, 30 years, retaining a deposit of sizable, often million-dollar amounts as collateral for a claim for payment of rent.
The above considerations tend to give a negative answer to the question in the title of this article. This is because it is difficult to call any of the collateral established by issuers as fully secure. The decision to invest in private placement bonds should therefore be preceded by a detailed analysis of the issuer’s financial situation, as well as the determination of the actual reason why the company decides to issue bonds. The issuer’s search for ways to cover its growing debt will certainly not herald a good investment for a potential bondholder.
Have questions or concerns – write to us: kancelaria@rsplegal.pl
Want to contact the author directly: Judyta Garwacka – Polisiak, Attorney at Law, e-mail: judyta.garwacka@rsplegal.pl
