Under the Dutch Act on Confirmation of Extrajudicial Restructuring Plans (“CERP Act” or “Dutch Scheme”, in Dutch: Wet homologatie onderhands akkoord, or WHOA), companies can restructure their excessive debt by agreeing on a composition with their creditors and shareholders. Most corporate financing is provided by banks and/or other financiers such as lease companies, factoring companies, private equity firms and/or other shareholders. To ensure repayment, those financiers – often a company’s largest creditors – generally require security in the form of mortgage rights or rights of pledge. A right of mortgage or pledge gives the creditor a preferred position. Under section 278(1), Book 3 of the Dutch Civil Code, these creditors have priority over ordinary creditors to the collateral that has been given in mortgage or pledge. Under sections 248(1) and 268(1), Book 3 of the Dutch Civil Code, they are also entitled to exercise their rights without requiring a court ruling (in Dutch: parate executie). Section 57(1) of the Dutch Bankruptcy and Insolvency Act (Faillissementswet) designates them as secured creditors, meaning that they can bring their rights to bear even if the debtor that granted the mortgage or pledge is insolvent. With the introduction of the Dutch Scheme, the question is whether or not it prevents creditors from exercising their rights of mortgage or pledge.
Position of pledge and mortgage holders
The Dutch Scheme gives companies in financial distress an opportunity to restructure their excessive debt by offering their creditors an extrajudicial composition. This can also include financiers with rights of pledge or mortgage, which form a separate class in the composition, as preferential creditors. The Dutch Scheme increases the capabilities of distressed companies to reorganise, based on the premise that the company’s operations should continue without interruption as much as possible while the Dutch Scheme applies. If third parties proceed to exercise rights – including vendors with a retention of title but also pledge and mortgage holders – this could disrupt the operations and so make the composition less likely to succeed. To prevent this from happening, the company’s board of directors or (if one has been appointed) the restructuring expert may ask the court to impose a cooling-off period under section 376 Insolvency Act. So where does this leave pledge and mortgage holders?
What a cooling-off period means for pledge and mortgage holders
It takes time for a composition to come about. During that time, the risk exists that creditors that are aware of a company’s financial struggles will not sit still, but instead will seek redress to secure their rights. This can badly disrupt the company’s operations and so depress its value as a going concern. By limiting the possibilities for third parties to exercise their rights, a cooling-off period prevents the restructuring process from being disrupted.
Although the rules governing cooling-off periods under the Dutch Scheme are the same as for cooling-off periods in situations of insolvency and suspension of payments, they also include a number of specific provisions; for more details, see our blog about cooling-off periods under the CERP Act.
Section 376(2)(a) Insolvency Act prevents pledge and mortgage holders from enforcing their rights of recovery against pledged assets and claims and against mortgaged registered property during the cooling-off period, except if the court authorises them. Among other implications, this means that pledge and mortgage holders cannot take recourse against the pledged or mortgaged collateral during the cooling-off period by means of a regular or forced sale.
Section 376(7) and (8) Insolvency Act contain specific provisions for pledge holders with pledges on, or rights of usufruct to, registered claims. While the cooling-off period continues, the holder of a right of pledge on or right of usufruct to a registered claim may not announce the pledge, take receipt of payments or offset payments against a claim on the debtor; during a cooling-off period in insolvency or a suspension of payments, conversely, it is permitted for pledge holders to announce their rights and take receipt of payments. Why then do pledge holders not have the authority to do so during a cooling-off period under the Dutch Scheme?
Holders of pledges on claims: restrictions on their rights in the Dutch Scheme
For holders of pledges on claims, two arguments can be made why their possibilities for exercising their rights should be severely restricted during a cooling-off period under the Dutch Scheme:
- if the pledge is announced, only payments can be made to discharge obligations to the pledge holder, and the debtor will no longer receive any revenues and its survival as a going concern will be in immediate jeopardy;
- if the pledge is announced, this might upset debtors and so, with contracts drying up, similarly jeopardise the company’s continued existence as a going concern.
Does this mean that holders of pledges on claims are left with nothing?
The decision to restrict the powers of holders of pledges on registered claims during the cooling-off period is justified by the fact that the debtor needs to have access to sufficient operating capital to continue its operations. To safeguard the pledge holder’s rights, section 376(7) Insolvency Act states that the debtor must “provide sufficient alternative security” for the pledge holder’s recourse based on the right of pledge. As a rule, that alternative security will involve pledging new claims that result from the continued operations: as the “debtor in possession”, under the Dutch Scheme the company retains the authority to manage and dispose of its assets, which allows it to continue its operations and pledge new claims.
The rules for cooling-off periods under the CERP Act provide several guarantees for the parties whose rights can be suspended by a cooling-off period, including holders of pledges on registered claims. As already noted, section 376(7) Insolvency Act requires sufficient alternative security. Pledge holders should be careful that the alternative security is sufficient, however, and should demand regular updates about the claims, as well as the debtor’s aging analysis and a list of claims noting any features such as intercompany claims, claims that are available for offset by the debtor and claims on debtors from countries where judicial debt collection and/or enforcing foreign judgments is expensive or difficult.
What facilities are available to pledge holders to safeguard their position?
Pledge holders need to stay alert to ensure that their interests are sufficiently safeguarded and that sufficient alternative security is provided for recovering their claims under the pledge. If those interests are not sufficiently guaranteed, for example if the alternative security that is provided is not sufficient or loses value while the composition is being prepared, the pledge holder can draw on the following facilities:
- under section 376(2)(a) Insolvency Act, the pledge holder may ask the court to authorise recovery of the claims from the assets pledged by the debtor;
- any creditor (whether or not a pledge holder) that believes that no grounds exist for imposing a cooling-off period, or that a cooling-off period will materially harm its interests (for example because the alternative security is or becomes insufficient), may ask the court to lift the cooling-off period (section 376(10) Insolvency Act);
- under section 376(9) Insolvency Act, either when ordering a cooling-off period or when it is already in place, and acting either on its own motion or on the request of the debtor, the restructuring expert or a creditor affected by the cooling-off period, the court may impose relief to secure the creditors’ interests, including an order to periodically share information about claims, an aging analysis etc.;
- under section 376(9) Insolvency Act, when ordering a general cooling-off period, and either on the request of a pledge holder, mortgage holder or other party or on its own motion, the court may appoint an observer within the meaning of section 380 Insolvency Act;
- the court will hear the creditor’s views in connection with a ruling on whether or not to extend the cooling-off period (section 376(5) Insolvency Act), impose relief within the meaning of section 376(9) Insolvency Act, or lift the cooling-off period (section 376(10) Insolvency Act).
The purpose of the cooling-off period in the Dutch Scheme is to allow companies to continue their commercial operations with as little disruption as possible. A cooling-off period under the Dutch Scheme facilitates this by suspending and/or restricting the rights of creditors, including severely restricting the rights of holders of pledges on registered claims while the cooling-off period lasts. However, it seems that the rules offer those pledge holders sufficient safeguards to prevent unnecessary or improper use of the facility. It is also vital for pledge holders to closely monitor developments and regularly demand information from the debtor or (if appointed) the restructuring expert, to establish whether the alternative security is sufficient and the creditor’s interests are properly safeguarded. If not, the pledge holder will need to take action.