Special Update on Legislative Changes re Pledges and Mortgages

 

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On 6 December 2011 the President signed Federal Law No. 405-FZ amending the Civil Code, the Pledge Law, the Mortgage Law and some other laws with a view to improving procedures for the enforcement of pledges and mortgages.

The key changes are as follows:

  • the amendments imply, with limited exceptions, the need to apply to a notary to enjoy extra-judicial enforcement (both when signing a security agreement and when enforcing);
  • possibility to realize secured property in accordance with the terms of a security agreement based on a court ruling;
  • changes in the methods of extra-judicial realization available for different types of property (e.g., mortgaged immovable property may not be directly sold to a third party, it may only be sold by way of an auction or acquired by the pledgeholder for itself); and
  • shorter terms for registration of mortgages.

Extra-Judicial Enforcement

Arrangements re extra-judicial enforcement

  • Under the amendments, the possibility of extra-judicial enforcement is to be provided for in a security agreement, the parties may no longer make a separate agreement on extra-judicial enforcement.

Need to apply to a notary

  • The amendments provide that if an agreement on a pledge of movable property is notarized, the pledge may be enforced based on a notary’s executive endorsement without resort to court. A similar rule is provided for mortgages over immovable property: enforcement of a mortgage in an extra-judicial procedure based on a notary’s executive endorsement is permitted based on a notarized mortgage agreement.
  • This language allows for different interpretations. In particular, it is not clear whether a pledgeholder is permitted to realize secured property by way of an extra-judicial procedure without a notary’s executive endorsement and therefore without the need to have a pledge (mortgage) agreement notarized (e.g., in instances where a pledgor is ready to voluntarily transfer the pledged property to the pledgeholder for further realization).
  • Overall, the amendments are worded based on the assumption that extra-judicial realization only occurs where there is a notary’s executive endorsement. For example, (1) the list of grounds for conducting an auction for the sale of pledged movable property is limited to a court ruling and a notary’s executive endorsement; (2) it is determined that the proceeds from extra-judicial realization of pledged property shall be distributed either by the auction organizer or, if no auction takes place, by the notary; and (3) the list of methods of enforcement entailing state registration of a transfer of title to mortgaged immovable property is limited to enforcement either based on a court ruling or on a notary’s executive endorsement.
  • Therefore, the more likely interpretation of the amendments is that extra-judicial enforcement of security will only be possible based on a notary’s executive endorsement, which, in turn, may only be granted with respect to a notarized pledge or mortgage agreement. Therefore, it is necessary that a security agreement be notarized for the purpose of using the extra-judicial procedure for the enforcement.
  • An exemption is expressly envisaged only for instances where, in accordance with a pledge agreement, the pledged property is held by the pledgeholder (although, in practice, pledged property commonly stays with the pledgor) – no notary’s executive endorsement is required in that case and therefore there is no need for the pledge agreement to be notarized in such case.

Notary’s executive endorsement

  • According to the amendments, a pledgeholder may ask the notary to make an executive endorsement in the event of non-performance or improper performance of a secured obligation (rather than the pledgor’s incompliance with the arrangements on extra-judicial enforcement, as previously).
  • The amendments introduce a detailed procedure for a notary to make an executive endorsement. In addition to the current requirement concerning an “undisputable” nature of the pledgeholder’s claims, it is now clearly envisaged that a notary will refuse to make an executive endorsement on a security agreement if the pledgor submits: (1) documents evidencing discharge of the secured debt, lack of grounds for enforcement or presence of grounds preventing enforcement; or (2) evidence that a court has applied interim measures with respect to the pledged property (the pledgor has 14 days to submit those documents after receiving notice from the notary with a suggestion that a secured obligation be performed). The notary will also refuse to make an executive endorsement if he/she sees himself/herself that there is no basis to enforce or that enforcement is not allowed under the law.
  • Therefore, the possibility of extra-judicial realization will largely depend on the way notaries will practically apply executive endorsement standards.
  • Based on a notary’s executive endorsement the pledged property will be seized by a court bailiff (or attached in case of immovable property or shares) and, as previously, will be handed over to the pledgeholder for further realization or, if so requested by the pledgeholder, sold in accordance with the procedure established for judicial enforcement. Extra-judicial enforcement based on security agreements made prior to the amendments
  • There are special rules on the state registration of a transfer of title to immovable property upon enforcement based on a mortgage agreement made before the amendments take effect. Transfer of title is to be registered based on: (1) a mortgage agreement providing for the possibility of extra-judicial enforcement, with a notary’s executive endorsement on it (or an agreement on extra-judicial enforcement if drawn up as a separate document); (2) the mortgagor’s notarized consent to extra-judicial enforcement, and (3) documents confirming sale of the mortgaged property at an auction or its acquisition by the pledgeholder.
  • Therefore, extra-judicial enforcement under mortgage agreements made previously will also require the obtaining of a notary’s executive endorsement. The possibility of extra-judicial enforcement of mortgages based on mortgage agreements that were not notarized will depend on whether the notaries are prepared to apply executive endorsement to such mortgage agreements.
  • The amendments do not expressly provide for any transitional rules on extra-judicial enforcement of agreements on pledge of movable property made previously. Apparently therefore, the above approach with respect to mortgages may be also applied by analogy to enforcement under those pledge agreements.
  • It remains unclear whether the pledgeholder enforcing security extra-judicially after the amendments take effect will be able to use realization methods not envisaged under the amendments (but envisaged under its pledge or mortgage agreement): i.e., sell the property pledged by an individual who is not an entrepreneur through a commission agent; acquire the mortgaged immovable property for a third party; or acquire for itself the immovable property mortgaged by an individual who is not an entrepreneur.

Enforcement Based on a Court Ruling

Instances where a court ruling needs to be obtained

  • The amendments have changed the list of instances where a pledgeholder needs to go to court to enforce its security. In particular, the list will no longer include instances where the pledged (mortgaged) property belongs to an individual and a third party’s consent was required for the pledge. Therefore, it will be possible to enforce extrajudicially (1) security granted by married individuals, and (2) a pledge over participation interest granted by an individual being one of the participants of a limited liability company (irrespective of whether such individual is married). An exception relates to residential premises: the pledgeholder will still need to go to court to enforce a mortgage over residential premises granted by an individual.
  • The list of instances where resort to court is needed has been extended to include the following: (1) the secured property is subject to a prior and a subsequent pledge (mortgage) whereby different enforcement procedures or different realization methods apply, or (2) the property is pledged (mortgaged) to several co-pledgeholders to secure different obligations.
  • Finally, pledgeholders will need to go to court in case the pledgor is absent only where the pledgor is an individual who was officially recognized as a missing person.
  • Presumably, the need to enforce security based on a court ruling in statutory instances does not rule out possible further realization of the secured property in accordance with the security agreement (please see below).

Realization as per the terms of a security agreement based on a court ruling

  • The amendments allow the parties to agree that the pledged or mortgaged property will be realized based on a court ruling in accordance with the terms of a pledge (mortgage) agreement.
  • In this case pledged movable property is to be sold at an auction (i.e., the pledgeholder may benefit from an auction organized on its own as opposed to public sales arranged by a court bailiff that would take place in case of judicial sale). The amendments are not clearly worded as to whether other realization methods (i.e., sale without an auction or acquisition of the pledged movable property by the pledgeholder) may also be used in such case.
  • For mortgaged immovable property, the amendments expressly provide that an auction or acquisition of the mortgaged property by the pledgeholder are available in such case.

Price

  • It is specified that in case of judicial enforcement the agreement on the price is to be reached between the pledgor and the pledgeholder in the course of judicial proceedings, and in the absence of such agreement the price will be determined by the court.

Methods of Extra-Judicial Realization of Pledges and Mortgages

  • The amendments expressly state that a pledge agreement may provide for several methods of extra-judicial realization of pledged movable property, and it is the pledgeholder who may choose the particular method, unless agreed otherwise.
  • However, the amendments are not that straightforward with respect to mortgages over immovable property, so the concerns as to whether it is appropriate to specify several methods of extra-judicial realization in a mortgage agreement remain.
  • The scope of available methods of extra-judicial realization has changed. Thus, realization of pledged movable property through a commission agent is no longer available for pledges granted by individuals who are not entrepreneurs. Only auction is available in such case.
  • As to mortgages, the pledgeholder may no longer acquire the mortgaged property for a third party. In addition to an auction, the only other opportunity left for the pledgeholder is to acquire the mortgaged property for itself. Moreover, the pledgeholder may not acquire mortgaged property for itself if the mortgage is granted by an individual who is not an entrepreneur. On the other hand, the prohibition for the pledgeholder to acquire mortgaged property where it is a land plot has been lifted.

Procedure for Extra-Judicial Realization of Movable Property

Notice prior to realization

  • The pledgeholder will be entitled to realize pledged property no sooner than upon the expiry of 10 days from the day when the pledgor receives relevant notice (a pledge agreement may envisage a longer “grace period”). Apparently, the reference is to the notice a notary gives to the pledgor before making an executive endorsement, containing a suggestion that the secured obligation be performed.
  • If the pledged property is held by the pledgeholder in accordance with the pledge agreement, a different rule applies: the pledgeholder is entitled to realize the pledged property if the pledgor does not submit documents confirming the discharge of the secured debt within 20 days of the receipt of the pledgeholder’s notice with a suggestion concerning performance of the secured obligation.
  • The amendments contain detailed rules for giving notices in connection with the enforcement of security and describe how to determine the moment of receipt of the notice by the addressee.

Price

  • The amendments envisage that the pledged movable property may be acquired by the pledgeholder or sold to a third party (including through a commission agent) at a price equal to or even higher than the market price; such market price is to be determined by an independent appraiser.
  • An interested party who does not agree with the appraisal may claim from the pledgeholder damages incurred due to realization at the price determined by the appraiser.

Auction

  • The amendments specify that an auction for the sale of pledged movable property stands for an open auction; the auction organizer is to be indicated in the pledge agreement.
  • Further, the amendments describe a procedure for conducting the auction in greater detail, ranging from specific requirements to the contents of an announcement of the auction to the requirement on the signing of a separate agreement on the sale and purchase of the pledged property (in addition to the auction minutes).
  • Finally, if the pledgeholder tried to realize the pledged property by sale through a commission agent and the commission agent failed to sell it within the term specified in the pledge agreement or, if none is agreed, within a reasonable term, the property is to be sold at an auction. Mortgaged property may only be realized at an auction or acquired by the pledgeholder for itself

Timing

  • If the pledged property is not realized within the term specified in the pledge agreement or, if none is agreed, within a reasonable term, the pledgor may claim from the pledgeholder damages caused by the delay.

Transfer of title

  • The amendments specify that if the pledgeholder chooses to acquire the pledged property, it will obtain title to the property as of the moment the property is transferred to it, or, if the pledgeholder already holds the property, as of the moment the pledgor receives an enforcement notice from the pledgeholder (unless the law provides for a different moment for title to a particular property to arise). Therefore, obtaining title to the pledged property, generally, depends on obtaining possession of such property. Specifics of extra-judicial enforcement of pledges over certain types of movable property

Pledge of participation interest

  • The amendments expressly recognize the possibility of extra-judicial enforcement of a participation interest pledge. As noted above, given the lifting of the restriction on extrajudicial enforcement when a pledge was granted by an individual and required a third party’s consent (a participation interest pledge requires the participants’ consent), it will be possible to enforce a pledge of participation interest extra-judicially even if it was granted by an individual.
  • The amount of stamp duty payable for the notarization of a participation pledge agreement has been changed: it will range from RUB 1,500 to RUB 150,000 (around US$ 50 to US$ 150,000). No appraisal of the participation interest will be needed to calculate the amount of the duty (such amount will depend on the value of the participation interest specified in the pledge agreement).

Pledge of traded shares

  • The amendments expressly allow the pledgeholder to acquire pledged shares traded on a stock exchange. Such shares are to be acquired at the price which is indicated (or the procedure for the determination of which is indicated) in the pledge agreement or, if none is agreed, at the price determined by the appraiser. It will also be possible to sell such shares through a commission agent, using similar rules on pricing.

Pledge of rights

  • The amendments have slightly changed the list of property to be evaluated by an appraiser for its sale at an auction. In particular, such property includes property rights; the previous exemption for receivables has been lifted.
  • It is specified that if the pledgeholder uses such realization method as acquisition of the pledged rights, they will pass to the pledgeholder when the pledgor receives its notice of acquisition of the rights (unless the law provides for a different moment of transfer of certain rights).

Distribution of proceeds

  • In case of extra-judicial realization of pledged property, the proceeds will be distributed by the notary (or the auction organizer, if there was an auction).
  • By analogy with the rule envisaged in the Mortgage Law, the amendments mention distribution of proceeds not only among the pledgeholders who submitted their claims, but also among “other creditors” of the pledgor. This raises a concern as to whether the proceeds may be used to discharge unsecured claims (although, on the contrary, the amendments to the Enforcement Law prohibit attachment of pledged property to secure claims of creditors who do not enjoy priority over the pledgeholder).
  • Besides, according to the amendments, the distribution of proceeds to pay fines and penalties is to follow the distribution of proceeds to discharge all the other claims.

Mortgage

Specific enforcement issues

Enforcement where the secured debt is to be discharged by way of periodic payments

  • The rule allowing the pledgeholder to enforce the mortgage upon systematic (i.e., more than three times in a twelve-month period) non-performance of the secured obligation, even if each delay is insignificant, applies both in case of judicial and extra-judicial enforcement. As previously, the application of this rule may be excluded in a mortgage agreement.

Specifics of acquiring mortgaged residential premises

  • The amendments provide for instances where the secured debt is considered fully discharged even if the current value of the mortgaged property is insufficient for that: this will happen provided (1) the mortgaged property constitutes residential premises, (2) it is acquired by the pledgeholder (where this is allowed by the law), and (3) the amount of the secured debt is less than or equal to the value of the mortgaged property as determined at the time the mortgage was granted. Thus, if the value of the mortgaged residential premises allowed to secure the debt in full when a mortgage loan was granted but decreased afterwards, the debt will still be considered discharged in full if the pledgeholder acquires such mortgaged premises.

Issues other than enforcement

Registration of a mortgage; termination of the record on a mortgage

  • The amendments shorten the current one-month term for registration of mortgages over land plots, buildings and non-residential premises: such mortgages are to be registered within 15 business days and, if a mortgage agreement is notarized, within 5 business days of the submission of the required documents. In the latter case it is the notary who is responsible for the legal expert analysis of the documents and the legality of the transaction.
  • If a mortgage agreement is notarized, it may be registered, in particular, based on an application of the notary who notarized it.
  • A mortgageholder or a mortgagor may ask the notary to apply for the termination of the registration record on the mortgage. The mortgagor’s application is to be accompanied by a number of documents, including one confirming the discharge of the secured debt and signed by the pledgeholder.

Mortgage of buildings and premises

  • The parties will no longer be able to agree that the mortgage of a land plot does not extend to the mortgagor’s buildings located or being built thereon: mortgage over a land plot will always extend to such buildings.
  • Where a building is mortgaged there will no longer be any need to also mortgage the lease rights to the underlying land plot (as opposed to a land plot owned by the mortgagor), because the mortgage over the building will extend to the land lease rights automatically.
  • The amendments expressly provide that where non-residential premises are mortgaged, the right to share in the common title to the relevant building and the share in title to the relevant land plot (rights of a co-tenant of the land plot) are deemed mortgaged as well.

Statutory mortgage

  • A statutory mortgage over a building or premises (both residential and non-residential) acquired (built) with borrowed funds will arise upon registration of the mortgage over such building or premises (rather than registration of the borrower’s title to such building or premises, as was the case previously). Registration is to be effected based on an application of the mortgageholder (mortgagor).

Pledge of Aircraft, Vessels and Rolling Stock

The amendments confirm that pledge (mortgage) agreements with respect to aircraft, sea and river vessels, rolling stock and spacecraft do not need to be notarized.

The amendments will enter into force on 7 March 2012, save for the rules regarding stamp duty for notarization of participation interest pledge agreements, which entered into force on 8 January 2012.

For further information please contact Igor Ostapets or Irina Dmitrieva in the Moscow office of White & Case, tel + 7 495 787 3000 .

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