Enforcement on a Pledged Commercial Undertaking in Case of Insolvency

The Law on Registered Pledges (LRP) stipulates that the initiation of bankruptcy proceedings shall not stop an already commenced execution on pledged property. Given such a scenario, the insolvency administrator should pass the pledged property to the creditor, who has the right to sell it on their own behalf and to the expense of the debtor. Should the sale fail to be completed within 6 months of registering the execution, each subsequent creditor, who registered an execution commencement, may sell the pledged property.

Despite the seemingly clear legal provisions governing the contention between the two proceedings, in reality problems occur in cases where the pledged asset is the commercial undertaking of the debtor, only a single pledgee has commenced the execution and subsequently, bankruptcy proceedings against the debtor have been initiated.

Pursuant to the LRP, the insolvency administrator should resign the business to the pledgee, who in turn is empowered to organize its sale within 6 months time. There are, however, cases when the pledgee’s inaction leads to the impossibility to finalize a sale. If, in addition to the above, we consider the hypothesis of a single creditor, who proceeded with the execution of the pledge, the pledged assets could remain at the disposal of said creditor for an indefinite period of time due to the lack of another creditor, who has rights over the undertaking and seeks to sell it.

In such a scenario, when the debtor is facing the above described enforcement phase under the LRP, and bankruptcy proceedings are opened up against them, all other creditors have to make their claims within the initiated proceeding. In this case, through, the bankruptcy estate remains empty as the debtor’s business has been resigned to the pledgee within the other proceedings. Thus, it appears that creditors would have to wait on the pledgee to entirely satisfy their claims through the sale of the business and return the remaining funds raised from the sale (or individual elements of the business ) to the bankruptcy estate, as far as there are any left.

Practical problems are aggravated by contradictory case law on a number of issues: can the pledgee, who failed to sell the pledged property within the legally binding term and lacking another pledgee who commenced an execution, conduct the sale after that term has expired; can the commencement of execution be renewed; for how long can the pledged property remain at the pledgee’s disposal without them actually conducting the sale; is it necessary for the pledgee to raise claims within the initiated bankruptcy proceedings, as well as other similar matters.

In the above case, the pledgee’s delay (regardless of whether it is intentional or not) in selling the pledged undertaking may reduce the latter’s value and be thus considered harmful to the bankruptcy estate, respectively injuring other creditors’ interests.

On the other hand, there is a real risk that the pledgee, having failed to sell the commercial undertaking, is unable to satisfy their claims. Having relied on execution under the LRP, the pledgee might have omitted to file a claim under the bankruptcy proceedings. Should they then conscientiously return the pledged assets to the bankruptcy estate, the pledgee would have no rights over them, due to the fact that they are not considered a creditor under the bankruptcy proceedings.

In connection with the above, we believe that part of the problem arising from the two proceedings can be overcome if pledgees are made aware of certain risks and advised to always make claims under the bankruptcy proceedings, not just rely on execution under the LRP. The above described situation could also be avoided through some legislative changes, envisioning the exofficio institution of the pledgee, who has commenced an execution under the LRP, as a creditor under the bankruptcy proceedings.

The lack of explicit regulation regarding the above hypotheses, combined with the existence of ambiguous case law, creates substantial difficulties in providing adequate protection of creditors’ interests. Thus, legislative changes and/or creating a unanimous case law in this regard is badly needed.