Assignment for security of rights under a promissory note
Assignment of rights for security is a popular method of securing claims on the Polish market. This is due to the great flexibility of this instrument and the absence of such formalities as registration in court. In short, such assignment consists of transferring to the lender claims held by the borrower against third parties (e.g. receivables for the sale of goods). If the credit is not repaid on a timely basis, the proceeds from the claims assigned for security can be used to satisfy the lender’s claims. But can the rights under a promissory also be assigned in this manner?
In various financing transactions, a common security is assignment of rights under intra-group loans. This makes intra-group financing more strongly subordinated to repayment of external debt financing (e.g. bank credit). In some capital groups, due for example to tax advantages, instead of traditional loan agreements governed by the Civil Code, another legal instrument, the promissory note, is used. Then it should be considered what type of security to establish against such promissory notes so that, as in the case of assignment of rights under loans, the subordination of such intra-group financing is reinforced.
Assignment or registered pledge?
A well-regulated and proven method of security is a registered pledge on the rights under a promissory note. Unfortunately, sometimes a pledge cannot be used due to business arrangements or the structure of the transaction. Moreover, a registered pledge entails certain formalities and costs, such as registration in court and making a pledge endorsement on the promissory note. In addition, each promissory note means a separate pledge, with a court free and registration proceeding. If there are numerous promissory notes, establishing such security becomes costly and time-consuming. Endorsing the promissory notes can also give rise to problems because of the great formalism of this procedure, difficulties in the construction of a trust endorsement for security, and the ban on endorsement of the promissory note often occurring in promissory notes incorporating intra-group loans. In this situation, assignment for security offers greater flexibility.
Assignment only of unendorsed promissory notes
Under Art. 517 §1 of the Polish Civil Code, the provisions on assignment do not apply to claims connected with a bearer instrument or an instrument that is transferrable by endorsement. Pursuant to Civil Code Art. 517 §2, transfer of claims under a bearer instrument occurs through transfer of ownership of the instrument, for which delivery of the instrument is essential, as (under Art. 91712) transfer of rights under a bearer instrument requires delivery of the instrument. There is no doubt that a completed promissory note can be transferred by endorsement, but there are doubts whether the claim under a completed promissory note can be transferred through an assignment based on the Civil Code. A literal reading of the above provisions suggests that this solution is impermissible.
But the case law, relying on a functional and purposive interpretation of the regulations, takes the position that the ban set forth in Civil Code Art. 517 §1 applies only to a claim under a promissory note that has already been endorsed (Supreme Court of Poland judgments of 5 February 1998 (case no. III CKN 342/97), 6 November 1998 (case no. III CKN 7/98), and 8 October 2008 (case no. V CSK 124/08)), i.e. when the rights to the claim have already been transferred using the formal mechanism provided for in the law of promissory notes (endorsement). This is the prevailing view of the Supreme Court. In justification of this view, the courts indicate that the specific method provided for in Civil Code Art. 517 §2 for transfer of claims incorporated into bearer securities does not exclude the possibility of transferring them under the general rules set forth in Civil Code Art. 509–518 (with the necessary modifications). Thus an assignment for security of rights under an unendorsed promissory note will require conclusion of an assignment agreement in accordance with the Civil Code. It should be borne in mind that due to the security nature of the assignment, it should be made in writing with a certified date (Art. 84(2) of the Bankruptcy Law).
Necessity to deliver promissory note document
But despite the above conclusions, an assignment of rights under a promissory note will still be covered by Civil Code Art. 92112, which provides that transfer of rights under a bearer instrument requires delivery of the document. It is impermissible to transfer the claim itself associated with the bearer instrument by way of assignment without delivering the document itself, because otherwise the debtor might be exposed to the risk of having to pay the same claim to two different creditors, even though the promissory note had not been endorsed. Because a promissory note claim is incorporated into the promissory note itself, delivery of the promissory note is essential for the assignment to be effective. It should be pointed out in this respect, however, that delivery as such is essential only for the effectiveness of the assignment, and does not have to occur at the same time and place as conclusion of the agreement on assignment for security. The agreement itself, without physical delivery of the promissory note, will be valid and binding, although the assignment will not be effective until physical delivery of the promissory note, and in the interim will essentially exist in suspended animation.
This situation will occur in particular when the security on promissory note claims will have a lower priority of satisfaction (e.g. in secondary financing of the mezzanine type, or in refinancing, until the refinanced debt is repaid). Thus an assignment for security of rights under a promissory note may also be used when there is a need to establish security with a lower-ranking order of satisfaction.
Return of promissory note in the event of conditional assignment
With respect to an assignment with a lower ranking priority of satisfaction, it should be pointed out that no one can lawfully assign to another more than the assignor himself holds. Thus an assignment for security of rights that have already been assigned to another entity as security with seniority in satisfaction must be a conditional assignment. The basic condition will be the restoration to the assignor of the rights to the property. But then the risk arises that the promissory note document will be returned to the assignor’s possession and the assignment will remain ineffective. For this reason, the parties should consider signing an understanding between the senior creditor, the junior creditor, and the debtor setting forth the rules for return of the promissory note documents after payment of the senior debt and release of the security. Such an understanding should specify that the senior creditor will transfer the promissory note documents directly to the junior creditor, bypassing the debtor, and the debtor unconditionally and irrevocably consents to this procedure. Such a legal construction ensures that after payment of the senior or refinancing debt, the lower-ranking security will become effective without the debtor’s involvement, upon delivery of the promissory note by the senior creditor.
In summary, an assignment for security of claims under unendorsed promissory notes is permissible under Polish law and can offer an interesting and simpler alternative to a pledge on promissory notes, mainly due to the ease and speed of establishing such security, and also execution, the rules for which can essentially be addressed in the agreement on assignment for security, in line with the principle of freedom of contract.
Mateusz Tusznio, adwokat, Banking & Project Finance practice, Wardyński & Partners