General principles
Levy of execution on pledged property
Realisation of pledged property

The Supreme Arbitrazh Court has approved the Resolution on Certain Matters Relating to the Enforcement of Legislation on Pledges (10/2011). The document, which was issued on February 17 2011, summarises court practice in the application of pledge and mortgage legislation since the law was reformed in 2008, and offers interpretations of a number of controversial issues. However, the resolution does not cover all problematic situations in this area - the issue of providing security in favour of an agent, such as a bank in a syndicated lending arrangement, remains unresolved.

General principles

Altering the terms and conditions of an obligation (eg, increasing the interest rate or extending the loan period) without the pledgor's consent does not, in itself, constitute grounds for termination of the pledge that secures the obligation. In this case the pledge secures the obligation on the original terms and conditions, unless the parties have agreed that the pledge will secure the principal obligation as amended. There are strong grounds to consider that when parties enter into a pledge agreement, they may agree possible alterations to the principal obligation (eg, an increase in the loan amount by a defined sum) that the pledge will continue to secure - this is generally termed 'consent expressed in advance'.

The resolution reaffirms the court's position that agreements for pledges of aircraft, seagoing vessels and rolling stock do not require notarisation.

A mortgage continues to subsist in the event of an owner subdividing one or several premises within a non-residential building that is covered by a pledge.

Levy of execution on pledged property

The resolution confirms that a pledge agreement can provide for both court procedures and out-of-court procedures for levying execution on pledged property. An agreement on an out-of-court procedure for pledge enforcement does not prevent a pledgee from seeking enforcement of the pledge in court. Moreover, a pledgee may claim in court for pledged movable property to be transferred to it for realisation by means of an out-of-court procedure, if the agreement so provides.

Where a pledgor disposes of pledged property (eg, by selling or leasing it) without the pledgee's consent, the latter may accelerate the principal obligation and levy execution on the pledge. However, a defence exists for good-faith acquirers. Execution cannot be levied on pledged property where:

  • the pledgor sells the pledged property (ie, movable property) for a consideration; and
  • the purchaser is unaware that the acquired property has been pledged (and could not reasonably be expected to be aware of the fact).

Where the pledged property is held by the pledgee and ceases to be in its possession against its will, execution may be levied on the pledge, regardless of whether the purchaser of the property is aware of the pledge arrangement. A pledgee cannot challenge a transaction whereby the pledgor disposes of pledged movable property, but may challenge subsequent agreements for the disposal of a mortgaged real property, concluded without the pledgee's consent, if the law expressly so provides. In particular, the pledgee may challenge a subsequent mortgage agreement or agreement on alienation of a mortgaged land plot that is entered into without the pledgee's consent.

Where execution is simultaneously levied under an out-of-court procedure on the same pledged property by subsequent and original pledgees, the pledgees must jointly notify the pledgor of the commencement of the execution procedure.

The resolution clarifies the controversial issue of whether a pledge may secure claims for recovery of something received under an invalid agreement (ie, a restitution claim). It emphasises that in accordance with Article 337 of the Civil Code, parties to pledge agreements may provide that the pledge secures not only obligations arising out of the agreement, but also claims for the recovery of something received pursuant to the agreement if the latter is invalid.

Realisation of pledged property

An indication in the agreement of the manner of realisation of pledged real property is an essential condition of an agreement on an out-of-court procedure for levying execution. Thus, such an agreement may not provide for several means of realisation, to be invoked as the pledgee chooses, as this would be invalid; rather, a pledgee is restricted to claiming for a levy of execution in court.

However, this does not apply to agreements about pledged movable property. The parties to a pledge agreement or an agreement on an out-of-court procedure for levying execution may indicate several methods for realisation of such property. In general, the choice of a specific method resides with the pledgor, unless the agreement stipulates that the pledgee must choose the manner of realisation.

If an agreement on an out-of-court procedure for levying execution is silent on the issue, realisation is carried out by public auction (which may be arranged by a commission agent). If pledged property is to be realised by sale to a third party other than by public auction, or by appropriation by a pledgee, the movable item must be in the pledgee's possession. It appears that where the pledged property rests with the pledgor under the terms of the agreement, the pledgor must transfer the property to the pledgee; only then can the pledgee realise or appropriate it. If the pledgor refuses to do so, the pledgee is entitled to claim in court for the transfer of the property for realisation.

These provisions aim to protect acquirers of pledged property. Where a pledgee does not possess the pledged property, but nonetheless sells it without notifying the purchaser that the property is in the possession of the pledgor or another party, the purchaser may require that the purchase agreement be terminated and may seek damages. It may also unilaterally refuse to perform its obligations under the agreement if the pledged property is not transferred.

In the event of the realisation of rights by means of appropriation, the right passes to the pledgee once the pledgor receives a statement from the pledgee regarding the transfer of such right. It is essential to comply with the procedure for notifying the pledgor of the commencement of execution. In addition, the debtor must be notified of the claim assignment. If the court procedure for levying execution is applied and a public auction is declared not to have taken place, the pledgee may apply to the court to demand a reduction in the initial selling price of the pledged property, provided that the pledgee can show evidence of a substantial drop in the market price of the property since the entry into effect of the court's execution order. Previously, the law in this area allowed for alterations in the initial selling price only if a petition was brought to alter the means and procedure for enforcement of the court's decision on the basis of newly discovered circumstances.

For further information on this topic please contact Vladimir Dragunov at Baker & McKenzie - CIS Limited by telephone (+7 495 787 2700), fax (+7 495 787 2701) or email ([email protected]).