In its decision of 11 July 2013, Reference No. 21 ICdo 21/2012, the Supreme Court of the Czech Republic comprehensively expressed its opinion on the substantive legal aspects of re-pledging a receivable burdened by a lien and the possibility of negotiating a contractual waiver of re-pledging receivables. According to the decision, the pledging of a receivable does not preclude the possibility of establishing another lien on the same receivable. This decision is crucial for pledgees, typically financing banks.

Case background

The Supreme Court of the Czech Republic dealt with a case in which the plaintiff registered its receivable secured by a pledge over the trade receivables of the insolvency debtor in the insolvency proceedings against the debtor. The insolvency administrator denied the registered receivables on the grounds that the trade receivables serving as a security to registered receivables had already been pledged, and that therefore the "pledge over such receivables was not established by reason of the factual impossibility of performance by the garnishee."

The plaintiff subsequently brought an action against the insolvency administrator and sought the determination that the plaintiff has a receivable secured by a (second in row) pledge to the trade receivables of the insolvency debtor.

The defendant in turn argued that with regard to the pledged receivables, it was agreed in the first security agreement that the pledgor "must neither establish to the pledged receivables other rights of third parties nor allow their establishment by a third person, and neither assign these receivables to a third party nor undertake to do that", and as a result of this agreement, the second security agreement is invalid due to inconsistency with the law. In addition, the defendant claimed that the debtor had breached its obligation to refrain from anything that impairs the pledge to the detriment of the pledgee.1

The Court of First Instance upheld the action, stating that the agreement regarding the prohibition of disposing of the pledge as described above is invalid because it interferes with the pledgor’s right to dispose of the pledged receivables. The Court of Appeal confirmed the decision of the Court of First Instance.

Supreme Court ruling

On this factual basis, the Supreme Court of the Czech Republic considered the following questions as essential:

  1. whether the pledgor may pledge a receivable, which has already been pledged, to another creditor; and
  2. whether the agreement, in which the pledgor agrees that it may not re-pledge the receivable to another creditor or agree with its pledging made by another pledgor, is valid.

The Supreme Court of the Czech Republic pointed out that from a Czech law perspective a lien is a right in rem and that its primary function is to secure the receivable. The lien secures, among other things, a receivable of a pledgee from the moment of its creation and in the event that such secured receivable is not discharged in a timely manner, a lien fulfils its reimbursement function.2 If the receivable represents a lien, the creditor of the pledged receivable does not lose its rights with regards to the receivable, and can therefore dispose of the receivable. Among other things, the receivable can be assigned to another creditor, unless otherwise stated by law.

However, if the reimbursement function of the lien takes effect, the garnishee is required to fulfil the debt to the creditor (pledgee) after the due date of the receivable, regardless of any dispositions performed by the pledgor with the pledged receivable. If there are more liens connected with the receivable,3 the garnishee is required to first fulfil the debt towards the creditor whose lien is first in line with regards to the date of its establishment. Only after the fulfilment of this debt can the debt towards other creditors be fulfilled in the order of the establishment of liens or in the order dictated by other aspects set by the law.

Conclusion

In the present case, the Supreme Court of the Czech Republic upheld the decision of the lower courts that the denial of the right to satisfy the secured receivable from the side of the defendant is not justified, although the Supreme Court of the Czech Republic based its reasoning on a different source. Effectively, the Supreme Court of the Czech Republic concluded that pledging the receivable does not exclude the option to establish another lien over the same receivable and, accordingly, to re-pledge the pledgor’s receivables in favour of another pledgee.

The Supreme Court of the Czech Republic also concluded that the agreement prohibiting the re-pledging of the same receivable is binding only between contracting parties, and does not have orga omnes effects. The pledgee, in whose favour such prohibition would be negotiated, can therefore require only the damages that would occur in the event of a breach of the contractual obligation by the pledgor.