A syndicated loan involving several lenders requires a plain and transparent security structure that will be easy to enforce if an event of default occurs. For this purpose a security agent is often appointed, who holds all of the established security interests. In these cases a parallel debt is typically created according to which any amounts owed from time to time by any of the borrowers and/or guarantors to the lenders are also owed to the security agent (abstract acknowledgement of debt). Such parallel debt claim of the security agent constitutes a secured claim under each security document.
The purpose of this article is to provide an overview of how the parallel debt is treated by the courts of Poland and Czech Republic in the event that the security grantors become insolvent.
The parallel debt concept, involving an abstract acknowledgement of debt in favour of the security agent reflecting claims of all lenders, is not known in Polish statutory law. Nevertheless, it has become a market standard to also include the parallel debt clauses in relation to Polish obligors in the loan documentation governed by foreign law (mainly by English or German law).
Generally, Polish courts will decide on the enforceability of the parallel debt claim governed by foreign law by applying the relevant foreign law provisions and, if necessary, by consulting an expert in the field of that foreign law. Thus, as a general rule, a parallel debt concept enforceable under the applicable foreign law will also be regarded as enforceable by Polish courts. This may change in the event of insolvency. Abstract obligations assumed by the bankrupt without any consideration are exposed to the risk of being ineffective in the event of insolvency. This may potentially apply to the parallel debt concept as well.
In at least two insolvency proceedings in which Noerr Poland was involved as the lenders’ counsel, the parallel debt claim governed by German law was finally acknowledged by the insolvency courts (the decision of the Local Court in Olsztyn dated 27 August 2010, case no. V GUp 7/07/Zw 227(GUz 11/08), and the decision of the Local Court in Elbląg dated 30 January 2009, case no. V GUp 11/07 ZW-165, both unpublished). In addition, in its decision given on 9 October 2009 (case no. IV CSK 145/09) the Polish Supreme Court ruled on a case in which a German law governed parallel debt was involved. Even though the Supreme Court did not explicitly acknowledge the parallel debt in the said decision, it did not contest the concept of this parallel liability as such. All the above court decisions were made within or in relation to the insolvency of the Schieder Group (a major manufacturer of furniture), being one of the biggest insolvencies in Poland in recent years. The claims based on the parallel debt clauses, which came to a total of approximately €250 million, were raised by two security agents representing different groups of lenders. Even though the parallel debt claims were not acknowledged by the aforementioned local courts in full, the reason for the partial rejection was not the concept of the parallel debt as such, but the upstream guarantee and the failure to provide sufficient evidence of outstanding indebtedness instead.
Taking the above court decisions into consideration, the risk of the parallel debt concept being unenforceable in Polish insolvency proceedings seems to be low. However, since the said decisions by the local insolvency courts are not binding in other proceedings, the risk cannot be completely ruled out.
As an alternative to the foreign law governed parallel debt concept, Polish statutory law provides for two main legal concepts that can be applied in order to facilitate the establishment of security interests for syndicated loans:
- the concept of joint and several creditorship (debtor owes the whole performance to each of the creditors, and by satisfying one of the creditors the debt to all of them is extinguished);
- the concept of mortgage/pledge administrator (this only applies to mortgages and registered pledges; these security interests can be established in favour of an administrator who is then solely entitled to enforce them; the secured claims are claims of all creditors).
Similarly to Poland, Czech law does not regulate the concept of parallel debt and an abstract acknowledgement of debt is not possible under Czech law. As a result, it would not be possible under Czech law to have a security trustee in a syndicated loan scenario unless it were a joint and several creditor in respect of the loan facility. In order to achieve a standard security trustee structure even in situations where Czech security is provided (by the borrower or a guarantor), it has therefore become market practice especially in international syndicates to use a parallel debt structure under which the parallel debt is created under foreign law (e.g. German law) recognising an abstract acknowledgement of debt. In most of these cases the loan documentation itself is typically also subject to foreign (i.e. non-Czech) law (typically English or US law).
For many years this practice remained untested. While the question of validity of a parallel debt structure has been touched upon in a couple of Czech bankruptcies, no decision by a higher court is available yet.
As the agreement on abstract acknowledgement of debt as such and often the loan agreement as well is governed by non-Czech law, the validity could only be challenged by a Czech bankruptcy administrator or court if this concept was against Czech public order (ordre public).
A conflict between the concept of parallel debt with Czech public order laws was recently invoked by an insolvency administrator in connection with the bankruptcy of OKD, a.s. – a leading Czech coal mining company (“OKD”). In these insolvency proceedings (which also happen to be one of the largest-scale in Czech history), CITIBANK N.A. London branch (“CITIBANK”), acting in its capacity as a security agent, raised a claim for almost Kč9.5 billion (approximately €350 million) based on a parallel debt structure. In this case, the loan agreement is governed by the laws of New York.
Under Czech law, every obligation (except for some securities) must have its causa, i.e. an economic reason for its creation. If the creditor fails to prove such causa of a respective obligation, the claim is not enforceable and, in an insolvency situation, the insolvency court will have to strike the claim out. The lack of causa is one of the reasons the insolvency administrator of OKD rejected CITIBANK’s parallel debt claim. In his opinion, the requirement for the existence of causa applied equally to obligations governed by law other than Czech law. This conclusion was based on the assertion that the causa requirement falls under the Czech public order doctrine which prevails over the agreed foreign law. In September 2016, CITIBANK brought an action to have the validity and value of its claim determined. To this date, the court has not ruled on this matter.
For the sake of completeness, it should be noted that Czech courts have dealt with several cases concerning parallel debt claim validity in the past. In previous identified cases, the insolvency courts tended to accept the validity of parallel debt claims and “parallel” creditors were thus satisfied together with other “ordinary” creditors – this existing case law nevertheless lacks sufficient reasoning in respect of the parallel debt concept.
It can be anticipated that the court decision in the OKD case, especially its reasoning, will establish a precedent in the field of parallel debt enforceability in the Czech Republic.
It is worth mentioning that since 2014 Czech law has introduced new provisions intended to allow the use of security trustees (section 2010(2) of the Czech Civil Code). According to this new provision, where a third person is administering security for the creditor, this person can claim the same rights and has the same obligations towards the debtor as the creditor. While this could be seen as an alternative to parallel debt when structuring syndicated loans, this provision has not been tested yet (in particular regarding its enforcement) and using this new instrument does not necessarily provide more legal certainty at the moment compared to a standard parallel debt structure.