Extract taken from 'The Lending and Secured Finance Review' – edition 5

Credit support and subordination

i SecurityGeneral

If security is to be taken over assets located in Sweden, it is important to have the security created in accordance with Swedish law. Though Swedish courts may recognise the validity of a security interest created under a non-Swedish law governed security document, assuming it is valid under the law governing the security document, the enforceability in Sweden is nevertheless subject to the requirement that necessary actions to create and perfect the relevant form of security under Swedish law have been taken.

Security can be created over nearly every type of asset. However, it is not possible to create security over all or substantially all of the assets of a particular company under a single all-asset-encompassing security document, and, hence, security must be taken on an asset-by-asset basis.

Below is a brief overview of the common methods of taking security over certain assets; namely, how security over these assets is typically created, perfection requirements and the extent of any registration, tax or other costs involved.

Real estate

Security over real estate is created by way of a mortgage and registration with the Land Registration Authority. Upon an application by the legal and registered owner of a real estate, the registration authority issues mortgage certificates, which, when pledged and handed over to a creditor, represent a security right with a certain value and a certain priority. Mortgage certificates can be issued in either paper or electronic form. A mortgage certificate in electronic form will be regarded as handed over to the creditor when it has been transferred to the creditor's account in the mortgage register (or to the account of a third party representing the creditor) kept by the Land Registration Authority. The electronic mortgage system is available to local banks only.

Certain assets (e.g., machinery) may be regarded as industrial accessory equipment or fixtures, and would then be covered by a mortgage.

In essence, the security interest created by a mortgage entitles the secured creditor to payment out of the proceeds from a sale of the relevant real estate up to an amount equal to 115 per cent of the amount of the mortgage certificates issued and held by it as security.

The issuance of a new mortgage certificate attracts a stamp duty cost of 2 per cent of the amount secured (i.e., the face value of the mortgage certificate). However, any mortgage certificates already issued can be pledged again without incurring any additional stamp duty.

Tangible movable property

The only practical way to create security over tangible movable property is by way of a business mortgage. The reason is that security by way of a pledge over such property requires the transfer of possession of the property, and the pledgor must be excluded, both legally and practically, from dealing with the pledged property. Consequently, it is difficult to obtain perfected security over tangible movable property other than through a business mortgage.

A Swedish company may file an application with the Companies Registration Office for the issuance of business mortgage certificates, which, when pledged and handed over to a creditor, represent a security right with a certain value and a certain priority. Business mortgage certificates can be issued in either paper or electronic form. A mortgage certificate in electronic form will be regarded as handed over to the creditor when it has been transferred to the creditor's account in the business mortgage register (or to the account of a third party representing the creditor) kept by the Companies Registration Office. The electronic business mortgage system is available to local banks only.

A business mortgage covers all of the pledgor's movable property (other than cash at hand and bank deposits, shares and other tradable financial instruments and securities) used in the pledgor's business. However, security by way of a business mortgage does not prevent the pledgor from disposing of the relevant assets, and it is also subordinate to other perfected pledges over the same assets, even if such pledges are created after the business mortgage. A debtor may pledge, for example, receivables that form part of a pre-existing business mortgage, and the pledge of the receivables will then rank ahead of the business mortgage.

A business mortgage gives the secured creditor a specific right of priority enforceable in bankruptcy and execution. A secured creditor who holds a business mortgage certificate is, in conjunction with a levy of execution or bankruptcy, entitled with the right of priority to which the business mortgage is entitled pursuant to law, to receive payment for its claim from the assets covered by the business mortgage up to the face amount of the business mortgage certificate (plus a supplement).

The issuance of a new business mortgage certificate attracts a stamp duty cost of 1 per cent of the amount secured (i.e., the face value of the business mortgage certificate). However, any business mortgage certificates already issued can be pledged again without incurring any additional stamp duty.

Shares and financial instruments

Security over shares and other financial instruments is created by way of a pledge. A share pledge is perfected by transfer of possession of the relevant share certificates (if the relevant shares are in certificated form and share certificates have been issued) to the pledgee (endorsed in blank) or, if no share certificates have been issued, through notification of the pledge to the company's board of directors.

If the shares or other financial instruments are in dematerialised registered form and held on a securities account, perfection is made by registration with Euroclear Sweden or, if held on a deposit account, through notification of the pledge to the account bank. Other financial instruments that are not in dematerialised form (i.e., in bearer form) require transfer of possession to be perfected.

Contractual rights and receivables

Security over contractual rights and receivables is created by way of a pledge. The pledge is perfected through notification to the contractual counterparty or receivable debtor, as applicable. If the receivables are in the form of a bearer promissory note (or similar), the pledge is perfected by transfer of possession of the relevant promissory note to the pledgee (endorsed in blank). Proceeds are to be paid directly to the pledgee and the pledgor may not have control over any account to which payments are made.

Security over receivables may be cumbersome for the pledgor as it must have no disposal rights in respect thereof. A pledge requires that the secured creditor has total control over the payment of the receivables, meaning that all debtors must be notified of the pledge and instructed to pay to an account that is not controlled by the pledgor.

Security over receivables can also be created by way of a business mortgage.

Cash deposits

Security over cash deposits on bank accounts is created by way of a pledge. The pledge is perfected through notification to the account bank. The pledgor must not be allowed to withdraw funds standing to the credit of the pledged account without the express consent of the secured creditor.

For practical reasons, it may be undesirable to block the bank account, and the parties may, therefore, sometimes agree that the pledge over the bank account will not be perfected until the occurrence of an event of default (or similar triggering event). However, non-perfected security will be subject to a three-month hardening period from the date of perfection and could be clawed back in a following bankruptcy.

Intangibles and intellectual property rights

Security over patents and trademarks is created by way of a pledge registered with the Patent and Registration Office. No similar registration is available for copyrights and, given that there is no counterparty or official registry to which a notification of a pledge can be given, this form of security may not be created over copyrights or goodwill.

Security over patents and trademarks can also be created by way of a business mortgage, which would also cover copyrights and goodwill.

ii Guarantees and other forms of credit support

Guarantees are common in Swedish secured (and unsecured) lending transactions. There are no formal requirements, but guarantees are normally made in writing. It is common to include the guarantee in the loan agreement and to make the guarantor a party to the loan agreement. Separate guarantees – either unilateral or documented in an agreement – are also common if, for some reason, the guarantor will not be a party to the loan agreement.

Negative pledge undertakings are commonly included in both loan agreements and security documents.

iii Priorities and subordination

Contractual and structural subordination are common ways to ensure a certain priority order. On more complex leveraged finance transactions, an intercreditor agreement will regulate the priority of debts and security, whereas in lesser structured transactions, a short-form subordination undertaking or agreement may be used. Under the intercreditor or subordination agreement, the parties will contractually agree on a certain order of priority. The ranking of security is normally dealt with in the relevant security documents (i.e., the security provider will grant first and second ranking security to certain creditors, in either the same security document or in separate security documents), and will be underpinned by the intercreditor or subordination agreement.

Structural subordination (i.e., where the creditors lend to different entities in the corporate structure) is common on mezzanine transactions, although there has been a firm pushback from mezzanine lenders on structural subordination.

Intercreditor agreements have not been fully tested by Swedish courts, so there is uncertainty as to whether some of the provisions of standard intercreditor agreements will be upheld (in particular, release provisions in respect of subordinated debt). Further, in the case of formal bankruptcy proceedings involving a Swedish company, the bankruptcy administrator can elect whether the estate will be bound by the intercreditor agreement.

In the case of the insolvency of a borrower being declared bankrupt, the ranking and priority is dependent on the type of claim. There are three main types of claims, namely claims with special priority (e.g., secured claims, claims secured by mortgage and claims secured by seizure), claims with general priority (e.g., claims given priority because of public interest) and claims without priority.

Within the group of claims with special priority, the claims will be entitled to be paid out of the proceeds from a sale of the assets being subject to the relevant security.

If any assets remain after the claims with special priority have been discharged, claims with general priority will be discharged out of the remaining assets. Within the group of claims without priority, all claims rank equal in priority (pari passu) and will be discharged pro rata.