Introduction

On 10 November 2016, the European Court of Justice (the "ECJ") rendered a judgement on the interpretation of the requirement of 'possession or control' for financial collateral arrangements ("FCA's") (C-156/15ECLI:EU:C:2016:851, Private Equity Insurance Group/Swedbank). This ruling is important because it could be argued that the ECJ's interpretation of the requirement of possession or control differs from the interpretation given to it in Netherlands legal practice and literature. In this newsletter, we will discuss the ruling and its consequences for the Netherlands practice. Firstly, we will describe what FCA's are and what the requirement of possession or control entails.

FCA's and the requirement of possession or control

Under an FCA, certain financial assets, such as cash and securities, are provided as collateral by means of (i) the creation of a right of pledge or (ii) a title transfer. Title 7.2 of the Netherlands Civil Code ("NCC") contains certain provisions on FCA's. This title implements Directive 2002/47/EC on financial collateral arrangements (the "Directive").

The Directive is only applicable if the collateral is brought "in the possession or under the control of the collateral taker". However, the Directive does not specify when the requirement of possession or control is satisfied. The Directive does provide that a right of substitution (the replacement of collateral with other collateral, for instance to replace cash for securities) and a right to withdraw excess collateral (the release of collateral when the value of the collateral is higher than the value of the secured obligation) for the collateral provider shall not prejudice "possession or control".

The requirement of possession or control has not been included in the Netherlands legislation implementing the Directive. Based on the parliamentary documents, it was assumed in practice and literature that it would be sufficient for obtaining "possession or control" that the collateral taker could, in case of default of the collateral provider, deprive the collateral provider of the right to dispose of the collateral. Such clauses are therefore commonly included in FCA's governed by Netherlands law.

ECJ ruling on the requirement of possession or control and its interpretation

In the case that was brought before the ECJ, it concerned a right of pledge created on cash held in a current account for the benefit of the bank where that account was held. The ECJ assessed whether, in this case, the requirement of possession or control was met. The ECJ indicated what is required for "possession or control":

"It follows that the taker of collateral, such as the collateral at issue in the main proceedings, in the form of monies lodged in an ordinary bank account may be regarded as having acquired ‘possession or control’ of the monies only if the collateral provider is prevented from disposing of them."

The ECJ does not elaborate on how the collateral provider can be "prevented from disposing" over the cash.

In our view, a distinction can be made between two scenarios: (i) the collateral taker is granted a contractual right to (whether or not in the event of default of the collateral provider) prevent the collateral provider from disposing over the cash and (ii) the collateral provider is prevented from disposing over the cash as a matter of fact.

In light of the opinion of the Advocate General Szpunar of 21 July (ECLI:EU:C:2016:586) it could be argued that it follows from the ruling that the requirement of possession or control (merely) requires that the collateral taker should have the contractual right to prevent the collateral provider from disposing over the monies (scenario (i) above).

It cannot however not be excluded, and the wording of the ruling seems to support this view, that the requirement of possession or control should be interpreted so as to entail that the collateral provider is deprived of the right to dispose over the cash (scenario (ii) above) and that the ECJ's interpretation is therefore stricter than that of the Advocate General. In this scenario, a clause pursuant to which the collateral taker can only deprive the collateral provider of its right of disposal in case of default – a clause common in FCA's governed by Netherlands law - would not be sufficient to constitute "possession or control". A possibility to conform to scenario (ii) is to block the account in which the collateral is deposited.

For the avoidance of doubt, parties could agree that the collateral provider does have a right of substitution or right to withdraw excess collateral (see above under "FCA's and the requirement of possession or control"). According to the Directive, such rights do not prejudice "possession or control" and the ruling does not impact this.

Finally, we note that in our view the interpretation given by the ECJ on the requirement of possession or control applies mutatis mutandis to scenarios in which (i) the collateral does not consist of cash, but of securities and (ii) the account is held with a third party instead of with the bank which is also the collateral taker.

Impact

The question arises what the impact of the ruling for collateral arrangements governed by Netherlands law is that do not satisfy the requirement of possession or control.

The requirements for creating a right of pledge over collateral are laid down in Book 3 NCC. In legal practice and literature, it is assumed that, in the context of a so-called disclosed pledge over cash and securities, the collateral provider can be granted a right to dispose over the collateral. This means that, under Netherlands law, even when parties intend to create a FCA-pledge, but the requirement of possession or control has not been satisfied, generally, a valid right of pledge will nonetheless have come into existence.

Although the collateral arrangement will usually be valid, not satisfying the requirement of possession or control does have consequences for the collateral taker:

  • Firstly, in the event of insolvency of the collateral provider, it cannot invoke certain safeguards for FCA's, such as the inapplicability of (i) the retroactive effect of insolvency to 00.00 hours and (ii) a possible freeze.

  • Secondly, it is not possible for the parties concerned to agree that the collateral taker will be granted certain powers, such as (i) a right of use (the right of the collateral taker to dispose over the collateral as if it were legally entitled to the collateral) and (ii) a right to appropriate securities provided as collateral in case of default of the collateral provider. Such clauses are invalid if the collateral arrangement does not constitute an FCA.

Final remarks

As described above, the ECJ ruling on the requirement of possession or control may have implications for both existing FCA's and FCA's that will be concluded in the future. In light thereof, it is advisable to check whether these FCA's satisfy the requirement of possession or control under the stricter interpretation of scenario (ii), what the impact is when the requirement is not met and whether measures should be implemented with respect to existing collateral arrangements in order to satisfy the aforementioned requirement.