Member Article

Parallel debt is a legal concept applied in international financing transactions that involve multiple lenders. In order to simplify the administration of security (for example, to avoid the need for retaking or reregistering security for a fluctuating group of lenders) and to reduce costs, the banks select a single entity from among them to administer the security. However, this creates a problem under Polish law: how to structure the secured claim and security instruments so that one bank can hold the security for the benefit of all the other lenders? 

Security as an accessory obligation under Polish law

The purpose of security is to guarantee repayment of the debt which it secures (for example, a loan). As a result, security creates an accessory obligation which is incidental to the principal obligation, and that state is technically referred to as the “accessoriness” of security (in Polish akcesoryjność, or in German Akzessorietät). While it is subject to several exceptions and diverging interpretations, this rule nonetheless is a key feature of debt security. One of its effects is that the creditor under the principal claim is also the beneficiary of the security established to protect that claim.

The accessoriness principle is not spelled out in the law but rather follows indirectly from the provisions applying to specific forms of security. When establishing debt security it is theoretically possible under the principle of freedom of contract to have one agent represent several creditors.

However, the risk of this solution being challenged is so high that in practice no creditor is willing to run it. The Polish Parliament has recognised the problem of the maladjustment of Polish law to the intricacies of syndicated lending and, for selected types of security instruments, has introduced a system whereby several creditors can establish joint security. In the case of mortgages and registered pledges, it introduced the concept of the security administrator, to whom a single security for the claims of several creditors can be granted. Regrettably, in practice this turned out to be an insufficient remedy for the problems that arise when securing syndicated loans. First, the administrator handles only two types of security, while larger transactions normally require a wider range. Second, the practical use of security administrators is held back by drawbacks in the very rules that govern them. Therefore, a different solution was worked out in cross-border syndicated financing transactions involving Polish security instruments governed by Polish law, namely parallel debt.

Structure of parallel debt and its admissibility under Polish law

Parallel debt is a separate (parallel) obligation to pay to the security agent, economically equal to the total amount of all the secured obligations - the “primary” debts - owed to each creditor under the same legal transaction (e.g. a loan agreement). This effect is achieved by a covenant made by each of the obligors to pay the security agent sums equal to the total secured obligations owed to all creditors under the finance documents, as and when they fall due. Thus, instead of securing many primary debts owed to many lenders (and multiplying the security associated with these debts), a single debt to one security agent is established in parallel to the primary debts. Typically, to avoid double recovery, each reduction of the underlying debts also reduces the parallel debt.

As a single receivable, the parallel debt may, from the Polish law perspective, be freely protected with any type of security. This ensures consistency of administrative and enforcement measures associated with the security because it requires only one entity to handle a single aggregate set of security instruments. In Polish practice, parallel debt commonly occurs as a receivable created under foreign law (mainly English law), but protected by a Polish security. The question therefore arises whether receivables created under a parallel debt clause governed by English law can be validly secured by Polish security.

Compliance with Polish law

First, we should examine whether the choice of foreign law for the secured claim is made in a manner consistent with Polish law. Second, we must consider whether the given parallel debt structure violates Polish public policy. Under Polish private international law, the application of foreign law to parallel debt will not be possible if its effects are contrary to fundamental principles of the Polish legal order.

Moreover, pursuant to the Brussels I Regulation (44/2001), a foreign court decision, such as one ordering payment of parallel debt, cannot be recognised in Poland if recognition would be manifestly contrary to Polish public policy.

In light of this regulation the question arises whether the principle of accessoriness - which prevents the creation under Polish law of a structure analogous to parallel debt - may be recognised as a basic principle of the Polish legal order. Such classification does not appear to be justified.

The fundamental principles of the legal order are the most basic rules bearing the weight of the entire national legal system, while the principle of accessoriness is merely a creation of civil-law doctrine, and even in Polish law it is subject to numerous exceptions and exclusions. Are there, therefore, other factors that increase the risk to parallel debt established under foreign law being challenged in Polish courts? An analysis of the case law would be helpful in this respect.

Case law on parallel debt

Despite the widespread use of parallel debt, the body of Polish case law in this area is not large. First to be mentioned is the ruling by the Supreme Court of Poland of 9 October 2009 (Case No. IV CSK 145/09). It was issued in a situation of actual use of parallel debt established under foreign law.

The court did not bring this type of debt into question (it questioned the security itself, but on a different basis). However, in this case (which concerned bankruptcy issues) the parallel debt had not been challenged by the appellant and, as a rule, the Supreme Court considers cassation appeals only within the scope of the allegations raised. It is hard to claim, therefore, that this ruling finally dispelled the doubts associated with parallel debt.

There have been several cases in which the lower courts referred to parallel debt directly. Particularly noteworthy was a decision by a bankruptcy court which considered the admissibility of a parallel debt. The court explicitly accepted the validity of the parallel debt and recognised the validity of a security package established under Polish law to protect parallel debt arising under English law. In this decision, the Polish bankruptcy court allowed against the bankruptcy estate both claims payable under an English judgment: the primary debt and the parallel debt (each was entered as a separate claim, whereas the security agent’s claim under the parallel debt was recognised as a secured claim). The court also explicitly acknowledged that the existence of a parallel debt alongside the primary debt did not violate the Polish legal order.

The court repeatedly emphasised in this decision that the repayment of one of the two claims (primary or parallel) automatically reduced the other debt by the same amount and, consequently, there was no possibility of double recovery. The court even suggested that this mechanism is comparable to the Polish mechanism of a joint and several receivable, but noted that in contrast to debts to joint and several creditors, the primary debt and the parallel debt were separate receivables.

It appears from our practice that the vast majority of provisions in the agreements we have come across provide for the automatic reduction of the parallel debt upon payment of the primary debt, and vice versa. This seems to be a natural consequence of the very purpose of parallel debt: to simplify the debt security scheme, rather than create yet another separately paid receivable.

It is also worth looking at the case law of other civil-law jurisdictions, because they also use parallel debt in establishing debt security. Particularly relevant here is the French Supreme Court’s judgment of 13 September 2011 in the Belvédère case, where the debtor attempted to challenge the parallel debt mechanism by arguing that it may lead to double payment of the same receivable, which would be contrary to public policy. The French Supreme Court rejected this argument because the parallel debt clause expressly provided for automatic reduction of the primary debt as the parallel debt was paid off. This position is therefore consistent with the above decision of the Polish bankruptcy court.

To sum up, Polish rulings have generally accepted the parallel debt mechanism and, consequently, also the Polish security for repayment of such debt. Thus, a solution that has developed in practice to meet market expectations seems to have won the approval of the courts, helping to reinforce the certainty of financing transactions.