October 2021

Ordinances n°2021-1192 and 2021-1193 of September 15, 2021, respectively reforming security law and amending Book VI of the French Commercial Code, implement mandates of the PACTE Law of May 22, 2019^[1] to: modernize security law^[2], improve the articulation of security law with collective proceedings law^[3] and transpose the (EU) Directive 2019/1023 of June 20, 2019^[4], known as the "Restructuring and Insolvency Directive"^[5]. For technical reasons, the latter two pieces were united in the same ordinance.

The aim of the security law and articulation of securities with collective proceedings overhaul was to simplify security law in order to modernize it and make it easier to understand, strengthen legal certainty and efficacy of securities while preserving the balance between the interests involved, particularly in the context of collective proceedings, and thereby make French law more attractive.

The implementation of the Restructuring and Insolvency Directive introduces into French law the rules set out in the directive and makes choices among the options offered by it. The purpose of the directive is to strengthen the efficiency of preventive and insolvency proceedings, facilitate use of preventive proceedings and improve the position of secured creditors, especially those holding security.

Thanks to the simultaneous agenda of these reforms, the PACTE Law has paved the way for an unprecedented consistency and efficiency work in the position of secured creditors in France. Its preparation was enlightened by extensive public consultations^[6] and the transposition of the Restructuring and Insolvency Directive part was furthermore conducted under close cooperation between France and Germany^[7]. The result is a cornerstone reform^[8] that materially recasts the situation of secured creditors at all stages of security life.

Ordinance 2021-1192 related to securities will not come into force until January 1, 2022, in order to give parties the time to modify their templates of agreements. Ordinance 2021-1193 modifying collective proceedings law enters into force on October 1, 2021, a transposition deadline imposed by the Directive, except for certain provisions related to securities whose effective date is postponed so as to be aligned with the schedule of the reform of securities. In both cases, the new provisions will not have retroactive effect.

This paper outlines the key changes in security law and in the treatment of secured creditors in restructuring and insolvency proceedings that together substantially strengthen the position of secured lenders within a recast balance of interests.

MODERNIZED AND SIMPLIFIED SECURITIES

1. Reduction in the number of legal privileges and suppression of the retroactivity of real estate privileges

Legal privileges prime security holders that do not have property security or exclusive rights on the secured asset.

The reform abolishes several obsolete both general and special privileges on movables, such as allowances due to workers and employees.

The nine special real estate privileges become special legal mortgages, with the consequence that priority is given from the date of registration and no longer retroactively from the date on which the secured debt arose. This secures the foreseeability of rights of creditors registering a security interest on the same property asset.

2. Suppression of obsolete security interests on tangible movables

Security interests that had become obsolete or duplicated the civil pledge of tangible movables, or were insufficiently attractive, disappear including the pledge of tools and equipment, the commercial pledge, the lien on petroleum products, the pledge of inventory, the automobile pledge and the hotel lien. The general legal regime on pledge suffices to replace them.

3. Enlarged scope and simplified enforcement for the pledge of tangible movables

The pledge of tangible movables may now cover fixtures (meubles immobilisés par destination) (such as equipment for wind farms, solar power plants or industrial or mining installations), which removes this type of installation from the onerous regime of mortgage in financing transactions.

Moreover, the simplified method of realization previously reserved for commercial pledges is extended to all pledges set up as a security for professional debt. It allows proceeding to a public sale at the expiration of an eight-day formal notice with no response, without judicial intervention, even when the creditor is not provided with an enforcement order.

The pledge of tangibles movables remains the default regime for assets not covered by a specific security interest, and as such applies to digital assets such as cryptocurrencies.

4. Exclusive right of creditor over pledged receivable enshrined

It is clarified that the pledgee holds an exclusive right to the payment of the receivable, in principal and in interest, as soon as the pledge is notified to the debtor, and also a right of retention on the pledged receivable. The exclusive right, which was recognized by the latest case law, is now founded on a right of retention on the pledged claim. The pledgee is fully protected against competing creditors, like an assignee by way of security, however with respect to a pledged bank account, he is not allowed to block the sums in the pledged account solely on the grounds of the opening of collective proceedings.

5. Contractual freedom relating to cash dividends and cash accounts related to pledged financial securities account

The current law on the pledge of financial securities account seemed to require the opening of a cash account with a credit institution to receives future payments related to the pledged financial instruments, at the same time as the creation with pledged financial securities account.

The reform expressly sets out the possibility to exclude dividends and repayment of financial securities in cash from the scope of the pledge of financial securities accounts. Furthermore, in order to reduce the difficulties and delays that may arise for the opening of such account, in particular when the pledgor has its registered office abroad, the cash account may be opened at any time from the signing of the declaration of pledge until the date on which the security interest can be realized. If this account is opened, the pledge will be retroactive to the date of the declaration of pledge and, if not, the cash yields will be excluded from the scope of the pledge.

6. Validity of multiple-ranking security interests in the case of pledges of receivables and financial securities accounts

The feasibility of multiple ranks in the pledge of receivables and the pledge of financial securities accounts is expressly set out. This puts an end to the uncertainties existing on the validity of multiple ranks, that were in particular based on the exclusive nature of the right of retention. The rank of creditors is determined according to the date of the security agreement, which is consistent with the rule that a pledge of receivables becomes effective against third-parties at the date thereof.

7. Easing of the formalism of the pledge of a business

The obligation to register the pledge agreement within a one-month time limit under penalty of nullity is abolished. The pledge will only be unenforceable against third parties as long as it is not registered.

8. Simplification of formalities related to the evaluation of the property in a fiducie by way of security

Fiducie Security (fiducie sûreté) is renamed fiducie by way of security (fiducie à titre de garantie). Its formalism is lightened: the evaluation of the transferred property or right is no longer a condition for the validity of the fiducie agreement. Likewise, its enforcement is simplified, the trustee now has the possibility, if he is unable to find a buyer for the price determined by the expert, to sell the property or right at a price lower than the one determined by the expert, under his responsibility.

9. Creation of two new property security interests

While property security enjoys the highest treatment in the event of an insolvency, two property security interests come to birth.

• Assignment of civil receivable by way of security

This new security is designed to overcome the limitations of the Dailly assignment of receivables, which is only available to credit institutions in the European Economic Area and to certain designated lenders, and can only be used to secure a loan granted to the assignor, but not as security for surety obligations or unregulated lenders. Since a 2007 case law, the assignment of receivables could no longer be used as a security.

This new property-security on receivables follows the same formalities as the assignment of receivables (requirement of a writing, notification to the assigned debtor or tripartite agreement). The transfer of ownership of the receivable is temporary, which implies that if the secured claim is paid in full before the assigned claim is paid, the assignee will automatically recover ownership of the assigned claim. If the creditor receives sums under the assigned receivable before the secured receivable maturity, these sums must be charged against the receivable when it is payable. Otherwise, the assignee is free to dispose of the sums paid and, when the secured receivable is fully performed, has the obligation to return them to the grantor.

• Assignment of sums of money by way of security

The practice of cash collateral (gage espèces), being the transfer of cash by way of security^[9], is codified under the new assignment of a sum of money as security, which has the advantage of removing the former security from the uncertainties arising from the conflict between its denomination of pledge on a fungible thing and its effective nature of property security. The new security is aligned on the general law regime of the assignment of a receivable. It is enforceable against third-parties trough remittance of as soon as the sum of money is handed over, without any need for publication. Unlike the assignment of a receivable by way of security, the cash pledge operates a definitive transfer of ownership of the receivable.

10. New reference to “trading platforms” for the realization of a security interests without prior appraisal by expert

The enforcement of fiducie by way of security, pledge of tangible movables and pledge of financial securities required the evaluation of the asset posted as security by an expert for purposes of its transfer to the secured creditor, except when the said asset was traded on a regulated or organized market. It is now referred to "trading platforms" instead of "regulated market" or "organized market", a notion that includes not only regulated markets, but also multilateral trading facilities, organized trading facilities, and all types of platforms where assets are traded, such as crypto-currency trading platforms.

11. Easing of conventional real estate securities

The principle of the prohibition of mortgages on future property is abolished, which contrasted with the regime of other real securities.

In addition, the third-party purchaser of the mortgaged property is given the possibility of opposing to the mortgagee the benefit of discussion, which case law used to refuse in certain cases, and he can henceforth, like the guarantor, oppose to the creditor all the exceptions belonging to the main debtor.

Finally, the causes of mortgage extinction listed in the Civil Code are no longer limited.

12. Simplified enforcement of contractual security interests

The secured creditor who already has an enforcement order can immediately initiate a seizure without court permission, which limits the delays causing losses of value.

13. Clarification of retention of title

Retention of title is a very strong security since the creditor can reclaim the asset if the secured debt is unpaid, including in the case of insolvency proceedings of the purchaser. A conflict may however arise between the seller and two types of third parties holding competing rights from the purchaser: The pledgee who has been granted a pledge on the asset and the sub-purchaser, because in the event of resale of the asset before payment, the seller's retention of title right is carried over on the sub-purchaser’s receivable.

The first conflict is arbitrated in favour of the pledgee in good faith, i.e. unaware that the asset did not belong to the grantor. He alone can have the pledge cancelled. Therefore, he can assert the pledge against the seller with retention of title.

As regards the second conflict, the sub-purchaser can oppose to the seller both the exceptions inherent to the debt and those arising from his relations with the reseller- debtor before he had knowledge of the carry-over.

14. Increased protection of the grantor of a security interest securing a third party’s debt

Where the grantor of security secures a third-party’s debt, he will enjoy some of the protections afforded to the personal guarantor^[10]: creditor’s duty to warn and information obligation and right to require enforcement against the debtor first.

15. Personal guarantee (cautionnement) modernization

Changes aim to simplify formalism, codify case law, reduce litigation and remove excessive sanctions in the event of breach of formal requirements or breach of creditors’ duties.

The absence of the strictly predetermined handwritten mentions is no longer a cause of nullity of the guarantee as long as this statement indicates with sufficient precision the nature and scope of the guarantor's commitment.

The requirement of proportionality between the guarantee amount and the guarantor’s patrimony and revenues and the duty of the professional creditor to warn the personal guarantor, are stated in the Civil Code: Sanctions are limited to the effective prejudice suffered by the guarantor.

The civil or commercial nature of the personal guarantee is aligned with the one of the guaranteed debt, so as to submit litigation relating to the personal guarantee to the same jurisdiction as that relating to the underlying debt.

Lastly, the guarantor may oppose to the creditor not only all exceptions inherent to the debt but also, which was denied to him, the exceptions personal to the main debtor except those related to his default.

16. Generalization of the electronic signature

All security agreements can now be executed by electronic signature, while this was reserved for securities contracted for the needs of the debtor's profession.

TREATMENT OF SECURITY INTERESTS AND SECURED CREDITORS’ CLAIMS IN CASE OF COLLECTIVE PROCEEDINGS

The reform has stricken a new balance between secured creditors and debtors, where the efficacy of security is enhanced, and the position of secured creditors is improved in insolvency proceedings.

STRENGTHENED RIGHTS OF CREDITORS BENEFITING FROM SECURITY INTERESTS

1. Shortening of the stay period of enforcement of securities

The accelerated safeguard proceeding is modified to become the reference restructuring proceeding implementing the directive and may only be opened after a conciliation. The maximum duration of the observation period and therefore of stay of enforcement of security during the accelerated safeguard phase will not exceed 4 months.

The maximum duration of the observation period of the safeguard proceeding is reduced from 18 to 12 months.

2. Effect of the new mechanism of creditors classes

• Secured creditors form the highest class of affected parties, protected by the absolute priority rule

The reform enshrines the disappearance of the creditors' committees imposed by the Restructuring and Insolvency Directive, replaced by classes of affected parties, called upon to vote on the plan (above thresholds of more than 250 employees and EUR 20 million in turnover or EUR 40 million in turnover). The vote to adopt the plan takes place by class, by a two-thirds majority of votes cast in each class.

A creditor is considered an affected party when its rights are directly affected by the draft plan.

Classes are at least two in number, and sub-classes may be set up. Creditors with security interests necessarily constitute a class. Unsecured creditors form one or more classes and shareholders, if they are affected (e.g., conversion of debt into equity), are also grouped in a class.

The new scheme elects the absolute priority rule according to which the higher class of affected parties must always be satisfied by the same or equivalent means in order for a lower class to obtain payment. This rule ensures the predictability of the rights of secured creditors affected by the plan, since they must be paid in full in priority to any other creditor, unless the court grants an exception at the request of the debtor where it is necessary to achieve the objectives of the plan.

If one or several classes have voted against the plan, the court cannot impose forced cross-class plan unless a majority of classes, including the secured creditors class, have voted in favour of the plan, or the plan has been approved by at least one class of affected creditors in the money, other than a class of capital holders. With the combined play of this rule and the absolute security rule, the secured creditors class is therefore unlikely to be imposed a plan which it has not approved.

• Fall back protection for dissenting secured creditors

Secured creditors subject to a plan approval despite their negative vote, benefit from another safety net. In accordance with the best interest test, the court must verify that they do not find themselves in a less favourable situation, as a result of the forced application of the plan, than they would be in if the order of priority for the distribution of assets (in judicial liquidation) or the sale price of the business (in reorganisation proceedings) were applied, or if a better alternative solution was not validated (in fact a continuation of activity scenario).

The dissenting creditor with a security interest will therefore be protected at least to the extent of the value of its security, and the quality of its security interest.

Furthermore, for all creditors, the plan may not impose lower annual payments than 10% after the 6th year against 5% today.

• The class of bondholders with a veto right disappears

The bondholders, most often unsecured, who formed a committee, no longer constitute a class. They can no longer oppose to the plan.

• The creditor benefiting from a fiducie by way of security is deemed to be an unaffected party

As a matter of principle, under the previous rule which has been maintained, creditors who benefit from a fiducie by way of security are deemed to be unaffected parties up to the secured portion of their security. They do not sit in the classes and as such cannot be subject to debt rescheduling or haircuts or forced inter-class enforcement of the plan.

Although a symmetrical provision is not provided for other creditors benefiting from other forms of property security, it appears that the same rule would apply to them.

3. Legal certainty of substitution of security interests performed during the suspect period

The Civil Code enshrines the case law of the Cour de cassation which authorizes substitution of security interests during the suspect period, when the new security replaces previous security of equivalent nature and basis.

4. Respect of ranking of claims and subordination agreements enshrined

New rules for the classification of claims establish in detail the order of privileges and security interests in safeguard or reorganisation proceedings and in liquidation proceedings.

Further, it is established as a principle that subordination agreements entered into before the opening of the proceedings must be taken into account. This was not systematic until now, as they could be set aside by the plan. Subordination agreements entered into before the opening of the proceedings must be declared at the time of the setting up of the classes, otherwise they will not be enforceable in the proceedings.

5. Post money privilege

The "new money" privilege, previously reserved for providers of loans in conciliation proceedings, is extended to all forms of cash contributions (which covers all working capital financings) and to safeguard and reorganisation proceedings, with a view to encourage the financing of the continuation of the company's activity for the duration of the proceedings. Claims secured by the post money privilege cannot be subject to rescheduling or hair cut in possible subsequent collective proceedings without creditor’s consent.

NEW PROTECTIONS FOR DEBTORS AND GUARANTORS

1. Possible stay of enforcement during conciliation proceedings

The president of the court who has opened conciliation proceedings may, at the request of the debtor, impose a grace period on a creditor who does not accept, within the deadline provided, the request made to the creditor to suspend the payment of his receivable for a period of two years.

2. Stay of legal actions for the beneficiary of security interest set up by the debtor to secure a third-party’s debt

The stay of payment and prohibition of enforcement proceedings is no longer limited to the debtor’s creditors and now applies to the beneficiary of a security interest granted by the debtor to secure a third-party’s debt.

3. Generalization of the unenforceability of undeclared claims

The reform extends the obligation to declare claims to security interests granted on the debtor's assets as security for third party’ debt. In addition, undeclared claims become unenforceable against the debtor's guarantors and against the debtor in reorganisation proceedings.

4. Prohibition to increase the base of a security interest after the opening judgment

It is prohibited to increase the base of a contractual security interest or a contractual right of retention after the publication of the opening judgment, because this deprives the debtor from cash flow and hinders the continuation of the business. Topping-up provisions, widely used in pledges of financial securities, requiring the increase of the security asset base in the event that its value has decreased, in the proportion of the decrease in value can no longer be effective after the commencement of a proceeding.

5. Extension of voidness regime of security posted during the “suspect period” to all contractual security interests and to contractual rights of retention

The regime of void acts made during the suspect period is extended to all security interests and contractual right of retention set up during the suspect period and is no longer limited to mortgages, pledges and privileges. However, the exemption in favour of the assignment of receivables taking place under a framework agreement concluded prior to the date of cessation of payments remains.

6. Rebound of honest entrepreneurs

The "rebound of honest entrepreneurs", part of the Restructuring and Insolvency Directive aiming at allowing swift forgiveness of debt of individual debtors no later than three years after a previous proceeding, is implemented through the professional recovery proceeding and the simplified judicial liquidation procedure, now available for individuals without any threshold conditions, provided that the debtor's assets do not include real estate.

In conclusion, the ordinances implement significant changes in the position of creditors holding security in France, that will facilitate financings and refinancings and improve the legibility, foreseeability, legal certainty and efficiency of secured creditors’ rights in work-out scenarios.