In a recent judgment, the Dutch Supreme Court (Hoge Raad) decided that the provision in the Dutch Civil Code (DCC) regarding the ability to change the priority for security rights over real estate, ie rights of mortgage, now also applies to rights of pledge. This judgment provides for the possibility to change the priority of a right of pledge which is different from the order of execution or registration and sets out the requirements for the establishment of such change in priority.
In this blog post, we will further elaborate on the priority of rights of pledge under Dutch law. Dutch law now provides for the possibility of a change in priority in case multiple rights of pledge are granted and the order in which they have been established does not lead to the preferred priority.
Executive summary and key takeaways
The deed granting a right of pledge can now also provide for a change in priority of rights of pledge established prior to the execution of such deed. All pledgees whose priority will change due to the new right of pledge must consent to such change in priority. This deviates from the current default rule, the prior tempore rule (order of execution rule).
Dutch law provides for the granting of multiple security rights on the same asset or receivable and security rights will rank in the order of registration or disclosure, the prior tempore rule. If two or more rights of pledge are granted on the same asset or receivable on the same day, in principle, two rights of pledge of the same priority are established. This differs where it is clear what time each of the rights of pledge were established and (as a result) it is possible to determine which right of pledge ranks higher due to when it was established.
The prior tempore rule can be impractical where security is granted in relation to a financing agreement and the parties contemplate granting new security which must be highest in ranking. In practice, to solve this issue (and, essentially, to arrange for a change in priority) creditors contractually agree upon the preferred order of priority in an intercreditor agreement, which is set out in the waterfall. However, to ensure the change in priority has effect under property law, a release and retake of all relevant security is required, ie a right of pledge has to be released, a ‘new’ right of pledge with the highest priority will be granted, following which the right of pledge (now second in priority) may be granted again. Such ‘release and retake’ is very cumbersome and can be quite risky.
Even though rights of pledge and rights of mortgage are similar security rights, there is a more practical, statutory solution for rights of mortgage. The DCC provides for the possibility to include a provision in a notarial deed of mortgage reflecting that this right of mortgage ranks higher than it would, based on the registration of the right of mortgage in the land registry. For this change in priority, all mortgagees of which the priority of their right of mortgage changes are required to consent to the change in priority. Much to the dissatisfaction of pledgees in practice, until the Dutch Supreme Court's judgment on 9 April 2021, no similar provision existed for rights of pledge.
Rights of pledge and rights of mortgage are similar security rights. Although in practice there is a need for the possibility of a change in priority of rights of pledge, this possibility is not provided for in the DCC. It is in line with the (system of) the law to assume that a change of priority may also be effected with regard to a right of pledge. With regard to the above, the provision to change the priority of a right of mortgage is, as noted by the Supreme Court, suitable for analogous application to rights of pledge. This means that following this judgment of the Supreme Court, it is possible to, where multiple rights of pledge have been granted on the same asset, agree for a ‘new’ right of pledge on the same asset to have a higher rank than would be the case if solely taken note of the timing of establishment of its right of pledge. A requirement of this is that the deed of change of priority (or one or more separate deeds which should be read in conjunction with such deed) reflects that the pledgees under the other rights of pledge whose rank changes, consent to such change. The consent of the pledgees is subject to the same procedural requirements that applies to the establishment of a right of pledge.
A certain change in priority of rights of pledge can either be established simultaneously with the execution of the deed of the ‘new’ right of pledge (meaning that the deed of change of priority of the rights of pledge is included in the deed of the new right of pledge) or subsequently. The change in priority of the rights of pledge is only binding against parties who consent to their legal position in relation to the secured asset or claim being affected by the change in priority, ie pledgors whose priority does not change but whose legal position is affected, other secured parties and attaching parties who consent to the change in priority. For example, if the first ranking and third ranking pledgee agree to swap places as regards their priority, the second ranking pledgee does not need to consent to such change in principle as their priority does not change. However, if the claim of the (originally) third ranking pledgee is higher than the claim of the (originally) first ranking pledgee, the legal position of the second ranking pledgee changes due to the change in priority of the first and third ranking pledgees. Hence, the change in priority is only binding against the second ranking pledgee if the second ranking pledgee consents to such change.
The Supreme Court specifically sets out the requirements for a change in priority of an undisclosed right of pledge on receivables. To effect such change, a notarial deed or private registered instrument should be executed when granting a (new) right of pledge or thereafter. The consent of the related pledgees or other secured parties must be included either in the deed of pledge including the change in priority or in one or more separate (registered or notarial) deeds which should be read in conjunction with such deed of pledge.
The Supreme Court does not refer to rights of pledge on shares and it is therefore unclear whether the ability to change priority also applies to deeds of pledge over shares.
The judgment from the Supreme Court set out above may have certain advantages and disadvantages:
- It may lead to uncertainty in relation to the priority of a right of pledge as it may be that the deed indicates that the right of pledge is the highest-ranking right of pledge. In practice however, the priority of the right of pledge may have been amended by the execution of a different deed.
- It may be very useful in, for example, a restructuring or refinancing in which only one of two or more facilities will be refinanced. If security has been granted for each of the facilities and the facility highest in the waterfall will be refinanced, this would result in all security granted in relation to this facility being released and re-granted. Accordingly, it is important to ensure that as and when the new facility is established, the new security will also rank highest.
Dutch law now provides for the possibility of a change in priority in case multiple rights of pledge are granted and the order in which they have been established does not lead to the preferred priority