Bui Duc Giang
Attorney at law and Ph.D in law[1]
KEY POINTS:
- A security interest may be perfected not only through registration but also through the receipt of delivery of the secured asset in case of a pledge or the taking of the asset’s possession in case of a lien;
- Priority of competing security interests over the same asset depends on the date of enforceability against third parties of those security interests and, in the absence of enforceability against third parties, on the date of their creation;
- Expenses for taking care of, taking over, and realizing, a pledged or charged asset rank before the secured creditor(s)’ claims and any surplus must be returned to the securing party.
When a bank takes security over the assets of a legal person or an individual, its concern is not only that such security will be effective but also that the security interest will take priority over other parties’ interests in the assets concerned. Civil Code No. 91/2015/QH13 dated November 24, 2015 (with effect from January 1, 2017) (the new Civil Code) contains various new rules on priorities that this article tries to point out.
1. Types of security
Article 292 of the new Civil Code provides a list of nine security interests including pledge, charge[2], security deposit, deposit securing the return of leased property, escrow deposit, reservation of title, guarantee, reputation-based security and lien[3]. As such, the lawmakers have added two new security interests to the list of security interests provided in the 2005 Civil Code. Those are reservation of title and lien.
Under Article 346 of the new Civil Code, a lien means the right of a creditor lawfully holding an asset being the subject matter of a bilateral contract (the “lienee”) to retain the asset in case the debtor (the “lienor”) fails to perform an obligation or improperly performs the obligation. It is created by operation of law and does not require registration to be effective. However, it may not be extended by contract.
With regard to reservation of title, pursuant to Article 331 of the new Civil Code, in a purchase and sale contract, the ownership over an asset may be reserved by the seller until the obligation to make payment is fully discharged. Unfortunately, the new rules on reservation of title in the new Civil Code are controversial since they are particularly unfavorable for creditors[4].
Furthermore, regarding guarantees, Clause 3, Article 336 of the new Civil Code expressly provides that the parties may agree to use a security interest over an asset to secure the performance of the obligation of the guarantor.
It is a pity that the Code has missed the opportunity to take a position on the validity of third-party security which remains a controversial issue in lending practice[5].
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2. Validity and enforceability of security interests
The new Civil Code draws a distinction between enforceability against the parties to the security contract (validity against the parties) and enforceability against third persons (enforceability against third parties).
Under Clause 1, Article 310 of the new Civil Code, an asset pledge contract shall be valid (against the parties) as from the time the contract is entered into, unless otherwise agreed by the parties or provided by a law[6].
Likewise, as per Clause 1, Article 319 of the new Civil Code, an asset charge contract shall be valid (against the parties) as from the time the contract is entered into, unless otherwise agreed by the parties or provided by a law[7].
Pursuant to Article 297 of the new Civil Code, “a security interest shall be enforceable against a third person as from the date of registration or from the time where the secured party obtains or takes possession of the secured asset”.
As such, the usual way of perfection of a security interest is its registration with the relevant security registration office. Exceptions to this rule are the cases of pledge and lien. Indeed, a pledge is enforceable against third parties from the time where the pledgee receives delivery of the asset (Clause 2, Article 310 of the new Civil Code)[8]. A lien shall be effective against third parties from the time when the lienee takes possession of the asset (Clause 2, Article 347 of the new Civil Code).
Under Clause 2, Article 297 of the new Civil Code, once a security interest becomes enforceable against third parties, the secured creditor may exercise its right to recover the secured asset and shall have priority for payment.
3. Priority of competing security interests
Clause 1, Article 308 of the new Civil Code deals with the particular case of competition amongst security interests created over the same asset. It provides that in case an asset is used to secure the performance of several obligations, the order of priority for payment between the secured creditors shall be determined as follows:
- Where all the security interests are enforceable against third parties, priority shall be determined according to the order in which enforceability against parties was established;
- Where certain security interests are enforceable against third parties while others are not, the obligations secured by the security interests which are enforceable against third parties shall be paid first;
- Where all the security interests are not enforceable against third parties, priority shall be determined according to the order in which the security interests were created.
As such, priority depends first on the date of enforceability against third parties of the security interests and, in the absence of enforceability against third parties, on the date of their creation.
Those priority rules apply to the case in which an asset is used to secure more than one loan. This case is specifically dealt with in Article 296 of the new Civil Code under which:
- An asset may be used to secure several obligations if, at the time of establishment of the security transaction, the value of such asset is greater than the aggregate value of the secured obligations, unless otherwise agreed by the parties or provided by law.
- In case an asset is used to secure several obligations, the securing party must notify the subsequent secured creditors that the secured asset is being used to secure other obligation(s). The grant of security on each occasion must be made in writing.
- Where the asset must be realized in order to pay one obligation which has become due and payable, the remaining obligations which have not yet become due and payable shall also be deemed to become due and payable and all the secured creditors may take part in the realization of the asset. The secured creditor which has provided notice of realization of the asset shall be responsible for realizing the asset, unless otherwise agreed by all the secured creditors. If the parties wish to continue to fulfill the obligations which have not yet become due and payable, they may agree that the securing party will use other property to secure them.
Furthermore, the priority rules provided in Article 308 concern only priorities for payment of competing secured creditors over the same asset. In other words, they determine which creditors will be paid in priority in case this asset is realized (e.g., by way of sale to a third party). In case of a lien, the lienee’s right to retain the asset until payment is not subject to those rules since there is no priority for payment between the lienee and the bank which has taken security over the asset concerned[9].
If an asset is subject to an agreement on reservation of title, the buyer may neither pledge nor charge it in favor of its lender as Article 309 and Clause 1 of 317 require that the pledged or charged asset be the asset of the securing party. Therefore, in principle, there will not be conflicts of priority between the seller and the bank.
Under Clause 1, Article 308 of the new Civil Code, it is possible for the secured creditors to agree among themselves to vary the priority conferred by law. This is achieved by a contract between the parties by way of a priority agreement by which the order of priorities of the security interests is altered. However, this text further indicates that the subrogatee of a right to priority payment shall only be entitled to priority payment within the scope of the security interest of the subrogator.
4. Payment of proceeds of realization of pledged or charged property
Article 307 deals with the fate of proceeds of the realization of a pledged or charged asset as follows:
- The proceeds of realization of a pledged or charged asset, after payment of expenses for taking care of, taking over,[10] and realizing, the pledged or charged asset, shall be paid according to the order of priority mentioned in section 3 above.
- Where the amount of proceeds of the realization of the pledged or charged asset after payment of expenses for taking care of, taking over, and realizing, the pledged or charged asset is greater than the value of the secured obligation(s), then the difference must be paid to the securing party.
- Where the amount of proceeds of the realization of the pledged or charged asset after payment of expenses for taking care of, taking over, and realizing, the pledged or charged asset is smaller than the value of the secured obligation(s), then the unperformed portion of the obligation(s) shall be deemed to be an unsecured obligation, unless the parties have agreed on the attachment of additional secured asset. The secured creditor has the right to demand the party having the secured obligation(s) to perform the unpaid portion of the obligation.
The above principles will apply equally to the case where an asset is used to secure more than one loan and to the case an asset is used to secure one single loan. The basic rule is that expenses for taking care of, taking over, and realizing, the pledged or charged asset rank first and the secured creditor(s) will have priority over the proceeds while any surplus must be returned to the securing party.
Those principles will also apply to the case of appropriation of the secured asset by the secured creditor in lieu of performance of the secured obligation[11].
In light of the above, it can be inferred that the new rules of the new Civil Code bring a clearer legal framework on priorities. Unfortunately, they fail to address certain points however important, such as priority between a seller under a reservation of title and a bank taking security over a receivable that the buyer has acquired after (unlawfully) re-selling the asset to a third party or the possibility for the parties under a priority agreement to agree that proceeds of the realization of all security interests should be applied in a particular way, irrespective of who is technically entitled thereto.-
