Uncertainties Surrounding the Commercial Pledge over Stock in Trade - International Law Office

Introduction
Commercial Pledge Regime Is Less Favourable to Creditors
Is There a Future for the Pledge over Stock in Trade?
Comment

Introduction

The Order of March 23 2006 amended security law with a view to providing the French marketplace with more flexible and efficient securities. As a result of this reform, there have been considerable changes in this area of law.

One of the new security interests created by the order is the pledge over stock in trade (gage des stocks) under Articles L527(1) and following of the Commercial Code, which is reserved to banks granting loans. The pledge over stock in trade is a non-possessory pledge. The recognition of non-possessory pledges is one of the major innovations of the reform; although French law already offered special pledges on movables without dispossession, these had a limited scope.

The pledge over stock in trade was introduced on the initiative of the Ministry of Finance, which was keen to create a specific regime likely to facilitate credit. Surprisingly, the pledge over stock in trade may not be as favourable to creditors as the new all-purpose pledge under the Civil Code (also a non-possessory pledge); therefore, one may wonder whether the commercial pledge should be maintained in the French security law landscape.

Commercial Pledge Regime Is Less Favourable to Creditors

The scope of the commercial pledge over inventory is determined by the nature of the secured claim. The claim must arise from a credit granted to either a legal person or a natural person in the execution of his or her professional duties. Surprisingly, despite such limited scope, this regime is not very different from the all-purpose pledge regime, and is even less favourable in certain respects. Moreover, the major advantages of the commercial regime can be included in a Civil Code pledge.

Similarities between civil pledge and commercial pledge
Pledged assets
In contrast to the Civil Code regime (which is not limited as regards the nature of the pledged assets), the scope of the pledge over stock in trade is defined as follows in Article L527(3) of the Commercial Code:

"The trading stocks of raw or supplying materials, semi-finished, residual or finished products, as well as goods pertaining to the debtor and estimated in kind and value at the date of the last stocktaking, may be pledged, except for the goods subject to a retention of title."

In light of this definition, there is little room for dispute over the nature of eligible inventories.

This wording may be read as implying that only existing assets can be pledged. However, Article L521(1) states that the agreement in writing must designate present or future pledged assets. Further, Article L527(5) provides that the creditor's priority right is automatically transferred from the alienated stocks to the substituted stocks. Therefore, future assets can be pledged under this regime (which is also the case under the new Civil Code regime).

Assets that are subject to a retention of title cannot be pledged under the commercial regime or the civil all-purpose regime. Such exclusion is logical, but it may involve practical difficulties since it is not compulsory to publish retentions of title.

Under the two regimes, the pledged assets cannot belong to a third party; moreover, the parties can agree that the share of the pledged assets will diminish in direct proportion to the paying off of the creditor.

Compulsory agreement in writing
Like the all-purpose pledge, an agreement in writing is required for the pledge over stock in trade to be valid and enforceable. The requirement that the agreement be in writing shows that this regime is more protective of creditors. In particular, the goods must be covered by an insurance policy; therefore, the name of the insurance company that guarantees against destruction and fire must be included in the agreement.

Failure to meet these requirements is penalized by nullity. However, the scope of this penalty is uncertain: it is unclear whether the whole agreement is automatically void (as in the case law on mandatory requirements in Dailly assignments) or whether it remains in force insofar as the missing element does not affect the consent of the parties to the pledge agreement (in accordance with the case law on mandatory requirements in personal guarantees).

A custodian may be designated in the pledge over stock-in-trade agreement. However, the law provides no details on the custodian's duties and liability in case of loss of the pledged materials or goods; therefore, the parties are advised to provide for these.

Registration
Like the Civil Code pledge, the pledge over stock in trade must be registered in order to be valid. Registration is carried out with the Trade and Companies Registry of the jurisdiction where the debtor has its head office or domicile. Registration must be done within 15 days of the execution of the pledge agreement; otherwise the pledge is deemed to be void.

Registration aims to ascertain the rank of the creditors based on the date of registration of their security. Creditors registered on the same day must share the secured asset. A pledge made during the so-called 'suspect period' before the opening of insolvency proceedings may be declared void.

Conflicts with other security interests
The secured creditor might compete with other creditors with rights over the same assets. In theory, problems will not arise if the secured creditor competes with a seller with retention of title, since goods sold with retention of title cannot be subject to a pledge. However, since most retention of title clauses are not published, a conflict may arise and the seller with retention of title will be favoured. However, the grantor might be held liable for not having informed the secured creditor of the existence of the retention of title.

In case of conflict with a creditor with a pledge with dispossession, the creditor with a registered non-possessory pledge takes precedence, provided that the non-possessory pledge has been registered and regardless of the right of retention attached to the possessory pledge. By analogy, the same applies to the pledge over stock in trade.

Finally, in case of conflict between two creditors with a pledge without dispossession, the outcome depends on the date of registration, since both security interests are registered.

Downside of pledge over stock in trade
In contrast to the Civil Code pledge, in a Commercial Code pledge the pacte commissoire - a stipulation allowing the creditor to become the owner of the pledged assets in case of default of payment of the secured debt by the debtor - is considered as unwritten. Hence, the creditor must obtain court approval to transfer the stock or sell it at auction.

Advantages of the commercial regime may be included in a Civil Code pledge
The commercial law regime has certain peculiarities.

Obligation of the grantor to maintain the value of the pledge
The grantor of a pledge over stock in trade is responsible for preserving the inventory. The creditor is protected by the following measures:

• The debtor must prove that the goods are covered by an insurance policy against fire and destruction;
  
  
• A custodian may be designated;
  
  
• The creditor may at any time check the state of the pledged stocks; and
  
  
• The debtor must keep a list of the pledged stock in trade at the disposal of the creditor, as well as the accountancy information on any transaction involving the pledged stocks.

Should the trading stocks lose more than 20% of their value, the creditor may request that the debtor restore the value of the security or reimburse part of the loan in proportion to the loss of value. Should the debtor fail to do so, the creditor may request full reimbursement of the secured debt (which is thus considered to be accelerated).

Pursuant to the 'rule of indivisibility', the pledged stocks remain the security of the credit institution until full payment of the loan.

Early repayment of the loan
In case of early repayment of the debt, the debtor is not obliged to pay the interest to accrue until the date of maturity. If the creditor refuses the offers made by the debtor, the latter may consign the offered sum under Article L521(9) of the Commercial Code.

However, all such provisions may be stipulated in a civil law pledge.

Is There a Future for the Pledge over Stock in Trade?

Downsides
The pledge over stock in trade appears to be far less advantageous to credit institutions than the new all-purpose civil law pledge due to its perfection formalities and the prohibition of the pacte commissoire; moreover, its protective rules (in particular, the rule relating to the 20% loss in value) may be included in a civil pledge if the parties so agree.

Furthermore, the existence of two different regimes may be seen as an unnecessary complication in French security law. In particular, the fact that the civil and commercial pledge must be registered with two different registries (created by Decree 2006/1803 and Decree 2006/1804, respectively) renders the detection of pledges more difficult.

Is the option between the two regimes available?
Several authors, including representatives of credit institutions, have suggested that banks should be obliged to use the commercial pledge over stock in trade wherever it can be used, and that the Civil Code pledge be made available to credit institutions only where the requirements of the commercial regime are not met. However, such a solution appears excessive and unfounded.

No provision or principle expressly prevents creditors that are eligible for a Commercial Code pledge from using a Civil Code pledge if they meet the requirements. Arguably, it would be illogical to apply a stricter regime to credit institutions financing professional activities. The creation of a special pledge over stock in trade aimed to offer a less formal pledge to credit institutions granting loans to commercial entities. Therefore, preventing credit institutions from using the Civil Code pledge would not be in line with the purpose of the legislation.

Comment

Although not as flexible as it could have been, the pledge over stock in trade still represents an additional tool for credit institutions. When considering whether to take a pledge over stock in trade, credit institutions will weigh the pros and cons and choose the type of pledge on a case-by-case basis. Practice will show whether the pledge over stock in trade is used or, more probably, whether the all-purpose regime is preferred. Arguably, the suppression of the pledge over stock in trade may represent a step towards the goal that the French legislature sought to achieve when reforming French security law - that is, facilitating the creation and enforcement of security interests and simplifying this area of law.

For further information on this topic please contact Jean-François Adelle or Anne-Lyse Blin at JeantetAssociés by telephone (+33 1 45 05 82 80) or by fax (+33 1 47 04 87 98) or by email (jfadelle@jeantet.fr or alblin@jeantet.fr).