Until recently, Swiss regulations had no direct impact on the country's corporate lending market or the documentation of corporate loans. However, the increased capital and liquidity requirements that apply to banks in Switzerland have limited the overall volume of available credit facilities. Increased capital requirements have also led to an increased focus on the collateral aspects of lending transactions to ensure that particular transactions can be treated as secured for regulatory purposes (as opposed to mere revenue-based loans).
Swiss banks which aim for preferential treatment of their risk-weighted assets tend to focus on credit enhancement strategies involving collateralisation. Further, investment funds, which have grown in the debt market in recent years, tend to focus more on collateralised loans. As most of these funds investing in the Swiss debt market are domiciled abroad, cross-border aspects have become even more important. Moreover, the increased capital requirements have led to a growing number of secondary loan market transactions, in respect of which the transfer of (ancillary) security rights – together with the credit risk itself – is vitally important.
This article provides an overview of the forms of security interest that can be taken over assets in Switzerland, including cross-border issues such as choice of law and the recognition of foreign insolvency proceedings in Switzerland. It also considers formalities regarding creation and perfection and rules relating to the enforcement of security interests.
Common forms of security interest
The main types of security interest under Swiss law are:
- pledges;
- full title transfers or assignments for security purposes; and
- mortgages over real estate, aircraft and ships.
Pledges and mortgages are considered accessory security interests. Among other things, this means as follows:
- The validity of a pledge or mortgage depends on the continuing validity of the secured obligations.
- The holder of the secured obligations must be identical to the holder of the relevant security interest.
- On transfer, a security interest is transferred to the transferee of the secured obligations by operation of law.
- A pledge or mortgage cannot be vested in a third party acting as a security holder in its own name and right. Therefore, certain principles must be applied when a third party (eg, a security agent) administers a security interest on behalf of the secured parties (eg, in syndicated loans).
In contrast, a transfer or assignment for security purposes is a non-accessory security interest. Therefore, the validity of the transfer or assignment does not depend on the continuing validity of the secured obligations, and the above restrictions do not apply.
Guarantees and sureties are also widely used in secured lending transactions.
Security over book-entry securities
The Federal Intermediated Securities Act (FISA) governs security interests over intermediated securities or book-entry securities, which include all intermediated securities, regardless of whether the underlying securities are certificated or uncertificated. Book-entry securities are fungible claims against or membership rights in an issuer that are credited to the securities account of an intermediary. The intermediary must be a regulated entity such as a bank or securities dealer. Any transfer of claims or membership rights that qualify as book-entry securities (in particular, any transfer or creation of security interests over such book-entry securities) must comply with FISA.
There are three ways to create a security interest over book-entry securities:
- by transfer;
- by control agreement, which also provides for the creation of a limited security interest covering a certain quota and/or a defined maximum value of book-entry securities in an account or specified book-entry securities credited to the securities account; or
- by granting a security interest to the intermediary.
Security interests can be granted over real estate, including:
- parcels of land and buildings thereon;
- co-ownership shares in immovable property (eg, apartments or entire floors of a building);
- distinct and permanent rights recorded in the land register (eg, the right to build on a parcel of land for a limited period); or
- exploration rights (eg, mines).
Such security interests can be granted in the form of a mortgage or mortgage certificate (ie, a negotiable instrument that can be pledged or transferred for security purposes and can exist in either paper or paperless form).
Security over tangible movable property, shares and financial instruments, claims and receivables and intellectual property are usually granted in the following forms:
- Pledges – these are the most widely used form of security over tangible movable property, shares and financial instruments, claims, receivables and IP rights. According to Article 891 of the Civil Code, a pledge entitles the lender to:
- liquidate the pledged property on the debtor's default; and
- apply the proceeds to repay the secured claims.
- Outright transfer or assignment for security purposes – the transferee acquires full title in the transferred or assigned assets or rights. However, the security agreement will provide that the transferee can use its title to liquidate the assets or rights only if the debtor fails to apply the proceeds to repay the debt.
Transfers have certain advantages over pledges on the bankruptcy of a Swiss security provider and in multi-lender transactions because transferees are entitled to enforce the security interest by way of private enforcement. However, lenders may have concerns over them assuming liability in relation to the assets or rights.
Creation and perfection of security interests
The formalities for creating and perfecting a security interest depend on the type of security and asset used as collateral.
Security over real estate Mortgages and mortgage certificates must take the form of a notarised deed (ie, the security agreement must be notarised). Further, the valid perfection of a mortgage and mortgage certificate requires its registration with the land register (Article 799 of the Civil Code).
A transfer is a common method for creating a security interest in respect of mortgage certificates. The valid creation of a security interest requires the following:
- A transfer agreement must be signed (not necessarily in writing, although this is strongly advised).
- In case of a paper mortgage certificate, the transfer of the relevant mortgage certificate is required in respect of bearer certificates. If the mortgage certificate is in registered form, an endorsement to the creditor is required. The endorsement must not be blank (ie, the transferor must write the name of the transferee and must sign the back of the mortgage certificate).
- In case of a paperless mortgage certificate, the transferee must be registered with the land register by written notice by the transferor.
Security over movable property A security interest over collateral is not validly created if the security provider retains possession and control over the assets (Articles 714 and 884 of the Civil Code). Accordingly, lenders do not typically request security over movable assets such as inventory and machinery where operating companies are concerned. However, this principle does not apply to certain movable property such as aircrafts, ships and railroads. With the latter assets, the security is perfected by the entry of the security in the relevant register.
In general, the perfection of a pledge or an outright transfer requires both a valid security agreement (not necessarily in writing, although this is strongly advised) and the secured party obtaining actual possession of the relevant assets (or at least depossession of the security provider). As such, the security provider cannot continue to have sole control over the pledged or transferred assets and therefore cannot dispose of that asset without the consent of the secured party.
Security over shares and financial instruments The valid creation of a security interest requires a valid security agreement. With respect to the perfection of a security interest, different rules apply depending on whether the shares and financial instruments are certificated or uncertificated.
The perfection of a security on certificated bearer instruments requires only the delivery of the certificate to the secured party (eg, the pledgee). In the case of certificated registered instruments, the certificate must be delivered and either endorsed or accompanied by a declaration of assignment. Uncertificated shares and financial instruments must be pledged, transferred or assigned in writing.
The articles of association of the corporate entity whose shares are being pledged or transferred or assigned as security can include additional requirements for the creation and/or perfection of the security interest.
Security over book-entry securities Transfer The security provider must instruct the intermediary (with whom the security account in which the relevant securities are booked is held) to transfer the relevant book-entry securities into the secured party's security account. The book-entry securities are credited to the securities account of the secured party and become the property of the secured party once the credit entry is made. The secured party can therefore transfer and dispose of the book-entry security, regardless of whether it is entitled to under the security agreement.
When the security agreement ends, the secured party must return to the security provider the same quantity, type and quality of book-entry securities received as collateral.
Control agreement An irrevocable control agreement is entered into between a security provider and an intermediary with whom the security account is held. The control agreement should state that the intermediary must follow the secured party's instructions without the need for prior consent or cooperation on the part of the account holder (and/or security provider).
In practice, the agreement is often made as a tripartite agreement including the secured party. The existing security interests of the intermediary holding the security account are deemed to be subordinated to the security interest of the secured party if the latter is not informed about the existing security interest of the account holding intermediary at the signing of the control agreement at the latest. A notification can be included in the control agreement and acknowledged by signing the agreement.
Unlike a security interest created by transfer, the book-entry securities remain credited to the securities account of the security provider and remain the property of the security provider. Therefore, disclosure obligations under the Stock Exchange Act are inapplicable and the security provider is not exposed if the secured party becomes subject to insolvency or similar procedures. The security provider can dispose of the securities (within the limitations of the control agreement, if any). Therefore, it is advisable to ensure the control agreement restricts or excludes the right of the security provider to sell or exchange securities to the extent of the security interest. Article 25 of FISA also provides for the creation of a limited security interest covering only either:
- a certain quota and/or a defined maximum value of book-entry securities in an account; or
- specified book-entry securities credited to the securities account.
Grant to intermediary A security provider can grant a security interest to an intermediary. The security interest is created by an agreement which does not require any particular form or content (and can even be set out in the intermediary's general terms and conditions). A security under Article 26 of FISA can be perfected only with the intermediary with whom the security account is held. If the security will be granted to a party other than the intermediary with whom the security account is held, the security interest needs to be granted by way of a control agreement or by way of transfer.
Security over claims and receivables The grant of a security on claims and receivables is based on the same principles as security over movable property. However, there are some differences when compared with movable property:
- The pledge of claims is established by written agreement (typically, the same instrument as the undertaking to grant a pledge). The essential terms of the pledge agreement must be in writing. This requirement is satisfied if the pledge agreement is signed by the pledgor. The signature of the pledgee is not required as its acceptance is assumed by law. If there is a promissory note or similar instrument with regard to the pledged claim, the promissory note must be handed over to the pledgee for the completion and perfection of the pledge. A promissory note is a unilateral written confirmation of the debtor evidencing that a specific debt exists. The loan agreement does not qualify as a promissory note and therefore, according to leading Swiss doctrine and case law, need not be transferred.
- An assignor must sign an assignment of receivables or other claims and not just a related undertaking in the assignment or security agreement. Notification to the third-party debtor is generally not required for valid creation, but is required for perfection of the security interest and enforceability against a third-party debtor. Transfer restrictions in the underlying arrangements governing the assigned receivables or rights can jeopardise the valid creation of the assignment and may require the consent of the third-party debtor.
- If the underlying agreements governing the receivables do not exclude an assignment, notification of the obligors of the assigned receivables is not required. However, the parties to the transaction might opt to notify the underlying obligors in order to prevent them from validly discharging their obligations by making a payment to the originator as debtor. If the parties decide to transfer the receivables via an assumption of contract, the consent of the underlying obligors is required for the transfer to be valid and effective. Notification is usually effected by informing the obligors in writing.
Security over bank accounts The valid creation of a right of pledge over a bank account requires a written pledge agreement. To enforce the pledge against the account bank, the pledge must also be notified to the account bank. However, notification is not necessary to perfect the pledge. The agreements between the account bank and the pledgor often provide for a security interest (or rights with a similar commercial effect) for the benefit of the account bank with respect to the balance on the bank account, which would take precedence over any subsequent security interest unless a waiver is obtained.
Security over other rights To pledge other rights, a written pledge agreement must be drawn up and any formalities required for the transfer of the right must be observed.
In relation to intellectual property, transfers, assignments and pledges are created by a written agreement. Registration of the agreement is not required, although it is advisable. This is because only a registered security holder can enforce its security interest against another party that is relying (in good faith) on information registered in the relevant public register.
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