NEW DECISION OF THE CJEU ON THE TREATMENT OF FINANCIAL COLLATERAL IN BANKRUPTCY

Court of Justice of the European Union (“CJEU“) issued a judgment C-107/17 on 25 July 2018 that could have a significant impact on the interpretation of financial collateral provisions in insolvency events. The Supreme Court of Lithuania requested a preliminary ruling concerning the interpretation of Council Directive 2002/47/EC of 6 June 2002 on financial collateral arrangements  (the “Directive“).

The referring court explains that Aviabaltika and Ūkio bankas entered into a security financial collateral arrangement within the meaning of Article 2(1)(c) of the Directive and that an enforcement event occurred after the commencement of the insolvency proceedings against the collateral taker, namely, in the present case, Ūkio bankas. It therefore questions, in particular, whether that collateral could be enforced by the collateral taker in order to enable it to recover its claim against the collateral provider, namely Aviabaltika, arising from that company’s failure to discharge financial obligations covered by that arrangement.

An interpretation of Article 4(5) of the Directive whereby the security financial collateral arrangement would become ineffective as a result of the commencement of insolvency proceedings against the collateral taker, preventing that party from effectively recovering its claim from that collateral and obliging the collateral provider, in practice, to pay to the collateral taker the amount of that collateral a second time. Such actions would be contrary to both the wording of that article and the objectives pursued by the Directive. Indeed, such an interpretation would result in  an arrangement being rendered ineffective to a large extent and could, as the case may be, cause financial difficulties for that collateral provider, contrary to the objective of limiting contagion effects in case of a default of one of the parties.

As Article 4(5) of the Directive does not specify the way in which the effectiveness of financial collateral is to be ensured notwithstanding the commencement of insolvency proceedings, it is for the Member States to provide for appropriate means of ensuring such effectiveness, which could include a measure whereby the financial collateral is excluded from the collateral taker’s assets.

Supreme Court of Lithuania further asks whether Article 4(1) and (5) of Directive should be interpreted as requiring the  collateral taker provided under a security financial collateral arrangement to recover its claim, arising from a failure to discharge the financial obligations covered by that arrangement, primarily from that collateral.

CJEU explains that the expression “the collateral taker shall be able to realise”, used in paragraph 1 thereof, indicates that, in cases entailing the enforcement of the financial collateral, the taker has the option, rather than an obligation, to realise that collateral. In addition, the phrases “subject to the terms agreed in” and “in accordance with its terms”, used in Paragraphs 1 and 5 of that Article, show that Directive gives priority to the terms of the arrangement.

In conclusion, the provisions must be interpreted as not requiring the collateral taker provided under a security financial collateral arrangement to recover its claim, arising from a failure to discharge the financial obligations covered by that arrangement, primarily from that collateral, but that such option for the collateral taker should exist, even in an insolvency event.