Comments on Supreme Commercial Court Decision “About Some Issues of the Law on Pledges”

Dmitry Chernyy and Sergei Kartoshkin of Muranov, Chernyakov & Partners comment on the Decision #10 of the Plenum of the Supreme Commercial Court of February 17, 2011 “About some issues of the law on pledges”.

First of all, it is worthwhile remembering that decisions of the Supreme Commercial Court do not change the law but simply affect the law enforcement practices to a greater or lesser extent by providing guidelines to lower courts as to how they should interpret and apply the law. This applies to Decision #10 of the Plenum of the Supreme Commercial Court of February 17, 2011 “About some issues of the law on pledges”.

The decision focuses on issues concerning extrajudicial foreclosure and other aspects of the sale of the collateral.

For example, in practice problems appear when, in violation of the law, creditor-pledgee who is stronger economically forces the pledgor to agree to extrajudicial foreclosure. To counteract such practices the Supreme Court reminded that if such an agreement violates the statutory prohibition on foreclosure then this agreement is void.

In order to protect bona fide persons the Plenum also paid special attention to the form of the agreement on extrajudicial foreclosure. Thus, if an agreement on non-judicial foreclosure is a separate document it must meet the same requirements to form as the main contract on pledge.

In addition, the Supreme Court has considered cases when the consent of another person is required to enter a pledge agreement and foreclosure can only be made by the court. This in particular includes cases such as: when a sole trader pledges a movable property which is in common ownership; a shareholder in a limited liability company pledges his or her share in the company, if the pledgee is not another shareholder; or a tenant pledges the right to lease the land.

A considerable amount of controversy is caused when the pledgee, in violation of law, forecloses on the pledged property out of court and then sells it. In such cases, the question is: how to protect the rights and interests of the pledgor?

The Plenum has not disregarded this problem. According to art. 5 of the decision if a pledgee is not entitled to non-judicial foreclosure but sells the property to a third party, the pledgor is entitled to demand the property from the purchaser and if the property is retained by the pledgee, from the pledgee.

I would like to consider the guidance provided in paragraph 13 of the decision. For example, many disputes arise when the creditor and the debtor agree to change the terms of the principal obligation (for example, to increase the period of time for performance) and then the pledgor makes every attempt to remove the encumbrance from the pledged property on the grounds that the main agreement was terminated. The Supreme Commercial Court proposed the following solution to the problem: changing the size or date of execution of the secured obligation (e.g. due to changes in interest rates on the loan or the maturity of the loan) cannot be regarded as grounds for termination of the pledge.

This has already caused a debate among law professionals. The media has suggested that this provision can be used for unfair appropriation of the pledged property or raider seizures.

However, in our opinion, this fear is unfounded and exaggerated:

First, even when there is no change in the terms of the secured obligation, nothing prevents the creditor and the debtor from agreeing that the debtor deliberately does not perform the obligation, so that the lender is able to foreclose on the collateral provided by the third party.

Second, in the same paragraph the Plenum provides effective mechanisms to protect the interests of the pledgor from the abuse by the pledgee. When the principal obligation is increased the courts should bear in mind that the pledge continues to exist to the extent in which it would have existed without such changes unless the agreement stipulates otherwise. When the period of performance is increased the limitation period for foreclosure depends on the limitations of the principal obligation as if the period of performance was not changed.

We have covered only a few of the provisions of the decision of February 17, 2011 and we strongly recommend all legal practitioners to read the full text of this decision.

Should you have any questions, please do not hesitate to contact Dmitry Chernyy or Sergei Kartoshkin on +7 495 783-74-50 at Muranov, Chernyakov & Partners.