Think Carefully Before Offering a Business Share as Collateral for Debt

written by: Dr. Stjepan Lović Adrian Tomislav Miletić, attorneys from OD Grubišić & Lović & Lalić

In legal transactions, it is common to secure creditors’ claims with a lien on real estate, primarily due to its stable value and relatively simple possibility of sale in enforcement proceedings. The subject of security can also be a business share that the debtor or a third party holds in a limited liability company (d.o.o.) or shares in a joint-stock company.

Considering some differences in the legal regime of securing claims on business shares compared to securing materialized and non-materialized securities, such as shares, this article focuses exclusively on securing claims on business shares.

An Uncertified Contract is Null and Void

A lien is a limited real right on a specific item that authorizes the lien creditor to satisfy a specific claim from the value of that item if it is not fulfilled upon maturity. A lien can encumber a specifically determined movable or immovable item capable of monetization, as well as a specifically determined property right suitable for the creditor to satisfy their claim. Since a business share in a d.o.o. is a collection of subjective property rights belonging to its holder, it can be the subject of a pledge.

When it comes to the method of acquiring a lien on a business share, in practice, it is most often a voluntary lien established by a legal transaction between the lien creditor and the lien debtor, in a manner prescribed for the transfer and acquisition of that right. The lien debtor may or may not be the debtor of the claim secured by the lien. The Companies Act stipulates that the contract for acquiring a lien on a business share must be executed in the form of a notarial deed or a private document that must be certified by a notary public.

The legal solution that prescribes a strictly formal form for concluding the contract for acquiring a lien is a significant change introduced in the Companies Act by the amendment in 2019. The consequence of the lack of a legally prescribed form when establishing a lien on a business share is the nullity of such a legal transaction. Thus, the legislator equated the prescribed form for concluding a contract that transfers a business share and establishes a lien on it.

When the Lien ‘Takes Effect’

In addition to achieving normative compliance in the form of these legal transactions, the amendment from 2019 significantly contributed to legal certainty and publicity when establishing a lien on a business share. The notary public participating in the conclusion of that contract is obliged without delay to compile a list of the members of the company instead of the members of the management, indicating which business share is pledged and to deliver one copy to the registration court and one copy to the company.

The Law on the Register of Judicial and Notarial Securities of Creditors’ Claims on Movable Property and Rights stipulates that judicial and notarial liens based on an agreement between the parties concluded in accordance with the provisions of the Enforcement Act are acquired by registration in the register maintained by the Financial Agency.

Based on the cited provisions of the Law on the Register of Judicial and Notarial Securities of Creditors’ Claims, it follows that such registration has a constitutive effect and that for the establishment of a lien on a business share, a proposal for registration must be submitted to the Financial Agency, whereby it is considered that the lien is acquired at the time when the proposal for registration is received by the Financial Agency, provided that such proposal is accepted.

Although the encumbrance of the business share by a lien is also registered in the book of business shares, the lien arose already upon registration in the aforementioned register of the Financial Agency, and the registration of the lien in the book of business shares is of a declarative nature.

Thus, the legal regime of the lien on a business share has significantly approached the legal regulation of the lien on real estate, and the register itself, which is publicly accessible, serves the publicity function that land registers provide to liens on real estate.

The Rights of the Member Remain, but…

By establishing a lien on a business share, its holder does not lose their status as a member of the company, and they continue to possess all the membership rights, as well as obligations, that they have based on law and the company agreement. This means that the holder of the business share (the lien debtor) continues to possess all property and management rights within the scope defined by the company agreement, such as the right to vote at the company assembly and the right to a share in the company’s profits. The lien creditor when establishing the lien must be aware that the lien debtor themselves, as well as the company assembly, can make decisions that may be contrary to their interests.

What the Company Assembly Can Do

The lien debtor can, for example, transfer the encumbered business share if they have not otherwise obligated themselves by a contract concluded with the lien creditor. The company assembly can also, by its decision, issue new business shares that will have greater voting rights than the business share on which the lien was established, which reduces the value of the encumbered business share. The registration court will carry out changes in the Court Register if the formal and procedural legal prerequisites are met.

According to the Companies Act, a decision to increase the obligations of members towards the company arising from the company agreement or to reduce the rights of certain members based on that agreement can only be made if all members of the company to which the increase in obligations or reduction of rights applies agree; otherwise, they could challenge it.

However, the scope of the previously mentioned provision of the Companies Act is limited exclusively to the members of the company, and it cannot be interpreted as granting that authority to lien creditors. Therefore, the lien creditor does not have a direct means to prevent the assembly’s decision that would amend the company agreement, which would indirectly reduce the value of their lien on the business share.

Possible Protective Clauses

Therefore, it is in the interest of the lien creditor to negotiate protective clauses such as a prohibition on the disposal of the business share or a prohibition on status changes. The contracting parties can limit the autonomy of the lien debtor’s participation in decision-making at the company assembly by the legal transaction establishing the lien.

Thus, for example, they can foresee the obligation of the lien debtor to obtain the consent of the lien creditor before voting on significant decisions that may affect the interests of the lien creditor. Furthermore, to protect the interests of the lien creditor, it is possible to negotiate a prohibition on the company incurring debts that could reduce the value of the business share in the company.

It should be noted that such protective clauses have effect only between the contracting parties who agreed to them and would not bind any other members of the company. Therefore, although the lien debtor is obliged to consider the legal interests of their lien creditor, decisions contrary to those protective clauses could still be made, but in that case, the lien creditor would have a contractual claim against the lien debtor, primarily for damages.

Satisfaction of Claims by Sale

The process of satisfying the lien creditor’s claim from the value of the business share depends on the contractual provisions on which the lien is based. Namely, if the claim for which the pledge is given arises from a commercial transaction, the lien creditor has the right to extrajudicial satisfaction of their claim, unless the lien debtor has explicitly excluded such satisfaction. When it is not a claim arising from a commercial transaction, the lien debtor must at the time of establishing the lien or subsequently explicitly in writing allow for extrajudicial satisfaction.

Such extrajudicial satisfaction can be carried out by public auction or in another agreed manner, for example, that the lien creditor sells the business share themselves. For this purpose, the lien debtor can also issue a power of attorney for the sale of the share in advance. Such a satisfaction process is extremely favorable for the lien creditor as it is a quick and efficient way to satisfy the claim, and this is because the formalities prescribed by the Enforcement Act do not apply to extrajudicial satisfaction under Article 337 of the Law on Ownership and Other Real Rights. In this regard, the contracting parties can agree on the conditions of sale, the method of assessing the minimum price at which the business share can be sold, or choose an appraiser who will assess the market value of the business share.

If Agreement Fails, Enforcement Applies

In a legal transaction where extrajudicial satisfaction is not agreed upon, it is necessary to carry out the enforcement procedure prescribed by the Enforcement Act. Enforcement on a business share is carried out by seizing the share, its assessment, and sale, and satisfying the enforcement creditor.

After the enforcement decision is made, it is delivered to the management of the company that maintains the book of business shares. By delivering the enforcement decision to the management of the company, the seizure of the business share is executed.

The company is obliged immediately after receiving the enforcement decision to register that the seizure has been executed in the book of business shares and is liable to the lien creditor for any damage that may arise from the failure to do so. The lien debtor is prohibited from disposing of the business share after the seizure.

After assessing the value of the business share with the help of an expert or authorized appraiser, the sale is approached either by auction or by direct agreement conducted by the court bailiff. The lien creditor is satisfied from the achieved price based on the court’s decision conducting the enforcement. If the achieved price is higher than the secured claim, the excess will belong to the lien debtor. The buyer becomes the holder of the business share based on the decision on the award and is then registered in the book of business shares of the company.

Fiducia on the Business Share

The creditor’s claim can also be secured by fiducia on the business share. The institute of fiducia is regulated in the chapter of the Enforcement Act called ‘Judicial and Notarial Security of Claims by Transfer of Ownership of Things and Transfer of Rights’. The agreement on establishing fiducia provides that for the security of a certain claim, ownership of a thing belonging to the security opponent (fiduciant) is transferred to the fiduciary (creditor) or that a certain right, such as a business share, is transferred to the fiduciary for that purpose. The claim being secured must be specific, as well as the information on when the claim will be due.

The transfer of the business share has already been carried out before the due date of the claim by signing a record or notarial deed and registering the transfer of authority on the business share for security in the register of the Financial Agency. Since the amendment to the Companies Act in 2019 also prescribed a mandatory form of notarial deed or private document certified by a notary public for establishing a lien on a business share, the legal regulations regarding the establishment of a lien and fiducia on a business share are now equalized.

It is important to note that the fiduciary does not immediately become a full-fledged holder of rights to the business share, but a conditional authorized person of that right. Unless otherwise agreed with the fiduciary, the fiduciant will retain property and management rights concerning the business share.

What is the Difference

The difference in relation to securing by lien is that, under certain assumptions, the fiduciary can more easily become a full-fledged holder of the business share if they have an interest in it. Namely, the lien creditor cannot unilaterally decide to retain the item that has been pledged to them, although there is no obstacle to purchasing the business share as a buyer in the event of its sale, for example, at auction, provided that all legal conditions are met.

On the other hand, the fiduciary is authorized after the due date of the secured claim in accordance with the enforcement procedure rules to sell the pledge with the help of a notary public. Instead, with the help of a notary public, they can request the fiduciant to inform them within thirty days whether they require the business share to be monetized with the help of a notary public.

In the case of non-response, it will be considered that the fiduciary has become the full-fledged holder of the business share for a price corresponding to the amount of the secured claim with interest and costs and taxes. The fiduciant is authorized to determine the minimum price at which the business share can be sold, which must not be lower than the secured claim, increased by interest and costs of the creditor that will predictably become due.

After potentially receiving a notice from the fiduciant that they require the sale of the business share, the fiduciary is obliged within fifteen days to authorize the notary public to proceed with the sale. If the notary public fails to sell the business share within three months from the day the fiduciary authorized them to do so, it will be considered that the fiduciant has waived the right to request the sale of the business share. In that case, it will also be considered that the fiduciary has become the full-fledged holder of the business share for a price corresponding to the amount of the secured claim with interest and costs and taxes. Thus, the claim that was secured by fiducia on the business share is considered fully satisfied.

What is More Favorable for Whom

Therefore, the primary way to realize the creditor’s claim secured by fiducia is also through satisfaction from the price of the business share achieved by its sale, rather than a full transfer of the business share to the creditor. The transfer of the business share will only be possible at the debtor’s proposal, or by their passive holding in response to the creditor’s call to express whether they want the sale of the business share, or by unsuccessful sale of the business share with the help of a notary public. Fiducia can thus be attractive to the creditor who prefers to potentially become the full-fledged holder of rights to the business share in the company where such a business share is their business interest.