In a judgment dated 13 October 2015 in proceedings between a bank and its client the Arnhem-Leeuwarden Court of Appeal ruled that the bank was allowed to terminate the credit agreement with the client on the grounds that the client had caused a reduction in the value of shares pledged to the bank.
Arnhem-Leeuwarden Court of Appeal 13 October 2015 (ECLI:NL:GHARL:2015:8354)
On 2 September 2004 a Dutch bank and its client entered into a credit agreement in which the bank provided the client with a Swiss Franc loan for approximately EUR 2,000,000. The client was the sole shareholder of the company, which owned the country estate on which the client lived. As security for the client's obligations under the credit agreement, the client created a right of pledge over the shares in the company. The deed of pledge stipulated that the borrower must refrain from activities which would or could, among other things, result in a reduction of the value of the shares. On 10 February 2012 the client procured that the company granted a right of mortgage over the country estate to a third party as security for the repayment of a EUR 2,500,000 loan made by that third party to the client. The bank took the position that the creation of the right of mortgage over the country estate resulted in a reduction of the value of the shares in the company and, hence, the bank terminated the credit agreement.
After summary proceedings before the District Court of Arnhem, an appeal was filed. The Court of Appeal had to determine whether the creation of the right of mortgage provided sufficient ground for the bank to prematurely terminate the credit agreement. In its judgment, the Court of Appeal referred to the criterion applied in the Supreme Court ruling dated 10 October 2014 (ECLI:NL:HR:2014:2929) that premature termination of a credit agreement in a specific event, taking into account the circumstances, is only unlawful if premature termination does not meet the standards of reasonableness and fairness under Dutch law.
The Court of Appeal considered that the company did not have material assets other than the country estate, valued at EUR 3,500,000, and that the right of mortgage was created as security for at least EUR 2,500,000 of debts. In the event of an enforcement of the right of mortgage, chances were slim that proceeds would be generated beyond what was owed to the third party, especially given the fact that sale proceeds tend to be lower in enforcement scenarios. Consequently, the Court of Appeal considered that the credit agreement was effectively no longer fully secured by the right of pledge over the shares in the company. On the basis of these considerations the Court of Appeal ruled that it was sufficiently plausible that the value of the shares had been reduced as a result of the creation of the right of mortgage over the country estate and that the client, who had procured the creation of the right of mortgage by the company, was therefore in breach of its obligation to refrain from actions which could result in a decrease of the value of the shares.
Provisions prohibiting a borrower or security provider to refrain from action which could result in a reduction of the value of collateral are omnipresent in Dutch security agreements. This is one of few occasions on which such provision is the subject of court proceedings. The judgment of the Court of Appeal demonstrates that courts are willing to interpret such provision widely and that all kinds of action which could result in the reduction of value of collateral may be deemed to constitute a breach of the obligations of the borrower and provide a valid ground for termination of the credit agreement by the bank.
This article was published in the Banking and Finance Update of December 2015.