Debt collaterals / securities

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Proper collateral / security for a claim – a creditor’s right resulting from a specific legal relationship – reduces the risk that the other party will default on their obligation. The mere fact that the creditor has the appropriate security can discourage the debtor from making any attempts at avoiding responsibility. However, if the debtor refuses to render a performance, pay a debt or perform any other contractual obligation, the secured creditor can obtain satisfaction for their claims relatively easily.

Types of collaterals / claim securities in Poland

There are two types of securities:

  • personal security (which allows the creditor to seek satisfaction against all debtor’s assets) and
  • collateral security which allows the creditor to obtain satisfaction from the debtor’s specific assets, even when the asset owner changes.

A security can be established in the case of the sale of goods and services, as well as other contracts, depending on the needs and the nature of a specific legal relationship. It is strongly recommended that the right security is established upon the execution of a contract, however, it is also possible to introduce appropriate solutions to guarantee payment by the debtor at the extrajudicial stage of debt collection.

The most popular forms of securities for claims are the following:

Contractual penalties

Contractual penalties are one of the most popular ways of securing a debt in business transactions; they are the go-to security for the widely understood construction industry in particular, but they can be used in almost every area of operations ran by economic actors.

What is a contractual penalty?

In accordance with the definition provided in Polish Civil Code, the parties to a contract can agree that in the event of a failure to perform a non-monetary obligation or inappropriate performance of a non-monetary obligation, the damage caused will be remedied with the payment of a specified sum of money. So, a contractual penalty is a sum of money that the defaulting party is required to pay to the other party to the contract as a flat-rate compensation.

You should note that:

  1. a contractual penalty can be used to secure only non-monetary obligations (e.g. in the case where a contract is terminated due to the fault of the other party, the delivery of goods is delayed, etc.),
  2. in principle, a contractual penalty is stipulated so that the creditor does not need to prove the exact value of the damage suffered,
  3.  the value of a contractual penalty or at least the method of calculation should be set forth in the contract (it can be expressed as a sum or a percentage).

The functions and advantages of a contractual penalty

There are many reasons why contractual penalties are so popular as a method of securing payments. These are the key functions of contractual penalties:

  1. guarantee function – a debtor is more motivated to perform their contractual obligations with due diligence if they know that failure to do so will lead to specific financial consequences,
  2. compensation function – a creditor can claim the payment of a contractual penalty before the court without the need to prove that they suffered losses as a result of the other party’s failure to perform or inappropriate performance of a contractual obligation or to demonstrate what is the exact value of the losses so suffered.

The key advantages of contractual penalties are that they are easy to establish (no special form is required) and no fees are required to introduce them.

Contractual penalties – potential risks to the creditor

It is important to remember that even the most carefully drafted contractual penalties will not have the desired effect if the debtor is insolvent.

Moreover, unless the parties agree otherwise in the contract, a contractual penalty will be due only in circumstances within the debtor’s control, in other words circumstances which occurred due to the debtor’s fault. If the failure to perform or inappropriate performance of an obligation results from circumstances which the debtor could not have foreseen or prevented or circumstances within the creditor’s control, the creditor is not entitled to claim the payment of the contractual penalty.

As already mentioned above, a contractual penalty is a form of a flat-rate compensation. So, unless the contract provides otherwise, the sums that the creditor will be entitled to seek from the debtor will be limited to the stipulated contractual penalty, even if losses suffered by the creditor as a result of the other party’s default are higher than the contractual penalty.

It is also important to note that the court is authorized to reduce the amount of contractual penalties. The court uses this option when the amount of a contractual penalty is much higher than the value of the contract, the obligation was to a large extent performed by the debtor or the amount of the contractual penalty is otherwise unreasonable.

You should keep these aspects of a contractual penalty in mind, when you want to include this type of security in a contract.

Promissory note / Bill of exchange

Negotiable instruments such as a promissory note and a bill of exchange are one of the oldest forms of debt security still in use. They are a type of a security (a financial instrument) that contains the debtor’s unconditional promise to pay a sum of money stated in the instrument.

On the one hand, given that the law places strict requirements on the form of these negotiable instruments, much care and though must go into drafting, which some of those wanting to use them may find burdensome. On the other hand, they are one of the safest and the most effective ways of securing the repayment of a debt. In some cases, where a business partner is temporarily out of cash and unable to pay for goods or services, these instruments may even be used as a substitute for money.

The two most popular types of negotiable instruments are:

  • promissory notes and
  • bills of exchange.

Mandatory elements of promissory notes and bills of exchange

When a party issues a promissory note or a bill of exchange to another, they enter into a form of a contract whereby the issuer (drawer) undertakes to pay a specified sum to their creditor (payee) within a specified time limit.

These instruments are subject to extremely strict requirements. The following are obligatory elements of promissory notes and bills of exchange:

  1. the designation “promissory note” or “bill of exchange” inserted in the body of the instrument and expressed in the language used to draw up the instrument;
  2. a promise or unconditional instruction to pay a specified sum of money;
  3. maturity date;
  4. payment location;
  5. the name of the person to whom or at whose instruction the payment is to be executed;
  6. designation of the date and place of issuance;
  7. signature of the issuer of the instrument;
  8. in the case of a bill of exchange, also the name of the person who is to make the payment (drawee);

If a document misses any of the above elements, it is not valid as a promissory note/ a bill of exchange. It is assumed that a promissory note or a bill of exchange without a maturity date is payable at sight. If not stated otherwise, the location stated next to the drawee’s or issuer’s name is considered as the location where the payment is to be executed, as well as the place of residence of the drawee or the issuer. A promissory note or a bill of exchange without the location of issue is considered to have been issued in the place stated next to the issuer’s name.

Promissory note

A promissory note, which is much more popular in business transaction than a bill of exchange, contains a promise to pay. The important thing about a promissory note is that the issuer makes the commitment in their own name.

Bill of exchange

Unlike a promissory note, a bill of exchange contains an instruction to pay a sum indicated in the instrument by the issuer to a specified person referred to as the drawee.

Blank promissory notes and bills of exchange

Both a promissory note and a bill of exchange can take the form of a blank instrument, sometimes referred to as incomplete. Its characteristic feature is that the parties agree to leave out the necessary elements of a promissory note or a bill of exchange or to add extra elements if appropriate conditions are satisfied. A blank instrument must always be signed by the issuer or acceptor (in the case of a bill of exchange) with the intention to be bound under such an instrument and the goal to transfer it by endorsement after it is completed. A blank promissory note and a bill of exchange should also contain its name in the body of the document. Later, such an incomplete promissory note or a bill of exchange is delivered to the payee. The appropriate information will be filled in upon terms and conditions determined by the parties in a promissory note/ a bill of exchange agreement. The sum of money to be paid by the issuer is the element that is most often left out of the instrument, to be completed by the payee.

It is important to note that a complete promissory note or a bill of exchange gives rise to a commitment between the parties that is detached from the reasons and conditions of the issuance of the instrument.  A blank promissory note and a bill of exchange are tied closely to the agreement executed between the issuer and the payee referred to as a promissory note/ a bill of exchange agreement (porozumienie wekslowe). The agreement authorizes the transferee to fill in the blank instrument and sets out the terms and the method of filing it in. If the agreement has a written form it is called a promissory note/ a bill of exchange declaration (deklaracja wekslowa). If the debtor delivered the blank instrument without providing any instructions as to the way it should be filled in, it is assumed that they have no objection to the instrument being filled in by the transferee.

The role of a promissory note and a bill of exchange in debt collection

A promissory note and a bill of exchange, if drafted properly, can materially facilitate the recovery of a debt by way of judicial proceedings.  Firstly, it can be used as a basis for the issue of a payment order under injunction proceedings, which makes debt collection less expensive and faster compared to debt collection under standard judicial proceedings.

Submission to enforcement

The advantage of the debtor’s statement on voluntary submission to enforcement (commonly referred to as the “three sevens” because of Article 777 of the Polish Civil Procedure Code where this procedure is described) is that generally a debt secured with such statement can be recovered under enforcement proceedings without the need of going through the judicial process and obtaining a court judgment. The statement on voluntary submission to enforcement, which must have the form of a notarial act to be valid, replaces a court judgment and, following a simple procedure, becomes an enforcement order required for the debt enforcement officer to hold enforcement proceedings.

A debtor can voluntarily submit themselves to enforcement in a notarial act in respect of:

  1. the obligation to pay a sum of money or deliver things designated as to their kind with the number of them specified in the notarial act or the obligation to deliver a thing designated as to its identity, if the date for the performance of this obligation or the event to which the performance of the obligation is tied are specified in the notarial act;
  2. the obligation to pay a sum of money with its maximum amount expressly stated in the notarial act or determined under an indexation clause, if the event to which the performance of the obligation is tied and the date by which the creditor can apply for declaration of enforceability with respect to that notarial act are specified in the notarial act;
  3. the encumbered asset to obtain satisfaction for a secured creditor’s monetary claim.

Although points 1 and 2 both concern a payment obligation, there are distinct differences between the two statements. In the first case, the sum of money is stated in the notarial act, and in the second case, only the upper limit of the potential debtor’s financial liability is stated. In addition, the first type of statement on voluntary submission to enforcement can also concern the obligation to deliver a thing. This statement is typically used, for instance, in the case of immovable property sale, where the seller submits themselves to enforcement in respect of the delivery of the immovable property sold to the buyer within a specified time limit.

The third type of the statement, outlined in point 3, is limited to only these assets belonging to the debtor which are encumbered with a security.

As mentioned above, a statement on voluntary submission to enforcement lets the creditor satisfy their claim without the need to seek judicial intervention to obtain an enforceable judgment. A notarial act containing the debtor’s statement is referred to as an enforcement title (tytuł egzekucyjny). If the conditions specified in the notarial act are fulfilled (specific circumstances occur), the creditor may apply to the court for declaration of enforceability in respect of the interim enforcement order. Once the court declares it enforceable, the interim enforcement order becomes final, making it possible for the creditor to apply to a debt enforcement officer to initiate enforcement proceedings against the debtor. This process is much shorter and less expensive than litigation.

Pledge

A pledge is a limited real right in a movable – an asset belonging to a collateral debtor (pledgor). A right can also be pledged. A pledge can be established as a security for a claim that already exists, as well as a future and conditional claim (Article 306 of the Polish Civil Code). In accordance with the Polish Law, which regulates this legal instrument, a person wanting to secure a specific claim can encumber a movable with a right whereby the creditor (pledgee) will be able to obtain satisfaction against the asset, irrespective of whether the title to the asset was transferred to another, with priority over the personal creditors of the owner of the asset (entitled to seek satisfaction against all the debtor’s assets). In practice, in the event of a default by a debtor who pledged their asset, the collateral creditor has the right to obtain satisfaction of their claim directly from the pledged asset.  A creditor has the right to obtain satisfaction from the pledged asset before other creditors, provided that they are not secured with a pledge established earlier on the same thing. A debt secured with a pledge is typically recovered by way of judicial enforcement proceedings.

Accessory nature of a pledge

It is worth noting that a pledge is accessory, which means that the existence of a pledge is permanently attached to the existence of the claim it secures. A pledge cannot be transferred separately from the claim it secures, and the transfer of a claim secured with a pledge requires the transfer of the pledge. If a claim is transferred without the pledge, the pledge ceases to exist by operation of the law.

The form of establishing a pledge

In order to ensure that a pledge is validly established, the debtor must hand over the pledged asset to the creditor. The Civil Code places no requirements as to the form of the pledge agreement, which means that it can be executed verbally. However, the recommended form of a pledge agreement is a written agreement with authenticated date. In this form, the pledge will be effective with respect to the pledgor’s creditors. This is especially important in enforcement proceedings, allowing for the creditor secured with the pledge to take a part in the distribution of the sum obtained as a result of enforcement. This is to ensure that the claim secured with the pledge participates in the distribution of the sum obtained as a result of enforcement along with a mortgage, a registered pledge and a tax lien.

It is worth noting that a creditor has no right to dispose of or use the pledged asset, whereas the owner of the asset (the debtor) has the right to dispose of the asset freely, with the pledge placed on the asset remaining intact.

The creditor has the right to obtain satisfaction from the pledged asset only in cases provided for in the agreement between the parties, for instance, in the case of a failure to pay a debt by the debtor.

The pledged asset

The law states expressly that a pledge can be placed on a movable. In practice, a pledge is established on, among others:

  1. movables designated as to their identity – e.g. the debtor’s car,
  2. movables designated as to their kind/type – things that exist in masses and are easy to exchange for others of the same kind/type, e.g. a ton of coal,
  3. a property right or a share in a right (e.g. a share in co-ownership of real estate),

You should bear in mind that a pledge cannot be placed on immovables. A debt can be secured on immovable property by means of a mortgage.

Benefits of a pledge

  1. the costs of placing a pledge on an asset are low,
  2. a pledge in effective with respect of the debtor’s other creditors,
  3. a creditor secured with a pledge has a relatively privileged status among other creditors in enforcement proceedings,
  4. a creditor secured with a pledge can recover their debts from the pledged asset even after it has been sold by the debtor,
  5. a creditor can obtain satisfaction against the pledged asset even if the statute of limitation on the principal debt ran out (except for when the creditor is a business and the debtor is a consumer),

Registred pledge

Its features and properties are set out in a separate legislation on a registered pledge and pledge register. A registered pledge and an ordinary pledge are distinctly different.

The key features of a registered pledge:

  1. a registered pledge agreement must be executed in writing; a verbal agreement on the establishment of a registered pledge is not possible and produces no legal effects,
  2. a registered pledge is established validly even if the pledged asset is not handed over to the creditor as the registered pledge is created upon entry in the pledge register,
  3. a monetary claim secured with a registered pledge does not have to be specified, which means that a registered pledge can be used to secured claims of variable value, e.g. in the case of a trade credit,
  4. a registered pledge can be used to secure only monetary claims,
  5. a registered pledge can be established on movables and negotiable proprietary interest (except for rights that can be mortgaged or mortgaged debts),
  6. a record in the pledge register is public, which is meant to protect the interests of the creditor and the potential buyer of the asset encumbered with a registered pledge,
  7. a creditor secured with a registered pledge can seek satisfaction against the pledged asset before other creditors.

Pledge register

A registered pledge must be listed in the pledge register to be valid (the entry is constitutive). The fee for the record of a registered pledge is fixed and is equal to PLN 200. Additional fee of PLN 100 is collected if the record of the registered pledge is to be rectified or stricken off.

Special elements of a registered pledge agreement

Typically, a creditor secured with an ordinary pledge seeks satisfaction in the course of enforcement proceedings, i.e., a compulsory sale of the pledged asset under a special procedure. However, in the case of a registered pledge, the parties to the agreement establishing the pledge can agree that, in the case where the debtor defaults on their obligation, the creditor’s claim will be satisfied by transferring the title to the pledged asset to the creditor or by selling the pledged asset by public tender.

In the registered pledge agreement, the parties can also stipulate that the pledged asset will not be disposed of or encumbered before the release of the registered pledge. The disposal of an asset encumbered with a registered pledge in violation of this stipulation will be invalid, unless the person to whom the asset was transferred or the person for whose benefit it was encumbered was unaware of the stipulation at the time of the execution of the contract with the pledgor and could not have known about it despite due diligence.  Seen as this stipulation is disclosed in the pledge register upon the creditor’s request, a third party will find it hard to prove that they had no way of knowing about it before acquiring the pledged asset.

Mortgage

A mortgage is a limited real right used specifically for the purpose of encumbering immovables/ real estate located in Poland. In accordance with the legal definition, in order to secure a specific claim resulting from a specific legal relationship, one can encumber immovable property with a right of the creditor to seek satisfaction from the immovable property, irrespective of whether the title to it was transferred to another, with priority over personal debtors of the owner of the immovable property (collateral debtor).

A mortgage in created upon entry in a land and mortgage register of Poland.

There are several types of mortgages, but this discussion will focus only on contractual mortgages.

The mortgaged asset

Mortgages are typically created over immovable property / real estate, whatever their type.

However, a mortgage can also be placed on:

  1. the right of perpetual usufruct along with buildings and infrastructure on the land owned by the perpetual usufructuary;
  2. the cooperative member’s right to a dwelling unit;
  3. a mortgaged debt.

A mortgage can also be placed on a fractional share in immovable property belonging to the co-owner (collateral debtor).

The object and scope of security: the debts secured with a mortgage

A mortgage can be established to secure a specified debt (claim) resulting from a specified legal relationship. A mortgage can be used to secure only monetary claims.

A mortgage can also be established as a security for future debts, namely ones that do not exist yet at the time when the mortgage is created. A mortgage can also be used to secure several debts resulting from separate legal relationships owed to the same creditor.

The pros and cons of using a mortgage as a contractual security for a debt

A contractual mortgage established as a security for a debt resulting from a legal relationship between the parties has a number of advantages, which make it the most efficient type of security for a debt. The key advantages are the following:

  1. in principle, a debt secured with a mortgage is satisfied before other debts (except for enforcement costs, child/ spousal maintenance, salary and debts secured with maritime mortgage),
  2. a mortgagee can seek satisfaction against the mortgaged immovable property irrespective of who is the owner of the immovable at any given time,
  3. the creditor has the right to request the owner of the immovable property or a third party to discontinue any activity that may impair the value of the mortgaged immovable,
  4. in the case of restructuring proceedings, a debt secured with a mortgage cannot be included in the arrangement with the creditors without the mortgagee’s consent.

These advantages make a contractual mortgage one of the most efficient types of security for a debt, often reached for by, among others, banks offering mortgage loans, but it is also used by businesses in connection with, for instance, a trade credit.

That said, one should bear in mind that a contractual mortgage, despite all the obvious advantages, is not always the best solution. The main reason is that a mortgage must be created on the basis of a notarial act and requires the completion of a number of formalities related to the disclosure of the mortgage in a land and mortgage register. As such, it is a relatively expensive form of security (the notarial fee is determined in proportion to the value of the principal debt). If the debtor defaults on the debt, the mortgagee can seek satisfaction against the mortgaged immovable property only, and not other assets owned by the debtor, which may be easier to dispose of. The process of enforcement against immovable property may be long and burdensome and often entails restrictions that prevent a fast sale of the property (e.g. if natural persons live there).

Banking guarantee / insurance guarantee

On of the strongest and most common collateral / security is the banking guarantee (or insurance guarantee) where a bank or other financial institution undertakes an obligation to pay certain amount at request of designated beneficiary.

FAQ

What is the best / strongest collateral / claim security in Poland?

The answer depends on the type of claim, however in the first place we shall name – mortgage and submission to enforcement, afterwards we could also list registered pledge and bill of exchange. All collaterals can be established parallelly.

On what assets the mortgage n Poland can be established?

As a rule the mortgage in Poland may be established only on real estate and exceptionally also on the mortgaged debt.

Can registered pledge be established on real estate?

No, registered pledge in Poland can be established only on selected movable assets.

What is the benefit of bill of exchange in Poland?

The bill of exchange gives certain benefits in debt recovery process. The claim secured by the bill of exchange is eligible for fast track procedure with lower court fees. In addition bill of exchange allows to apply for court injunction, which if issued may be enforced after lapse of 14 days.

What is submission to enforcement or 777 in Poland?

Submission to enforcement, also called Article 777 CPC is one of the strongest securities / collaterals in Poland – allowing the creditor to start immediate enforcement without litigation.

Can a contractual penalty be established in Poland for late payment?

No, Polish law does not allow penalties for late payment. Such clauses would be void. Late payment may be punished with interest.

Is the court allowed to reduce the contractual penalty in Poland?

Yes, Polish Law allows the court to evaluate the breach and reduce the agreed contractual penalty if justified.

How to establish a mortgage in Poland?

Establishment of mortgage in Poland requires a visit at the Notary of the property owner (buyer) and entry to the Land Registry.

Expert team leader DKP Legal anna szymielewicz
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