Assignment of the mortgage rank – a mean for balancing the dynamics of projects implying existence of financing contracts

Siranus Hahamian
Siranus Hahamian
Diana Bejenaru
Diana Bejenaru

» Opening remarks

It is widely acknowledged that the entry into force of the Civil Code in 2011, inspired by the Civil Code of Quebec and the Uniform Commercial Code of the United States of America, brought novelty elements to the system of securities provided for the enforcement of civil obligations[1]. A recently introduced institution in Romanian law and less used in practice is the assignment of rank of real estate / movable mortgages, as self-standing operation, not dependent on the claim and even on the mortgage right itself.

The assignment of rank may have a series of benefits by reference to financing contracts for various projects, especially those that involve the existence of several creditors and a dynamic of the latter during development and implementation.

From the perspective of the developer of the project (as a borrower) financed through such a contract, the co-participation of several banking institutions might represent both an advantage and an issue with respect to fulfilling the formalities necessary to ensure the publicity of the related securities.

» The dynamics of financing contracts

The starting point is that a successful implementation of the financed project postulates a temporary agreement between several banking institutions which decide to cooperate and to jointly carry out specific large-scale operations. Such institutions draw in significant financial resources, share the risks and profits pro rata with the monetary resources provided, undertaking an increased risk compared to the operations normally performed.

In order to secure the financing quotas, the project developers establish a complex array of securities. In most cases, the provision of securities represents a precedent condition for the execution of the financing contract and / or of its performance, the securities being requested in advance, prior to the onset of the claim in consideration of which they are established.

Given the magnitude and complexity of the financed projects, as well as the freedom to contract in general, during the contracts’ implementation a number of situations generating changes in the coordinates initially considered by the parties might arise, such as the withdrawal of an initial creditor and / or the accession of a new creditor. These aspects require the insertion of the new participants within the already existing contractual mechanisms, which will take over from the obligations of the existing creditors and / or increase from their own resources the amount of the financing.

In this situation, it is easy to understand that the new creditor will seek to have an equal position with the original creditors. Bearing in mind this objective, the borrower may be put in a position to ensure the equality between the lenders, initially, through the provision of securities equivalent to those already established and, subsequently, in terms of order of preference and rank of mortgages, in a straightforward manner both for the new creditor and for the initial parties to the financing contract.

Considering the imperative provisions that establish the order of preference and the rank of mortgages, the assignment of mortgage / rank, as well as the conventions regarding the order of the claims’ collection may represent an indispensable legal mechanism and may exempt the parties from excessive publicity formalities, especially in relation to securities under the form of real estate mortgages.

»The principle of creditors’ equality

Security enforcement is, as a rule, governed by the principle of creditors’ equality, which is manifested even within the classes of creditors with the same rank.

In the matter of mortgages, the rank is determined based on the principle prior tempore potior iure, which considers:

(i) in the case of real estate mortgages, the order of registration of the applications with the land book (in accordance with art. 890 para. (2) of the Civil Code and art. 2421 of the Civil Code), and

(ii) in the case of perfected movable mortgages, the order of registration with the Archive of Secured Transactions or of perfection (according to art. 2420 of the Civil Code).

The rank of the mortgage is all the more preferred as the mortgage was registered earlier with the relevant publicity register, regardless of whether it is a legal or conventional mortgage[2].

As we have shown, if during the course of the financing changes in the structure of the initial creditors occur, the borrower may be put in a position to ensure and maintain equality between creditors as initially agreed, especially in regard to claim collection.

By automatically applying the legal provisions in such a situation, any new creditor intending to become a party to an ongoing financing contract will have an inferior position to the original creditors. Unless otherwise stated, the mortgages established in its favor will have a lower rank, according to the prior tempore potior iure principle.

Therefore, in order for the new creditor to benefit from an equal rank, at first glance, it appears that, with the accession of a new creditor, all the formalities for constitution and publicity of the mortgages must be resumed to ensure the latter an equal position in relation to the existing creditors (it is hard to believe that a new creditor would join an ongoing financing without having a rank equal to that of existing creditors).

These efforts become even more significant especially by reference to the publicity  formalities (with the land book, where it is expressly provided that the real estate mortgage is validly established conditioned by the fulfillment of the registration formalities with the land book) in the context in which in order to ensure the equality in rank a new registration process is required, which implies the de-registration of the previously registered mortgages and their subsequent re-registration in favor of all creditors. The fees for the re-registration are calculated at the value of the claim, similar to the case of the first registration (practically, the fees calculated at the value are paid again).

However, the rule of creditor equality allows some exemptions, which may be of assistance regarding certain aspects generated by the dynamics of financing contracts.

» The mortgage assignment in general

In the current legislation, the mortgage right is validly established by (i) concluding the legal deed whereby the mortgage is provided, and (ii) carrying out the publicity formalities.

Pursuant to art. 2358 para. (1) and art. 2427 para. (1) of the Romanian Civil Code, the mortgage right, including its prerogatives on the right to enforce and the right of preference, as well as its rank, may be assigned in whole or in part.

With respect to the assignment parties, the mortgage right or its rank may be assigned by a mortgagee in favor of another mortgagee or of an unsecured creditor.

For the practical use of the analyzed case, the operation requires one or more initial creditors seeking withdrawal from the financing contract (as assignors) and one or more creditors seeking adherence to such a contract (as assignees).

While the assignment of the mortgage is the classic option involving the transfer of both the rights that the mortgage covers and the rank given through its registration with the public registers, the assignment of rank involves only a transfer of the assignor’s mortgage rank to the assignee, different and separate from the secured claim, as well as from the mortgage right itself, only the rank of the assignor’s mortgage being transmitted to the assignee’s mortgage. Accordingly, the assigned rank will be designated to another mortgage right.

» Agreements regarding the change in rank

The agreements regarding the mortgages’ change in rank imply an exchange of rank between creditors, being expressly regulated in art. 2427 para. (1) final sentence of the Civil Code: “the mortgagees may agree to change the rank of their mortgages, subject to registration with the corresponding publicity register”.

This appears to be a useful and appropriate alternative when negotiating an adherence in a financing contract, as each new lender has an interest in imposing its own standards and a personalized approach when establishing a mortgage, the assets subject to mortgage, as well as other clauses, depending on its particularities, the applicable material law, etc., flexibility uncharacteristic to the mortgage assignment.

We concur with the view that the assignment of the rank operates only when it is made in favor of another mortgagee whose mortgage has a lower rank[3], regardless of whether these mortgages are immediately successive in rank or there are interpolated mortgages with intermediate ranks. Understandably, the new lender (assignee) will have to initially request the constitution of its mortgage, in order to make possible the transfer of the higher rank of the mortgage of the assigning lender to it.

This mechanism may be applied both (i) between creditors with different mortgage ranks, as well as (ii) between same rank creditors, in order to prioritize their ranks (so that a creditor is placed in a position of superiority over another creditor who, according to the law, would have been on the same position with the former).

The first configuration of the agreement on the change in rank – between creditors of different ranks – may be a useful tool during the implementation of financing contracts, especially when one of the creditors wishes to withdraw from the financing, being replaced by another creditor.

A possible solution, given the circumstances, is to conclude an agreement to change the ranks between, on one hand, (i) the creditor wishing to withdraw / assign its quota in the financing contract, holding a higher-ranking mortgage and, on the other hand, (ii) the creditor wishing to enter the contract, who may benefit from the establishment of a lower-ranking mortgage pursuant to art. 890 para. (2) of the Civil Code. It is this difference in rank that makes possible to conclude the agreement on the change in ranks, so that the adhering creditor takes the withdrawing creditor rank.

The agreements entail, first of all, an identical value of the secured claims, in accordance with art. 2427 para. (3) of the Civil Code: “In all cases, the assignment of the rank is made within the limit of the secured claim whose rank has been assigned, and the exchange of rank is made within the limit of the mortgaged claim which has the preferred rank.”

Since both the mortgage right and the priority rank generate real rights, its assignment, either onerous or free of charge, must be done through a legal instrument complying with the validity requirements for transferring the mortgage right.

Another validity condition of the agreement, as per art. 2358 para. (1) of the Civil Code, is the requirement to determine the amount within the mortgage agreement, this determination envisaging the value of both the secured claim and the mortgage right.

Last but not least, we believe that the borrower should not be a party to the mortgage change in rank agreement, under the sanction of nullity, as, unlike the assignment of the mortgage, the borrower does not have to repay the debt to another creditor, the hypothesis being that both creditors benefit from secured claims. This also follows from the interpretation of the provisions of art. 2358 para. (2) of the Civil Code on the assignment of the mortgage / rank. Even if the debtor’s notification appears as a necessity, this does not imply obtaining the debtor’s consent as a validity condition for the assignment of rank, resulting that this notification may be subsequent to the mortgage / rank assignment.

Nevertheless, the borrower’s active involvement when negotiating and signing the mortgage change in rank agreement is advisable as it can prevent misunderstandings and can also protect the interest of the other parties to the financing.

Regarding the opposability formalities towards third parties, as well as towards the parties to the financing contract, these are achieved by registration with the land book and / or in the National Publicity Register for Movable Property. We consider, in principle, that the provisions regarding the innoposability of the rank assignment against the holders of mortgages registered between the date of registration of the two ranks provided in art. 2427 para. (2) of the Civil Code are not applicable in the case at hand, since the mortgage whose rank shall be assigned will always be opposable to the holders of subsequently registered mortgages.

As regards the land book, such a procedure could prove to be more cost-effective in terms of fees, considering that for a mortgage rank assignment agreement the general registration/ deregistration fee of Lei 75 should be applicable (due to the fact that both creditors have already paid the fees at the claim value when initially registering the mortgages between which the change in rank is made).

» Agreements for subordination of claims

Finally, in the event that the original lenders agree on the order in which their claims will be collected, they have the option to conclude a subordination of claims agreement with the lender seeking accession to the financing contract.

Agreements for subordination of claims, recognized also by French law, were among the first contractual instruments that emerged as exceptions to the creditors’ equality principle.

In Romanian law, during an arbitral dispute organized under ICC rules, in which the substantial applicable law was Romanian law (dispute settled under the Civil Code of 1864), it was decided that the subordination of claims by conventional means is valid (Case 12.464 / MS).

In the above – mentioned case, although the Civil Code of 1864 did not expressly regulate this possibility, the arbitral tribunal, stemming from several particular contractual clauses and from the similarity between French and Romanian law, ruled that subordination of claims is also possible under Romanian law.

Contrasting to previous regulations, art. 2326 para. (1) of the current Civil Code expressly provides for the conventional subordination of claims, as an exception from the creditors’ equality principle.

It remains to be seen, on a case-by-case basis, which of the presented mechanisms best fulfills the requirements of the parties, both in terms of protection of commercial interests and of the actual implementation costs.

[1] ISPAS Petruta Elena, Securities for the enforcement of civil obligations. The order of creditors in the matter of liens and real estate securities Publication: Pandectele Romane no. 6 of 2019.
[2] Constitutional Court of Romania, Decision no. 626 of 27.10.2016.
[3] Al. Oproiu, Can a mortgage be transmitted without the claim it secures? in RRD no. 6/1988, pg. 44-49

Siranus Hahamian, Managing Associate IJDELEA MIHAILESCU
Diana Bejenaru, Associate IJDELEA MIHAILESCU