What happens to your rights as a secured creditor during the insolvency proceedings: preference and payments

Do you hold a mortgage, pledge or other form of security over the assets of a company that is experiencing difficulties? Naturally, you think that this security will ensure that you get paid first if things go wrong. After all, that's the main purpose of a guarantee. However, when your debtor is the subject of collective proceedings - safeguard, receivership or compulsory liquidation - the reality becomes more complex. The law governing companies in difficulty introduces specific rules that often limit, or even temporarily paralyse, the preferential rights and payment options of creditors, even those who are guaranteed.

Understanding how your rights are affected is essential if you are to adapt your strategy and best defend your interests. This article explores the restrictions imposed on your preferential rights during the various phases of the insolvency proceedings, as well as the exceptions and derogations that may work in your favour.

During the observation period: patience and restrictions

The observation period, which follows the decision to open a safeguard or receivership procedure, is a phase designed to assess the company's situation and draw up a recovery plan. During this period, which can last several months, the watchword for creditors prior to the judgment is patience.

The impossibility of immediately exercising its preferential right

Two fundamental rules freeze the rights of secured creditors from the opening judgment:

1. Stopping individual lawsuits : L'Article L. 622-21 of the French Commercial Code prohibits all creditors whose claims arose prior to the opening judgment from taking or continuing legal action to obtain payment or seizure of the debtor's assets. In practical terms, this means that you can no longer force the sale of the mortgaged or pledged property in order to repay yourself. Any seizure proceedings you may have initiated are automatically suspended.
2. Prohibition on payment of previous debts : L'Article L. 622-7 of the French Commercial Code prohibits the debtor from paying any claim that arose prior to the opening judgment (with a few very limited exceptions, such as maintenance claims). Your debtor cannot therefore, even if he wanted to, pay you the sum guaranteed by your security.

These rules combined prevent you from exercising your preferential right immediately. Your guarantee still exists, but you cannot use it to obtain priority payment immediately.

What happens if the asset to which your guarantee relates is sold during this period? This is possible, if the juge-commissaire authorises it because the sale is deemed necessary for the continuation of the business (article L. 622-7). But even in this case, you will not receive the sale price directly. L'Article L. 622-8 of the French Commercial Code provides that the part of the price corresponding to claims guaranteed by special securities (such as yours) must be paid by the court-appointed agent (administrator or judicial representative) into a special account at the Caisse des Dépôts et Consignations (CDC). Your money is temporarily frozen. It will only be distributed at the end of the observation period, depending on the solution adopted by the court (safeguard plan, recovery plan or liquidation).

The (rare) options for early payment

Waiting for the end of the observation period can be long and uncertain. The law does, however, provide for a number of mechanisms that allow payment to be made before the end of the observation period, subject to strict conditions.

• Provisional payment (Art. L. 622-8 al. 2) : You may ask the official receiver to authorise you to receive part of the price deposited with CDC, corresponding to your guarantee. However, this possibility is subject to restrictions. The judge may require you to provide a bank guarantee to ensure repayment of the sums if, in the end, your claim is rejected or if you are not ranked high enough to receive this amount (for example, if even better-placed creditors are paid before you). The Treasury and social security bodies are exempt from providing this guarantee. The judge may also waive this requirement by a specially reasoned decision, but this is at his discretion. The amount awarded is a provision, not a definitive payment, and depends on the analysis of your claim and your ranking.
• Substitution of guarantee (Art. L. 622-8 al. 3) : If the debtor or administrator needs to use the proceeds from the sale of the encumbered asset immediately (for example, to finance the business), they may offer to replace your initial security with an equivalent guarantee (typically a bank guarantee). If you accept, you release the property and the sale price can be used. If you refuse, the official receiver may decide to impose the substitution if the proposed security is deemed to be genuinely equivalent. You may appeal against this decision.
• The key exception: the effective right of retention (Art. L. 622-7, II): Therein lies a considerable advantage for certain creditors. If you hold materially your debtor's property as collateral (for example, in a pledge with delivery where you keep the pledged item), you have a powerful right of retention. The official receiver cannot impose a substitution of guarantee. To recover its property, if it is necessary for the continuation of the business, the debtor (or the administrator, with the authorisation of the judge) will have no choice but to pay you in full the amount of your secured debt. This is a major exception to the ban on payments. Note that this exception applies mainly to "real" retention of title, with physical detention. So-called "notional" retention, granted by law to certain non-possessory pledges, is not enforceable during the observation period (article L. 622-7, I, para. 2).

During the execution of a safeguard or recovery plan: controlled payments

If the observation period leads to the adoption of a safeguard or recovery plan, the aim is to continue the business and gradually pay off the liabilities. How are your rights as a secured creditor treated in this context?

The principle: payment according to the schedule in the plan

The general rule is that all previous creditors, including those with security interests, are subject to the repayment terms set out in the plan (article L. 626-18). The plan often imposes payment deadlines (of up to 10 years) and sometimes even partial waivers of debts. For the duration of the plan, your preferential right is "dormant". You have to wait for the due dates set out in the plan before you can be paid, just like the other creditors.

Exception: sale of an encumbered asset during the plan (Art. L. 626-22)

What happens if the property covered by your guarantee is sold? for the execution of the plan? The law (article L. 626-22) and case law distinguish between two situations:

1. The sale was NOT part of the plan: The debtor, having regained a certain freedom of management, decides to sell an encumbered asset that was not specifically earmarked for repayment in the plan. In this case, the case law considers that the rules of collective proceedings do not apply in the same way. The sale price does not have to be paid to the administrator. Ordinary law reigns, and the creditor registered on the property sold could potentially exercise his preferential right to be paid directly from the sale price, outside the constraints of the plan.
2. The sale WAS provided for in the plan (or accompanies the plan via a partial sale of assets): Here, the sale is part of the execution of the procedure. Thearticle L. 626-22 applies. As in the observation period, the portion of the price corresponding to the securities is paid to CDC by the administrator. Secured creditors may then :
   • Request a provisional payment (as in the observation period, often against security).
   • Receive an advance payment on the consigned price. This payment is deducted from future dividends under the plan. The amount of dividends remaining to be received will therefore be reduced proportionately to take account of this earlier payment. The distribution is always made according to the order of privileges between the secured creditors and after payment of the creditors with the highest ranking (super-privileged employees, legal costs, etc.).
   • Accepting (or having the court impose) a substitution of collateral to allow the company to use the prize. Here again, the effective right of retention is an obstacle to an imposed substitution.

What happens if the debtor does not meet the plan's deadlines?

Imagine that the debtor does not honour the payments provided for in the plan. Can you, as the secured creditor, resume your individual proceedings and seize the collateral? The answer is nosince a reform in 2008.

L'Article L. 626-27 of the French Commercial Code now gives the commissioner for the execution of the plan the monopoly to initiate compulsory collection of unpaid dividends. He may do so without necessarily requesting the cancellation of the plan. The individual creditor, even a secured creditor, has lost the right to act alone to recover missed instalments under the plan. This is an important limitation on the individual right of action.

Specific exemptions favouring certain creditors

In addition to the general mechanisms, certain specific guarantees offer, by their nature or by express legal provision, particular advantages in terms of payment in the context of insolvency proceedings.

Retention rights: a major advantage

As we have already mentioned, the right of effective retention (physical possession of the property) is particularly powerful:

• It allows you to demand payment in full against return of the asset, whether in the observation period (if the asset is useful) or in compulsory liquidation (without the condition of usefulness).
• If the liquidator sells the property, the right of retention is transferred to the price (article L. 642-20-1), giving the retainer a absolute payment priorityThis also applies in liquidation to fictitious retention (non-possessory pledge). In liquidation, the same applies to fictitious retention (non-possessory pledge).

Retention of title: a right to payment often given priority

The seller who has stipulated a retention of title clause also benefits from favourable mechanisms:

• Full payment option (Art. L. 624-16) : If the asset sold is still owned by the buyer in the proceedings and is necessary for the business, the administrator (or the debtor authorised by the judge) may choose to pay the entire outstanding price immediately in order to retain the asset and neutralise the seller's restitution claim. If a deferred payment is accepted by the seller, his claim to the price then benefits from the privilege of subsequent useful claims.
• Claiming the resale price (Art. L. 624-18) : If the buyer has resold the property before the opening judgment (or even after if the sale is lawful), the original seller may claim directly from the sub-purchaser the resale price that has not yet been paid to the original buyer. He has an exclusive right to this price up to the amount of his own claim.

The security trust: variable protection

This modern form of security, in which ownership of an asset is transferred to a trustee to secure a debt, has its advantages, but there are some nuances:

• If with dispossession (the debtor no longer has use of the asset, e.g. sums of money): The beneficiary creditor largely escapes the constraints of the procedure (no suspension of proceedings). Payment in return for the return of assets is possible under safeguard/restructuring if the asset is deemed necessary (article L. 622-7).
• If without dispossession (the debtor retains the use via a loan agreement): The situation is less favourable. The provision agreement is treated as an ongoing contract, and the creditor is subject to the suspension of proceedings during the observation and the plan. It can only realise its guarantee in the event of non-compliance with the plan, liquidation or sale.

The lessor: possibility of payment on exercise of option

When the leasing contract comes to an end during the procedure, the lessor's situation may improve if the purchase option is exercised:

• The juge-commissaire may authorise the debtor (in safeguard/rehabilitation) or the liquidator to pay any outstanding amounts (including previous unpaid rents) to exercise the purchase option and definitively acquire the property, if this is justified by the continuation of the business or the needs of the liquidation (articles L. 622-7 and L. 641-3).
• Similarly, if the contract is assigned as part of an assignment plan, the assignee who exercises the option must pay the sums due to the lessor.

Navigating the payment rules of collective proceedings is complex, even for a secured creditor. Preferential rights are not absolute and depend on the stage of the proceedings, the nature of the security and the decisions taken by the procedural bodies. Our team will be happy to help you understand your rights and the options available to you.

Sources

• Commercial Code: articles L.622-7, L.622-8, L.622-13, L.622-17, L.622-21, L.622-23-1, L.624-16, L.624-18, L.626-11, L.626-18, L.626-22, L.626-27, L.631-14, L.641-3, L.641-11-1, L.641-13, L.642-20-1
• Civil Code: articles 2286 (right of retention), 2333 et seq. (pledge), 2011 et seq. (trust)