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Pledges give rights to creditors

02.05.2001

Kristjan Melikov

A pledge can be either a security over movables or a real security. A pledgor can be either a debtor or a third party. In the event that a debtor fails to perform obligations that are secured by a pledge, the creditor is entitled to enjoy the value of the pledged property.

A pledgor's property can be pledged, as can possessions, securities and proprietary rights. A claim that has been secured by a pledge is preferred to any other claims in respect of the pledged property.

Possessory Pledges

The transfer of possession of an item from the pledgor to the pledgee creates a possessory pledge. If the item is already in the pledgee's possession, entering into a pledge contract creates a pledge. A possessory pledge contract must be entered into in writing if the value of the pledged item exceeds Ekr500. Movable property can be subject to one security only.

A possessory pledge extinguishes by termination of the secured claim. A possessory pledge may also extinguish by destruction of the pledged movable, and if:

• one person becomes the pledgee and owner of the pledged item;
• the pledged item is no longer in the possession of the pledgee and the pledgee cannot reclaim it; or
• the pledgee returns the pledged item to the pledgor or notifies the pledgor of discharge of the pledge.

The pledgee is required to preserve and maintain the pledged item. The pledgee does not have the right to use a pledged item, unless otherwise agreed. When a possessory pledge extinguishes, the pledgee must return the pledged item to the pledgor. Satisfaction of a claim of a pledgee is effected by sale of the pledged item.

The right to sell a pledged item is created for the pledgee if a claim secured by the pledge is not satisfied according to the claim. An agreement whereby the pledgee acquires the pledged item for satisfaction of a claim secured by the pledge is void. The pledgee is required to notify the pledgor of the sale of the pledged item one month in advance. Advance notice may be given after creation of the right of sale. A pledged item is sold by public auction. The pledgor and third persons that have rights in the pledged item must be notified of the auction's time and location. Anyone can participate in the auction, including the pledgee and pledgor. The obligation of the pledgor is deemed to be performed to the extent of the money received from the sale of the pledged item. The necessary sale expenses are deducted from the sale money. Money remaining after payment of sale expenses and satisfaction of the claim of the pledgee is returned to the pledgor.

The rules of possessory pledges are applied to other types of pledge, unless otherwise provided by law.

Registered Pledges

In the case of registered security over movables, a movable is encumbered with a pledge so that the pledged item remains in the pledgor's possession and the pledge is registered pursuant to the procedure provided by law.

Registered security over movables is created on the basis of a pledge contract upon registration of the pledge in a register. Registered security over movables is used for things that have been entered in a register (eg, ships, vehicles and shares).

Upon creation of the right to sell, a creditor has the right to demand delivery of a pledged item from the possession of the pledgor in order to sell it. In the meantime, the pledgee is not entitled to transfer or re-pledge the pledged item.

Registered security over movables may be established over a registered patent, trademark, industrial design, utility model or other form of registered intellectual property.

Pledges of Securities

Securities may be pledged so that the person for whose benefit the pledge is established may demand satisfaction of a claim out of the pledged securities. A pledge of bearer securities is created upon delivery of the securities to the pledgee. A pledge of other securities is created upon delivery of the securities on the basis of a written pledge contract or endorsement. Pledged shares do not grant the pledgee the right to participate in a general meeting as a shareholder. The shareholder retains this right.

If bearer securities, bills of exchange or other securities that may be transferred by endorsement are pledged, the pledgee has the right to submit a claim arising from the specified securities regardless of the due date of the claim. The debtor shall perform the obligation of the securities to the pledgee.

Commercial Pledges

Pursuant to the Commercial Pledge Act an undertaking may establish registered security over all movables in the ownership of the undertaking. This security is a commercial pledge. A commercial pledge must be entered in the register specified by law. A commercial pledge is created on the basis of an application after a corresponding entry is made in the commercial pledge register.

Commercial pledges do not extend to the following:

• money in a cash register or credit institution;
• stocks, shares, investment fund shares, contributions in cooperatives or participation in other companies belonging to an entrepreneur;
• promissory notes or other loan documents that are commonly used;
• other securities;
• property on which another class of registered security over movables or pledge may be established;
• property to which a mortgage established on the immovable before or after establishment of the pledge extends;
• property on which a possessory pledge is established; or
• property which, pursuant to law, cannot be subject to a claim for payment.

A commercial pledge secures a claim to the extent of:

• the amount of the pledge;
• the unpaid interest on the claim for three years before the sale of property encumbered with the commercial pledge in satisfaction of the claim;
• the fine for delay and expenses for collection of the debt;
• the insurance premiums paid by the pledgee on behalf of the owner of property encumbered with the commercial pledge; and
• other collateral claims.

Claims secured by all other types of pledge remain in the first order of satisfaction under bankruptcy laws. From January 1 2003 claims secured by commercial pledge will be demoted to fourth order. 

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