Taking counsel

  • 2005-01-12
  • by Rita Svedaite, associate at Sorainen Law Offices in Vilnius
Security instruments in the Baltics: what are they?

The choice of proper security to ensure the fulfilment of debtor's obligations is very important for all businesses in the Baltic states for many reasons. First, security instruments safeguard the interests of the creditor in case of a violation of obligations on the part of the debtor. They also protect the rights of the creditor if the insolvency proceedings against the debtor are initiated.

Currently security instruments in the Baltics might be classified into three main categories - the mortgage, the pledge and other security instruments. The mortgage is used for immovable property (real estate) such as buildings, apartments or land plots. The legislation of all three Baltic states requires the mortgage agreement to be concluded in writing, notarized and registered with the local public register.

In case the same real estate is mortgaged several times to different creditors, the claims are satisfied in accordance with the chronological rank of the mortgages entered into the register. In practice, Baltic banks usually prohibit mortgage to other creditors, and mortgages are not used in other businesses like trade.

A pledge may be established on movable assets that belong or will belong to a debtor in the future (equipment, stock, etc.) and the rights such as receivables and securities. The pledged property usually remains in the possession of the debtor, or it may be transferred to the creditor. In order to receive full protection, creditors should also register the pledge of the movable property with the public register.

Estonian legislation contains specific regulations concerning the pledge of shares. A contract to pledge shares of a private limited liability company must be notarized, and the management board of the company has to be notified. Despite the pledge, the debtor retains all the rights of the shareholder including voting rights and the rights to demand dividends. A pledge of shares of the public limited liability company requires only a written agreement and is registered with the Central Depository of Securities.

Legislation in the Baltic states implements EU legal provisions establishing specific requirements for the particular type of pledge. For instance, in Lithuania a simplified procedure has been established for financial collateral arrangements - i.e. a pledge of financial instruments, shares in companies, debt and other securities, or money with the exception of cash - when one part of the transaction is a credit or financial institution, insurance company or other subject specified in the law. The provision of the financial collateral should be evidenced in writing, but no other formal acts for the validity of the arrangement are required. The financial collateral arrangement comes into effect in accordance with its terms notwithstanding the commencement or continuation of winding-up proceedings or reorganization in respect of the debtor or creditor. In the occurrence of an enforcement event, the creditor has the right to unilaterally realize the financial collateral.

Legislation of all three Baltic states also establishes other security instruments, such as guarantee and surety, when the guarantor or the surety grantor undertakes to be liable for the debtor - another party or the third person. According to the general rule, upon the fulfilment of the debtor's obligations, the guarantor and the security are entitled to recover their loss from the debtor.

Thus Baltic legislation provides for a wide number of security instruments that are able to ensure the interests of the creditor in the most proper way. As practice shows, businesses operating in the Baltic states prefer holding a mortgage or a pledge as security, while an unconditional first demand bank guarantee is considered to be the second best. The guarantee and the surety usually are used as a supplementary security in risky transactions.

Rita Svedaite is an associate at Sorainen Law Offices in Vilnius